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A social science that examines how people choose among the alternatives available to them
The condition of having to choose among alternatives
One for which the choice of one alternative use of the good requires that another be given up
- One for which the choice of one use does not require that we give another.
- Ex: gravity holding you down doesn't mean your neighbor is floating up to space.
Scarcity and the Fundamental Economic Questions
- 1) What should be produced?
- Using the economy's scarce resources to produce one thing requires giving up another
- 2) How should goods and services be produced?
- Should a firm employ a few skilled or a lot of unskilled workers? Should it produce in its own country or should it use foreign plants?
- 3) For whom should goods and services be produced?
- A decision to have one person or group receive a good or service usually means it will not be available to someone else.
- The value of the best alternative forgone in making any choice.
- Every choice has an opportunity cost and opportunity costs affect the choices people make
Three features that distinguish the economic approach to choice from the approaches taken in other social sciences:
- Economists give special emphasis to the role of opportunity costs in their analysis of choices
- Economists assume that individuals make choices that seek to maximize the value of some objective, and that they define their objectives in terms of their own self-interest.
- Individuals maximize by deciding whether to do a little more or a little less of something. Economists argue that individuals pay attention to the consequences of small changes in the levels of the activities they pursue.
- The margin is the current level of an activity; the edge from which a choice to be made.
- A choice at the margin is a decision to do a little more or a little less of something.
The branch of economics that focuses on the choices made by individual decision-making units in the economy- typically consumers and firms- and the impacts those choices have on individual markets
The branch of economics that focuses on the impact of choices on the total. or aggregate, level of economic activity
- The scientific method is used as a systematic way to examine the economy
- Identify the issue at hand
- Assumptions- try to figure out what are the major influences of businesses or people
- Develop a hypothesis. Hypotheses can only be proven wrong
- Test hypothesis using statistics- systematic ways of trying to figure out outcomes without certainty
A set of simplifying assumptions about some aspect of the world.
Latin phrase meaning "all other things unchanged".
Unlike hypotheses, they can be shown to be correct
Value judgments that cannot be tested.
Production possibilities model
Shows the goods and services that an economy is capable of producing given the factors of production and the technology it has available
The set of rules that define how an economy's resources are to be owned and how decisions about their use are to be made
Consumption and Income Graph
- Consumption is a function of income so this is a positive graph (/).
- Even if we have zero income, people still spend money which is why the graph never starts at zero
- The space in-between of zero and the first dot on the consumption (y-axis) is called the autonomous consumption
Price and Quantity Graph
Price and quantity is an inverse graph () because when price is high the quantity is also high.
Factors of Production:
- Items we consider scarce:
- Land- any natural resource needed to create the produce.
- Labor- direct human effort to get the job done
- Capital- Capital is what we produce so we can produce other things i.e. plants, buildings, equipment, computers, or software. All of what a company has is considered their capital. Barter systems, or the trading of goods, is used sometimes rather than paying for service.
- Entrepreneurship- the "risk taker"; the individual that brings together the others to hopefully create a viable product. The chances of success are relatively poor, but without the entrepreneur these products wouldn't exist.
Economic returns (incomes or cost) for the factors of production
- Land- rent.
- Labor- wages. Wages are income for people, but cost to businesses.
- Capital- interest. If the rate of return is high enough then the business will make the expenditure.
- Entrepreneurship- profit.
- In a market system, prices are the key to resource allocation. It determines where and how much of the above factors are needed.
Production Possibilities Curve
A graphical representation of the alternative combinations of goods and services an economy can produce.
- The curve shows a fully employed, efficient economy based on a set of assumptions.
- A point inside of the curve would be inefficiency or unemployment. If this happens then business's have to figure out what happened and to try to move the point closer to the curve
- A point outside of the curve is not possible because the curve is already showing you the best possible outcome at the time.
- Everyone wants an outward shifting production Possibility Curve.
- A point outside of the curve becomes possible with economic growth.
- Inward shifting of the curve represents where productive capabilities have been destroyed such as war or natural disaster. It doesn't mean that we are in a recession.
- The amount of output per worker. We track this closely because it shows us over time how much stuff we produce on a per person basis.
- Example: We can produce 10,000 pens a worker per month. Because we identified this, we can increase the amount to 11,000 pens per worker. However, captial is needed to increase this. We identify capital as the most important because if you combine it with your workforce to get the best production rate; the company will use money to buy better, more efficient machines such will increase their capital in the end.
Three ways to receive a productivity increase:
- Increased living standards= give workers a raise. This is not completely negative because they can use their increase of profits to pay for the raises. This benefits the workers.
- Increase profitability. The money will go to shareholders which will increase the net worth of the stock. In turn, they can use the money and put it back into the business to increase productivity in the future. This benefits the owners.
- Lower prices. This helps the consumers and make them want to purchase more of the product. It is a way on the macroeconomic scale to help companies
Market Capitalist Economy
- An economy where resources are generally owned by private individuals who have the power to make decisions about their use.
- A market capitalist system is often referred to as a free enterprise economic system.
Command Socialist Economy
The government is the primary owner of capital and natural resources and has broad power to allocate the use of factors of production.
Combines elements of market capitalist and of command socialist economic systems.
Institutions that bring together buyers and sellers.
Sectors of the economy
The household sector and the business sector are a constant flowing cycle. We give the household sector real, physical things such as land, labor, capital and entrepreneurship. The household sector also receives rent, wages, and profit. The business gives back to households by giving the goods and services they want.
Determine what is going to be produced. They are the goods and services and the payments for the goods and services
Factor (resource) Markets
How product markets are produced. We become the suppliers and business's become the demander. We give them factors of production and we receive rent, wages and profit.
Is the quantity buyers are willing and able to buy at a particular price during a particular period, all other things unchanged
A table that shows the quantities of a good or service demanded at different prices during a particular period, all other things unchanged.
Five non-price determinants of Demand
- Tastes and preferences
- Population- population associate with the item we are interested in such as the population of moms receiving Christmas gifts
- Price of "other goods" (substitutes)
- First is an increase in demand.
- This can happen when there is an increase in income, increase in tastes and preferences like advertisement, or an increase in population (if a popular demographic segment grows then generally there will be an increase in demand)
When a reduction in the price of one good increases the demand for another, the two goods are complements
If a reduction in the price of one good reduces the demand for another, the two goods are called substitutes
Normal vs. Inferior Goods
- A good for which demand increases when income increases is called a normal good.
- A good for which demand decreases when income increases is called an inferior good.
A variable that can change the quantity of a good or service supplied at each price
When the amount by which the quantity supplied exceeds the quantity demanded at the current price.
- When the price is above equilibrium then the quantity demanded would be lower than the quantity supplied which creates this
- If inventories are above desired level then prices have to be cut.
- When the price is below equilibrium then the quantity demanded is higher than the quantity supplied. This is a clear indication that prices are too low.
General Shifts in the Supply and Demand graph
- If there is a decrease in supply then the price will go up and the quantity would decrease
- If there is an increase in supply then demand increases and prices fall
- If there is a decrease in demand, then quantity exchange falls and prices fall
Shifts in both Supply and Demand
- Government puts these in place, so prices cannot become too low.
- Most known for is Agriculture price supports or minimum wage.
- The price floor must be above equilibrium or it will do nothing.
- This causes decrease in the demand but increase of supplied.
- A price floor in minimum wage would make more people want jobs, so there would be a surplus of people. This would also increase the rate of unemployment because companies would not be able to afford to hire as many people
- This is where the government mandates a maximum price.
- This ceiling has to be below equilibrium. This would increase the demand causing shortages
Product and Factor Markets
- The circular flow model shows that goods and services that households demand are supplied by firms in product markets.
- The bottom half of the exhibit illustrates the exchanges that take place in factor markets. Factor markets are markets in which households supply factors of production—labor, capital, and natural resources—demanded by firms.
The profits kept by a company.
Profits distributed to shareholders
- Short for real gross domestic product
- The total value of all final goods and services produced during a particular year or period, adjusted to eliminate the effects of changes in prices.
- Referred to as gross domestic product (GDP)
- The total value of final goods and services for a particular period valued in terms of prices for that period.
A sustained period in which real GDP is rising.
A sustained period in which real GDP is falling.
- The government tries to estimate the graph by creating a best fit line.
- When the real GDP is below the best fit line then it is called the recessionary gap.
- When it starts to go up again it is the output graph.
- We want growth to be about 3% a year.
- The government conducts this survey to try to figure out if we are a fully employed economy.
- This includes agricultural workers.
- They come to us directly to try to figure out how many are working.
- They do a random sample with 60,000 houses and infer the rest of the population.
- Another way the government tries to find out if we are a fully employed economy.
- Agricultural workers not included.
- The government goes to businesses and ask how many jobs they are providing.
- This counts how many jobs there are not people so if a person has 2 jobs they will be counted twice.
- Generally, this year we have seen a growth in payroll employment. The number, however, was far below expectations so they consider it a negative number.
Calculated as the number of unemployed divided by the civilian labor force. However, you are considered employed even if you just work a single hour.
What is the Civilian Labor Force composed of?
- Those who are employed
- Those who are unemployed
- People who want to work, are able to work, but they are no longer looking for work.
- If you are in this situation then you aren't considered unemployed. They are in the "not in labor force" category.
What is considered "unemployed"
You must want to work, be able to work and are actively searching for work
Why might the low unemployment rate in Columbus be bad?
Business's might not come to Columbus because they know there are limited workers and of those limited workers, they don't know how many are actually qualified
Five types of unemployment
- When business's hire temporary part-time workers for the holiday seasons
- Government tries to set a trend line where they go through a season adjustment process which takes out the effects of seasonality.
- Government doesn't care about this unemployment
- When a person voluntarily leaves a buisness or when a person is unemployed for a short period of time (they leave one job, but have another lined up).
- J.O.L.T.S report shows how many people quit voluntarily
- Government does not care about this
- Deals with a business cycle
- When an activity (i.e building a house) is not being done, so everyone involved (construction workers) involved isn't making as much. This hurts everyone because they aren't spending as much so other business's aren't making as much.
- Occurs when there is a mismatch between the job skills of those unemployed and the job skills required for the current open jobs.
- This requires retraining schools and may even call for the need of free community college
- Always centered around what happens when the US enters a new free trade agreement
- If you allow free trade along countries then in net terms, everyone would be better off
- The government realizes that jobs will be lost when they are moved overseas
- Gets the most attention from the government
Expenditure approach for GDP
- C: Consumption expenditures
- I: Investment Spending
- G: Government expenditures
- (X-M): Net exports
Consumption Expenditures in GDP
- 2/3 of all economic activity is the consumer
- Durable goods- anything that has a life expectancy of greater than 3 years (automobiles, household appliances, jewelry)
- -This is the smallest portion, but it is important because it is highly cyclical in goods
- Nondurable goods- life of less than 3 years such as milk or medicine
- -These two make up less than half of consumer spending
- Services- make up more than half of consumer spending such as utilities, health care, or electricity
Government Expenditures in GDP
Unemployed benefits and social security are not included in these
Investment Spending in GDP
- Residential fixed investments (housing)- This is investment because houses are the kind of things that add to our economic infrastructure. When a house is built it is a multi-generation expenditure. It is also cyclical because when we are in recession houses aren't being built as often.
- Nonresidential fixed investments (machines and equipment). We want this to grow so we can replace the old technology with new technology.
- Change in the level of business inventories. Businesses are constantly producing things that we would want to buy.
- -If a business produces a new car and it is immediately sold then it shows up under durable goods, but if they are produced and just sit in a lot then they fall under this category
Net Exports in GDP
- (X-M): "X" represents gross exports- when everything is produced and done in the US (positives) and "M" represents gross imports- when things are done overseas (negative)
- Net Exports is always negative becuase we import more than we export
Income Approach for GDP
- Looking at all of the income generated during a period of time. What is a cost to us is revenue to the business. It is two different ways to look at the same thing
- Add together rent, wages, interest, and proprietor's income (economic return and corporate profit). These 5 things are considered the national income.
- Once you add indirect business taxes then you get Net Domestic Product (NDP)
- Last thing added is Depreciation (CCA). Economically, depreciation means the physically wearing of the capital. Business will charge you for the capital that will go down over time.
- All 7 of these things make up GDP.
What is a good economic growth rate
We want a fully employed price-stable economy which is a constant growth rate of 3%. If there is a 0% unemployment rate then prices will just continue to go up and up.
- Where the value of the dollar goes down, so you pay more and more for essentially the same thing.
- Causes people to have the mentality where they need to buy things quickly before prices go up. This is bad because everyone will want to be constantly buying things and no one is working to make the products. This creates a shortage where the prices would be driven up even more.
- An inflation rate in excess of 200% per year.
- This happened in Zimbabwe when the the inflation was $2 million by the end of the year.
A situation where the rate of inflation is getting lower and lower as time progresses.
- The opposite of inflation.
- It is where prices are constantly falling as measured by some price index. This is not a good thing because if we aren't buying it then we don't need to produce items. If there isn't a need to produce items then people won't have jobs.
A number whose movement reflects movement in the average level of prices.
Consumer Price Index (CPI)
- Is given the most attention
- They look at the different weights of the different categories such as the quality of products that change over time as well as how trends change.
- It overstates inflation and is extremely hard to predict.
How the inflation rate is determined
- You divide the CPI from one year by the CPI from the year before.
- Inflation= Aug 2015/ Aug 2014= .2% within one year.
- In the US, we are shooting for a consumer inflation rate of about 2% (excluding food and energy since they are extremely volatile)
Producer Price Index
PPI is the same concept of the CPI except it is at the business level. It is viewed as something that may happen to consumer prices
GDP Implicit Deflator
- It is the best measure of inflation because it looks at everything associated with production
- It is not a fixed weight deflator. It changes automatically as the consumer rate changes looking at Consumption Expenditures at its "core".
Effects of Inflation/Deflation
- Reduces the effectiveness of the pricing mechanism
- -Prices are the key to resource allocation according to macroeconomics. Bad decisions are made because pricing is messed up not allowing resources to be used to their maximum capacity. It will direct us in one way or another.
- For example, people buying a house will typically need to borrow money from a financial institution and they will receive an interest rate. Nominal interest rate= real interest rate + full compensation for expected inflation.
- Arbitrarily redistributes the income and wealth. Inflation rewards borrowers and hurts lenders. If lenders predict the incorrect interest rate then they are out of a ton of money.
How does the US make up for the large money deficit in the country?
- It sells treasury bills, notes, and bonds. These treasury securities are fixed income securities and sold in an auction process.
- T-Bills are < 1 year (short term financing)
- T-Notes anything maturing between 2-10 years
- T-Bond is anything greater than 10 years
- The 10 year T-Note is the most popular and countries or individuals will place bids on it.
- When they auction if off, the interest rate they have to pay is a coupon rate
- If you want a 10,000 t-note and the coupon rate is 2.05% then the government will pay $205 every up until year 10. Once they give you the final payment, you also receive the $10,000 back.
- These are completely liquid.
Primary Financial Markets vs. Secondary Markets
- Primary are when financial instruments are created and sold for the very first time.
- -If a company sells a new stock, then it is a primary market
- Secondary markets are when existing instruments are being resold.
- -When the owner of a certain stock is constantly changing.
The relationship between the total quantity of goods and services demanded (from all the four sources of demand) and the price level, all other determinants of spending unchanged.
- Aggregate demand increases because our desire to buy things increase. The aggregate supply doesn't change. The vertical difference is the price increase
- This causes recession which has high unemployment and double digit inflation
- Aggregate demand decreases and price increases
Classical Economics Theory (assumptions)
- Believed in the correctness of "Say's Law"- supply creates its own demand. Consumption is the result of income, so as businesses are supplying items, they are going to employ people. People will then buy more things because they have more money and the cycle continues.
- All savings will be invested. Even though you save money which "leaks out" of the financial cycle, it will be invested by the financial institution thus not interrupting the flow of the economy.
- Wages/prices are flexible within an economy. They change based on market circumstances. If Samsung makes a better phone, apple would have to lower their prices even though they are so expensive and popular right now.
- -Once you put these three things together, will be at or near full employment overtime. Short term, we can have disruptions in the change which can lead to unemployment. The government can't force the market to be better.
- The last assumption is that there can be no "money illusion". This means that you can't fool people by giving them more money when in fact they aren't actually gaining anything. They will notice that their "raise" doesn't actually buy them more items.