Economics Notes
Mrs. Willis
Fundamental
Economic Concepts
Defining Scarcity in Context pg 3
-Scarcity exists when wants are
greater than the resources available to satisfy those want…forces people to
make choices.
-Resources
are limited and wants are unlimited.
-TANSTAAFL-
There ain't no such thing as a free lunch.
-Opportunity cost:
the value of the next best thing…real costs that are measurable in terms of the
real value that is forgone when a choice is made.
--Production
possibilities: many diff. Combos of goods and services can be produced w/
the same resources. Producing 1 good will reduce the possibility of prod.
Another good…represented by the production possibility curve.
-All resources are not good
substitutes for all others with the same efficiency.
Factors
of production pg 4
-Factors
of production:
All production of goods and services requires the use of resources: land,
capital, entrepreneurial resources
-Land
resources: natural resources that come from nature
-Labor
resources- human capital, skills and knowledge of humans.
-Capital
resources- real capital, goods that are produced to be used later to prod.
Final goods and services for consumption.
-Entrepreneurial
resources: decision making involved in using resources to produce goods and
services.
The
Role of Incentives in a Market Economy pg 4
-Incentive:
a reason
for people to take risks.
-Competition:
seller’s efforts to attract buyers. Will happen when markets are few of
barriers to entry or exit..signal of profits is strong.
-Effects
of competition:
- Lower prices of product
- Better quality of
product
-Ceteris
Paribus-Latin
phrase meaning "all other things being equal." Economists assume
cetris paribus when analyzing economic trends.
The
Science of Economic Decision-Making pg 5
-Economics: the science of personal and
group decision-making.
-The
greater the difference b/t the benefits and the cost of a decision, the easier
it is to make a choice. Often difficult when benefits and costs are similar.
Marginal
Analysis pf 5
-Marginal
Decision Making: the choices that are a matter of degree. The margin is the diff.
B/t the costs of 2 alternatives or the diff. B/t 2 benefits.
-Positive
Economics-what
is-analyzes facts or data to establish scientific generalizations about
economic behavior.
-Normative
economics-what
ought to be-involves value judgments about what the economy should be like, and
includes goals.
Microeconomics: study of the indiv. Parts
of the economy and the actions of the individs and firms.
Macroeconomics:
study of
economy as a whole: focus on aggregate behaviors of prodcers and consumers.
Economic
Systems pg 6
-a group of people in regions
to organize their economic activities. Systems are developed around:
- traditional practices
- planning or command
dominated systems
- market principles
dominated
-Develop
what to produce, how to produce, and who will receive the benefits of the
production
Market
Systems pg 7-Free enterprise, aka capitalism, private enterprise, free market.
-The
rights of the individ. and private ownership is highly valued. Have laws of
supply and demand. Individ profit is encouraged.
Planned
or Command Systems: a group makes economic decision as a whole, or the economic decisions
are made by the government n the name of society. Hinges on how decision makers
hold their power. Close relationship b/t political structure and economic
structure. Ex: Soviet Union
Traditional
Systems:
Rare, found in lesser-developed regions. Economic decision-making is powered by
tradition, usually resulting from moral, religious, or cultural forces.
**Pure
market systems do not exist. Most are Mixed market Systems.
Mercantilism
pg 7:
economic practice characterized by central planning, strong government control,
and heavy reliance on exports to build wealth in gold and silver. Found in
Europe through the 26t-18th century.
Socialism: systems in which a group
voluntarily shares their resources for the good of the group.
-Laissez-faire:
policy by which government leaves things alone.
Microeconomics:
-Market:
any
situation in which resources, goods, or services are exchanged. Found in many
forms when an exchange takes place.
-Price:
a signal to a producer that resources can be used to create a product that will
result in profit. Common point of reference for value.
Supply
and Demand Theory
-motivates
producers to use resources to create goods and services, and these signals
motivate consumers to use the goods and services to satisfy their wants.
-Markets
are fluid and ever changing.
Law
of Supply of 10
-the quantity supplied is
directly related to the price, ceteris paribus. As price increase, the
willingness of producers to increase the quantity supplied will increase.
-At
higher prices, producers will offer more. However, resources will be limits at
1 point.
-Willingness
to supply goods and services is determined by resource costs relative to market
price.
-Higher
the profit, the greater incentive to produce.
-Factors
determining the costs of production are: resource costs, transaction costs, and
an expected normal profit.
Law
of Demand pg 11
-the
quantity demanded is inversely related to the price, ceteris paribus. As the
price increases, there is less willingness to purchase a good or service.
-Demand curve slopes
downward.
-Demand
begins w/ tastes and preferences and a utility for the object.
-Budget
constraint: a low income may not allow a person to demand goods or services
w/o giving up other important wants.
-Demand
of a product will be affected by substitutes.
-Complementary
goods: 2 goods for which the demand for one affects the demand for the
other. Ex: French fries and ketchup.
-Marginal
Utility: additional utility of consumption of an addn’l unit of a
good/service. The utility may decrease as more of a good is consumed: diminishing
marginal utility. Ex: 1 candy bar vs 20 candy bars.
-Individ’s
demands for goods/services drive the market demand.
Equilibrium pg 11
-The interxn of
supply and demand determines equilibrium price and qntity.
-Equilibrium
price:
price at which the quantity supplied and quantity demanded are the
same….sometimes called the “market clearing" price.
Elasticity pg 12
-Demand
and supply curves are curved in reality.
-Inelastic
demand: change in price may not change the quantity demanded.
-Elastic:
refers to the relationship b/t a change in price to the change in quantity
demanded. If a small change creates a great change in quantity demanded, the
price is said to be elastic.
-Price
elasticity of demand: % of change in the quantity demanded divided by the %
change in price. If number is greater than 1, the price is elastic.
Ex:
Change in quantity = 33% Change
in price = 25%
.33
/.25 = 1.32 1.32 > 1 Elastic
demand
-Cross-price
elasticity: the relationship b/t the demand for 1 product and the price of
another. Sub good will have a + cross price elasticity. A zero says the 2
products are unrelated.
Shifts in Demand
and Supply pg 13
-A change in any factor that
influences demand or supply may cause a shift-a movement of the demand or
supply curve to the left or right.
-Movement
along the curve: consumer may change the quantity demanded due to a change
in the price
Behaviors of
Producers
-Producers seek profit
maximization. Profits are the difference b/t revenue and costs.
-Producers
have fixed costs- major capital expenditures, do not change with level
or production. Also have variable costs-costs that change with the level
of production.
-Producer
will continue to produce as long as the marginal revenue (increase in
total revenue from the sale of the next unit of prod.) is greater than or equal
to the marginal cost (the cost of the next unit of prod).
Markets and
Competition pg 13
-Competition
results in lower prices and an improvement in the quality of goods and
services.
-Perfect
Competition: a market with many buyers and sellers, with unrestrained entry
or exit, identical goods and services, and equal access to market info for all
competitors.
-real
world markets that are close are those for commodities, such as wheat.
Monopoly pg 14
-market types that are
non-competitive markets, in which production or price is controlled by a single
producer. Incentives do not exist in this market.
-this
control may be acquired through:
- patent: government grant of
the exclusive right to make, use, and/or sell an invention for a specified
period of time.
- copyright: legal right of the
creator to exclusive control of an original literary or artistic product.
-Results when 1 firm has such
size(economy of scale) that no other prod. can use the resources as
efficient.
-May
result when there are significant barriers of entry to the market.
-Regulated
monopolies: operate
w/ strict price controls and universal service requirements. They recover costs
and price.
-monopolistic
competition: market in which there are a sig # of sellers that produce
differentiated products and few barriers to entry. None of the companies have a
advantage that is so significant that is limits competition. Ex: Microsoft
Oligopoly:
A market
that is controlled by a few firms. Products may be identical. Ex: auto
industry.
Price Floors and
Ceilings pg 15
-Price
ceiling:
maximum legal price for an item. Government interferes when the free market
doesn’t achieve the social or political goals of society.
-Shortage:
a situation where the demand exceeds the supply at the market price. Results
in upward pressure on price, which causes the producers to increase supply.
-Price
floor may result in a surplus: when the supply exceeds the demand. Price
would fall, and a new equilibrium would be set on the curves.
Production
Decisions pg 16
-based
on the costs of the resources relative to the price of the output
Explicit
costs: expenditures for resources used in
production
Implicit
costs: opportunity
costs of time and capital resources forgone when a decision is made to produce.
Total
product: #
of units produced
Avg.
product: #
of units produced per unit of input
Marginal
Product: additional
output from the addition of a unit of input.
Productivity:
measure of
output per unit of input and is used as a measure of economic efficiency.
Labor
productivity:
measure of labor resource efficiency.
-Using
improved inputs, such as better skilled labor or better technology, can
increase productivity.
Macroeconomics pg
17
-analysis
focuses on aggregate behavior of peeps,
businesses, & govs. Also, output, prices & employment.
Circular Flow
Model pg 17
-represents the
constant flow of resources from owners to producers and flow of goods and
services from producers to consumers.
-All
resources are owned by the Household Sector. All production takes place in the
Business sector.
-households
provide land, labor, capital, to businesses/firms.
Say’s Law
-demand creates profit
signals to which producers respond à consumer sovereignty: consumers
are the driving force of the market.
-Says’ law: French economist Jean Baptiste Say said that supply creates it own
demand. Total demand must equal total value of production. Underlying principle
of supply-side economics. If barriers to increasing output and
employment are removed, the economy will grow since people will have greater
capacity to demand the goods that are produced.
Aggregate
Supply and Demand pg 18
Aggregate demand:
total demand in an economy. A function of all wants and income level equaling
Gross Domestic Product. Vert axis = price level Hor Axis = total output.
-Downward
slope to the right.
Aggregate Supply: relationship
b/t total quantity of output and the price level. Slopes upward.
-Equilibrium
Price level:
point at which the aggregate demand and aggregate supply curves intersect.
Measuring Economic
Activity pg 19
-Leading
economic indicators: things that indicate the direction the economy will take in the future.
Ex: new car purchases, etc.
-Concurrent
economic indicators: provide a sense of current economic activity. Ex: employment rates
Lagging
economic indicators: confirm past levels of economic activity. Ex: length of unemployment.
Index
of Leading Economic Indicators: weighted index of 12 measurements that indicate the
direction of economy over a year.
National Economic
Goals
Employment
Act of 1946 and Humphrey-Hawkins Act of 1978: under these mandates, congress and the
executive branch must design and implement public policies that purse the goals
of growth of output, full employment, and price stability.
-HH
Act established no more than 4 % unemployment rate. They also require an annual
report from the Prez and the Prez’s council on Economic Advisors to the
Congress.
Interest
Rates:
tools used to stimulate or slow growth. Also manipulating money supply does
this too.
Measuring Output
pg 19
Gross
Domestic Product: the total value of all final goods and services produced w/in a given
time period using factors of production w/in an economy (nation).
GDP = C + I + G +
X
C
= total spending on consumption I =
investment G = government
purchases X = net exports
Gross national
Product pg 20
-involves the value of the
production of a nation’s permanent residents, or nationals, regardless where
they work. Domestic residents are primarily in the US.
Problems:
-neither GDP nor GNP says
anything about the quality of life of the nation, nor on externalities:
external benefits or costs of an economic activity that are not born by the
producer or consumer. Ex: air pollution.
-Doesn’t
include goods & services that were produced outside trad. markets, &
non-market transactions.
-GDP
expressed in terms of current dollar value is called the nominal GDP.
-Dividing
the GDP by the size of the population: per capita gross domestic product.
-Real
GDP growth: measure of economic growth after adjusting for inflation.
Measuring the
Price Level pg 21
-overall
level of prices is measure by using the CPI
Consumer
Price Index: measurement of change in the cost of a fixed basket of
products and services. US Bureau of Labor Statistics puts it out monthly. Also
called “cost of living” index or “measure of inflation.”
GDP
price inflator: measures changes in price level relative to the growth of the GDP from
yr to yr.
Cost
push inflation: caused by a rise in the costs of actors of production, increase in
costs of labor, natural resources, capital goods, that can push prices up.
Demand
pull inflation: caused by consumer demand bidding up the prices of goods and service.
Deflation:
a decrease
in the general price level of the economy.
-Those
who owe money benefit by repaying debts with inflated dollars.
-Those
that owed money will receive payments that have reduced purchasing power.
Labor
force: # of
people who are employed plus the # of people who are seeking employment.
Unemployment
rate: # of
unemployed people divided by the labor force.
Business Cycle pg 21
-model
of the predictable increases and decreases in economic activity
Recession:
when the
GDP does not grow and declines over a period of time
Depression:
severe and long-term downturn in business
activity, severe unemployment.
Expansion:
sustained
period of growth.
Rational
expectations
-theory where people’s
expectations about the future can actually guide economic decisions.
Index
of Consumer Confidence: tracks the optimism and pessimism of consumers regarding the
performance of the economy.
Money pg 22
-tool that facilitates trade
-Money
has 3 basic functions:
- is a Medium of exchange
- serves as a unit of
account or measure of value
- is a mechanisms to
store value.
-Currency
must be durable, transportable, distinguishable, difficult to counterfeit.
-Most
money is available in demand deposits for checking accounts. Only 25% is
in money.
Interest
rates: cost of using money or credit to purchase something in the present and
pay for it later. Great demand for available funds causes interest rates to
increase. Less demand for funds causes a decrease.
Gresham’s Law pg
23
-16th
century: Thomas Gresham proposed that bad money
replaces good money in the market. Bad money = form of money that people prefer
to spend. Good money = any form of money that people prefer to keep.
Monetary
Policy:
-consists
of actions that influence the money supply and interest rates.
-Increasing
supply of $ in the economy will cause interest rates to fall à increasing prod. and consumption.
-
Decreasing supply of $ in the economy will cause interest rates to riseà slowing prod. and consumption.
-Federal
Reserve System (Fed) implements monetary policies. Established in 1913 by
the US Central Bank. Has the Board of Governors and 12 regional federal banks.
Governors are appointed by the Prez.
Quantity Theory of
Money
-Goal
of monetary policy is to control of supply of money to achieve an optimal level
of output and employment w/out inflation.
-Expressed
by Quantity theory of money, MV = PQ, which is called the equation of
exchange.
M=
money V= velocity of money P = price Q= quantity of output
-Types of money supply: M1
and M2:
M1
= cash in
the hands of the non bank public
M2
= broader,
included M1 as well as savings accounts.
-Tools
of monetary policy are open market ops, changes in discount rate, and member
bank reserve rqrments.
-Federal
Open Market Committee- determines targets for key interest rates, mainly
the Fed Funds Rate-the rate from which banks borrow overnight from other
banks.
-If
expansionary policy is desired to combat recession, the Fed will buy government
securities, which causes banks reserves to increase. With more reserves, the
banks can offer more loans.
-Banks
are rq’rd to put a reserve in Fed Bank.
If Fed changes reserve requirement, this will cause change in the money
multiplier- is the reciprocal of reserve requirement: 1/reserve ratio =
money multiplier.
-Fed
does not set interest rates, it sets the discount rate: rate at which Fed
reserve Banks loan funds to member banks.
-Wealth
effect: when
people feel wealthier, they tend to increase their demand for goods and
services.
Real
interest rate: rate charged over and above the anticipated inflation rate.
Fiscal Policy pg
25
-involves the use of
government spending and taxation to influence the level of economic activity.
The gov can give businesses or people more or less income to spend.
-Tax
revenues are intended to provide public goods.
Budget deficits: when the
government takes in less tax revenues than what it spends
Budget
surplus: when
the government takes in more tax revenues than what it spends
National
debt: Net
of gov. deficits and surpluses over the years. Called public debt. 1999 = US
had a debt of 5.7 trillion dollars
Keynesian
Economics
John
Maynard Keynes pub. a book , The General Theory of Employment, Interest,
and Money in 1936. Said in periods of decreased demand and
output, govt policies could be used to replace private spending.
In
the Model, national output is divided into 4 sectors:
- Consumption
- Gov. spending
- Private investment
- Net exports
When
slow down occurs in 1 and 3, 2 can step in to relief the depression.
-Keynes
theory was used in the Great Depression by Franklin D Roosevelt to rebuild
after the depression.
Government
Spending
US
office of Management and Budget classifies federal spending into 3 broad
categories:
- discretionary outlays
(national defense, domestic programs, international progs)
- mandatory outlays
(social security, deposit insurance)
- Net interest.
-Largest
budget item: $403 billion for Social Security. $251 billion for income security
programs, $203 bil. for Medicare, and $291 bil. for national defense.
International
Trade and Global Economic Development
-Growth of US except during
Depression of 1929. World War I helped with growth out of the Depression.
Phillips
curve:
trade-off between inflation and unemployment. As price increase, unemployment
decreases. Stagflation: high unemployment and high inflation.
-Extreme
poverty persists in some area that lack natural resources, access to capital,
or underlying legal and political structures that have hindered economic
growth.
-Economic
development must have:
- natural resources
- human resources
- access to capital
resources
- Investment
-Countries
do not have to have all 4.
-Countries
are classified into 3 categories based on per capita GDP:
- developed countries: US, large industrial
base, use of tech, and skilled workforce
- developing countries: Mexico, dependent on
agriculture, not lots of tech
- less-developed
countries: Africa, have natural resources, but depend on external capital
investment for development. Per capita GDP of $3000 or less. Have higher
birth rates, infant mortality rates, and low literacy rates, and low life
expectancies
Theory of Trade pg
29
Comparative
advantage:
used when he/she chooses to produce 1 or more goods for which the opportunity
cost is low.
Absolute
advantage: Advantage
in 1 market
Exchange
rates: price
of 1 nation’s currency in terms of another country’s currency
Tariffs: used to
prevent unfair trades such as dumping and to discourage dependency on other
nations. A tax on imports
Quotas:
a limit on
the quantity or value of a good that can be imported/exported.
General
Agreement on Tariffs and Trade (GATT): Many nation committee that’s goal is to reduce
tariffs and promote free trade. Have ongoing discussions, called rounds.
World
Trade Organization: 140 nations are in WTO. Was
created in 1995 to administer the goals and agreements of GATT. Headquarters
are in Geneva, Switzerland.
North
America Free Trade Agreement: Effective Jan 1, 1994: supports the gradual removal
of barriers to free trade in North America and effectively aims to establish a free
trade zone which includes US, Mexico, and Canada.
-In
Europe, the Maastricht Treaty of 1991, brought an end to border controls
and tariffs and began monetary coordination. Renamed European Union, and
its currency is the euro. Composed of 15 nations.