Foundations of Personal Finance Ch. 1

1 What Is Economics?

Chapter Objectives Distinguish between needs and wants. Compare different types of economic systems. Define scarcity in terms of needs and wants. Analyze a decision in terms of trade-offs and opportunity cost. Explain the role of profit motive in the economic system of the U.S. continued

Chapter Objectives Evaluate how competition among producers influences the price of goods in a market economy. Interpret the relationship between supply and demand.

Economic Systems In earliest times families were the basic economic unit Self-sufficient families grew their own food provided for members’ needs and wants only consumed what they produced continued

Economic Systems The family lost its role as the basic economic unit as people moved away from agricultural base new ways of organizing production through specialization and technology emerged larger quantity and wider variety of goods and services became available

Types of Economic Systems Four types of economic systems: Traditional Market or free enterprise Command Mixed

Traditional Economy Found mostly in underdeveloped countries Change comes slowly People tend to stick with what they know and do as they always did People are governed by strong cultural, religious, or tribal leadership

Market Economy Decisions and activities of consumers impact businesses Businesses react to consumers’ needs Businesses have the opportunity to grow and profit Individuals are given incentives to succeed continued

Market Economy A marketplace brings consumers and producers together to exchange goods, services, and money continued

Market Economy Examples: Market for all goods and services in an economy Market for cars Market for a certain brand of sneakers

Command Economy Commonly found in socialist and communist countries A central authority, usually government, decides how resources are allocated decides who will produce what sets prices and decides how much to produce

In Your Opinion Why might some people choose to live under a command economy?

Mixed Economy Combines features of command and market economies Exists in the U.S., China, Great Britain, Japan, and many other nations Most economies are mixed Though mixed, the U.S. economy has minimal government involvement

The Challenge of Scarcity Needs and wants are unlimited Resources are limited Economic systems attempt to resolve the problem of scarcity Scarcity is a problem for individuals, families, companies, and nations continued

The Challenge of Scarcity Nonhuman resource Examples: natural resources, capital, or physical things used to make and distribute other goods and services Human resource Examples: human labor, good health, skills, knowledge, education, entrepreneurship

Trade-Offs and Opportunity Cost Scarcity forces everyone to make choices, which involve trade-offs opportunity costs

Scarcity and Economic Systems Three problems for all societies: What and how much to produce How to allocate resources in producing goods and services How to divide the goods and services produced

How the U.S. Economy Works Flows of goods, services, and resources between producers/sellers and consumers/workers continued

How the U.S. Economy Works Flows of payments for goods, services, and resources between consumers/workers and producers/sellers

Four Qualities of a Market Economy Private ownership and control of productive resources Profit motive Free economic choice Competition

Private Ownership and Control of Productive Resources Individuals and businesses have the right to own property such as possessions, real estate, business enterprises freedom to decide how to use resources

Profit Motive Provides incentives for entrepreneurs to take risks to start new businesses businesses to produce goods and services investors to buy stocks, bonds, and other investments people to sell their resources: labor, land, ideas, capital

Free Economic Choice Consumers can choose how they earn income what to do with their money: spend, save, or invest what, where, and how much to buy continued

Free Economic Choice Businesses can choose what they produce how and where to produce it how and where to sell what they produce what to do with their profits

Competition Competition among businesses and individuals affects prices wages quality of goods and services features of goods and services quality of customer service innovation continued

Competition Businesses must innovate to be competitive and successful by investing in research and development (R&D) Advances in technology drive innovation U.S. invests more money in research and development than any other country in the world continued

Competition Market economies can provide the best products and services at the lowest prices

Laws of Supply and Demand Supply is closely connected to price Businesses produce more of something when they can sell it at higher prices When price rises, supply rises When price falls, supply falls continued

Laws of Supply and Demand Price and supply move in same direction in the supply curve continued

Laws of Supply and Demand Demand is closely connected to price When price rises, demand falls Consumers buy more of something at a lower price than at a higher price When price falls, demand rises continued

Laws of Supply and Demand Price and demand move in same direction, opposite the supply curve

Equilibrium Laws of supply and demand work together When demand and supply are relatively balanced, the market is in equilibrium Equilibrium is an ideal continued

Equilibrium Equilibrium price is when quantity supplied equals quantity demanded

Changes in Demand Trigger Price Adjustments Price rises when demand is greater than supply demand rises and supply stays the same Example: airline ticket prices are highest during peak travel times continued

Changes in Supply Trigger Price Adjustments Price falls when supply is greater than demand supply rises and demand stays the same Example: stores drop prices for winter coats and hats at end-of-season clearance sales

The Market’s Answer to Scarcity Demand in the marketplace determines what and how much to produce Businesses decide how to allocate resources in producing goods and services Forces of supply and demand in the job market determine how to divide goods and services produced

In Your Opinion Is understanding the free enterprise system important to the study of personal finance?

Central Ideas of the Chapter Economics is the study of how people use scarce resources to satisfy their unlimited needs and wants. In a free enterprise system, market forces allocate the resources.

Foundations of Personal Finance Ch. 1 Glossary of Key Terms Back command economy. A system in which a central authority, usually the government, controls economic activities. consumer. A buyer and user of goods and services. demand. The quantity of a product or service consumers are willing to buy. economic system. Structure in which resources are turned into goods and services to address unlimited needs and wants. 40

Foundations of Personal Finance Ch. 1 Glossary of Key Terms Back free enterprise system. See market economy. Also called capitalism. goods. Physical items such as food and clothing. human resource. Qualities and characteristics that people have within themselves. innovation. The process of creating something—new or improved products and new ways to do things and solve problems. 41

Glossary of Key Terms Back market economy. A system in which privately owned businesses operate and compete for profits with limited government regulation or interference. marketplace. An arena in which consumers and producers meet to exchange goods, services, and money. mixed economy. A combination of market and command systems.

Foundations of Personal Finance Ch. 1 Glossary of Key Terms Back needs. Items a person must have to survive. nonhuman resource. External resources, such as money, time, equipment, and possessions. opportunity cost. The value of the best option or alternative given up. producer. An individual or business that provides the supply of goods and services to meet consumer demands. profit. The total amount of money earned after expenses are subtracted from income. 43

Foundations of Personal Finance Ch. 1 Glossary of Key Terms Back resources. Any input used to generate other goods or services. scarcity. The challenge of stretching resources to cover needs and wants. services. Work performed. supply. The amount of a product or service producers are willing to provide. technology. The application of scientific knowledge to practical uses and product development. 44

Foundations of Personal Finance Ch. 1 Glossary of Key Terms Back trade-off. Part of making choices that involves evaluating two or more options and selecting just one; the item given up in order to gain something else. traditional economy. System in which economic decisions are based on a society’s values, culture, and customs. wants. Items a person would like to have that are not essential to life. 45