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Transcript
ECONOMICS Economics is the study of how best to allocate scarce resources among competing uses. Allocation questions: WHAT to produce with our limited resources. resources HOW to produce the goods and services we select. FOR WHOM goods and services are produced; that is, who should get them. Chapter 1 ECONOMICS: THE CORE ISSUES 2 THE ECONOMY IS US SCARCITY: THE CORE PROBLEM The economy is an abstraction that refers to the sum of all our individual production and consumption activities. Scarcity is the lack of enough resources to satisfy all desired uses of those resources. We The economy is us us—the the aggregation of all of our supply and demand decisions. But can change economic outcomes. we cannot have everything we want. want 3 FACTORS OF PRODUCTION FACTORS OF PRODUCTION Factors of production are resource inputs used to produce goods and services. Land, 4 labor, capital, entrepreneurship Land refers to all natural resources such as crude oil, water, air and minerals. It is not just the ground. Labor refers to the skills and abilities to produce goods and services. Both 5 quantity and quality of human resources 6 FACTORS OF PRODUCTION (CONT.) LIMITS TO OUTPUT Capital includes the final goods produced for use in the production of other goods, (e.g., equipment, structures). Entrepreneurship is the assembling of resources to produce new or improved products and technologies. It’s not just a matter of what resources you have but also of how well you use them. No matter how an economy is organized there is a limit to how fast it can grow. The most evident limit is the amount of resources available for producing goods and services. 7 GUNS VERSUS BUTTER 8 OPPORTUNITY COSTS Scarcity — the imbalance between our desires and available resources—forces us to make economic choices. One of the persistent choices about resource use entails t il d defense f spending. di Opportunity cost is the most desired goods or services that are forgone in order to obtain something else. It is what is given up in order to get something else. Resources employed in national defense must be taken from other industries. An increase in national defense implies more sacrifice of civilian goods and services. The peace dividend refers to defense cutbacks that free up resources to produce more civilian goods. 9 PRODUCTION POSSIBILITIES 10 THE PRODUCTION POSSIBILITIES CURVE Production possibilities are the alternative combination of final goods and services that could be produced in a given period of time with all available resources and technology. Each point on the production possibilities curve depicts an alternative mix of output. 11 Shoe Production Total Labor Shoe Output Labor per Shoe TV Assembly Total Labor Required Labor Not Used Potential Output Increase in TV for Shoes of TVs per Day Output 10 5 2 10 0 0 10 4 2 8 2 2.0 2.0 10 3 2 6 4 3.0 1.0 10 2 2 4 6 3.8 0.8 10 1 2 2 8 4.5 0.7 10 0 2 0 10 5.0 0.5 12 PRODUCTION POSSIBILITIES THE PRODUCTION POSSIBILITIES CURVE 5 A OUTPUT OF SH HOES Scarce resources – there’s a limit to the amount we can produce in a given time period with available resources and d ttechnology. h l Opportunity costs – we can obtain additional quantities of any desired good only by reducing the potential production of another good. B 4 C 3 D 2 E 1 0 1 Production possibilities illustrates two essential principles. 2 3 4 5 F OUTPUT OF TELEVISIONS We must give up increasing amounts of other goods to get more of a particular good. 14 13 THE COST OF NORTH KOREA’S MILITARY INCREASING OPPORTUNITY COSTS OUTPUT OF S SHOES 5 A B 4 3 2 Step 3: give up another shoe C p 2: get g two TVs Step Step 4: get one more TV D E 1 0 North Korea’s inability to feed itself is due in part to its large army. Resources used for the military aren’t available for producing food. food Step 1: give up one shoe 1 2 3 4 5 F OUTPUT OF TELEVISIONS 16 15 EFFICIENCY THE COST OF NORTH KOREA’S MILITARY Efficiency means getting the maximum output of a good from the resources used in production. Every point on a production possibilities curves is efficient. A production possibilities curves shows potential output, not necessarily actual output. There’s no guarantee that resources will always be used efficiently. FOOD OUT TPUT G P Reduced food output C O N Military buildup H MILITARY OUTPUT D B 17 18 INEFFICIENCY UNEMPLOYMENT Countries may end up inside their production possibilities curve if: 5 are inefficiently combined. All available resources are not used. OUTPUT OF SHOES Resources In 1992 as many as 10 million Americans were looking for work each week, but no one hired them. A 4 B 3 Y 2 C Unemployment 1 1 0 2 3 4 OUTPUT OF TELEVISIONS 5 19 ECONOMIC GROWTH 20 ECONOMIC GROWTH A point outside the production possibilities curve suggests that we could get more goods than we are capable of producing! All output combinations that lie outside the production possibilities curve are unattainable with current resources and technology. OUTPUT OF S SHOES 5 A X Currently not attainable B 4 C 3 2 1 0 1 2 3 4 OUTPUT OF TELEVISIONS 21 ECONOMIC GROWTH 22 ECONOMIC GROWTH Production possibilities increase with more resources or better technology. OUTPUT OF F SHOES 5 The production possibilities curve shifts outward. 0 23 PP2 PP1 OUTPUT OF TELEVISIONS 24 ECONOMIC GROWTH OUTPUT CHOICES Economic growth is an increase in output (real GDP) — an expansion of production possibilities. Production possibilities define the output choices confronting a nation: There are millions of points along a production possibilities curve, and each one represents a specific mix of output. We can choose only one of these points at any time. time WHAT to produce HOW to produce FOR WHOM to produce An economy is largely defined by how it answers the WHAT, HOW and FOR WHOM questions. THE INVISIBLE HAND OF A MARKET ECONOMY The market mechanism is the use of market prices and sales to signal desired outputs (or resource allocations). The essential feature of the market mechanism is the price signal. 26 To maximize their profits, producers seek to use the lowest-cost method of producing a good. A market distributes goods to the highest bidder. 27 COMMAND ECONOMIES The market decides the mix of output in an economy. Individuals who are willing and able to pay the most for a good tend to get it in a pure market economy. Laissez faire is the doctrine of leave it alone — of nonintervention by government in the market mechanism. The laissez-faire policy favored by Adam Smith, as espoused in the Wealth of Nations, has always had its share of critics. 28 GOVERNMENT INTERVENTION & COMMAND ECONOMIES Karl Marx emphasized how free markets tend to concentrate wealth and power in the hands of the few, at the expense of the many. According to Marx’s Das Kapital, markets permit capitalists to enrich themselves while the proletariat toil long hours for subsistence wages. Who is going to get the output produced? THE INVISIBLE HAND OF A MARKET ECONOMY FOR WHOM 25 HOW There are lots of different ways of producing goods and services. Someone has to make a decision about which production methods to use. WHAT Marx argued that the government not only had to intervene but had to own all the means of production. 29 John Maynard Keynes seemed to offer a less drastic solution. Keynes conceded that the market was pretty efficient in organizing production and building better mousetraps. However, However individual producers and workers had no control over the broader economy. Keynes believed the cumulative actions of so many economic agents could easily tip the economy in the wrong direction. In Keynes’ view, government should play an active but not an all-inclusive role in managing the economy. 30 A MIXED ECONOMY MARKET FAILURE A mixed economy is one that uses both market signals and government directives to allocate goods and resources. Most economies use a combination of market signals and government directives to select economic outcomes. A market failure is an imperfection in the market mechanism that prevents optimal outcomes. If the market signals don’t don t give the best possible answers, we say that the market mechanism has failed. A government failure is government intervention that fails to improve economic outcomes. 31 EXAMPLES OF GOVERNMENT FAILURES SEEKING BALANCE Forcing an industry to clean up its pollution in a manner which is excessive. Mandating pollution control technologies that are too expensive or even obsolete. Imposing excessive taxes and transfer payments so that the total economic pie shrinks making society as a whole worse off. 32 None of these failures has to occur, but they might. The challenge for society is to minimize failures by selecting the appropriate balance of market signals and government directives. It requires that we know how markets work and why they sometimes fail. We also need to know what policy options the government has and how and when they might work. 33 WHAT ECONOMICS IS ALL ABOUT MACRO VERSUS MICRO Understanding how economies function is the basic purpose of studying economics. Macroeconomics is the study of aggregate economic behavior, of the economy as a whole. Microeconomics is the study of individual behavior in the economy, economy of the components of the larger economy. We seek to know how an economy is organized, how it behaves, and how successfully it achieves it b i objectives. basic bj ti 34 End versus means: Economists don’t formulate an economy’s objectives. Instead, they focus on the means available for achieving given goals. 35 36 THEORY VERSUS REALITY IMPERFECT KNOWLEDGE Ceteris paribus is the assumption that nothing else is changing. Although the assumption of ceteris paribus makes it easier to formulate economic theory and policy, it also increases the risk of error. If other things do change in significant ways, our predictions (and policies) may fail. It may be impossible to understand and explain how the economy works without getting tangled up in subjective value judgments. When economic behavior changes, changes our theories must be adapted. Everyone wants full employment, low inflation, and a chicken in every pot. How are we going to attain these goals? 37 38 TO INTERVENE OR NOT? MACRO INTERVENTION: FED INTERVENTION Should we rely on Adam Smith’s invisible hand to lead us into the glow of the economy tomorrow? Should the government intervene to be sure we get to the right destination? 39 End of Chapter 1 ECONOMICS: THE CORE ISSUES To avert macro failure, the government regulates credit conditions. Specifically, the Federal Reserve (the central bank) tries to keep interest rates at the right level by regulating bank behavior. 40