UNIT 1- Basic Economic Concepts

What is Economics?

• Economics = a social science concerned with how resources are used to satisfy people’s wants

• Scarcity = limited resources for production relative to wants for goods and services

  • wants are unlimited, resources are limited

• For scarcity to exist:

  • a resource must be limited relative to wants, must be wanted, and must have alternative uses

• Rare and scarce are different

  • scarcity → product has to be wanted

• Efficiency → we want to obtain the greatest output possible with scarce resources

  • don’t waste

• Free Goods = any good you can have an unlimited amount of without having to sacrifice anything

• Factors of Production = resources used to produce goods and services

  • resources include:

    • land (any natural resources)

      • minerals, natural gas, oil, etc.

    • labor (any human resource)

    • capital = a produced factor of production used to produce other goods and services

      • physical capital (machinery, factories, etc.)

      • human capital = increase in labor productivity from acquired skills and the development of people’s abilities

      • financial capital

        • money isn’t viewed as a factor of production

    • all of these are scarce because they’re limited relative to wants

    • labor is most important factor of production

Making Economic Choices

• Trade-offs = a choice between alternative uses of a given quantity of a resource

  • everyone makes trade-offs… they’re choices

  • everytime we make a choice, we give something else up

• Opportunity costs = the value of the best alternative not chosen

  • what we give up/sacrifice

  • based on value

  • ex) chose to come to school today- trade off

    • not coming to school and value of sleeping in- opportunity cost

• Everything has a cost

• Production Possibilities Frontier = used to illustrate the impact of scarcity on the economy

  • assumptions:

    1. Resources are fixed- can’t increase any resources

    2. Resources are fully employed- all resources are being used

    3. Technology is fixed

    4. Only two things can be produced

  • constant cost → the opportunity cost is always the same (unusual)

    • resources aren’t perfect substitutes for one another, so it’s unusual

• increasing cost → opportunity cost increases as you produce more of a given product

  • use your best resources first

    • quality of resources goes down

  • more you put into something, less you get out of it

  • goal of economy: improve technology and improve efficiency to grow PPF

Basic Economic Questions

1. What to produce?

   1. How much of the different goods and services will be produced with available resources?

2. How to produce?

   1. production methods

3. For whom to produce?

   1. Who gets what’s produced? How much do they get?

Principle Types of Economic Systems

• Market Economy = an economic system in which the basic economic questions of what, how, and for whom to produce are resolved primarily by buyers and sellers interacting in markets

  • free economy, free enterprise, capitalism

  • profit drives production

  • you don’t do what’s necessarily best for society, you do things for profit

• Centrally Directed (Common) Economy = an economic system in which the basic economic questions are resolved by the government

  • government dictates economy

  • government officials called Central Planners

    • Central Planners decide what gets produced

  • usually put a lot of money into military

    • negatively effects consumer

• Mixed Economy = an economic system in which the basic economic questions are resolved by a mixture of market, command, and traditional

  • traditional economy is very rare today

    • based on traditions and customs

• US economy is a mixed economy

  • government plays a role with military, government agencies, etc.

  • heavily dependent on market system

• We classify economies by their most dominant characteristics

Absolute/Comparative Advantage

• Absolute Advantage = when one producer can produce a product more efficiently than another product

  • one is simply better than the other

• Comparative Advantage = both producers gain when they produce the goods they have the lower opportunity cost in producing

  • LOWER OPPORTUNITY COST

  • leads to specialization

    • specialization = a situation in which workers concentrate their efforts in areas they have an advantage

      • specialization leads to a greater output and greater efficiency

• Steps to determine absolute/comparative advantage

  • input or output problem

    • input = resources to produce an constant output

    • output = production given a constant resource

  • absolute advantage: input → less resources, output → more production

  • comparative advantage: input → into/under, output → over

  • comparative advantage is always based on LOWER OPPORTUNITY COST

• Specialization and Gains from Trade

  • gains from trade → we use opportunity cost numbers to determine gains from trade

• Interdependence = the reliance of different individuals and businesses on each other

Determining Market Prices: Supply & Demand

• Demand = the quantity of a good or service consumers are willing and able to purchase at specific prices

  • service = when we pay someone to do something for us

  • effective demand → in order for demand to exist, you must have the ability to pay for it

  • law of demand → consumers will tend to purchase more of a good or service at lower prices and less of a good or service at higher prices

• Supply = the quantity of a good or service producers are willing and able to sell at specific prices

  • law of supply → producers are willing to sell more of a good or service at higher prices and less of a good or service at lower prices

• Supply deals with the producer, demand deals with consumer

• Equilibrium (Market Clearing) Price = the price at which the quantity the consumers would like to buy is identical to the quantity the producers would like to sell

  • price is above equilibrium price → surplus

    • not of all what’s produced has been purchased

      • prices decrease to equilibrium (think sales)

  • price is below equilibrium price → shortage

    • prices have to increase to equilibrium

Determinants of Demand (Demand Curve Shifters)

• Tastes and Preferences

  • if something’s popular or in style, or something that could benefit us, there would be an increase in demand

  • if something’s no longer in style or harms us, there would be a decrease in demand

• Income

  • normal goods

    • an increase in income will increase the demand for normal goods

    • a decrease in income will decrease the demand for normal goods

    • normal goods = better options

      • new cars, high-quality food, vacations

  • inferior goods

    • an increase in income will decrease demand for inferior goods

    • a decrease in income will increase demand for inferior goods

    • inferior goods = cheaper options

      • cheap foods, generic brands

• Price of Substitute Goods

  • substitute = a product that is interchangeable in use with another product

  • an increase in the price of a good will cause a decrease in the demand for its substitute

  • a decrease in the price of a good will cause a decrease in the demand for its substitute

• Price of Complementary Goods

  • complement = a product that is employed/goes together with another product

    • peanut butter and jelly, cereal and milk

  • an increase in the price of a good will cause a decrease in the demand for its complement

  • a decrease in the price of a good will cause an increase in the demand for its complement

• Population (# of consumers)

  • more consumers, more demand

  • less consumers, less demand

  • greater demand for EVERYTHING in NYC compared to Endicott

• Consumer Expectations

  • expectation of future price

  • if consumers expect higher prices in the future, there will be an increase in demand

  • if consumers expect lower prices in the future, there will be a decrease in demand

Effects of Changes in Demand

• Increase in Demand

  • equilibrium price increases

  • equilibrium quantity supplied increases

• Decrease in Demand

  • equilibrium price decreases

  • equilibrium quantity supplied decreases

• Shifting the demand curve will cause a change in price and the quantity supplied

• Changing the price in the product will effect the Quantity Demanded for that product. THERE’S NOT SHIFT IN THE CURVE - YOU MOVE ALONG AN EXISTING DEMAND CURVE

Determinants of Supply (Supply Curve Shifters)

• Costs of Production

  • if the cost or price of any resource (land, labor, capital) decreases, supply increases

  • if the cost or price of any resource (land, labor, capital) increases, supply will decrease

  • #1 determinant of supply

  • wages (#1 cost of production)

  • business taxes

  • government regulations

  • energy costs (utilities)

  • anything that costs the business money

• Changes in Technology

  • better technology and greater efficiency increases supply

• Events that could cause an increase or decrease in production

  • natural disasters

    • can wipe out supply

• Government Policies (Quotas/Tariffs)

  • tariffs = taxes on imports

  • quota = limit on the amount of goods that can be imported

  • raise tariffs and decrease quotas → decrease in supply

  • high tariffs aren’t good because we have to pay them

• Number of Sellers

  • the more firms producing the same or similar products, the greater the supply

• Producer Expectations

  • if producers expect higher prices in the future, there will be a decrease in supply

  • if producers expect lower prices in the future, there will be an increase in supply

Effects of Changes in Supply

• Increase in Supply

  • equilibrium price decreases

  • equilibrium quantity demanded increases

• Decrease in Supply

  • equilibrium price increases

  • equilibrium quantity demanded decreases

• Shifting the supply curve will cause a change in price and quantity demanded

• Changing the price of a product will affect the quantity supplied for that product. THERE’S NO SHIFT IN THE CURVE - YOU MOVE ALONG THE EXISTING CURVE

Government Efforts to Set Prices

1. Price Ceilings

   • ceiling = the legal maximum price that may be charged for commodity

   • price ceiling is set below equilibrium price

     • equilibrium price is too high

   • price ceilings create shortages

2. Price Floor

   • floor = the legal minimum price that may be charged for a commodity

   • price floor is set above equilibrium price

     • equilibrium price is too low

   • minimum wage is a price floor

Macroeconomic Goals

1. Full Employment

   • Almost everyone that wants a job has a job

     • 4%-5% unemployment → full employment

     • 0% unemployment will never happen

2. Price Stability

   • We want to avoid huge fluctuations on the general price level of goods and services

     • Federal Reserve System has goal of 2% inflation per year

3. Economic Growth

   • The continued increase in the capacity of the economy to produce goods and services

     • constantly developing better technologies to be as efficient as possible

Business Cycle

• Business cycle = the pattern of expansion and contraction

• Phases:

  • expansion → up-swinging business cycle

    • real GDP increases

    • unemployment decreases

    • price level usually increases

  • peak → real GDP stops rising and begins to fall

  • contraction/recession → real GDP decreases

    • unemployment increases

    • price level usually decreases

    • recession → two consecutive periods of GDP decrease

      • severe recession = depression

  • trough → real GDP stops falling and begins to rise