Unit 1 Notes: Fundamental Economic Concepts

1. Economics - Is the study of how people try to satisfy unlimited wants and needs through the use of scarce resources

2. TINSTAAFL – “There is no such thing as a free lunch”- Nothing is free- Someone must pay for free items

3. Scarcity – The fundamental problem faced by all societies - Society may not have enough resources to produce all things

people want

4. The Factors of Production:A. Land – gifts of nature B. Labor – People C. Capital – tools, equipment

- Financial Capital – money to purchase capital

5. Entrepreneur – A person who takes risks for profit- They are often considered the 4th Factor of Production

6. Technology – Many economists add this to the factors of production

- Technology includes any use of the land, labor, capital that produced goods and services more efficiently

- examples – computers and robotics

7. Each society must answer 3 basic economic questions:A. What to produce? Ex Tanks or cars?B. How to produce? Ex Robotic or by handC. For whom to produce? Ex Consumers, military, or export?

8. People make bad economic decisions: A. Failure to make a budget B. Not saving regularly C. Failing to distinguish between wants and needs D. Failing to adapt your lifestyle to changed economic circumstances

9. Ethical Foundations of Economics:A. Ethics – Consideration of right and wrong B. Is our commercial system based on “economics” or

“greedonomics”?C. Ex of companies like Enron or people like Martha Stewart

D. Adam Smith – Father of modern Economics- appropriate to be self-interested but…- moral considerations generate self-restraint- greed is self-interest, without moral restraint - self-interest can advance interests of society - Sociability and Trust along with Competitive Markets and a

System of Justice – creates conditions in which self-interest promotes the broader interests of society

10. There are several segments of Economics:A. Description of Statistics: GDP, unemployment B. Analysis of Statistics: Why is gasoline expensive?C. Explanation of Economic Activity: How economies functionD. Predict Future Trends: economic forecasting E. Economic Ethics: values and economic decisions

11. Trade-Offs: Exchanging one thing for the use of anotherEx – Time playing Xbox vs time studying

12. Opportunity Cost: Value of next best alternative

Ex – Homework or working at Wal-Mart

13. The PPF or Production Possibilities Frontier:- illustrates opportunity cost- Diagram (next page) shows various combinations of

goods/services an economy can produce when all productive resources are fully employed

Guns 2 4 6 8 10

Butter 10 8 6 4 2

- Points along curve represent maximum output- Points inside curve represent idle resources - Points outside curve represent economic growth - Frontier – maximum combination of goods/services that can be produced

15. Needs vs Wants: A. Need - An item necessary for survival

Ex – food, clothing, water, shelterB. Wants – A way of satisfying a need

Ex – need = food want = pizza

16. Markets are Locations/Mechanisms that Allow for Buying and Selling:

A. Factor Markets – Productive resources bought and soldB. Product Markets – Producers sell goods/services to

consumers

17. The Circular Flow Diagram – Illustrates the flow of goods/services and money in a market system

18. Markets have Evolved into Cyberspace – buyers and sellers interact through computers without leaving their homes

19. A Market Economy – one in which consumers and businesses answer the what, how, and for whom to produce

Other terms – capitalism, mixed or free market economy

* Economic Systems and Decision Making: 1. Consumer Sovereignty – idea that consumers decide what will be produced2. Economic System – Organized way of providing for the wants and needs of society

3. Economic Systems: A. Traditional – Customs and beliefs guide economic decisions

- Advantages – Strong family ties, know what is expected of all - Disadvantages – Change is discouraged; few consumer goods Example – Nomadic herders in Mongolia

B. Command – The Government makes all decisions - Advantages – No career choices and few consumer goods- Disadvantages – lack of incentive to work; less inventiveness Example – North Korea

C. Market – Economic Decisions made by people - Advantages – individual freedom, competition, many

consumer goods - Disadvantages – young and old excluded, prices change, slow

to change - Example – United States

4. Social and Economic Goals of the United States are:A. Economic Freedom – to buy and sell most productsB. Economic Efficiency – Use resources wisely, conserveC. Economic Equity – policies benefit everyone fairly

D. Economic Security – protection against layoffsE. Full Employment – everyone who wants a job has one F. Price Stability – Little fluctuation, change over timeG. Economic Growth – economy over time will grow

5. Trade-Offs Among Goals: sometimes goals conflictEx – raising minimum wage causes prices to go up

6. Main Characteristics of a Free Enterprise (Market) Economy:- Economic Freedom – Choose job and employer- Private Property Rights – own and control property - Voluntary Exchange – Buyers and sellers act freely - Profit Motive – work to make money and not forced to work

7. Competition - Sellers compete with one another to attract customers while lowering prices

- Consumers compete with one another to find the best products at the lowest prices

8. Role of the Consumer – is to reject products or prices they don’t like

9. Role of the Government – A. Protector – of consumers ex impure drugs, etc.. B. Provider – of goods and services, a consumer

C. Regulator – of competition in market place D. Promoter – of national goals

* Comparing Capitalism, Socialism, and Communism* 1. Pure Market Capitalism – Adam Smith said a market economy was largely self-regulating and didn’t require government involvement (laissez-faire)

A. based on prices, profit, private propertyB. Government’s Role is limitedC. Individuals answer all economic questions Example – United States

- Pros of Market Capitalism:- consumer satisfaction - Freedom to choose- Producers supply what consumers want

- Cons of Market Capitalism:- Ignores public goods- produce only for those who demand- allows for businesses to fail, have unemployment and less

productive resources

2. Pure Socialism – Arose from dissatisfaction with living and working conditions during the Industrial Revolution

A. The State owns most factors of productionB. There is very little private property

C. Prices are set by the State a. Democratic (market) Socialism – works in elected framework

ex – England b. Authoritarian Socialism – central government controls

economyex – China

- Pros of Pure Socialism:- people use election power- Addresses for whom directly

- Cons of Pure Socialism:- Government guarantee of jobs- little labor mobility - high taxes

3. Communism – Karl Marx’ “Communist Manifesto” (Das Kapital)- Series of class struggles would eventually result in collective

ownership of all capital (property)- Proletariat – workers- Marx envisioned – Socialism as the stepping stone to

communism - Example – North Korea

- Pros of Communism:- all workers are equal - no job uncertainty- centralized control and planning

- Cons of Communism:- no individual freedom - no incentive to work - little consumer satisfaction - few day to day changes

4. Summary of Capitalism, Socialism, and Communism:

Under……. Prices are set by….. Factors of production are owned by…….. Economic decisions are made by…….

Capitalism Supply and demand

Privately owned/operated Consumers, govt, and businesses

Socialism Government, supply/demand

Government and the people Government and business

Communism Government

Government Government and planning committees

* 3 Theories:- Everyone has their opinion as to how the economy should operate. 1. Classical 2. Keynesian

3. Monetarist

1. Classical: - Key premise: Competition is best for the market. - Competition creates better, cheaper products, more choices. - Supply creates wealth. - Smith’s “invisible hand”

- Encourage trade - Oppose excessive taxation - Stop monopolies, collusion and unions as they block competition.

* Examples of classical theorists – Adam Smith, Ricardo, Tea Party, Ron Paul, Conservatives, libertarians, etc..

2. Keynesian: - Key Premise: Competitive markets are flawed and cannot stay in balance. - Prices go up quickly but do not fall quickly - Full employment and production will not last - Gov’t must repair constant recessions.

- Slow inflation with tax increases and cut government spending. - Create demand during a recession by tax cuts and increased government spending. - Safety nets-social security, unemployment, minimum wage programs

* Examples of Keynesians – Keynes, democrats, Obama, Bush, Clinton, liberals

3. Monetarists – - Key Premise: Non-political fine tuning is best for the economy. - Politicians won’t raise taxes but they will cut them.

- Central banks think long run, not next election. - Use interest rates to encourage spending or saving. - Provide stable currencies

Key Economic Terms: 1. Consumer Goods – intended for final use by a consumer

Ex – toaster, book, etc.. (go to Wal-Mart)2. Capital Goods – a good used to make another good3. Durable Goods – Lasts more than 3 years

Ex – house, car, etc..

4. Non-Durable Goods – lasts less than 3 yearsEx – tires, pens, etc…

5. Services – work performed for someone else6. Consumers – people who use goods to satisfy wants

7. Conspicuous Consumption – use of a good to impress othersEx – Rolex watch, designer purse

8. Value – worth in dollars and cents 9. Economic Value – how much it is worth in market place

10. Wealth – sum of all products in value11. Utility – the capacity of an item to be useful 12. Paradox of Value – items of little value (water) but necessary for survival, have less value than a want (diamonds)

13. Specialization of Labor – workers concentrate on a task they specialize in14. Human capital – the sum of all skills, talents, abilities and health of people

15. Cost/Benefit Analysis – what you gain for what you give up16. Economic Interdependence – idea that actions of one country or state impact what happens elsewhere