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UNIT 1: INTRODUCTION TO ECONOMICS Honors Economics What is Economics? The social science that studies the choices that individuals, businesses, and governments make as they cope with scarcity and the incentives that influence and reconcile those choices. Scarcity Incentives Self-interest vs. Social interest The Micro and Macro Views of the World Microeconomics~ The study of the choices that individuals and businesses make and the way these choices interact and are influenced by governments. Macroeconomics~ The study of the aggregate effects on the national economy and global economy of the choices that individuals, businesses and government make. Core Economic Ideas 1. People make rational choices by comparing costs and benefits. A choice that uses the available resources to best achieve the objective of the person making the choice. 2. 3. 4. 5. Cost is what you must give up to get something. Benefit is what you gain when you get something and is measured by what you are willing to give up to get A choice made by it. comparing all A rational choice is made on the margin. relevant alternatives Choices respond to incentives. systematically and incrementally. Economics as a Social Science Identify the following statements as positive or normative: Economists seek to discover how the economic world works. 1. The gap between class must and upper class has grown over the In order to bestthe dolower this they distinguish between past three and decades. positive normative statements. 2. An increasestatements in the minimum wage will bring more teenage unemployment. Positive 3. The minimum wage should not be increased. A statement about “what is” 4. The poor pay too much for housing. Can be right or wrong 5. The number of farms has decreased over the last 50 years. Can be tested against facts 6. The population in rural areas has remained constant over the past Normative statements decade. A statement “what ought to 7. An increase in theabout tax on cigarettes willbe” decrease teen smoking. Dependsinon opinions 8. An increase thevalues, number of police on the inner-city streets will reduce Cannot be tested the crime rate. Cause and Effect Focus 9. The United States should place more emphasis on reducing carbon emissions. 10.Healthcare should be provided to every American. Economics as a Policy Tool: Evaluating the Opportunity Cost of Choice Personal Economic Policy Business Economic Policy Opportunity cost FOP Government Economic Policy Guns or Butter Use of the Production Possibilities Curve Production Possibilities Curve Cost Alternative good or service given up as a result of a decision. Every point on the PPF indicates a cost in on item or another. Efficiency Maximum production or output of goods and services. Any point on the PPF Underutilization Growth Efficiency Underutilization Growth Expanding the ability to produce. Shift of the entire PPF to the right Resources/Technology Production Possibilities Curve ~~~~~~~~~~ A graph that shows alternative ways to use an economy’s resources. FOP ACTIVITY In small groups you will complete the following: PART I Terms and Concepts (SIDE ONE) 1. Definition of the term factors of production 2. List and define the “four” factors of production PART II Scavenger Hunt (SIDE TWO) 1. Walk around and find examples of each in the creation of “education”. Chapter 1 Review Economics Defined Scarcity vs. Shortage Microeconomics vs. Macroeconomics Positive vs. Normative Factors of Production Opportunity costs vs. Trade offs Marginal Decision Making Guns vs. Butter Production Possibilities Frontier ECONOMIC SYSTEMS Chapter 2 The Three Economic Questions Because ALL economic resources are scarce, every society must answer three questions: What goods and services should be produced? How should these goods and services be produced? Who consumes these goods and services? What to Produce? 1. 2. 3. 4. Consumption Goods and Services- goods and services that are bought by individuals Capital Goods- goods that are bought by businesses to increase their productive resources. Government Goods and Services- goods and services that are bought by governments. Export goods and services- goods and services that are produced in one country and sold in other countries. What we ACTUALLY produce. Consumption goods and services (60%) Capital goods (15%) Export goods and services (9%) Government goods and services (16%) How Do We Produce? The difference in what combination of factors of production we choose to utilize. Developed nations / less developed nations Changes in the United States over time For Whom Do We Produce? This question is dependent on who owns and controls the factors of production. Given individual ownership of the factors of production, a nation will produce for the consumer that has the ability to purchase products. Types of Income: Rent (land) Wages (labor) Interest (capital) Profit (entrepreneurship) Personal Distribution of Income Richest 20% Fourth 20% Third 20% Second 20% Poorest 20% 0 10 20 30 40 50 60 Societies answer the three economic questions based on their goals and values. Economic Goals Economic Goals Economic efficiency Making the most of resources Economic freedom Freedom from government intervention in the production and distribution of goods and services Economic security and predictability Assurance a safety net will protect individuals in times of economic disaster Economic equity Fair distribution of wealth Economic growth and innovation Innovation leads to economic growth, and economic growth leads to a higher standard of living. Other goals Environmental protection, variety Four Economic Systems An economic system is the method used by a society to produce and distribute goods and services. Traditional Free Market Command/Centrally Planned Mixed Free Markets A purely free market can rarely exist, but in theory a market economy would answer the three economic questions through a system of exchange and trade. Advantages: Freedom, Efficiency, Growth, Flexibility, Variety The core factors that allow a market system to work efficiently: 1. 2. 3. 4. Profit motive Flow of information Accurate price levels Ease of product movement Adam Smith (1723-90) Father of modern economic theory Scottish social philosopher/professor Laissez Faire Economic Theory “An Inquiry into the Nature and Causes of the Wealth of Nations” (1776) 10 years to write and consisted of 5 volumes. Established Economics as its own discipline Core Principles of Adam Smith On the Division of Labor Increase in quantity of work 1. Dexterity of workers 2. Saves time: no switch from one activity to the next 3. Machines replace manual labor Division of physical and mental labor: professional specialization; expertise Increased productivity = increased wealth for everyone Motivation for labor Disposition to barter Invisible Hand of the Marketplace EXAMPLE Adam Smith and the Invisible Hand In every transaction, the buyer and seller consider only their self-interest, or their own personal gain. Self-interest is the motivating force in the free market. Producers in a free market struggle for the dollars of consumers. This is known as competition, and is the regulating force of the free market. The interaction of buyers and sellers, motivated by self-interest and regulated by competition, all happens without a central plan. This phenomenon is called “the invisible hand of the marketplace.” Back to Principles Circular Flow Model monetary flow physical flow Households Firms physical flow monetary flow Market Failure 1. 2. 3. 4. 5. The provision of public goods (shared consumption/ exclusion) The provision of merit goods (lack of funds/opt out – under consumption) Income inequalities (social tension/economic problems) Existence of shortages and surpluses (unemployment) Existence of negative externalities NPR Karl Marx (1818-1883) German philosopher, political economist and historian Developed radical approach to understanding and coping with the problems that occurred in free market systems, namely the Industrial Revolution Published the Communist Manifesto in 1848 with close friend Frederick Engels Marxism is rooted in an analysis of modern, Western thought. 18th century Enlightenment Classical Economics Utopian Socialism German Philosophy Marxism in Theory Dialectical materialism Materialism Philosophical doctrine stating that matter is the only reality and that everything in the world, including thought, will, and feeling, can be explained only in terms of matter. Opposite of idealism Dialectical The theoretical process in the social sciences in which change occurs based on contradictory, interacting forces The forces are based on existing class struggles Thesis Antithesis Synthesis Stages of economic development Pre-determined Tribal, Slave-Owning, Feudal, Capitalist, Socialist, Communist Frederick Engels Karl Marx The Communist Manifesto: Online Reading Assignment Introduction Part I Part II Part III Part IV Identify problems with each of the following according to Marx: 1. Reactionary Socialists (Feudal, Petty-Bourgeois , and German Socialists) 2. Conservative/Bourgeois Socialism 3. Critical-Utopian Socialism and Communism Centrally Planned Economies Definition ~The government, or central authority controls the factors of production. Modern Day Forms of Central Planning: Socialism~ a social and political philosophy based on the belief that democratic means should be used to distribute wealth evenly throughout a society. Communism~ a political system characterized by a centrally planned economy with all economic and political power resting in the hands of the government. Communist governments are authoritarian in nature. The Soviet Experiment The October Revolution (1917) Vladimir Lenin led the Bolshevik revolution and remainder the party and government leader until his death in January 1924. The new Soviet government was established two days after the revolution under the leadership of the Council of People’s Commissioners. Lenin was the chairman of the Council. Allowed peasants to seize land, workers to take over factories, nationalized banks, confiscated private accounts, foreign trade became the dictate of the state, abolished the existing judicial system, titles/ranks were abolished, and church land was confiscated. By June 1918 private industry had all but disappeared and the nationalization of land ensued. The Soviet Experiment (cont.) Land, labor and capital was all controlled by the state. The best resources were allocated to the armed forces, space program, and production of capital goods. Government committees decided the quantity, process and distribution of all products. The government created large state-owned farms and collectives to produce all agricultural products. Problems in centrally planned societies: 1. Performance falls short of the set ideals 2. Fail to meet consumer needs and wants 3. Little individual incentives to work hard 4. Lack of innovation 5. Expensive and inflexible government structure needed to manage the system 6. Sacrifice of individual freedoms to pursue societal goals Mixed Economies It is doubtful that any nation can exist successfully as a pure market economy. Most modern industrial economies mix features of free markets and centrally planned systems. An economic system that permits the conduct of business with minimal government intervention is called free enterprise. The degree of government involvement in the economy varies among nations. Nations are placed on a continuum (a range with no clear divisions) of mixed economies. On one end are centrally planned economies and onEconomies the opposite end are free markets economies. Continuum of Mixed Centrally planned Iran Iran North Korea North Korea Cuba Cuba South Africa China South Africa Botswana China Russia Russia France France Botswana Peru Greece Greece Peru United Kingdom United Kingdom Canada Canada United States United States Free market Hong Kong Hong Kong Singapore Singapore Economic Freedom: Contemporary Application The World Map The Heritage Foundation’s Analysis of Economic Freedom “Economic freedom is the fundamental right of every human to control his or her own labor and property. In an economically free society, individuals are free to work, produce, consume, and invest in any way they please, with that freedom both protected by the state and unconstrained by the state. In economically free societies, governments allow labor, capital and goods to move freely, and refrain from coercion or constraint of liberty beyond the extent necessary to protect and maintain liberty itself.” Business Freedom | Trade Freedom | Fiscal Freedom | Government Spending | Monetary Freedom | Investment Freedom | Financial Freedom | Property rights | Freedom from Corruption | Labor Freedom Check out the data: http://www.heritage.org/Index/TopTen.aspx CHAPTER 3: FREE ENTERPRISE Features of Free Enterprise 1. Freedom 2. Competition 3. Contracts 4. Self Interest 5. Profits 6. Private Property 7. Voluntary Exchange When does the government intervene? Regulation Public Goods and Services Negative Externalities Redistribution Programs Regulation Government Policies Designed to Mitigate Incomplete Information Regulatory Bodies: OSHA, SEC, FDA Laws: Truth in Lending Act, Truth in Advertising Act, Credit Card Act Antitrust Policies Administered by the DOJ and FTC Goals (To eliminate monopolies, promote social welfare and to make it illegal for managers to pursue strategies that foster monopoly power) Sherman Act (1890)~ Prohibits price-fixing, market sharing and other collusive practices designed to “monopolize, or attempt to monopolize” a market. United States v. Standard Oil of New Jersey (1911) Charged with attempting to fix prices of petroleum products. Standard Oil dissolved into 33 subsidiaries. The rule of reason: Not all trade restraints are illegal, only those that are unreasonable are prohibited Public Goods and Services Public Goods~ A good that is non-rival (shared consumption) and non-exclusionary in consumption. Non-rival (shared consumption): A good which when consumed by one person does not preclude other people from also consuming the good. Non-exclusionary: No one is excluded from consuming the good once it is provided. “Free Rider” Problem Individuals have little incentive to buy a public good because of their non-rival & non-exclusionary nature. Externalities The effects of a decision by consumers and producers that has an impact on a third party Positive Externalities – beneficial effects on third parties Negative Externalities – costs incurred by third parties Pollution Government regulations may induce the socially efficient level of output by forcing firms to internalize pollution costs The Clean Air Act of 1970 Government Safety Net: Redistribution Programs 1. 2. 3. 4. Cash transfers In-kind benefits Health related benefits Education benefits The Role of US Presidents: Income Redistribution Franklin Roosevelt New Deal Social Security, Unemployment, Aid to Dependent Children Lyndon Johnson War on Poverty Head Start, Medicare, Medicaid Bill Clinton Comprehensive AFDC-TANF welfare reform