The Discipline of Economics
How resources are used and can be used to their fullest potential
●Macro Econ vs. Micro Econ
Macroeconomics involves economic problems encountered by the nation as a whole.
Microeconomics is concerned with the economic problems faced by individual units within the overall economy.
●Positive vs. Normative Economics
Positive economics is based on the scientific method: hypotheses are formulated and tested.
Normative economics involves value judgments: not based on a scientific investigation but the way someone believes things ought to be.
A resource is anything that can be used to produce a good or service.
In macroeconomics every resource is classified into three categories: land, labor and capital.
Land only refers to all natural resources.
Labor encompasses all human attributes that are productive.
Capital is productive equipment or machinery.
Opportunitycost is what must be sacrificed to obtain something. In the macroeconomics, opportunity occurs in the following situation. If on nation decides to produce one more unit of A, how many units of product B will have to be sacrificed?
Using resources efficiently means using resources to their maximum potential.
●Production Possibilities Frontier
The production possibilities frontier shows the combination of two goods that can be produced if the economy uses all resources fully and efficiently.
Normative economics determines what point is more preferable. On efficiency grounds all the points along the frontier are equal. At points inside the frontier, resources are not being used fully. Points outside the frontier mean unobtainable results as long as the frontier doesn’t shift.
Factors that cause the frontier to shift:
1. changes in the amount of resources in the economy,
2. changes in technology and productivity.
●Law of increasing cost
The production possibilities frontier is not typically a straight line.
The law of increasing cost states that as more of a product is produced, the opportunity cost increases. The concave-to-the-origin frontiers are due to the law of increasing costs.
The law of increasing costs is due to the fact that some resources are more adept at production of one good than another. When resources are forced to work in an industry where they are not proficient, they are less productive.
The law of comparative advantage advocates specialization for increased output, which can improve productivity.
Comparative advantage means that a nation can produce the good with a lower opportunity cost (or lowest).
Trade can be mutually advantageous to both countries even if one country has the absolute advantage in all products, because mutually advantageous trade is based on comparative advantage, not absolute advantage.
Chapter 3 Economic Systems
●Fundamental Economic Issues
Each nation must decide what the best way is to use the resources at its disposal.
If it is decided to produce more than one item, then some amount of another item must be sacrificed.
Basic 2 questions:
1. How much, if any, of each good and service should be produced?
2. Who will get how much of each good and service?
●Strategies for Addressing Economic Questions
There are three basic ways to address the economic questions that are imposed upon a society:
1. government commands
3. a blend of government commands and capitalism.
●The Command Economy
A command economy is one in which the central government dictates what will or will not be produced, how much each item is to be produced and who is to get how many of the final products.
E.g.Cuba,North Korea– Socialism and Communism.
Con: No incentive to work.
Pro: No lower class, every goods is distributed equally.
Capitalism is an economic system where supply and demand determines the price. The government doesn’t run the economy but attempts to create an environment where prices can be determined in free markets. Price, consumers and suppliers determines how much of each item will be produced.
The right goods and services are produced is the right amounts – allocative efficiency.
Price in capitalist economies is determined by supply and demand.
The Law of Demand states that when the price of a product increases, the quantity demanded decreases, ceteris paribus (all other conditions remaining unchanged.)
Usually the price of the product is measured on the vertical axis and the quantity demanded on the horizontal axis.
To conform to the Law of Demand, the curves will slope downward.
The Law of Supply states that when the price of a product increases the quantity supplied increases, ceteris paribus. Therefore, the curve is upward.
The intersection of the supply and demand curves is the equilibrium point. The corresponding price is the equilibrium price, which will prevail in a free market.
Any shift along the curves will be rectified by the equilibrium conditions.
Equilibrium is a state of balance between opposing forces: surpluses and shortages. Only at the equilibrium price there is no surplus and shortage.
·Factors that cause Demand Curve to shift
1. changes of consumers’ tastes. Positive.
2. changes of the price of the substitutes (equivalent products). Positive.
3. changes of the price of the complimentary products. Inverse.
4. changes in the expected future price. Positive. – self-fulfilling prophecy
If the prices change, the point will only move along the curve. Only when one of the determinants changes, the curve will shift.
The change along the curve is change in the “quantity demanded”. The moving of the curve is the change in “quantity”.
·Factors that cause Supply Curve to shift
1. changes in the prices of resources required to make the product. Inverse.
2. changes in technology and productivity. Positive.
3. changes in the expected future price of the product. Inverse.
●The Mixed Economy
All of the countries in the world today use a blend of government commands and capitalism to address the fundamental economic questions that arise. All countries are on a spectrum where pure government commands and capitalism are on the two extremes.
●The Circular Flow Diagram
The circular flow diagram shows how resources are used to produce goods and services and how these goods and services are distributed.
Resources flow from households to firms. In return, households receive wages and profits. This exchange of resources for money is known as the market for resources. Household spend their money income to purchase the goods and services supplied by firms. This exchange of income for products is known as the market for goods and services.