The Economy and the Individual Unit 6

What is Economics? Chapter 18

The Fundamental Economic Problem Economics is the study of how we make decisions in a world where resources are limited Individuals have needs ( required for survival) and wants (things we would like to have) Fundamental economic problem is scarcity We do not have enough resources to produce everything everybody wants

The Fundamental Economic Problem Three Key Economic Questions What goods and services should be produced? How should these goods and services be produced? Who consumes these goods and services? How are they distributed? Economists use economic models to explain how our economy works Models are simplified representations to predict what will happen if the economy changed

Making Economic Decisions Scarcity forces us to make economic decisions These decisions involve trade-offs Trade-offs are made by individuals, businesses, governments and societies Economists call term opportunity cost (cost of the next best use of your time when you decide to one thing over another) Involves more than money, also inconvenience and discomfort to choices made

Making Economic Decisions Other Measures of Cost Fixed costs- expenses that are the same no matter how many units of goods are produced, cost remains the same Variable cost- change with number of products produced (wages, raw materials), expenses increase as business grows Total Cost- Sum of fixed and variable cost Marginal Cost- extra cost of producing one more unit, one measure of how to maximize profit Marginal Revenue- change in revenue that results in one more unit being sold Cost Benefit Analysis When marginal cost and its benefits are determined economist use a cost benefit analysis to compare marginal costs and benefits of a decision if benefit of more production exceeds cost you continue producing, if cost outweighs benefits you reject option

Being an Economically Smart Citizen U.S has a market economy (supply, demand and price help make decisions and allocate resources) Choices made by consumers affect the products made and prices that businesses receive Market economy is based in capitalism (where private citizens own most means of production) and free enterprise (business compete for profit without interference from government) Economic incentives influence behavior Incentives are rewards that are offered to get people to take certain actions

Being an Economically Smart Citizen Understanding the role of the government Economists think the role of the government should be to maintain competitive markets Competition forces businesses to use resources efficiently Government provides many services the private sector does not provide (schools, defense, social welfare services) Government also reward and punishes actions Can encourage production through subsidies Can use taxes and fines to discourage consumption and punish lawbreakers

The American Economy Chapter 19

Economic Resources U.S amount of output of its goods and services equaled $10 trillion or 30% of the worlds total output Goods are tangible products Services are work that is preformed for someone else

Economic Resources Factors of Production Resources necessary to produce goods and services Natural Resources- fields, rain, forests, minerals and other resources used to make products Labor- physical and mental efforts people use to produce goods and services Capital- tools, machinery, money, etc. used to make products Capital goods are the result of production Satisfy wants in aiding production of consumer goods Consumer goods are produced using capital goods Entrepreneurs- individuals who bring together factors of production, seen as the driving force of the American economy

Economic Resources Success of overall economy is measured by Gross Domestic Product (GDP) Total value of all goods and services produced in one year Only measures final goods, sale of used goods or goods used to make something are not counted GDP is a measure of standard of living (quality of life based on possession of necessities and luxuries that make life easier) GDP measures quantity not quality

Economic Activity and Productivity A market is a location or other situation that allows buyers and sellers to exchange certain economic products Markets can be global regional or national Consumers, businesses, government and foreign sectors are economic decision makers Flow of resources, goods and services and money in a market system is circular Model is called a circular flow diagram

Economic Activity and Productivity Consumers earn their income in factor markets (where productive resources are bought an sold) Workers earn wages, people who own land exchange it for rent, people who control capital (banks) exchange it for interest Individuals spend their incomes in the product market (where producers offer goods and services for sale) Business use this money to buy the factors of production they use They do purchase some of their own output, mostly on capital goods, to produce more goods and services Business sector is smaller than consumer sector (15-20% of GDP)

Economic Activity and Productivity Government sector produces goods and services (schools, national defense, transportation, housing) it purchases productive inputs from factor markets Receives revenues from services it provides but cost is rarely covered by fees Most government revenue is from taxes Uses revenues to purchase services in product markets

Economic Activity and Productivity Growth of economy occurs when total output of goods and services increases over time Growth leads to a higher standard of living Economies try to increase productivity by using resources more efficiently Business try to purchase more efficient capital goods and farmers try to farm the most fertile land

Economic Activity and Productivity Specialization can create increased productivity It occurs when an individual, business, etc. can produce a good or service better than anyone else When people specialize they are more productive than when they try to do many things Division of labor is breaking down of jobs into smaller tasks It is a form of specialization By doing a single task it is easier to improve the techniques of production

Economic Activity and Productivity Productivity increases when businesses invest in human capital Human capital is the skill and abilities of people Investment in training, education, healthcare increase productivity Employers are rewarded with higher quality products and increased profits Workers are rewarded with higher pay and better jobs Because of specialization the American economy has a high degree of economic interdependence We rely on others to produce goods and services we can’t make for ourselves

Capitalism and Free Enterprise American economy based on free markets and private ownership Capitalism is where private citizens own and use factors of production to make a profit with a minimum of government interference Our economic system has been the most successful on the history of the world Markets are the most important part of our economic system Markets set prices of goods and services Connect different parts of the economy (labor is sold on the factor market, goods and services purchased on the product market) Where buyers and sellers meet to negotiate product prices

Capitalism and Free Enterprise Under our economic system customer is most important, they decide what is produced and they have a choice of what to buy (consumer sovereignty ) In the U.S. we place a high value on our freedom of choice Choice in what we buy, where we work, business have the right to sell what they want Freedom also has costs Individuals need to accept consequences of decisions (example: if business fails government usually won’t bail it out)

Capitalism and Free Enterprise Private property rights Give us the freedom to own, use and dispose of our own property as long as we do not interfere with others Protected by the Constitution Gives us the incentive to save and invest because we can keep any gains we might earn

Capitalism and Free Enterprise Capitalism thrives on competition between buyers and sellers to get best products at best prices Keeps the cost of production low and quality of goods higher Competition rewards the most efficient producers Forces least efficient producers out of business Under free enterprise people are free to invest their own money into businesses to earn a profit Profit is the amount of money left over after all of the costs of production have been paid Profit motive is the driving force that encourages companies and individuals to improve their material well being

Capitalism and Free Enterprise Voluntary exchange is the act of buyers and sellers freely and willingly engaging in market transactions Buyer and seller benefit Heart of the market economy Both parties feel they will be better off (will profit) from the exchange

Capitalism and Free Enterprise Why do these groups cooperate ? According to Scottish social philosopher Adam Smith it is competition and our own self interest that keeps marketplace moving Smith wrote Wealth of Nations (1776) that described how the market functions Self Interest He said an economy is made up of countless transactions In each the buyer and seller consider only their own self interest and this motivates the free market

Capitalism and Free Enterprise Competition Because of self interest consumers have an incentive to look for the best prices Firms seek to make greater profit by increasing sales The struggle between producers and consumers is called competition Self interest is a motivating force and competition is a regulating force These forces working together to regulate the market was called by Smith “the invisible hand”

The Economy and You Free enterprise system gives consumers rights and protections Rights require consumer to take on some responsibility We need to know what we are buying, how to get the best value and we can’t always rely on business to protect us Consumerism is the movement to educate buyers about purchases they make, to demand better and safer products Congress has passed laws protecting consumers since the early 20th century, there are private interests that protect consumer rights as well

The Economy and You 1960’s special effort was made to protect consumer rights Consumer Bill of Rights was developed Right to safe products- one that will not harm health or lives Right to be informed- protection against fraud, deceit, misleading facts that keep us from making informed choices Right to choose- availability of products at fair process Right to be heard- consumer interests will be heard when laws are passed Right to redress- consumers need adequate ability to collect for damages caused by product

The Economy and You Consumer Responsibility Role as a consumer Follow directions of warranty Exhibit ethical behavior Respect the rights of the producer and seller Role as a consumer Disposable income (money left over after all taxes on it have been paid) Spent first on necessities of living Discretionary income (money left over after necessities have been paid) Income used to purchase wants

The Economy and You Purchases made can be in cash (or debit card) or paid with a credit card Credit cards can be paid all at once or in installments If not paid all at once consumer pays interest on money owed Late payments result in additional charges All steps of decision making involve an opportunity cost Need to consider goals in making purchases If you buy now will you have enough to spend later? Saving is an economic goal When individual saves it helps the whole economy Provides money for banks to loan out to others to invest and spend, allows business to expand Person with bank account earns interest on what they have in the bank