Economics
the study of how individuals and societies make choices under the condition of scarcity
scarcity
condition that exists when there are not enough resources to satisfy all of the competing uses; people want more goods and services than can be produced
types of resources
- labor (human resources)- land (natural resources)- capital resources- entrepreneurship
labor (human resources)
the physical and mental capabilities of individuals used in the production of goods/services
land (natural resources)
all types of natural resources
capital resources
equipment, machines, tools, infrastructure
entrepreneurship
the willingness to risk starting a business plus the imagination and ability to make the business successful
microeconomics
study of how individuals, households, and businesses make choices (behavior of the units)
macroeconomics
study of the economy as a whole (total behavior)
the two economic assumptions about human beings
1. Economics assumes people are rational. In other words, the assumption is that human beings do not intentionally make decisions that make them worse off.2. Economics assumes that people are self-interested. This second assumption is often misunderstood. Self-interest does not mean that people are motivated only by money. The self-interest assumption also includes motivations related to love, friendship, and helping others.
economic model
a simplified representation, such as a graph, of an economic environment
bar graph
features rectangles proportional to the values they represent
pie chart
circular graph divided into slices, where each slice represents a percentage
time series graph (line graph)
illustrates how the value of a variable changes over time
opportunity cost
the value of the next best alternative other than the choice that was made
trade-off
when you give up something to gain something else
direct costs
can be linked directly to a product or service, such as the raw materials or labor required to produce the product or service. Direct materials and direct labor are the most common direct costs.
indirect costs
affect an entire operation rather than a specific product or service. Utilities, depreciation, office supplies, and rent are examples of indirect costs. Usually, such costs are called overhead.
marginal decisions
how much" of an activity you should do
marginal benefit
additional benefit resulting from an action
marginal cost
the additional cost resulting from an action
four major types of economic systems
- traditional- command- market- mixed
the three basic economics questions
1) What should I produce?2) How should I produce it? 3) Who will buy the goods or services?
traditional economy
The kind of work people do, the goods people produce, and the way people use and exchange goods and resources are all followed by tradition. People produce only enough goods for their own needs and leave a very small amount for trading. In a traditional economy, the questions of what people are supposed to produce, how much they should produce, and who will receive the production are very predictable. Modern technology is not often used.
market economy
individuals and firms can determine what they want to produce, how much they want to produce, and who will receive the goods and services produced
command economy
he government makes all or most of the economic decisions. These governments say their choices are not driven by self-interest but are oriented toward improving the well-being of their citizens
gross domestic product (GDP)
measures the value of all the goods and services that a country produces during a specific year. a higher GDP generally indicates a higher quality of life for most people in a country
important difference between market and command economy
market = decentralizedcommand = centralized
inflation
an overall increase in the price level
mixed economy
combines characteristics of both a market economy and a command economy
private ownership
individuals are allowed to own property and use it in any legal way they see fit
Voluntary transactions
when individuals buy or sell willingly and without coercion. No one imposes a decision on an individual.
Adam Smith
father of modern economics; free-market economy
mercantilism
economic system of the major trading nations during the 16th, 17th, and 18th centuries, based on the premise that national wealth and power are best served by increasing exports and collecting precious metals in return
the invisible hand
a commonly used metaphor to describe the self-regulating nature of the marketplace
specialization of labor
division of labor; increases efficiency
factor demand
entrepreneur's demand for scarce factors of production used by businesses, such as natural resources, human resources, and capital resources; derived demand
derived demand
demand for one thing based on the demand for another
Labor productivity
a measure of how much a worker can produce in a given amount of time, usually helped by a machine or piece of equipment
Labor demand
is the number of hours that an employer is willing to hire based on the many variables it faces
Capital demand
the demand for physical capital; depends on the unit cost of capital
unit cost of capital
the cost of the physical capital used in production divided by the number of units produced
Factor supply
the availability and willingness of factors to supply their labor or their tools or their raw materials to a business at various prices
exogenous factors
external factors
Productivity
a measure of a worker's efficiency in converting inputs into a product that others are willing to buy
marketability
workers begin as apprentices to obtain the work experience that helps them increase their productivity, become more cost efficient, and generate more profits for the company. This experience also makes them more employable when looking for other work—their market value goes up
three uses of capital goods
- To produce other capital goods (such as a machine that makes hammers for sale to carpenters)- To make a consumer product (for instance, when the same machine makes hammers to sell to buyers)- To provide a service to a consumer (such as when your dentist uses an X-ray machine to check for cavities, or the computer that an accountant uses in doing an audit of a business' accounts.)
increase in interest rate by banks =
capital goods more expensive
determinants
factors that determine supply and demand
supply
the willingness and ability to bring to market (produce and/or sell) specific amounts of a good or service at different prices in a specific time period, considering all things remain the same
demand
the willingness and ability to buy specific quantities of a good or service
new technology = higher supply =
decrease in price
decrease in price =
higher demand
production function
demonstrates how inputs can be combined to produce outputs. It is the mix among three factors of production (natural, human, and capital resources) and the resulting output. explains how much production is possible if only one factor of production is increased or decreased, while the other factors remain the same
Total product
total quantity produced for each level of labor.
Average product (labor productivity)
total product divided by the number of laborers
marginal product
the difference in total product after the increase of one unit of labor
total productivity
the measure of the total product divided by the total inputs
short run
a period of time where at least one factor of production is a fixed quantity while the amount of other factors vary
Law of Diminishing Returns
by adding units of one resource, such as labor, there will be a point where adding additional units of that resource will add less to the output—or even reduce the total output
long run
a period of time long enough for a company to adjust its outputs based on every variable it can manipulate.
how is the law of diminishing returns addressed in the long run?
by adding other resources so the decrease in total production is eliminated. In the long run, because all variables can be manipulated, this theoretical maximum can be changed.
factor market
a market for the factors of production [inputs]
product market
market where products are sold [outputs]
consumer market
households purchasing and selling goods and services for their own use
utility
aka satisfaction; advantage, or fulfillment, a person obtains from consuming a good or service.
trade deficit
When a nation imports more goods and services than it exports
trade surplus
hen a nation exports more goods and services than it imports
Dependency Theory
a country's economy is directly impacted by the development and expansion of another country's economy
Absolute advantage
When someone can produce a certain good with fewer resources, that person has an absolute advantage over a trading partner.
comparative advantage
An individual, business, or country that can produce a certain good at a lower opportunity cost than its trading partners has a comparative advantage
specialization
when an individual, business, or country focuses its resources on producing a few goods or services and expects to trade for others
sole proprietorship
an unincorporated business owned by a lone individual
cooperative (co-op)
an organization owned and operated by people who use its services; they are designated as members, or user-owners.
franchise
relationship between the owner of a trademark, service mark, trade name, or advertising symbol and an individual or group (the franchisee) that wants to use this identity as part of a business
limited liability company (LLC)
a cross between the limited liability feature of a corporation and the taxation and operational features of a partnership
tort
any wrongdoing not involving breach of contract for which a legal action for damages may be filed.
S corporation
allows a business to avoid double taxation—once on the corporation profits and again on the shareholders.
partnership
a business owned jointly by two or more people
corporation
limited liability in terms of personal assets, continuity of life, centralization of management, and the ability to transfer ownership interests. large, large flow of cash, many employees, complex
c corporation
regular corporation
Property rights
give people the right to use their possessions as they choose—within the limits of the law.
perfect competition
economic model that describes a hypothetical market form in which no producer or consumer has the market power to influence prices
pure competition
involves many competitors that can enter or exit the industry with relative ease - technically does not exist
equilibrium price
the one price at which quantity supplied equals quantity demanded. If the seller puts a higher price on the products, consumers can find another farmer who will sell at the equilibrium price. If a farmer lowers the price below the equilibrium price, he or she will attract more consumers but at a lower profit.
equilibrium point
demand meets supply
monopolistic competition
may be a large number of firms with similar products that are differentiated by consumers
oligopoly
characterized by few companies because there is an extremely large capital investment required to enter the industry
monopoly
a business has no real competition; legal but not legal if formed by collusion
private enterprise
based upon the right to own private property; any business not owned by the government
private sector
Economic enterprises run by individuals or businesses
public sector
includes entities operated by national, state, or local governments
shares
units of a company; sold on the open market through a stock exchange
serendipity
the faculty of making fortunate discoveries by accident
revenue
the income generated by the sale of goods and services
profit
the difference between the total revenue generated from production of a good or service and the total cost of production of that good
marginal revenue
the revenue that was gained from the sale of one more unit of a good
marginal cost
the cost of producing one more unit of the good
average revenue
the average amount of money that is gained from selling each unit of a product. This is calculated as the ratio of total revenue to the number of units sold
average cost
the average amount of money spent on producing each unit of the product
sunk cost
a cost that is already incurred in the production process and cannot be recovered
fixed cost
remain fixed no matter how many units of goods or services you produce.
variable cost
costs that change with the quantity of production of the good or service
economic profit
lso includes opportunity costs as a part of the total costs when calculating profit
market structure
describes the relationship between buyers and sellers
homogeneous goods
goods sold by businesses that are almost exactly the same
maximum profit
In a perfectly competitive market, maximum profit occurs when the marginal cost of producing each unit is equal to the marginal revenue of producing that unit.
collusion
when producers agree on a fixed price on their products so all businesses end up making a profit
leakage
nonconsumption use of income, including savings, taxes, and imports. money escapes from the circular flow.
injection
money that is added to the circular flow. Examples include private investments and government spending on goods and services
equation for an economy that does not shrink or grow
S + T + IM = I + G + X
law of demand
everything else being equal, as the price of a good or service increases, the quantity demanded for that good or service decreases
quantity demanded
the amount of a product or service consumers are willing to buy at a given price, when all other variables are held constant
Determinants of demand
- income- tastes and preferences- substitutes and compliments- Consumer Expectations- number of buyers
inferior good
a good that experiences lower demand when income increases
complementary goods
goods that go together
substitutes
goods that can easily replace each other
determinants of supply
- resource prices (increase in production cost --> less willing to supply the market --> less production)- conditions of production (most willing to produce if conditions of production are good -- efficiency)- price of related goods (substitute and complimentary goods)- producers' expectations- number of suppliers
increase in supply (S) with constant demand (D) --> (equilibrium price + quantity)
decrease the equilibrium price (P) and increase the equilibrium quantity (Q)
decrease in supply (S) with constant demand (D) --> (equilibrium price + quantity)
increase the equilibrium price (P) and decrease the equilibrium quantity (Q)
increase in demand (D) with constant supply (S) --> (equilibrium price + quantity)
both equilibrium price and quantity increase
decrease in demand (D) with constant supply (S) --> (equilibrium price + quantity)
both equilibrium price and quantity decrease
price floor
used by the government to protect businesses and workers from prices and wages dropping too low; the lowest price at which a good or service can be purchased. may cause surpluses
price ceiling
used by the government to protect consumers from high prices. may cause shortages
elasticity
how much buyers and sellers change demand when price changes. It is equal to the percentage change in quantity divided by the percentage change in price. Graphically, a good has a higher elasticity of demand or supply if its demand or supply curve is flatter than another good
price elasticity of demand (PED)
the response to price changes for consumers
price elasticity of supply (PES)
the response to price changes for producers
supply of a good is highly elastic =
producers will produce a great deal more or less of the good as the price rises or falls
demand for a good is highly elastic =
consumers of the good will demand much more of the good as the price decreases and much less of the good as the price increases
determinants of elasticity of demand
- the availability of one or more substitute goods- necessity or luxury good (the more a good is thought to be an absolute necessity the less the demand will be affected due to any price change)- time (a longer time frame allows consumers to adjust their behavior)- portion of income- payer
Demand inelasticity
consumers are not very responsive to price changes
elasticity < 1
inelastic
elasticity = 1
unit elastic
elasticity > 1
Elastic
elasticity = 0
Perfectly inelastic; price changes have no impact on the quantity demanded
elasticity = ∞
Perfectly elastic; the price remains the same at all quantities demanded
The Price effect
an increase in price typically increases the revenue from a good. Likewise, a decrease in the price tends to lower revenue. If the price effect were the only effect, raising prices would always increase revenue. But a business knows raising prices will cut into its quantity demanded to some extent. How much? That is the subject of a second effect, the quantity effect.
The Quantity effect
an increase in price tends to decrease quantity demanded, whereas a decrease in price typically increases the quantity demanded. This works against the price effect. Which will be stronger, the price effect or the quantity effect? It depends on elasticity. For a good with inelastic demand, raising the price brings in more revenue and people feel as though they must have the good. In effect, the quantity demanded only falls a little.
determinants of elasticity of supply
- Excess Capacity (if a business has excess production capacity (such as equipment not in use, a shift not scheduled, or extra raw materials on hand), the business is most likely able to increase its production without increasing its costs, which allows it to react to a change in price and demand)- Factor Substitution (the ability of a firm to interchange production resources - labor, land, and capital - affects its elasticity to react to price and demand changes)- Length of Production Process (the longer it takes for a firm to produce its products or to ramp up for increased production, the less elastic it is in meeting changes in demand and price)
consumer surplus
the difference between a buyer's willingness to pay and the market price
factors affecting willingness to pay
how much the consumer values the good, the consumer's income, and the existence of substitutes
budget constraint
a set of product bundles that a consumer can purchase with a limited budget
consumer's optimal choice
combination of a budget constraint and consumer preferences that maximizes customer satisfaction within their own budget constraints
indifference map
A set of indifference curves with different degrees of satisfaction on the same graph
Interest
the amount earned on an investment
capital gain
When you purchase and then sell something (including stocks) at a profit
negative externality
arises when a third party receives an unwarranted cost
positive externality
a free benefit to a third party
social cost
cost to all involved parties
private cost
cost of producing a good or service, without considering any of the external costs
subsidies
grants of money that lower the cost of a good or service to account for social benefit
Market equilibrium
occurs when there is a balance between the forces that drive a free-market economy. This is the optimal, or ideal, level of output in an economy
excludable goods
when a consumer may not use the good unless the consumer pays for it (laptop)
non-excludable goods
all people can use it, even if they do not pay for it (lighthouse)
rival goods
prevents another consumer from using that good at the same time (hammer)
Non-rival goods
one person's use of a good does not reduce anyone else's use of it (TV programs)
excludable + rival good
private good (if you purchase a laptop, someone else cannot also purchase that same laptop, thus it is rival. In addition, the computer is excludable, because you must pay for the computer in order to use it.)
excludable + non-rival good
club good (movie theater - tickets)
non-excludable + rival good
common goods or common-pool resources
non-excludable + non-rival good
public goods
free-rider
When non-payers receive free goods or services
federal tax revenue
comes from federal income taxes and payroll taxes paid by employers
Payroll taxes
taxes that support programs such as Social Security and Medicare
what does most government spending go towards?
social programs, including Medicare, Medicaid, and Social Security (55%)national defense (20%)interest payments on the national debt (6%)
cost-benefit analysis
an economic examination that estimates what the cost of a project is and what the expected benefits are
who benefits from a non-excludable good or service without directly paying?
a non-payer
Sources for most state and local government revenues
state personal income taxes, sales taxes, property taxes
most federal tax revenue comes from
federal income taxes and payroll taxes
most federal revenue is spent on what?
social programs (medicare, social security)
most state and local govt revenue is spent on what?
goods and services (public education, road repair and construction)
Asymmetric information
occurs when someone in the market knows more than others in the market
What is the difference between a regulation and a law?
Laws in the United States are passed by Congress, a state legislature, or local governments and can be enforced directly by courts. Regulations are written by regulatory agencies.
statutory law
legislation passed by Congress
administrative law
regulations
Code of Federal Regulations (CFR)
compilation of federal regulations
Federal Register
publicizes information about new proposed regulations, required by Administrative Procedures Act
technology-based standard
regulation that specifies the method that needs to be used within an industry
performance-based standard
regulation that specifies a uniform end result, but allows businesses the flexibility to choose the best strategy
government failure
When the cost of solving a market failure is greater than the benefits
merger
combination of two or more companies, whether through the creation of a new entity or by one concern absorbing another
patent
a form of intellectual property that consists of a set of exclusive rights granted by a sovereign state to an inventor for a limited period of time in exchange for the public disclosure of an invention
commodities
basic goods that satisfy customer wants
bonds
written and signed promises to pay a certain amount of money on a specific date, or upon fulfilling a certain condition. issued by governments, companies, banks, public utilities and other large entities.
high capital cost
large initial investment
Federal Trade Commission (FTC) in coordination with the Department of Justice
reviews proposed mergers and can block or place conditions on them. Companies can challenge the FTC's decisions in federal court
OSHA
work safety
FDA
food and drugs
EPA
environment
trusts (monopolies)
monopolistic groups of corporations that banded together for the purpose of reducing competition and controlling prices throughout a business or an industry, prior to the enactment of antitrust laws, ILLEGAL!!
horizontal mergers
when two companies that make competing products merge to enjoy greater economies of scale or gain more market power. occur when one company is struggling and facing potential bankruptcy without the merger
vertical merger
a merger between companies that do business with each another but do not compete with each other
conglomerate mergers
when the businesses have little in common.
Entitlements
programs such as Medicare and Social Security that have eligibility requirements
proportional taxes
high-income and low-income families pay the same % taxes
progressive taxes
high-income families pay higher % taxes than low-income families
regressive taxes
low-income families pay higher % taxes than high-income families
marginal tax rate
the percentage of their income that someone has to pay
taxes on earned income are
progressive