2-1 understanding basic economics chapter 2. chapter 2 objectives after studying this chapter, you...

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Understanding Basic Economics

Chapter 2

Chapter 2 Objectives

After studying this chapter, you will be able to:

• Define economics and explain why scarcity is central to economic decision making.

• Differentiate among the major types of economic systems.

• Explain the interaction between demand and supply.

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Chapter 2 Objectives Cont.

• Identify four macroeconomic issues that are essential to understanding the behavior of the economy.

• Outline the debate over deregulation and identify four key roles that governments play in the economy.

• Identify the major ways of measuring economic activity.

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What Is This Thing Called the Economy?

Economy The sum total of all the economic activity within a given region

Economics The study of how a society uses its scarce resources to produce and distribute goods and services

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What is Economics?

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Microeconomics and Macroeconomics

Microeconomics The study of how consumers, businesses, and industries collectively determine the quantity of goods and services demanded and supplied at different prices

Macroeconomics The study of “big picture” issues in an economy, including competitive behavior among firms, the effect of government policies, and overall resource allocation issues

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Factors of Production

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Economic Impact of Scarcity

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Scarcity has two powerful effects: •It creates competition for resources •It forces trade-offs on the part of every participant in the economy

Opportunity cost The value of the most appealing alternative not chosen

Economic Systems

Economic system The policies that define a society’s particular economic structure; the rules by which a society allocates economic resources

Free-market, planned

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Economic Systems

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Free-market System

In a free-market system, private

individuals determine what products to

produce, how and when to produce them,

for whom, and at what price to sell them.

Thus they have the chance to succeed

or to fail by their own efforts.

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Capitalism

Capitalism or private enterprise are the

terms most often used to describe the

free-market system, one in which

individuals own and operate the majority

of businesses; where competition, supply

and demand determine which goods and

services are produced.

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Ideal Capitalist Economy(Pure Capitalism)

According to Smith, in the ideal capitalist

economy (pure capitalism), the market (an

arrangement beetween buyer and seller to

trade goods and services) serves as a self-

correcting mechanism as an “invisible hand”

to ensure that production mirrors the wants of

society, without regulation of any kind.

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Mixed Economy(Mixed Capitalism)

The government sometimes intervenes to

accomplish goals that are deemed socially

or economically desirable by way of tax

incentives or price controls. This practice

of limited intervention is characteristic of a

mixed economy or mixed capitalism.

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Planned System

Government controls all or part of a society’s resources and limits the freedom of choice in order to accomplish government goals.

Because social equality is a major goal of planned systems, private enterprise and the pursuit of private gain are generally regarded as unfair and exploitive.

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Communism

Communism is the most restrictive

planned economy that allows individuals

the least degree of economic freedom.

Communism exists in Cuba and North

Korea.

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Communism

Almost all resources are under government

control,

Private ownership is restricted to personal items,

Resource allocation is handled through rigid

centralized planning by a handful of government

officials.

The degree to which communism is

actually practiced varies. In its purest form;

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Socialism

Socialism involves a relatively high degree of

government planning and some government

ownership of capital resources.

However, government involvement is

focused on industries considered vital to the

common welfare.

Nationalization versus Privatization

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• Nationalization A government’s

takeover of selected companies or industries

• Privatization Turning over

services once performed by the government and allowing private businesses to perform them instead

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Understanding the Forces of Demand and Supply

Demand refers to the amount of a good or service that customers will buy at a given time at various prices.

Supply refers to the quantities of good and service that producer will provide on a particular date at various prices.

Demand refers to the behavior of buyers, whereas supply refers to the behavior of sellers.

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Understanding the Forces of Demand and Supply

Customer should buy more when the price is

low and buy less when the price is high.

Producers would offer more when the price is

high and offer less when the price is low.

The quantity supplied and the quantity

demanded continuously interact, and the balance

between them at any given moment should be

reflected by the current price on the open market.

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Advertising andAdvertising andPromotion SpendingPromotion Spending

Advertising andAdvertising andPromotion SpendingPromotion Spending

Consumer IncomeConsumer IncomeConsumer IncomeConsumer Income Consumer PreferencesConsumer PreferencesConsumer PreferencesConsumer Preferences

Price ofPrice ofSubstitute ProductsSubstitute Products

Price ofPrice ofSubstitute ProductsSubstitute Products

Price of Price of Complementary GoodsComplementary Goods

Price of Price of Complementary GoodsComplementary Goods

Expectations AboutExpectations AboutFuture PricesFuture Prices

Expectations AboutExpectations AboutFuture PricesFuture Prices

Price

High

erLo

wer

Demand

LowerHigher

Understanding Demand

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Understanding Demand

In most cases as the price of a good or service goes up, people buy less. In other words, as the price rises, the quantity demanded declines.

Alternatively, at lower prices, consumers generally are willing to purchase more goods and services.

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Demand Curve for Airline Demand Curve for Airline TicketsTickets

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Consumer Income

Consumer Preferences

Price of Substitutes

Price of Complementary Goods

Advertising-Promotion

Consumer Expectations

Number of Buyers

Variable Shifts Right When:

Increases

More Favorable

Increases

Decreases

Increases

Optimistic

Increases

Shifts Left When:

Decreases

Less Favorable

Decreases

Increases

Decreases

Pessimistic

Decreases

Expected Shifts in Demand Expected Shifts in Demand CurveCurve

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Demand Curve for Airline Demand Curve for Airline TicketsTickets

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Understanding Supply

The quantity of goods or service the

producers will provide at a given time at various

prices; refers to the behaviour of sellers.

In general, a company’s willingness to

produce and sell a good or service increases as

the price it can charge and its profit potential per

item increase.

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Goods andServices

Supply

Price

Variables Variables

Higher

MoreLess

Lower

Understanding Understanding SupplySupply

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Supply Curve for Airline Tickets

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Expected Shifts in Supply Curve

Costs of Inputs

Number of Competitors

New Technology

Suppliers Expect ThatFuture Sales Prices

Variable Shifts Right When:

Decreases

Decreases

Decreases Production Costs

Will Decline

Shifts Left When:

Increases

Increases

Increases Production Costs

Will Increase

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Supply Curve for Airline Tickets

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How Demand and Supply Interact

In the real word, variables that affect

demand and supply do not change

independently.

Instead, they change simultaneously

and continually.

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Equilibrium point :

The point at which quantity supplied equals quantity demanded

Because the supply and demand curves are dynamic, so is the equilibrium point.

As variables affecting supply and demand change, so will the equilibrium price.

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As variables affecting supply and demand

change, so will the equilibrium price.

For example, increased concerns about

passenger safety or longer lines at airport

security checkpoints could encourage travelers

to make alternative economic choices such as

automobile travel or videoconferencing, thus

reducing the demand for air travel at every price.

Supply and Demand

©2007 Prentice Hall2-36

10 15 20 25 30

Pairs of blue jeans (quantity)

Pri

ce$35

$30

$25

$20

$15

$10

Not enough demandD

Right pricemakes supply & demand equal

E

Not enough supply

S

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Competition in the Free-Market System

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Competition Rivalry among businesses for the same customers.

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Pure Competition

A marketplace of multiple buyers and sellers

A product or service that is nearly identical in features

Low barriers to entry

In theory, the ideal type of competition is pure competition, which is characterized by three conditions:

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Monopoly

At the other extreme, in a monopoly there

is only one producer of a product in a given

market, that single producer can determine

the price (with in regulatory limits).

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Oligopoly

An industry is dominated by only a few

providers (suppliers), a situation known as an

oligopoly.

Although few players, competition can be

extremely fierce because of so few alternatives.

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Monopolistic Competition

Most of competition in advanced free-market

economies is monopolistic competition, in which

a large number of sellers, no single company

dominates the market and offer products from

competition companies are distinguishable.

Categories of Competition

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Business Cycles

• Expansion

• Contraction

• Recession

• Depression

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Business cycles Fluctuations in the rate of growth that an economy experiences over a period of several years.

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Business Cycles

Economic expansion occurs when the economy is growing and people are spending more money. Consumer purchases stimulate businesses to produce more goods and services.

Economic contraction occurs when such spending declines. Businesses cut back on production, employees are laid off, and the economy as a whole slows down.

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Business Cycles

If economic contraction is severe, the nation

may enter into a recession, which is defined

as two consecutive quarters of decline in the

gross domestic product (GDP), a basic

measure of a country’s economic output.

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Business Cycles

A deep and prolonged recession can be considered a depression, which doesn’t have an official definition but is generally considered to involve a catastrophic collapse of financial markets.

Recovery is the period during which income, employment, production, and spending rise.

Unemployment

• Frictional unemployment

• Structural unemployment

• Cyclical unemployment

• Seasonal unemployment2-47

Unemployment rate The portion of the labor force (everyone over 16 who has or is looking for a job) currently without a job

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Types of Unemployment

Inflation and Deflation

©2007 Prentice Hall2-492-49

Inflation

An economic condition in which prices rise steadily throughout the economy

Deflation

An economic condition in which prices fall steadily throughout the economy

Government’s Role in a Free-Market System

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Regulation

Relying more on laws and policies than on market forces to govern economic activity

De-regulation Removing regulations to allow the market to prevent excesses and correct itself over time

Government’s Role in a Free-Market System

• Protecting stakeholders

• Fostering competition

• Encouraging innovation and economic development

• Stabilizing and stimulating the economy

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Every economy has a certain amount of “spendable” money in it at any given time, a quantity known as the money supply. Monetary policy involves adjusting the nation's money supply by increasing or decreasing interest rates.

Monetary policy is controlled by the Federal Reserve Board or Central Bank, a group of government officials who oversee the country’s central banking system.

Monetary Policy

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Fiscal policy involves changes in the government's revenues and expenditures to stimulate a slow economy or dampen a growing economy that is in danger of overheating.

On the revenue side, governments can adjust the revenue they bring in by changing tax rates and various fees collected from individuals and businesses.

Fiscal Policy

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On the expenditure side, local, state, and

federal government bodies constitute a huge

market for goods and services, with billions of

dollars of collective buying power.

Governments can stimulate the economy by

increasing their purchases, expanding

employment opportunities and increasing

demand for goods and services.

Fiscal Policy

Economic Measures and Monitors

• Leading indicators

• Lagging indicators

• Price indexes2-56

Interest rates

Unemployment rates

Housing data

Industrial productivity

Economic indicators

Statistics that measure the performance of the economy

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Price Indexes

Consumer Price Index (CPI)A monthly statistic that measures changes in the prices of a representative collection of consumer goods and services

Producer Price Index (PPI) A statistical measure of price trends at the producer and wholesaler levels

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Composition of the Consumer Price Index

National Economic Output

• Gross Domestic Product (GDP)

• Gross National Product (GNP)

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The gross domestic product (GDP) measures a country’s output—its production, distribution, and use of goods and services—by computing the sum of all goods and services produced for final use in a country during a specified period (usually a year).

The products may be produced by either domestic or foreign companies as long as the production takes place within a nation’s boundaries.


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GDP has largely replaced an earlier measure called the gross national product (GNP), which excludes the value of production from foreign-owned businesses within a nation’s boundaries and includes receipts from the overseas operations of domestic companies.

GNP considers who is responsible for the production; GDP considers where the production occurs.


Applying What You’ve Learned

1. Define economics and explain why scarcity is central to economic decision making

2. Differentiate among the major types of economic systems

3. Explain the interaction between demand and supply

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Applying What You’ve Learned

4. Identify four macroeconomic issues that are essential to understanding the behavior of the economy

5. Outline the debate over de-regulation and identify four key roles that governments play in the economy

6. Identify the major ways of measuring economic activity

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2-1 understanding basic economics chapter 2. chapter 2 objectives after studying this chapter, you...

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