Download Chapter 1: Fundamental Economic Concepts

Chapter 1: Fundamental Economic Concepts
Section 1: Scarcity and the Science of Economics
A) The Fundamental Economic Problem
a. If each of us were to make a list of all the things we want, it would include
more things than we could ever hope to obtain
b. Scarcity is the condition that results from society not having enough
resources to produce all the things people would like to have.
c. Economics is the study of how people try to satisfy what appears to be
seemingly unlimited and competing wants through the careful use of
relatively scarce resources.
d. A need is a basic requirement for survival and includes food, clothing, and
shelter.
e. A want is a way of expressing a need – sometimes considered a luxury.
B) Three Basic Questions
a. Because we live in a world of scarce resources and unlimited wants, we
must all make wise economic choices. Therefore, three basic questions
i. WHAT to produce – what will society produce to take care of their
needs. Military or food? Or in history – “Guns or Butter?”
ii. HOW to produce – how will these produces be produced? By
machine? Hand? Depending on what type of economic system you
have – do you have machines or men?
iii. FOR WHOM to produce – who will these products be produced
for? The rich? Poor?
iv. These questions must be answered in when we have limited
resources.
C) The Factors of Production
a. The factors of productions are required to produce the things we would
like to have. There are four factors of production:
i. Land – natural resources needed in order to make products.
Renewable and Non-renewable natural resources.
ii. Labor – people with all their efforts, abilities, and skills.
iii. Capital – the tools, equipment, machinery, and factors used in the
production of goods and service (capital goods). Financial goods –
used to buy tools and equipment (Money).
iv. Entrepreneurship – a risk-taker in search of profit who does
something new with existing resources.
v. Production – the process of creating goods and services.
D) The Scope of Economics
Economics is the study of human efforts to satisfy what appear to be unlimited
wants with limited resources.
a. Description – Gross Domestic Product (GDP) – the dollar value of all
goods and services produced within a country’s borders in a 12 month
period. GDP is the most comprehensive measure of a country’s total
output and is key measure of the nation’s economic health.
b. Analysis – we must see if the economy is doing well? How do prices,
taxes, income affect the economy?
c. Explanation – economics tries to explain how and why the economy
changes based upon data.
d. Prediction – economics is concerned with prediction and the study of
economics can help people make the best decisions. Therefore the study
economics helps us to become more informed and better decision makers.
Section 2: Basic Economic Concepts
A) Goods, Services, and Consumers
a. Goods: an item that is economically useful or satisfies an economic
want.
i. Consumer Good: is intended for final use by individuals
ii. Capital Good: goods used to produce other goods and services.
Ie. Tractors, etc.
iii. Durable Good: a good that is used on a regular basis for three
or more years.
iv. Nondurable Good: a good that lasts less than three years when
used on a regular basis.
b. Service: work that is performed for someone. The difference is that a
good is tangible (touch) and a service is intangible.
c. Consumers: is a person who uses goods and services to satisfy wants
and needs.
B) Value, Utility, and Wealth
a. Value refers to a worth that can be expressed in dollars and cents.
b. Paradox of Value: the situation where some necessities have little
monetary value, whereas, some non-necessities have a much higher
value.
c. Utility: the capacity to be useful and provide satisfaction. To have
value – economists decided it must be scare and have utility.
d. Wealth: the accumulation of those products that are tangible, scarce,
useful, and transferable from one person to another.
C) The Circular Flow of Economic Activity
a. The market is a location or other mechanism that allows buyers and
sellers to exchange a certain economic product. It is a place where
buyer and seller can come together.
b. Factor Market: the market where productive resources are bought and
sold. Land, labor, Money (capital).
c. Product Market: where producers sell their goods and services to
consumers.
D) Productivity and Economic Growth
a. Economic growth occurs when a nation’s total output of goods and
services increases over time.
b. Productivity: measures the amount of output produced by a given
amount of inputs in a specific period of time.
c. Division of Labor and Specialization
i. Division of labor takes place when work is arranged so that
individual workers do fewer tasks than before.
ii. Specialization takes place when factors of production perform
tasks that they can do relatively more effective than others.
iii. Henry Ford’s assembly line is an example of both Division of
Labor and Specialization.
d. Investing in Human Capital
i. Human capital: the sum of the skills, abilities, health, and
motivation of people. Education is a way of investing in
human capital.
e. Economic Interdependence
i. This means that we rely on others, and others rely on us, to
provide the goods and services that we consume.
Section 3: Economic Choices and Decision Making
To become a good decision maker, you need to know how to identify the problem
and then analyze your alternatives.
A) Trade-Offs and Opportunity Cost
a. There are alternatives and costs to everything we do.
b. Trade-Offs: whenever we make economic decisions we make choices
of one product or another.
i. Using a decision-making grid in one way to analyze an
economic problem
c. Opportunity Cost: cost often means more than a price tag place on a
good or service
i. Opportunity Cost: the cost of the next best alternative use of
time, money, or resources when one choice is made rather than
another.
ii. Part of making economic decisions involve recognizing and
evaluating the cost of the alternatives as well as making
choices from among the alternative.
B) Production Possibilities
a. Production Possibilities Frontier (Curve) is a diagram representing
various combinations of goods and/or services an economy can
produce when all productive resources are fully employed.
b. Identifying Possible Alternatives
c. Fully Employed Resources: all points on the curve represent maximum
combination of output possible if all resources are fully employed.
d. Opportunity Cost: in the Production Possibilities Curve – when
moving from one product – you give up the opportunity for another.
e. The Cost of Idle Resources: when resources are not fully employed,
your Production Possibility can never be reached.
C) Thinking Like and Economist
a. Build Simple Models
i. A model is a simplified theory or a simplified picture of what
something is like or how something works
ii. It is important to remember that models are based on
assumptions, or things that we take for granted as true.
iii. It is also important to keep in mind that models can be revised.
b. Employ Cost-Benefit Analysis
i. A way of thinking about a problem that compares the cost of an
action to the benefit received.
c. Take Small Incremental Steps
i. Make decisions by taking small, incremental steps toward the
final goal.
D) The Road Ahead
a. Free Enterprise Economy: one in which consumers and privately
owned businesses, rather than the government, make the majority of
the WHAT, HOW, and FOR WHOM decisions.
b. Topics and Issues: The study of economics has many different topics
and issues associated with it.
i. Standard of Living: the quality of life based on the possession
of necessities and luxuries that make life easier.
c. Economics for Citizenship: the study of economics help us become
better decision makers – both in our personal lives and in the voting booth.
Chapter 2: Economic Systems and Decision Making
All societies have something in common. They have economic systems – an organized
way of providing for the wants and needs of their people.
Section 1: Economic Systems
A) Traditional Economies: the allocation of scare resources, and nearly all other
economic activity, stems from ritual, habit, or custom. They dictate most
social behavior and individuals are not free to make decisions based on what
they want or would like to do.
a. Examples: African Mbuti, Australian Aborigines.
b. Advantages: everyone knows which role to play.
c. Disadvantages:
i. discourage new ideas and new ways of doing things.
ii. Strict roles in a traditional society have the effect of punishing
people
B) Command Economies: a central authority makes most of the WHAT, HOW,
and FOR WHOM decisions. People have little, if any, influence over how
the basic economic questions are answered.
a. Examples: North Korea, Cuba, former Soviet Union
b. Advantages:
i. Can change direction in a relatively short time due to command
structure.
ii. Shift resources on a massive scale when in the best interest of
the country.
iii. Many health and public services are available to everyone at
little or no cost.
c. Disadvantages:
i. Does not give the people the incentive to work hard.
ii. Requires large decision-making bureaucracy.
iii. Does not have the flexibility to deal with minor, day-to-day
problems.
C) Market Economy: people and firms act in their own best interest to answer
the WHAT, HOW, and FOR WHOM questions. People decisions act as
votes to inform producers what the people want.
a. Examples: United State, Japan, Canada, South Korea, Germany,
France, Great Britain
b. Advantages:
i. over time it can adjust to change.
ii. Changes are gradual due to the will of the people.
iii. There is a high degree of individual freedom. Small degree of
governmental interference.
iv. Decision making is decentralized. Everyone has a voice in the
way the economy is run.
v. Variety of goods and services available
vi. High degree of consumer satisfaction
c. Disadvantages:
i. does not provide for the basic needs of everyone in the society.
ii. Does not provide enough of the services that people value
highly.
iii. High degree of uncertainty that workers and businesses face as
the result of change.
Section 2: Evaluating Economic Performance
A) Economic and Social Goals – people share many broad social and economic
goals.
a. Economic Freedom:
i. people place a high value on the freedom to make their own
economic decisions.
ii.
Business owners like the freedom to choose where and how
they produce.
b. Economic Efficiency: resources are scare and that factors of
production must be used wisely
c. Economic Equity: Americans have a strong sense of justice,
impartiality, and fairness.
d. Economic Security: American desire protection from such adverse
economic events as layoffs and illnesses.
i. Social Security
e. Full Employment: people want their economic system to provide as
many jobs as possible.
i.
What is full employment in the US??
ii. How could we have full employment in the US??
f. Price Stability: To have stable prices.
i. Inflation: a rise in the general level of prices. In other words –
prices go up but the product stays the same – bubble gum as a
kid.
1. Income may rise to meet the rise of inflation.
ii. Deflation: a decline in the general level of prices. In other
words – prices go down on but the product stays the same.
1. Income can be cut.
iii. Fixed income: an income that does not increase even though
prices go up.
1. A fixed income – would it be better during inflation or
deflation?
g. Economic Growth: is needed so that people can have more goods and
services
h. Future Goals:
B) Trade-Offs Among Goals
a. People sometimes have different ideas about how to reach a goal.
b. For the most part, people, businesses, and government usually are able
to resolve conflicts among goals.
Section 3: Capitalism and Economic Freedom
Capitalism: where private citizens own the factors of production.
Free Enterprise: is another term used to describe the American economy.
A) Competition and Free Enterprise
a. Economic Freedom:
i. people can choose to have their own business or work for
someone else.
ii. Businesses also enjoy economic freedom to hire the best.
b. Voluntary Exchange: the act of buyers and sellers freely and willingly
engaging in market transactions.
c. Private Property Rights: the privilege that entitles people to own and
control their possessions as they wish
i. People are free to make decisions about their property and their
own abilities.
ii. They have the right to use or abuse their property rights
d. Profit Motive
i. Profit: the extent to which a person or organizations are better
off at the end of a period than they were at the beginning.
ii. Profit Motive: the driving force that encourages people and
organizations to improve their material well-being – is largely
responsible for the growth of a free enterprise system based on
capitalism.
e. Competition: the struggle among sellers to attract consumers while
lowering costs.
i. Buyers compete to find the best products at the lowest price.
B) The Role of the Entrepreneur
a. The entrepreneur organizes and manages, land, labor, and capital in
order to seek the reward called profit.
b. Many fail; however, the dream of success is often too great to resist.
C) The Role of Consumer
a. They determine which products are ultimately produced
b. Consumer Sovereignty: describes the role of the consumer as
sovereign, or ruler, over the market.
c. The dollars they spend are like votes used to select the most popular
products.
D) The Role of Government
a. Government has an economic role to play that reflects the desires,
goals, and aspirations of its citizens.
b. Protector: enforces laws against abuses.
c. Provider and Consumer: the government provides services (military)
and consumes products in the marketplace.
d. Regulator: preserving competition in the marketplace.
i. Interstate commerce
ii. Communications: telephone, etc
iii. Marketplace
1. “The Jungle”
e. Promoter of National Goals
i. The United States is a Mixed Economy in which people carry
on their economic affairs freely, but are subject to some
government interventions and regulations.
Chapter 3: Business Organizations
Sole-proprietorship
Partnership
Corporations
Section 1: Forms of Business Organizations
A) Sole Proprietorships: a business owned and run by one person. The most
numerous and profitable of all business organizations but the smallest in size.
a. Forming a Proprietorship: Easiest form of business to start because it
involves almost no requirements
b. Advantages:
i. ease of starting up
ii. ease of management – the owner can make fast decisions
iii. owner enjoys all the profit
iv. does not have to pay separate business income tax
v. psychological satisfaction of ownership
vi. ease of getting out of the business
c. Disadvantages:
i. unlimited liability: the owner is responsible for all losses and
debts of the business
ii. difficulty of raising financial capital
iii. size and efficiency of business
iv. inventory – must have on hand
v. limited managerial experience
vi. difficulty of attracting qualified employees
vii. No real fringe benefits
viii. limited life: ceases to exist when the owner dies, quits, or sells
the business
B) Partnership: a business owned by two or more people.
a. Types of Partnerships
i. General Partnership: in which all partners are responsible for
the management and financial obligations of the business
ii. Limited partnership: at least one partner is not active in the
daily running of the business
b. Forming a Partnership
i. Easy to start
ii. Articles of Partnership drawn up to divide responsibilities and
profit/debt
c. Advantages:
i.
ii.
iii.
iv.
v.
vi.
Ease of establishment
Ease of management
Lack of special taxes on a partnership
Can usually attract financial capital
Slightly larger size
Easier to attract top talent
d. Disadvantages:
i. Each partner is fully responsible for the acts of all other
partners
ii. Limited partnership
iii. Limited life – partner is responsibly for their debt
iv. Conflict between partners
v. Bankruptcy – court-granted permission to an individual or
business to cease or delay debt payments
C) Corporations
a. A corporation is a form of business organization recognized by law as
a separate legal entity having all rights of an individual.
i. Accounts for about 90% of all sales in the US
b. Forming a Corporation
i. Incorporate must file for permission from the national or state
government.
ii. A Charter is a government document that gives permission to
create a corporation.
iii. Stock – a piece of paper granting ownership of part of the
company
iv. Stockholder – a person who owns stock
v. Dividend – payment of profit to the owners of stock
c. Corporate Structure
i. Common Stock – basic ownership of the company
1. allowed to vote on board members
2. one vote for each share of stock
ii. Preferred Stock – nonvoting ownership of the company
1. receive dividends before Common Stock owners
2. are paid back their investment before common
stockholders in case the company goes under
d. Advantages:
i. Ease of raising capital
1. Bond – a way to borrow money for investment
a. principal – the base amount of money borrowed
b. interest – money paid for the use of the principal
ii. Can hire professional managers
iii. Limited liability of owners
iv. Unlimited life
e. Disadvantages:
i. Difficult to get charter
ii. Shareholders have little to say about day-to-day business
iii. Double taxation – corporate income tax and personnel income
tax
iv. Most government regulations
Section 2: Business Growth and Expansion
Merger: a combination of two or more businesses to for a single firm.
A) Growth Through Reinvestment
a. Income statement – a report showing a business’s sales, expenses, and
profit for a certain period of time.
b. Estimating Cash Flow
i. Net income – by subtracting all of its expenses, including
taxes, from its revenues.
ii. Depreciation – a non-cash charge the firm takes for the general
wear and tear on its capital goods
iii. Cash flow – the sum of net income and non-cash charges – the
bottom line
c. Reinvesting Cash Flows
i. When cash flows are reinvested in the business the firm can
produce additional products
B) Growth Through Mergers
a. When firms merge, one gives up its separate legal identity.
b. Reasons for Merging
i.
ii.
iii.
iv.
v.
Desire to be bigger
Efficiency
Acquire new product lines
Catch up or eliminate rivals
Lose its corporate identity
c. Types of Mergers
i. Horizontal merger – two or more firms of that produce the
same kind of product
ii. Vertical merger – firms involved in different steps of the
manufacturing process or marketing of products.
d. Conglomerates
i. A firm that has at least four businesses, each making unrelated
products, none of which is responsible for a majority of its
sales.
1. Diversification
e. Multinationals
i. A corporation that has manufacturing or service operations in a
number of different countries
ii. Have the ability to move resources, goods, services, and
financial capital across national borders
iii. They transfer new technology and generate new jobs in areas
where jobs are needed
Section 3: Other Organizations
A nonprofit organization operates in a businesslike way to promote the collective
interests of its members rather than to seek financial gain for the owners.
A) Community and Civic Organizations
a. Provide goods and services to their members while they pursue other
rewards.
B) Cooperatives
a. Is a voluntary association of people formed to carry on some kind of
economic activity that will benefit its members
b. Consumer Cooperatives: buys bulk amount of food and clothing on behalf
of its members.
c. Service Cooperatives:
i. Credit Unions
d. Producer Cooperatives: helps promote and sell the members products
C) Labor, Professional, and Business Organizations
a. Labor Unions: organizations of workers formed to represent its members’
interests in various employment matters
i. Collect bargaining – to work with companies to provide the best
coverage for its members – pay, health plans, working hours, etc.
b. Professional Associations
i. Groups of people in a specialized occupation that works to
improve the working conditions, skill levels, and public
perceptions of the profession.
c. Business Associations
i. Chamber of Commerce
ii. Better Business Bureau
D) Government
a. Direct Role of Government
i. The government supplies a good or service that competes with
private businesses
1. Power
2. Communications
3. Postal Services
4. Police, Fire, Schools, Courts, etc.
b. Indirect Role of Government
i. Public Utilities- companies that offer important products to the
public, such as water, electric.