Economics – Chapter One

Unit 1: Introduction to Economics
Unit 1: Chapters 1-3
Fundamental Economics
Chapter 1: What is Economics?
I. Economics: the study of how people seek to satisfy their unlimited needs and wants
given their limited resources, we must make choices; the science of decision-making
2 branches of economics
1. microeconomics – focus is on individual decision making, the economy’s
individual parts
2. macroeconomics – focus is on group decision making, the economy as a
What is the difference between a need and a want?
II. Scarcity: the condition that occurs because human wants and needs are unlimited,
while resources needed to meet these wants and needs are limited.
Goods: physical objects used to meet wants and needs
Services: Actions or activities that one performs for another
Making choices means you make trade-offs, the alternatives that we sacrifice when we
make a decision. The Opportunity Cost is the next best alternative not chosen; The most
desirable alternative given up as a result of a decision.
Thinking at the margin: deciding whether to do or use one additional unit of a resource
Production Possibilities Curves: a graph that shows the alternative ways to use an
economy’s resources
Guns or Butter PPF Application Questions
1 How many guns can be produced when no butter is produced? ____________
2 How much butter can be produced when no guns are produced? ___________
3 Imagine that a country wants to go from producing 0 guns to 40 Guns. What is the
opportunity cost in terms of butter?____________
4 If the production decision was to produce at the (20, 45) point; What does this
society care more about?_______________________________
Law of increasing costs: as we shift factors of production from making one good or
service to another, the cost of producing the second item increases; this is why PPF
curves drastically downward to the right.
Chapter 2: Economic Systems
All societies deal with scarcity by implementing an economic system which distributes
the scarce resources by answering the following BASIC ECONOMIC QUESTIONS:
What goods and services should be produced?
How should these goods and services be produced?
For whom are these goods and services produced?
Factors of Production: Land, Labor, Capital, Entrepreneurship (L,L,C,E)
Land: natural resources, anything of the Earth
Labor: the effort that people devote to a task for which they are paid
Capital: any human-made resource that is used to create other goods and
services; physical, financial, human
Entreprenuership: risk taking to combine resources for potential profit
Factor payments: the income people receive for supplying the factors of production
Land – Rent
Labor – Wages
Capital – Interest
Entrepenuership – Profit
4 types of economic systems:
1. Traditional
2. Market (Private)
3. Command (Public)
4. Mixed
Defining characteristics: essential traits that must be present in order to know what a
system is
1. A Market system: an arrangement that allows buyers and sellers to exchange; a place
where buyers and sellers freely interact with nearly perfect information; based on
voluntary exchange. Market economies are also called free markets or capitalism.
Individuals choose; private goods and services.
2. A Command system: is characterized by the presence of strong, central authority.
Government makes all decisions regarding the distribution of resources. This produces
public goods and services.
3. A Traditional system: is characterized by habit, custom, and ritual to decide the
questions of production and consumption. Traditional economies are usually small, close
communities. This generally means there is a large agricultural segment of this society.
4. A Mixed system: a society that has some combination of the above 3 systems.
How the three basic questions are answered in command (social) economies:
What to Produce: a committee of experts pool their knowledge and work out a central
plan based on the needs of society. Goods and services produced do not have to pass the
“test” of the market. Consumer choice involves purchasing or not. Producers meet
quotas established by committee. Profits are not an incentive.
How to produce: determined by central committee. Managers have some choice
involved in the process, but no control of resources provided to produce the goods.
For whom to produce: Equity for all is the goal. An even distribution of goods and
services among society’s members.
In a market economy, social decision-making occurs.
5 basic Economic Goals of the US economy:
1. Economic Freedom: freedom of consumers to decide how to spend or save
their incomes; freedom of producers to make decisions; freedom of workers
to choose their jobs
2. Economic Efficiency: achieving maximum benefit from a given amount and
combination of resources; it is improved only if the additional benefits
exceed the additional costs
3. Economic Equity: fairness to all members of society
4. Economic Security and Predictability: protection against economic risks
such as work injuries, unemployment, inflation, business failures, and
5. Economic Growth and Innovation: increasing the production of goods and
services over time. Target growth rate of GDP is 3% per year
Public Goods: goods and services available to all members of society; one member can
consume it and it is still available for other members e.g. schools, parks, roads, army,
Private Goods: individuals own
Effective Social-decision making:
Use basic economic decision-making model
1. Define the problem
2. List alternatives
3. List criteria
4. Evaluate the alternatives
5. Make a decision that minimizes social cost and maximizes social benefit
Chapter 2 vocabulary terms to know:
Specialization: the concentration of the productive efforts of individuals and firms on a
limited number of activities
Factor market: market in which firms purchase the factors of production from
Profit: a financial gain made in a transaction
Product market: the market in which households purchase the goods and services firms
Self-interest: one’s own personal gain
Incentive: an expectation that encourages people to behave in certain a way
Competition: the struggle among producers for the dollars of consumers
Invisible hand: term economists use to describe the self-regulating nature of the
Consumer sovereignty: the power of the consumers to decide what gets produced
Socialism: a social and political philosophy based on the belief that democratic means
should be used to evenly distribute wealth throughout society
Communism: a political system characterized by a centrally planned economy with all
economic and political power resting in the hands of the central government
Authoritarian: requiring strict obedience to an authority such as a dictator
Collective: large farm leased from the state to groups of peasant farmers
Laissez faire: the doctrine that states that government generally should not intervene in
the marketplace
Private property: property owned by individuals or companies not by the government or
the people as a whole
Free enterprise: an economic system characterized by private or corporate ownership of
capital goods; investments that are determined by private decisions rather than by state
control; and determined in a free market
Continuum: a range with no clear divisions
Transition: period of change in which an economy moves away from a centrally planned
economy toward a market based system
Privatize: to sell state run firms to individuals
Chapter 3:American Free Enterprise
Taxation: The Constitutions provides the Government with the right to tax in Article 1,
sections 2 & 9; the 16th Amendment provides the federal government the right to tax
Profit motive: the force that encourages people and organizations to improve their
material well-being
Open opportunity: the concept that everyone can compete in the marketplace
Legal equality: the concept of giving everyone the same legal rights
Free contract: the concept that people may decide what agreements they want to enter
Voluntary exchange: the concept that people may decide what and when they want to buy
and sell
E.1.6 Recognize that voluntary exchange occurs when all participating parties expect to gain.
Competition: the rivalry among sellers to attract customers while lowering costs
Private sector; market economy, capitalism, Adam Smith, Milton Friedman, Gary
Becker, F.A. Hayek, and University of Chicago
Consumers signal to producers what to produce by their “votes” in the economy; and they
signal how much they want produced (for whom to produce). Consumers can also join
Interest groups: private organization that tries to persuade public officials to act or vote
according to their interests.
Public sector; command economy, centrally planned, socialism, Karl Marx, John Kenneth
Galbraith, John Maynard Keynes, and Harvard University
The Limited Role of Government:
The 5th amendment in the Bill of Rights provides the constitutional authority to protect
property from the federal government. The 14th amendment protects property from State
governments. Federal and State statutes protect property from private individuals.
Promoting Growth and Stability
In order to promote growth, you have to first track it.
Microeconomics: the study of economic behavior and decision making in small units,
such as individuals, families and businesses.
Macroeconomics: the study of the behavior and decision making of entire economies.
Governments deal with entire economies so is studied in Macro.
Business cycles: a period of macroeconomic expansion followed by a period of
contraction. (growth, peak, recession, trough)
GDP: gross domestic product, the total dollar value of all final goods and services
produced in a nation’s economy in a given period of time (usually one year).
We have had 9 cycles since 1942, we may be about to complete a 10th.
Full employment: 5% of the workforce (anyone who wants to work) is actively seeking
another job.
The US economy policy goal is to grow at 3% a year, and keep prices stable. CPI:
consumer price index tracks changing prices of consumer goods and services.
Manipulating interest rates helps to stabilize prices. Increasing worker productivity and
technological advances helps shift the PPF outward to the right at 3% a year.
Providing Public Goods
Public good: a shared good or service, which is available to all members of society, and
you, cannot exclude non-payers
Public goods rationale: some goods can be provided for a society more efficiently if
produced by Government due to Economies of Scale: some economic activities are more
efficient when done on a large scale
the benefit to each individual is less than the cost that each individual would have
to pay if it were provided privately
the total benefits to society are greater than the cost
Free Rider problem: a person who benefits from the public goods and services without
sharing equally in its costs
Providing a Safety Net
(Redistributing the wealth)
Welfare system: government aid to the poor
Cash transfers are direct payments to the poor
Temporary Assistance for Needy Families (former AFDC)
Social Security (Medicare) FICA pays for this
Unemployment Insurance
Workman’s Compensation
In-Kind benefits: food stamps, subsidized housing, legal aid
Public Education