Chapter 1 Introduction McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved. Learning Objectives • Understand the importance of markets. • Identify three of the main forces shaping today’s economy. • Explain the debate over the role of government in the economy. • Define economics and discuss how prosperity is measured • Name some key disagreements in economics. 1-2 Objectives of Textbook • Tools of Economics • Role of Market Economy • Changing Nature of Economy 1-3 Tools of Economics • View the world from the perspective of an economist • To accomplish this, need to understand the key tools of analysis • Some of these tools include: – supply and demand – elasticity – production function – the multiplier 1-4 Role of Market Economy • In a market, buyers and sellers come together to voluntarily exchange goods and services for money. • Market transactions are activities that produce and exchange goods and services for which other people are willing to pay. • In this text we will study how markets work and how prices are set. 1-5 Changing Nature of Economy • Individuals, businesses, and even countries are subject to limits and constraints. • But these limits and constraints are constantly changing. – Goods that were once expensive are now commonplace. – Countries that were once poor are rapidly growing. 1-6 Key Forces Shaping Today’s Economy • Need to understand forces driving change • Three main forces at work: – Technological change – Globalization – Financial markets 1-7 Key Forces Shaping Today’s Economy • Technological change is an improvement in knowledge that increases the range of products and services the economy can deliver. – Examples: electricity, cars, and the Internet • Technology creates new ways of producing goods and services. • Technology is the critical factor in raising living standards. – Technology is also a possible solution to the energy crisis and global climate change. 1-8 Key Forces Shaping Today’s Economy • Globalization is the exchange of goods, services, ideas, and people among countries. – The world economy is becoming more global. – Does this trend benefit the U.S. economy? – There are many aspects to globalization, including: • trade in goods and services • flow of information and movement in money – Example: impact of China on the global economy 1-9 Key Forces Shaping Today’s Economy • Financial markets encompass all those parts of the economy that have to do with borrowing, investing, or transferring money. – Include the stock market, mortgages, banks, brokerage firms, and credit cards • Financial markets are constantly evolving. – Fuel economic growth by enabling companies, individuals, and government markets to raise money 1-10 Key Forces Shaping Today’s Economy • Interest rates are defined as the cost of money and are determined in the financial markets. – The central bank plays a key role in determining interest rates. • Subprime loans given to people who did not have enough income to qualify for ordinary mortgages are currently a major problem in the financial markets. 1-11 The Role of Government • Who should guide the economy: government, or businesses and individuals? – At one extreme is a centrally-planned economy, in which all economic activities are controlled from the top. – At the other extreme is a laissez-faire economy, where no government regulations or laws exist at all. • What is the role of competition in guiding the economy? 1-12 The Role of Government • Competition is the most consistent force for growth and progress. • The U.S. economy is the most competitive in the world. • There are some concerns over excessive competition. – Impact on job security, poverty, etc. 1-13 The Role of Government • Government plays a large role in the U.S. economy. – Makes laws, regulates businesses, etc. • Macroeconomic policy: making sure that the economy doesn’t fall into deep slumps where a lot of people lose their jobs, or overheat to the point where prices soar out of control. – Key role in the economy played by Federal Reserve 1-14 The Role of Government • The role played by the government and by private businesses differs across countries. • There is a global trend toward deregulation. – Deregulation is the process of reducing government control over industries. • There is a need to find a balance. 1-15 Economics Defined • Economics is the study of how individuals, businesses, and governments make decisions and make trade-offs in the face of scarce resources. • Role of scarcity and choice – Limited resources – Need to make trade-offs – Opportunity costs 1-16 Economics Defined • Two main areas of focus: – Macroeconomics • Studies the overall aggregate economy, focusing on issues such as growth, inflation, trade, and interest rates. – Microeconomics • Studies the behavior of individual units in the economy, such as households and businesses. 1-17 Measures of Prosperity • Improving individual prosperity is a key goal of economics. • Measure prosperity by using various indicators: – One key measure is GDP. • GDP is the dollar value of all the goods and services produced by the economy. – Other indicators of prosperity include wages, income, and consumption. • Use GDP to compare the level of prosperity among countries 1-18 World’s Largest Economies 1-19 Safety Net • Provides a measure of security for the poor, sick, and vulnerable – Consists of a wide array of government programs, including Social Security, Medicare, etc. – Objective is to improve the lives of lowincome households • Debate among economists as to whether enough is being done • Safety net programs in Europe are more comprehensive than in U.S. 1-20 Economics – Not an Exact Science • There is considerable policy disagreement among economists. – The role that government plays in the economy is one of the main debates. • Some key questions include: – How to fund Social Security and Medicare? – How to solve the health care problem? – How to improve the educational system? – What is an appropriate tax policy? 1-21 Why the Disagreement? • Reasons for policy disagreement are due to: – Political agenda – Lack of data – Winners and losers • The objective of this textbook is to present both sides of the discussion. 1-22 Appendix: Learning Objectives • Read data from a line graph or a bar graph. • Plot points on a graph using data from a table. 1-23 Appendix: The Basics of Graphs • Graphs have a horizontal axis (xaxis) and a vertical axis (y-axis). • Bar and line graphs are two different types of graphs. • A line graph can be upward-sloping or downward-sloping. 1-24 An Example of a Bar Graph 1-25 An Example of a Line Graph 1-26 Plotting Graphs from Data: Population of Cleveland 1-27 Plotting Graphs from Data: Population of Cleveland 1-28