Economics is the Social Science which seeks to solve the basic problem of meeting the unlimited wants of society using the worlds limited resources. Economics

Economics is the Social Science which seeks to solve the basic

problem of meeting the unlimited wants of society using the world’s limited resources.

Economics is the original Social Science.

Οἰκονομίαoikos (home, household) nomia (rules,

governance)

The first course of study in Economics was developed in classical Greece.

The Romans would later latinize Oiko to Eco, nomia to nomis.

They adapted the content to be applicable throughout their empire.

The Roman Empire was the world’s largest empire until the 20th century. Economics was taught throughout the empire, so when the empire began to recede, those

people left behind had been taught the skills needed to manage their households and livelihoods.

The empire would finally collapse in 475AD, leaving behind self-sufficient communities.

By the middle ages, the term “economics” is in use in English as a description for “the art of managing a

household”. Because of the isolation imposed after the collapse of the Roman Empire, the science of economics

gained increased importance. Walled cities were the norm, and had to use economics to survive.

By the beginning of the Renaissance, the term “Political Economy” has come into existence, referring to the management of a community, city, state, or country.

During the Renaissance, economics further developed as a philosophy. Instead of just solving problems, questions about right and wrong developed. This

resulted in two different types of Economics:

Positive Economics- Decisions are based upon efficiency.Normative Economics- Decisions are based upon

value judgments.

Concepts in Normative Economics became an important component of the Enlightenment.

During the 16th Century, England developed the first cohesive national economic policy when they implemented the Mercantilistic system.

MercantilismMercantilism is basically a system where the home

country exports as much as possible while importing as little as possible to maintain a

positive balance of trade, and thus to build a stockpile of gold. That gold could then be used to

enhance the government’s power. Production, pricing and sale of exports and imports is

controlled by the government.

The Modern Era of Economics

• Throughout the Renaissance and the Enlightenment, Economics gained scope and

influence.• The Enlightenment (or the Age of Reason) was a cultural movement of intellectuals, that sought to use reason to explain all issues, in

order to reform society and advance knowledge

• Although Mercantilism was successful in allowing England to gain political and economic dominance in Europe, it attracted the attention of competing powers, and they too began to adopt Mercantilistic policies.

• As more countries adopted Mercantilism, fewer countries were willing to buy English goods. England increasingly imposed harsher requirements upon their colonies to support the system. This led to opposition to both England, and to mercantilism.

• Adam Smith (b. 1723)– Attends college at Glasgow and Oxford, meets David Hume.– Publishes Theory of Moral Sentiments (1759)– Spends four years in Europe as a tutor, beginning in 1762. While abroad, meets the prominent enlightenment philosophers based in Paris, including Benjamin Franklin, Denis Diderot and Francois Quesnay.– Publishes A Treatise By Way of Inquiry into the Nature and Causes of the Wealth of Nations (1776 )

The Wealth of NationsThe publication of The Wealth of Nations in 1776 marked the beginning of the Modern Eraof Economics. It was not so technical that itcould not be understood by laymen, so it wasmuch more widely distributed than other textsof the period. Over 250000 copies were printedduring Adam Smith’s life.

• The Wealth of Nations is at it’s core a critique of Mercantilism, and a

statement of Adam Smith’s ideas about economic freedom, political

strength, and increasing the prosperity of individuals. It’s ideals

were gradually instituted in England, but took hold quickly in the new

governments of the United States and post-revolution France.

The main points in The Wealth of Nations include:

• The benefits derived from individual freedom in a laissez-faire economy

• National advantages in competitive foreign trade• Increasing productivity by allowing individuals to

benefit from modernization and ingenuity.• Using the scientific method to approach economic

problems.

• As the principles in The Wealth of Nations became more widely accepted, many different systems were developed to try to achieve specific goals. All of these systems seek to answer the same problem:

Relative Scarcity- All goods are scarce relative to the quantity that would be used if supply were unlimited.

Because of this basic principle, the way a systemuses resources is what will define that system.

Production

• In order to maximize satisfaction that can be achieved from those scarce resources, the concept of production evolved. There is a simple definition for production…

• Production – the creation of value.This involves acting upon a resource to convert it into a

more valuable form. The physical attributes of the resource of the same, it’s just re-arranged to be more

useful, thus more valuable. All production involves four components, called the four factors of production.

Production• While production is simply the “creation of value”,

different things have different types of value. We generally identify two types of things…

1. Goods – Tangible Items of Value2. Services – Intangible Items of Value

The Four Factors of Production• Regardless what is being produced, all four factors must be

present before production takes place.

1.Land (Natural Resources)-



1.Land (Natural Resources)-Anything that is naturally occurring

that is used in the production process.



1.Land (Natural Resources)2.Labor (Human Resources)-



1.Land (Natural Resources)2.Labor (Human Resources)-

Human effort exerted towards production



1. Land (Natural Resources)2. Labor (Human Resources)

3. Capital –




3. Capital – Anything that facilitates the manipulation of a natural resource. (also, the produced

means of production)



1.Land (Natural Resources)2.Labor (Human Resources)

3.Capital4.Entrepreneurship (Management)

The Four Factors of Production• Regardless what is being produced, all four factors must be present

before production takes place.


3. Capital4. Entrepreneurship(Management) – The

coordination of the other three factors so that production can take place.

The Four Factors of Production• Each factor of production earns a unique

reward. • This allows us to assign value

proportionately to each of the factors.• We refer to a concentration of value due

to one factor as “intensity”.

The Four Factors of Production• Each factor of production earns a unique reward. This allows

us to assign value proportionately to each of the factors.

1.Land – Economic Rent2.Labor -

3.Capital - 4.Entrepreneurship -



1.Land – Economic Rent2.Labor - Wages

3.Capital - 4.Entrepreneurship -




3.Capital - Interest4.Entrepreneurship -




3.Capital - Interest4.Entrepreneurship - Profits

Productivity• Productivity is a measure of the efficiency of

production. Some political and economic systems provide for greater productivity than others, but basically productivity is determined (and limited by) three factors…

1. The quality of available natural resources2. The quality of available human resources3. The quality of available capital

The Production Possibilities Frontier (or Curve)

0 0.5 1 1.5 2 2.5 30

0.5

1

1.5

2

2.5

3

Butter

Gun

s

Using our Resources to Serve Our Economic Self Interest

• Since the market does not make all of our choices for us in a mixed economy, we need another way to prioritize our wants.

• In our system, we typically use a measure known as Opportunity Cost.

• Opportunity Cost is defined as the value of the next best alternative. It is what one gives up in order to have the opportunity to spend the nominal cost required to purchase an item.

Making Choices in Mixed Economies

• Nominal Cost = the actual price or cost of an item.

• Opportunity Cost = the value of the next best alternative.

Calculate the real cost of going to college…• Nominal Cost = Tuition, fees, living expenses• Opportunity Cost= The value of anything you

could have done instead. If work is the next best alternative, how much would you have been paid?

Economic Systems

• Once we have successfully produced items in order to maximize the value of our scarce resources, we must still have a method or

system for deciding how to allocate or divide those resources.

• That method or system will be identified as an economic system, even though it is often

intermingled with a political system. As with Mercantilism, a government can often use

economic policies to incorporate their agenda, so the two types of systems usually operate

side by side.

Three Basic Economic Systems

Even though there are thousands of variations of economic-political systems,

all of them are one of three basic systems, or a mixture of two or more of the three.

Economic systems are identified by the way that they answer each of the four basic

questions.

Basic Questions of Economics• Regardless of which system we may live under, there are four

basic questions that the system must answer:

1. What will be produced?



1. What will be produced?2. How will it be produced?



1. What will be produced?2. How will it be produced?3. Who will produce it?



1. What will be produced?2. How will it be produced?3. Who will produce it?4. Who will receive it?

Three Basic Economic Systems• Every economic system in history has been

one of the three basic types, or a mixed system.

• The three types- Traditional, Market, and Command- develop in an evolutionary progression.

• We will discuss “Pure Systems”, but in reality, “pure or perfect” does not exist. These are so rigidly defined that they exist only in theory.

Traditional Economic System

• The traditional system is the one that naturally develops when people begin living cooperatively.

• Four characteristics of the Pure Traditional System1. Occurs in poor rural areas



• Four characteristics of the Traditional System1. Typically occurs in poor rural areas

2. Subsistence level production



• Four characteristics of the Pure Traditional System1. Typically occurs in poor rural areas

2. Characterized by subsistence level production3. Lack of efficient capital equipment

Traditional Economic System• The traditional system is the one that naturally

develops when people begin living cooperatively.• Four characteristics of the Pure Traditional System

1. Occurs in poor rural areas2. Subsistence level production

3. Lack of efficient capital equipment4. Isolation


• The Traditional System answers the four basic questions using tradition as a guide. All of the questions are answered by looking at what the society has traditionally done.

• What will be produced is decided by tradition…• How it will be produced, again decided by tradition.• Who produces it, and who receives it will also be

decided by how it has traditionally been done.


• Eventually an economy tends to evolve beyond the traditional system. Population growth causes the isolation to break down, allowing contact with groups who have access to different resources, or that are producing different items of value.

• This introduction to new things gives incentive to accept risk, and to try new products, methods of production, or social mobility.

• This leads to the adoption of…

Market Economic System

• The principal feature of the market system is that because of the possibility of trade, the answers to the four basic questions are now to be decided by the market.

• A market is defined as any interaction between a buyer and a

seller.


• The Pure Market system has four characteristics…

1.Many Buyers and Sellers



1.Many Buyers and Sellers2.No Barriers to Entry or Exit




3.No Government Intervention




3.No Government Intervention4.Homogenous Goods


• The end result of these four characteristics is a system that uses independent, voluntary participation by buyers and sellers, and freely fluctuating prices to determine the answer to all four questions.

• Adam Smith referred to this as the “Invisible Hand Principle”


• In the market system, all four basic questions will be answered by “the market”.

You can use your personal experience in buying and selling to see how these questions are addressed by the voluntary interaction between buyers and sellers.

Four Basic Questions

1.What will be produced?2.How will it be produced?3.Who will produce it?4.Who will receive it?


• The market addresses all four questions, even though it may seem that the questions are answered by one side (buyers or sellers), there is always some cooperation involved.

• “What” is answered by the communication. Sellers may offer what they want, but if buyers do not respond to what is offered, sellers will change to something that buyers want.

• “How” is also dependent upon buyers willingness to respond. If buyers do not like the “how”, they won’t buy, and sellers will again change their offerings.

Market Economic System• The “who” questions are answered in a market

economy by the cooperation or interaction of buyers and sellers, but consider the roles reversed. When you get a job, you become the seller of your time or skill. You may offer it to anyone, but unless they respond (as a buyer) you will need to find some other way to make the money you need.

• What you receive will also depend upon how much money you are able to earn, so what you do determines “who will receive” what is produced.


• The market system allows a great deal of freedom in how the individual decides to use the resources they have available.

• This freedom means that people will try to use those resources in the least wasteful, most advantageous way.

• Because of this, the market system is incredibly efficient. No one wants to waste resources that could be used to improve their own economic standing.

• Adam Smith referred to this as “serving one’s economic self interest”.


• This freedom, and the efficiency it leads to create several possible negative results.

• The drawbacks to the pure market system are based on it’s insistence on price motivation, and it’s lack of government intervention.

• This freedom can be abused, which leads to the excesses of capitalism. The poor can be taken advantage of, the environment can be polluted or misused, workers can be mistreated, and there is little recourse.


• The worst possible negative effects of abuse of the market system occurred in Europe during the late industrial revolution, although they still occur in developing markets around the world.

• Individual sellers can misrepresent themselves or their products to cheat or swindle customers with little chance of repercussions.

• Manufacturing firms can underpay their workers, provide poor or unsafe working conditions, or insist upon child labor.

Command Economic System

• Eventually the abuses of the market system lead to the development of alternate philosophies, some rooted in the ideas of the enlightenment. These lead to systems called “planned” systems, also known as “Command Systems”.

• In general, a command system is one where all four questions are answered by government order, or command.

• This requires a strong central power that is given (or seizes) control of the factors of production, and uses those factors to produce what is perceived as necessary by the government.

Command Economic System• The earliest command system was Utopian Socialism, a system based

on the teachings of the Physiocrats, lead by Jean Francois Quesnay. This was one of the earliest attempts to create a system that addressed the problems created by an unregulated market system.

• Robert Owen instituted Utopian Socialist ideals in the fabric mill at New Lanark, Scotland, and later in settlements at New Harmony, Indiana and New Hope Texas.

• There were other famous Utopian Socialist Experiments in Europe and the US, but none of these were long term successes.

• Eventually, the continued abuses lead to the development of “Scientific Socialism”.


• Scientific Socialism, which was the basis for most modern Socialist and Communist political systems was developed by Karl Marx and Friedrich Engels.

• In 1848, Marx and Engels published The Communist Manifesto, their most famous work and the basis for the political/economic system called Scientific

Socialism. The Manifesto was based on a series of pamphlets describing the inevitability of the failure of Capitalism, and the creation of a workers state, where the government directed the factors of production rather than profit-seeking capitalists.

Command Economic Systems

Communism and Socialism will represent the ultimate development and implementation of Command Economic Principles as an economic and political system.

Although the Communist Manifesto was published in 1848, the principles of Scientific Socialism aren't laid out until publication of Das Kapital in 1867.

There will not be a government built around these principles until the Russian revolution of 1917.


• After the Russian Revolution, there are revolutions or government overthrows in many countries, including China, Romania, Spain, Yugoslavia, Korea, Vietnam, Nicaragua, Cuba,and Sudan. Communist governments assume power in many areas left without government control after WW2.

• There were also unsuccessful attempts at revolution in Greece, Mexico, Brazil, Chile and India.

Communist and Socialist countries in 1980


Communist and Socialist countries in 2012(China, Vietnam, Laos, Cuba and North Korea)

Due to the realities of imposing and maintaining a Communist state, most of those governments failed, were overthrown, or abandoned their communist ideology after the 1980s. Currently there are only 5 Communist countries,

and the largest (China and Vietnam) are using “special enterprise zones” to develop market based systems,

resulting in great success and rapid growth.


• Economically, Socialism and Communism share identical goals.

• Politically, Communism must arise from Revolution, and uses military power to enforce it’s ideology, while Socialism follows democratic principles.

• The weakness of the command system is caused by the dependence on a central government efficiently and fairly distributing both work and resources. Because of differing philosophies, corruption and incompetence, no system has found a way to perfectly execute the theoretical goals of a Communist or Socialist state.

Mixed Economies• Since none of the three basic systems are able

to perfectly answer all of the four questions, all economies in the real world are to some degree “mixed economies”. That means that they have features borrowed from any of the systems, combined in ways that best serve the needs of that society.

Mixed Economies• Different countries use different components of the

basic systems to meet their own needs.• At it’s height, the USSR was a Communist, command

economy, yet was never able to eliminate the use of markets for the distribution of goods.

• Sweden, Norway and Finland are primarily socialist countries, with a great deal of government control, but still allowing consumers to use the market to make choices.

Mixed Economies

• The United States was started as a market system, but as it has evolved, more and more command programs have been instituted to make up for the shortcomings of the market system.

Government Intervention in the US Economy

• The US economy is mixed because our government intervenes to make up for the shortcomings of the market system.

• There are four main areas where the government intervenes in our economy


• The government intervenes in our economy…1. On behalf of the economically disadvantaged.• Social Security, “Welfare” programs, Medicare

and Medicaid, unemployment compensation, college grants and loans, and “enterprise” loans are all ways that the government intervenes trying to help those who cannot compete as effectively as others.


• The government intervenes in our economy…1. On behalf of the economically disadvantaged.2. On behalf of business.• The government uses both direct and indirect

intervention to help business succeed. Bailouts, direct investment, and protective tariffs are forms of direct intervention. Indirect intervention includes improvements to infrastructure and education that help businesses in general.


• The government intervenes in our economy…1. On behalf of the economically disadvantaged.2. On behalf of business.

3. To provide us with public goods and services.• Public goods are those things deemed necessary to

maintain or improve our quality of life, but that private industry cannot or will not provide.

• Eminent domain is the government’s power to take private property for public use.


• The government intervenes in our economy…1. On behalf of the economically disadvantaged.2. On behalf of business.3. To provide us with public goods and services.

4. To protect us from the effect of negative externalities.• Externalities are costs that arise outside of the market.

You did not agree to the transaction, but still bear costs associated with it. Natural disasters, pollution and climate change are examples of externalities.

Documents

Economics is the Social Science which seeks to solve the basic problem of meeting the unlimited wants of society using the worlds limited resources. Economics