1.1 What is Economics, and Why is it Important?

• economics: study of how humans make decisions in the face of scarcity

  • individual, family, business or societal decisions

• scarcity: want/need for goods, services and resources exceeds what is available

  • resources include labor, tools, land, raw materials, and time

  • at any point in time, only a finite amount of resources are available

  • due to scarcity, subjects must make choices about how to use resources in the best way possible

    • obtain most goods/services possible, maximizing resources

• choices about production

  • either produce everything consumed

  • produce some of what is consumed and trade for the rest

    • do not have to each produce everything we consume anymore because of division and specializiation of labor

• division and specialization of labor

  • formal study of economics began with Adam Smith’s Wealth of Nations in 1776

    • first to address economics in such a comprehensive way

  • first chapter introduces division of labor: production of goods/services is divided into number of tasks that different workers perform, instead of one person being responsible for all the steps, helping against scarcity

  • leads to greater quantity of output

    • specialization: workers focus on specific job in the process where they have an advantage based on different skills, talents, and interests

      • specializing in what they do bets is more effective than doing a combination of things they are either good or bad at

    • workers specializing in certain tasks work quicker with higher quality

    • allows businesses to take advantage of economic scale: as level of production increases, average production cost per unit decreases

• trade and markets

  • specialization only works if people can purchase other goods and services they do not know how to produce, through trade

  • market allows you to learn a specialized skillset and pay for the rest from other specialized workers

• why study economics

  • know about business/the market in general

  • solving major world problems

  • citizenship: voting on budgets, regulations, and laws in general

  • leads to well-rounded thinking: evaluating arguments in economic articles and conversations; new ways of thinking about current events, personal and business decisions, current events and politics

1.2 Microeconomics and Macroeconomics

• economics covers considerable ground

  • it is concerned with the well-being of all people

  • acknowledges production of goods and services, monetary investment, operation of businesses, government spending, taxes, regulations affecting production and consumption

• microeconomics: actions of individual agents within the economy like households, workers and businesses

  • household/individual budgets

  • deciding to work

  • saving vs. spending

  • what/how many products businesses sell

  • prices charged

  • means of production

  • number of workers

  • business finances

  • expanding/downsizing

  • theory of consumer behavior, theory of the firm

  • how marketes for labor and other resources work

  • how markets sometimes fail to do work properly

• macroeconomics: economy as a whole; broader issues

  • growth of economy

  • number of employed/unemployed

  • inflation

  • government deficits

  • level of imports/exports

  • monetary/fiscal policy

  • standard of living

  • what determines number of goods/services a nation produces (GDP)

• monetary policy: conducted by central banks

  • policies affecting bank lending, interest rates, financial capital markets, and availability of credit

• fiscal policy: determined by legislative body

  • involves government spending/taxes

1.3 How Economists Use Theories and Models to Understand Economic Issues

• economics analyzes issues and problems using economic theories based on assumptions about human behavior

  • theory: simplified representation of how two+ variables interact

    • takes complex, real world issue and simplifies it down to its essentials

    • good theories are simple enough to understand while complex enough to capture key features

  • model: more applied/empirical representation than theories, which are more abstract

• circular flow diagram: pictures economy as two groups (households and firms) that interact in two markets (goods/services market and labor market)

  • goods/services market: firms sell and households buy, providing firms with revenue

  • labor market: households sell labor to business firms/employers for wages, salaries, and benefits

    • labor/resources = inputs for firms

• economists carry a set of theories and apply them to issues/problems to see which one fits, then use the theory to gain insights

  • express theories as diagrams, graphs, and mathematical concepts

1.4 How to Organize Economies: Overview of Economic Systems

• societies organize economies in different ways

  • traditional economy: how it has always been done

    • oldest economic system used in parts of Asia, Africa, and South America

    • organized based on tradition

    • occupation passes down in family

    • most are farmers growign crops through traditional methods

    • everythiing produced is for consumption, so there is little economic progress or development

  • command economy: centralized in government

    • economic effort is devoted to goals passed down from a ruler/ruling class

      • ancient Egypt, medieval England, and manorial

    • government decids what goods/services will be produced and what prices it will charge for them

    • government decides means of production and sets wages

    • provides healthcare and education for free

    • current command economies: North Korea, Cuba

  • market economy: decentralized

    • market: institution that brings together buyers and sellers

    • based on private enterprises: private individuals/groups own and operate resources and businesses

    • supply of goods/services is based on demand

    • income is based on ability to convert resources into something society values

  • most economies are mixed, combining usually command and market on a spectrum

• index of economic freedom

  • researches at Heritage Foundation look at 50 different categories and give a score based on extent of freedom in each category

  • overall trend in recent decades has been shifting towards higher economic freedom

• regulations: government rules for economy

  • market-oriented economies have less regulations, just enough to maintain even playing field

  • minimum regulations include:

    • safeguarding private property against theft

    • protecting people from violence

    • enforcing legal contracts

    • preventing fraud and collecting taxes

  • in command economies, government heavily regulates decisions of production and pricing in the market

    • often have underground economies/black markets where buyers and sellers make transactions without government approval

• globalization: expanding cultural, political and economic connections between people around the world

  • one measure is increased international trade

  • improvements in shipping

  • innovations in computing and telecommunications for maintaining economic connections

  • increased information and ditigized products that can be transported faster and at lower costs

  • international treaties/agreements encouraging trade

• GDP (gross domestic product) measures size of total production in an economy

  • ratio of exports to GDP measures share of a country’s total economic production that is sold to other countries

  • US ratio is smaller because it contains more of its division of labor within borders

  • smaller economies need international trade to take full advantage of division of labor, specialization and economies of sacle (Belgium, Canda, Korea)