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Chapter 1: Limits, Alternatives, and Choices in Economics

Introduction to Economics

• Economics revolves around making optimal choices when dealing with scarcity.
• Economic wants are greater than what society can produce.
• Choices have to be made because of these limitations.
• Every choice has a subsequent economic effect.
• It is important to note the direct economic impact of choices.

The Economic Perspective

• Individuals and institutions make rational decisions in their own self-interest.
• This is achieved by comparing the marginal benefits and marginal costs.
• Central tenets of the economic perspective:
  • Scarcity and choice
  • Opportunity cost
  • Purposeful behavior to increase utility
  • Marginal analysis

Scarcity and Choice

• Resources are limited, leading to necessary choices.
• Every choice comes with an opportunity cost.
• Opportunity cost refers to what is given up when making a choice.
• Opportunity cost varies from person to person.

Purposeful Behavior

• Individuals and businesses make rational decisions to improve their situation rather than worsen it.
• Rational self-interest aims to maximize utility or satisfaction.
• Utility can be derived from helping others.
• Firms aim to maximize profits through rational production decisions.
• People make decisions with a desired outcome in mind.

Marginal Analysis

• Decisions are made by comparing marginal benefits and marginal costs.
• 'Marginal' means 'extra' or 'additional'.
• Choices are made when the marginal benefit exceeds the marginal cost to maximize utility.
• Choosing if something is "worth it" depends on whether marginal cost is greater than marginal benefit

The Scientific Method in Economics

• It is a systematic way of pursuing knowledge through observation, hypothesis formulation, testing, and refinement.
• Several elements are included
  • Observation
  • Hypothesis formulation
  • Hypothesis testing
  • Hypothesis acceptance, rejection, or modification
  • Continued hypothesis testing, if necessary

Economic Principles

• Generalizations are economic behaviors that are true for the average person.
• The other-things-equal assumption, or 'ceteris paribus assumption,' assumes no other factors change.
• Graphs are a graphical means of illustrating the relationship between variables.

Microeconomics and Macroeconomics

• Microeconomics studies individual consumers, firms, or markets.
• Macroeconomics studies the entire economy or major aggregates.
• Macroeconomics examines basic economic groups, like all households, businesses, government entities, or the foreign sector.
• Macroeconomics includes topics like total goods/services, unemployment rate, and inflation rate.

Distinction Between Positive and Normative Economics

• Positive economics involves factual statements, without subjectivity, supportable or disprovable with data.
• Normative economics involves subjective value judgments about what 'ought to be'.

The Economizing Problem

• The economizing problem is the idea of limited income versus unlimited wants of individuals.
• Budget line:
  • Attainable and unattainable combinations.
  • It shows trade-offs and opportunity costs.
  • It helps to illustrate the maximum combinations of two goods purchasable with a fixed income.
  • The budget line shifts with income changes.

A Consumer's Budget Line

• A consumer's budget line is the graphical representation of the budget line.

Global Perspective: Income Variability Among Nations

• Average income varies greatly among nations, indicating that it is dependent on income constraints.

Investment in Capital Goods

• Countries vary widely in the percentage of national income devoted to capital investments instead of consumer goods.
• Only capital investments generate future production capacity increases.

Society's Economizing Problem

• The economizing problem exists because resources are scarce for the economy as a whole.
• Resources are the inputs used to generate goods and services.

Categories of Economic Resources

• Land includes all natural resources in production.
• Labor includes mental and physical activities in production.
• Capital (investment) encompasses man-made production aids; it is not the same as money.
• Entrepreneurial ability is a specialized human resource distinct from labor; entrepreneurs take risks.

Functions of Entrepreneurs

• They employ the other factors of production.
• They take initiative, make strategic decisions, and innovate.
• They also take risks and earn profits.

Production Possibilities Model

• This shows different combinations of two goods an economy can produce.
• The assumptions of the production possibilities model:
  • Full employment
  • Fixed resources and technology
  • Two goods (consumer and capital)

Production Possibilities Curve

• Producing along the PPC indicates efficiency and maximum production.
• Production inside the PPC means inefficiency due to idle resources.
• It's possible to produce more of both goods when inside the PPC by utilizing idle or underused resources.

Increasing Opportunity Costs

• As production of a good increases, its marginal opportunity costs also increase.
• The PPC is concave due to these increasing opportunity costs.
• Constant opportunity costs would result in a straight-line PPC.
• Producing more of one good requires giving up more of another when operating efficiently on the PPC.

Marginal Benefit and Marginal Cost

• The economy decides how much to produce by comparing marginal benefit to marginal cost.
• The optimal production quantity occurs where marginal benefit equals marginal cost.

Unemployment, Growth, and the Future: Economic Growth and the Production Possibilities Curve

• Where an economy chooses to produce on its PPC today influences future economic growth.
• Capital, education, and research/development are goods for the future.
• Producing these goods today helps satisfy future wants and needs.

International Trade: Specialization and Production Possibilities

• Nations can specialize in producing goods that they produce more efficiently because of international trade.
• Resources are used more efficiently and international trade effectively increases resources.
• Overall this can shift the production possibilities curve to the right.

Common Pitfalls to Sound Economic Reasoning

• Biases
• Loaded Terminology
• Fallacy of Composition
• Post Hoc Fallacy
• Correlation but not Causation

Chapter 2: The Market System and Circular Flow in Economics

Economic Systems: Overview of Economic Systems

• Economic systems are institutional arrangements that coordinate economic activity.
• Systems vary by decentralized use of markets/prices and centralized government control.

Laissez-Faire Capitalism

• It relates to Adam Smith’s "The Wealth of Nations", which involves minimal government interference with self-correcting markets.
• The government protects private property from theft and provides a contract-enforcing legal environment.
• Individuals interact in markets for buying and selling.

The Command System

• Government ownership of resources where decisions are made by a central planning board is socialism/communism.
• Many formerly communist/socialist countries now use more market-oriented approaches.
• Includes countries such as North Korea, Cuba, Myanmar.

Laissez-faire vs. Command Economy

• The market system involves decentralized decision-making alongside some government control.
• Systems with private markets, private resource ownership, and self-interested behavior exists in much of the world.
• Financial incentives are possible, with some risk.
• The government plays a role in the U.S. version of capitalism.

Characteristics of the Market System: Private Property and Freedom of Enterprise

• Under a largely private system, individuals and firms own most private property, capital, and land resources.
• Private property combines with the freedom to negotiate contracts.
• The goal of this is enable the individual to control, gain, use and dispose of their property.
• Private property rights encourage investment, innovation, asset exchange, and economic growth.
• Intellectual property is encompassed by property rights through patents, copyrights, and trademarks.

Freedom of Choice and Self-Interest

• Freedom of enterprise allows the individual to obtain/use resources, and produce/sell products of choice.
• Freedom of choice describes how property/money resource owners use resources.
• Workers can choose training, with consumers buying options available to satisfy want.
• Self-interest is the market system driver: entrepreneurs maximize profits, resource providers maximize income, and consumers maximize satisfaction.

Competition and Market Prices

• Competition needs buyers and sellers to act independently which decentralizes economic power.
• Freedom to enter/leave is also needed.
• Markets/prices mirror decisions made determining product/resource prices that guide choices based on self-interests.

Technology, Capital Goods, and Use of Money

• Profit-making accrues to innovators in the market system.
• Complex capital goods are encouraged by the market system.
• Money facilitates trade as a medium of exchange.

Active, but Limited, Government

• The market system can experience shortcomings in efficiency.
• Overproduction of goods with social costs and underproduction of goods with social benefits can occur.
• Businesses can have a tendency to gain monopoly power.
• Governments can boost overall effectiveness of a market system.

The Five Fundamental Questions

• The economic choices of the production possibilities model are highlighted by these five questions.
  • What goods/services will be produced?
  • How will goods/services be produced?
  • Who receives goods/services?
  • How does the system adapt to change?
  • How does the system encourage progress?
• All economies, whether a market system or otherwise, must address these questions.

What Will Be Produced?

• Profit equals total revenue minus total costs.
• Consumers decide the production through dollar votes in a market system.
• Firms stop producing products without adequate "votes."
• Businesses must match production to consumer demands.

How Will the Goods Be Produced?

• Competition compels producers to choose the best production methods or face business failure when facing competition.

Production Techniques and Efficiency

• Efficient production technique: The mix in technology plus the necessary resource costs.
• Techniques are used to minimize per-unit costs and maximize efficiency:
  • Technology
  • Prices of necessary resources
• The "how to produce” question relates to techniques to produce $15 of soap with $2 profit.

Market System Dynamics

• Payment eligibility results in output determination under the consumer's willingness and ability to pay in a market system.
• Consumer income depends on the level of resources and price that the the resources obtain in the market.

How Will the System Change? – The Invisible Hand

• Because of consumer tastes, A market system is dynamic and adaptable due to consumer tastes and preferences.
• These changes help businesses make future choices.
• The business system resembles a communications network where customers communicate through dollar votes.
• Businesses respond with more, less, or no more production to adjust for changes in consumer communication.
• The demand for involved resources soon mirrors this reaction.
• Price, technology and amount to produce all shift when technology and prices change.

Progress and Innovation in Market Systems: How Will the System Progress?

• Accumulation and technological advancements are encouraged by the market system.
• If an entrepreneur/firm introduces a highly sought product, they will be rewarded with revenue and profits.
• Competition drives new technologies that will lower production costs and product prices.
• Creative destruction happens if products and methods destroy incumbents that do not adjust.

The Invisible Hand

• Competition tends to unintentionally promote society’s interests, even where individual firms only pursue their own interests.

1776 Wealth of Nations by Adam Smith

• The unity of private and social interest exists
• Virtues of the market system::
  • Efficiency
  • Incentives
  • Freedom.

Command Systems and Their Failures: The Demise of Command Systems

• Command systems regularly fail as countries such as the Soviet Union, North Korea, and pre-reform China struggled to produce adequate amounts of goods and services.
• Coordination Problem: correctly setting input supply targets for all goods and services failed when one factory’s output would result in another factory having a broken chain.
• If something goes wrong along the step any step, a chain reaction is initiated, which is more difficult the more the economy gets larger.
• There was no indicator of success without profits and losses in the system
• No price signal allowed the understanding that people desired more or less of a product resulted in surpluses and shortages.

The Circular Flow Model: Overview of the Circular Flow Model

• The circular flow diagram is an economic model displaying a closed private market system in which the private sector (businesses, consumers, governments) interact with each other.

Components of the Circular Flow Model

• The model displays:
  • Households
  • Businesses
  • Sole proprietorship
  • Partnership
  • Corporation
  • Product and resource Market
  • Real and money flow

Risk Management in Market Systems: How the System Deals with Risk (1 of 2)

• Markets place businesses in a position of risk.
• Whether risks are well managed reflects on firm effectiveness as well as profitability
• However profits flow among investors while other parties are not at risk with suppliers and employees always getting paid on time.

How the System Deals with Risk (2 of 2)

• Business owners and investors face risk:
  • Losses due to input shortages
  • Changes in consumer tastes
  • Natural disasters disrupting supply chains
• Employees and suppliers face guaranteed payments whether the firm gains a profit or not
• The economic benefits gained are the result of market owners bearing the burdens of business decisions.
• There are few opportunities to improve without a system forcing owners to consider market risk.

Case Study: Venezuela

• Due to the collapse of their oil industry and government mismanagement problems are being felt by the people of Venezuela
• Venezuelans lost an average of 24 pounds of body weight in 2017, and inflation in 2018 was 1.3 million percent.
• Millions of Venezuelans have fled the country
• The economy is collapsing and 90% of Venezuelans live in poverty.

Chapter 3: Demand, Supply, and Market Equilibrium

Markets: Competitive Markets.

• The focus is on what makes markets competitive.
• Competitive systems require many buyers and sellers that interact.

Demand: Demand Definition

• A demand curve or schedule that shows the numbers that consumers are willing to purchase.
• Consumers purchase amounts in specified time periods in prices that are possible.
• These assumptions lead to an amount consumers are willing to purchase at a given price:
  • Other things equal (ceritis paribus)
  • Individual demand
  • Market demand - add up all individual demand curves
• LO3.2

Law of Demand

• Other things being equal when price falls, the quantity demanded rises, and as prices increase, the demand is lessened.
• (inverse relationship, constrained income).
• LO3.2

Explanations of the Law of Demand

• When you have a Limited income you will want to purchase things at a lower amount and want to increase the price you can pay.
• The utility decrease happens when you have an added satisfaction over a good (diminishing marginal utility).
• Income and substitution are related
  • As the price diminishes, the amount one can purchase grows (or if it's more, one purchases that much less).
  • As price decreases/rises so does the consumption from over goods without consumption for other goods diminished. LO3.2

The Demand Curve

• Inverse relationships exist
• The graph slopes to match the law of demand
  • Down is less quantity over increased priciness _ Increased quantity over less price, the law says.

Changes in Demand

• To bring a change to the demand of corn (or an item) a change in a determinant has to come about.
• When you increase this price on a graph in the demand it shifts to the ride
• (Or if you have the inverse you will have decrease and a corresponding graph.
• These changes are distinct from quantities, which reflect the relationship given what happened previously.

Determinants of Demand (1 of 2)

• Change in consumer tastes and preferences
  • It must change people's tastes.
  • When consumers experience the same change, the demand curve goes that way.
    • If things are preferable, the demand will change to accommodate. -If things are unpfreferrable, the demand has the inverse
  • Change in people willing to buy items.
    • More people means more buy, less people means inverse.
    • Change in income Normal goods sell less when buyers are less wealthy, inverse for if wealthy.
    • Inverse for inferior goods
• (LO3.2)

Determinants of Demand (2 of 2)

• If related goods change their price.
  • With the prices increase on one complement the demand for other complementary items
    • The inverse goes for decrease

Law of Supply

• Supply means that you can get more products or less if you have a specific time and price.
• The only factor you can change, when working with these scenarios is to change the price or quantity of the good.
• Amount that can be purchased will increase or decrease together.

Supply Curve

• When the price gets higher the quantity increases and the fall happens in the inverse.
• Increasing the quantity on a supply graph will result in shift to the right.
• Inversely a loss of product would result in inverse also

Determinants of Supply

If you increase prices for resources used your supply decreases, inverse to the price decrease in resources leads to output increasing.

• Tech increases = output increasing, you have inefficiency= output decreases
• As more sellers begin to produce on the market economic profits are made. Where sellers begin to decrease the inverse is true Additional Determination of Supply Taxes = less, subsidies = more Another item increases price =decrease as the new is now preffered. inversely a lesser product leads to increased demand Change has producer effect = If a price is expected later, get the production from the new to decrease the supply.

Market equilibrium price and quantity

• Intersection for supply and demand.
• Over this excess quantity, the inverse is the shortage

Functionally Efficient Allocation

• Productive output is reliant of costs/ the tech needed in a mix.
• Most desired combination in what is valued by output Ration Function in pricing.
• You gain selling and buying forces by changing competition, price, decisions of how things will change given supply and demand. Changes in either mean changes, if the forces are great less or greater will result too