Chapter 1, 2 and 17-20

Economics and the New Economy

Unit 1 Notes

Why is it important to study Economics?

How does Economics affect you everyday?

“Economics is an apparatus of the mind.”—John Maynard Keynes

Economics is the study of how people try to satisfy unlimited wants and needs through the use of scarce resources.

Economics

There is no such thing as a free lunch. This is the key to understanding economics Nothing is free, someone must “pay” for

free items.

TINSTAFFL

ScarcitySociety may not have

enough resources to produce all the things

people want

The fundamental problem facing all societies

1. Land-gifts of nature, climate=rent2. Labor-people=wages3. Capital-tools, equipment=interest

capital increases production4. Financial capital-money to purchase capital

Factors of production

Entrepreneurs-a person who takes a risk for profit. Frequently considered a 4th factor of production according to many Economists.

Technology is now added to the factors of production. Technology includes any use of land, labor or capital that produces goods and services more efficiently.

Factors of production

What to produce?

How to produce?

For whom to produce?

Three basic Economic Questions

What to do? Failure to make a budget

Not saving regularly Failing to distinguish

between a want and a need

Failing to adapt your lifestyle to changed economic circumstances

People make bad economic decisions

Description of statisticsAnalysis of statisticsExplanation of economic theory

Predict future trendsEconomic ethics

Segments of Economics

Primary-gather raw materials

Types of Economic Activity

Change form of raw materials

Secondary

Business or professional services

Tertiary

Information systems, management, research

Quantiary

All countries have some type of economic activity.

As you go from primary to quandary your country is more industrialized.

Countries of the world

Trade-offs-exchanging one thing for use of another Opportunity cost-value of the next best alternative The PPF or Production Possibilities Frontier

illustrates opportunity cost. This diagram represents the various combinations of goods/services that an economy can produce when all productive resources are fully employed.

Our mythical country of Alpha produces guns ( military good)and butter (consumer good).

PPF or Production Possibilities Frontier

Needs-item necessary for survival

Wants-a way of satisfying a need.

Needs vs. Wants

Guns 2 4 6 8 10

Butter 10 8 6 4 2

PPF

*A *B *C

PPF Points along the curve

represent maximum output

Points inside the curve represent idle resources

Points outside the curve represent economic growth.

Frontier-maximum combination of goods /services that can be produced.

They want goods◦ Think of what we would do without if we didn’t

trade. To make money.

The USA relies heavily on trade:August 2009 numbersExports: $128.2 BillionImports: $158.9 BillionTrade deficit=exports-imports

Nations trade for several reasons

Ricardo argued that there is mutual benefit from trade even if one party (e.g. resource-rich country, highly-skilled artisan) is more productive in every possible area than its trading counterpart (e.g. resource-poor country, unskilled laborer).

As long as each concentrates on the activities where it has relative productivity advantage.

David Ricardo

When a nation finds it profitable to produce and export a limited amount of goods/services for which it is suited.

Specialization

If I can produce more of a good or service using all of my available resources than you can, I have an absolute advantage in producing that good or service.

If I can produce a good or service at a lower opportuncomparative advantageity cost than you then I have a.

Absolute and Comparative Advantage

A country should specialize in the good in which it has comparative advantage.

How doesThis work?

Specialization

Let's use our tropical island example to identify who has absolute and comparative advantage in the production of fish and coconuts.

Absolute and Comparative Advantage

In one hour Tom can cut down 16 coconuts or catch 8 fish.

In one hour Wilson the volleyball can cut down 21 coconuts or catch 7 fish.

Absolute and Comparative Advantage

So who has the absolute and comparative advantage in what product.

Absolute and Comparative Advantage

Tom Wilson

Coconuts/hour (A)

16 21

Fish/hour (B) 8 7

You can produce more that the other person/country.

Coconuts?

Fish?

Tom Wilson

Coconuts 16 21

fish 8 7

Absolute Advantage

Coconuts:Tom 8/16= .5Wilson 7/21=.66Fish:Tom 16/8= 2Wilson 21/7= 3

Tom Wilson

Coconuts (A)

16 21

Fish (B) 8 7

Comparative Advantage

The bottom line is that it is comparative advantage (opportunity cost) and not absolute advantage that yields an incentive for specialization and trade.

Now—Can Tom and Wilson trade with each other?

Tom Wilson

Coconuts 25 5

Fish 21 7

Just because Tom is am better than Wilson at everything, does this mean Tom should do everything?

Who has the absolute and comparative advantage?

Who should produce what?

Factor Markets-productive resources are bought and sold.

Product Markets-producers sell goods/services to consumers.

Recently markets have evolved into cyberspace, with buyers and sellers interacting through computers without leaving their h0mes.

Markets-mechanisms that allow for buying and selling

This diagram illustrates the flow of goods/services and money in a market system.

In a market economy-consumers and businesses answer the what, how and for whom to produce questions. Other terms include, capitalism and mixed or free market economy.

Circular Flow Diagram

Individuals

Factor Markets

Industry

Product Markets

Circular Flow of the Economy

Consumer Sovereignty-the idea that consumer s decide what will be produced

An economic system is an organized way of providing for the wants and needs of society.

Economic Systems and Decision Making

Traditional Economic System-customs and beliefs guide economic decisions

Advantages Disadvantages

Strong family ties Each know their role

and what is expected of them

Examples:

Change is discouraged, sometimes punished.

Few consumer goods

Command-the government makes all the decisions.

Advantages Disadvantages

No career choices Few consumer goods All economic questions

answered by the government

Economy can change direction quickly

Examples

No career choices Few consumer goods All economic

questions answered by the government.

Shortages may arise

Free Market-economic decisions made by people.

Advantages Disadvantages

Individual freedom Competition Many consumer goods

Examples:

Young, old excluded from economic decisions.

Prices change Economy slow to

change

The Constitution does not outline our economic system.

It does provide a framework.

What is their role in the Economy as outlined in the Constitution?◦ President◦ Congress◦ Supreme Court

The US Constitution and the Economy

Economic Freedom- to buy and sell most products

Economic Efficiency –use resources wisely, conserve

Economic Equity-policies benefit everyone fairly Economic Security-protection against layoffs Full Employment-everyone who wants a job has

one. Price Stability-little fluctuation, changes over

time Economic growth-economy grows over time.

Social and Economic Goals of the USA

Sometimes the goals are in conflict.Example:

New MPG guidelines.

Trade offs among goals

Economic Freedom

• Choose job• Choose

where to live

Private Property Rights

• Own and control property

Voluntary Exchange

• Buyers and sellers act freely

Profit Motive

• Work to make money

• Not forced to work

Characteristics of a free enterprise market economy

Sellers compete with one another to attract customers while lowering prices

Consumers compete with one another to find the best products at the lowest prices.

Competition

The role of the consumer is to reject products or prices they don’t like.

Be a smart consumer

You as the consumer

Protector of consumers Provider of goods and services The government is also a consumer Regulator of competition in Marketplace. Promoter of National goals. The role of the government can change over time or in an economic crisis.

Role of Government

Businesses have been accused of being greedy.

Charging too much and making huge profits, cheating workers and customers.

Greedonomics

Captalism

Adam Smith argued a market economy is largely self regulating and did not require government involvement.

Laissez-faire-role of government is limited.

Based on : prices, profit and private property.

Individuals answer all economic questions.

Pure Market Capitalism

Capitalism

Pros Cons

Wealth Consumer satisfaction Freedom to choose Producers supply what

consumer s want.

Ignores public goods Produce only for those

who demand. Allows for businesses

to fail Unemployment Less productive

resources exist.

Socialism

Arose from dissatisfaction with living and working conditions during the Industrial Revolution.

The state owns most factors of production Very little private property Prices are set by the state Democratic Socialism-works in an elected

framework Authoritarian Socialism-central government

controls the economy

Pure Socialism

Socialism

Pros Cons

People use “election” power

Address for whom directly

Government guaranteed benefits for all.

Government guarantee of jobs and benefits leads to very high taxes

Little labor mobility Prices can reflect high

taxes.

Karl Marx- ”Communist Manifesto” (Das Kapital) a

series of class struggles would eventually result in collective owner ship of all capital

Proletariat=workers Marx actually envisioned Socialism as the

stepping stone to Communism.

Communism

Communism

Pros Cons

All workers are equal No job uncertainty, no

unemployment Centralized control

and planning. No surpluses or

shortages

No individual freedom No incentive to work Little consumer

satisfaction Few day to day

changes. No safety net benefits

for individuals. Paid to work, not

based on skill level

Everyone has their opinion as to how the economy should operate.

We will look at three theories;◦ Classical◦ Keynesian◦ Monetarist

Economic theories

Key premise: Competition is best for the market.◦ Competition creates better, cheaper products,

more choices.◦ Supply creates wealth.◦ Smith’s “invisible hand”◦ Encourage trade◦ Oppose excessive taxation◦ Stop monopolies, collusion and unions as they

block competition.

Classical

Smith, Say, Ricardo, Marshall, Hayek, Friedman

Additionally: Ron Paul, Conservatives, Libertarians, Tea Partiers, Rush, Hoover

Classical Key figures

Key Premise: Competitive markets are flawed and cannot stay in balance.◦ Say’s Law is a myth◦ Prices go up quickly but do not fall quickly◦ Full employment and production will not last◦ Gov’t must repair constant recessions.◦ Slow inflation with tax increases and cut

government spending.◦ Create demand during a recession by tax cuts and

increased government spending.◦ Safety nets-social security, unemployment,

minimum wage programs

Keynesian

Keynes, Krugman

Government, CNN, FDR, Obama, George W., Democrats, Liberals, Cheney

Keynesian-key figures

Key Premise: Non-political fine tuning is best for the economy.◦ Politicians won’t raise taxes but they will cut

them.◦ Central banks think long run, not next election.◦ Use interest rates to encourage spending or

saving.◦ Provide stable currencies

Monetary—The Fed

Volker, Greenspan, Bernacke—who are they? Former and current Chairmen of the Federal Reserve.

Now you have seen all three? Which are you?

Monetary key figures

In finance, the exchange rates (also known as the foreign-exchange rate, ForEx rate or FX rate)

It is the value of a foreign nation’s currency in terms of the home nation’s currency.

The foreign exchange market is where currencies are bought and sold.

What is an exchange rate?

The supply and demand for USA dollars or other currency on the world market.

I can’t pay for my Italian car with American Dollars.

What determines exhange rates?

We sell exports and buy imports. Invest in other countries stocks and bonds. Build factories and stores in other countries. Hold currencies in bank accounts for future

exports, imports and loans. Speculate in currency rate.

Why do we exchange currencies?

If the value of the dollar is low on the world market-increased exports

If the value of the dollar is high on the world market-less exports

What kind of dollar do we have today?

How do exchange rates effect trade?

Fixed

A fixed exchange rate, wherein a currency's value is matched to the value of another single currency or to a basket of other currencies, or to another measure of value, such as gold.

Good/bad points

It is used as a means to control inflation.

And used to stabilize the value of a currency.

Illegal to trade currency at any other rate.

Fixed Exchange Rates

Floating

Supply and demand set the value of currencies on the foreign exchange market.

Good/bad points

This enables a country to dampen the impact of shocks and foreign business cycles

The exchange rate regimes of floating currencies may more technically be known as a managed float.

Floating Exchange Rates

Devaluation-In common modern usage, it specifically implies an official lowering of the value of a country's currency within a fixed exchange rate system.

DepreciationAn decrease in the

value of one currency relative to another currency. A unit of one currency buys less units of another currency

Currency depreciation/devaluation

AppreciationAn increase in the

value of one currency relative to another currency. A unit of one currency buys more units of another currency.

Currency appreciation

Balance of trade is the difference between the value of a nation’s exports and imports.

Trade surplus-more exports.

Trade deficit-more imports.

Trade

Trade surplus-exports exceed imports.

Trade deficit-imports exceed exports.

The USA has a deficit.How large is it?

Trade-deficit or surplus

Imports

We get products They get money to

use for investment.

Exports

They get products. We get money to use

for investment.

Benefits of imports/exports

Protectionists:Want trade

restrictions to the point they want trade eliminated.

National defense at risk

Infant industries-protect new businesses

Protect domestic jobs. Keep money at home-

buy American. Help balance of

payments-export more, import less.

Restrictions to world trade

Free traders: Believe all trade

should be allowed with no restrictions.

Trade=jobsTariffs hurt

consumersProtecting industries

helps bad businesses.

Trade provides a great variety of goods.

Trade=economic growth

More Trade

Tariffs-a tax on goods◦ Protective-raise the price of imported goods, limit

amounts◦ Revenue-tax added to price, no limit on amount.

Methods used to Restrict trade

Import quotas-limit the number of the item allowed into the country.

Health inspections-free of disease or insects, used for animals and plants.

Methods used to restrict trade

Embargo-no trade of a product (ivory) or no trade with the country (Cuba).

Methods to restrict trade

• Anchovies • Brooms • Ethyl alcohol • Milk and cream • Olives • Satsumas (mandarins • Tuna • Upland cotton • Wheat gluten • Wire Rod & Line Pipe

Tariff Restricted items

Goods subject to the EAR (Export Administration Regulations) including, but not limited to; chemicals, microorganisms, electronics, computers, telecommunication and information security devices, lasers and sensors, navigation and avionics, propulsion systems, materials and equipment using nuclear technology, software.

Wild animals or birds or their eggs (alive or dead) captured or killed contrary to law

Articles containing dog or cat fur Human corpses, human organs or body parts, human and animal

embryos, or cremated or disinterred human remains.

Export prohibited

Dumping is the selling of excess goods on foreign markets below cost.

Dumping abroad drives out competition and creates a monopoly of power and profits.

Dumping

Smoot-Hawley Tariff (1930) The US wanted to reduce imports by

increasing tariffs, other countries retaliated and raised tariffs against the US.

This contributed to the depression.

A brief history of trade agreements

1947-GATT-General Agreement on Tariffs and Trade

Free trade, lower tariffs and eliminate import quotas.

To help stimulate trade and economic growth after WWII.

Trade Agreements

1993-European Union (EU)

Trade bloc to abolish tariffs and quotas for members.

Common import rulesEuro is the common currency.

England will not join, as other countries are added incrementally.

Trade Agreements

Most Favored Nation ClauseThe receiving nation will be granted all trade advantages — such as low tariffs — that any other nation also receives. In effect, a nation with MFN status will not be treated worse than any other nation with MFN status. In the United States, MFN is called permanent normal trade relations.

African Union (AU)Among the

objectives of the AU's leading institutions are to accelerate the political and socio-economic integration of the continent

The AU is an intergovernmental organization consisting of 52 African states. Established on July 9, 2002

Supernationalistic Organizations

The United Nations (UN) is an organization whose stated aims are facilitating cooperation in international law, international security, economic development, social progress, human rights, and the achieving of world peace.

UN was founded in 1945 after World War II.

There are currently 192 member states, including nearly every sovereign state in the world.

3 of the 195 are not members—Kosovo,Taiwan and Vatican City

Supernationalistic Organizations

The United Nations (UN) is an international organization whose stated aims are facilitating cooperation in international law, international security, economic development, social progress, human rights, and the achieving

of world peace.

UN was founded in 1945 after World War II.

There are currently 192 member states, including nearly every sovereign state in the world.

3 of the 195 are not members—Kosovo,Taiwan and Vatican City

Supernationalistic Organizations

Leadership or predominant influence exercised by one nation over others, as in a confederation.

Who has the power?

Hegemonic Power

G7 Group

Take the G7 and add

Russia.

You now have the G8.

The G8 Group

BRIC Nations

Low GDP-low industrial production Most people are subsistance famers Weak property rights-few people control

land and property. Poor health conditions-few doctors,

shortage of hospitals, high infant mortality. Low literacy rates Raid population growth

Characteristics of Developing Nations

1st, 2nd, 3rd World countries

The international transfer of capital, goods, or services from a country or international organization for the benefit of the recipient country or its population.

Aid can be economic, military, or emergency humanitarian (e.g., aid given following natural disasters).

Foreign Aid

In its classic form is defined as a company from one country making a physical investment into building a factory in another country

Foreign Investment

investments in education, health, public administration, infrastructure, financial and private sector development, agriculture, and environmental and natural resource management.

Provide low or no interest loans (credits) and grants to countries that have unfavorable or no access to international credit markets.

World Bank

working to foster global monetary cooperation, secure financial stability, facilitate international trade, promote high employment and sustainable economic growth, and reduce poverty.”

Countries contributed to a pool which could be borrowed from, on a temporary basis.

International Monetary Fund

China, Japan and Germany are leading world exporters.

Emerging world markets in the near future:◦ Vietnam◦ Argentina◦ Panama◦ Indonesia◦ Brazil

Emerging world markets are challenging the status quo

The concept of sending work outside of the USA to lower labor and production costs.

Outsourcing

Multinational Corporation

Process of transferring ownership of a business, enterprise, agency or public service from the public sector (the state or government)

Two examples:◦ A company who currently has stock, buys all them

back.◦ The City of Alvin has Nike take over control of all

public parks.

Privatization

Business over the internet. The business world is ever changing.

Now you need an app.

E-commerce