FUNDAMENTAL
ECONOMIC CONCEPTS
Coach William Rooks
Economics Defined

A social science
studying the allocation
of scarce resources
and goods.

The study of how
individuals, businesses
and nations can best
allocate their limited
resources.
Terms to understand




Resources-inputs such as land, labor, capital, and
entrepreneurship used by society to produce
outputs. (things humans can put to productive use)
Goods-outputs; which are finished products.
Scarce-in short supply.
Allocate-to distribute according to some plan or
system.
Natural Resources


Defined: raw materials in nature used to produce
what humans need or want.
Renewable resources
A

natural resource that can be replaced over time.
Nonrenewable resources
A
natural resource that cannot be replenished over
time.
The Four Factors of Production
Land:
In addition to
property, land
is any natural
resource that
may be found
on the piece of
ground in
question.
EX: Gold
The Four Factors of Production Cont.
Labor:
The
contribution of
human workers
to the
production
process.
Mental effort.
Physical effort.
The Four Factors of Production Cont.
Capital:
All the structures
and equipment
involved in the
manufacturing
process.
Physical Capitalthe tools used to
produce goods.
Human Capitalthe knowledge in
a person’s head.
The Four Factors of Production Cont.
Entreprenuership:
A specific type of labor
that covers things like
the ability to:
Come up with new
products that people
want (creativity).
Organize and run a
new business
successfully
(managerial skills).
Manage employees
effectively
These people are risktakers and follow the
adage “with great risks
come great rewards.”
Scarcity
•
•
The lack of adequate resources to obtain all of our
wants.
Scarce and rare are different because some things
that are rare people do not want (hurricanes).
–
•
Scarcity exists because our wants almost always exceed
our resources.
Scarcity affects prices because the more scarce a
product, the more that item costs and visa versa.
Dealing with Scarcity

Higher Prices is one way to deal with scarcity.
 If
a storm disrupts the production of a good they may
have to raise their prices on that good to cover the loss
of supply and to avoid running out of their product.
 This allows the producer to make money while ensuring
the limited supply of their product lasts longer than it
normally would.
Dealing with Scarcity Cont.

Government regulation is another way scarcity is
dealt with.
 Price
Ceiling-maximum amount a product can be sold
for.
 Price Floor-minimum amount a product can be sold for.
 Rationing-allowing citizens to purchase only a certain
amount of a product to make sure there is enough of
the good to go around.
Economic Decision Making Model


When we come across instances where our resources
are limited, we must make decisions that require us
to choose between options that are all less than
ideal.
In order to make a decision we must follow the
decision making model.
Economic Decision Making Model
(Situation or Problem)

Coach Theiss is on a date with his wife to the
movies. He has five dollars in his pocket and his
wife has sent him after a coke and nachos. I am no
doubt hungry myself and even if I am not, I am
going to want something to eat. I decide I want a
hotdog nachos and a coke. Price list: Hot Dog$1.50, Nachos-$2.00, Chips-$0.75, Coke-$1.00
Economic Decision Making Model
(Step One)

The first thing a person must do is to define the
problem.
I
only have five dollars and what we want costs $7.50.
(one of us is going hungry)
Economic Decision Making Model
(Step Two)
•
Make a list of alternatives.
–
Option #1
•
–
Option #2
•
–
I could buy myself what I want. ($4.50) That would leave
only $.50 for Anita.
I could buy Anita her nachos and coke for $3.00 and have
$2.00 for myself.
Option #3
•
I could buy us each a hotdog and a coke and deal with
Anita’s reaction to not having nachos
Economic Decision Making Model
(Step Three)

State the Criteria (list priorities)
 Is
filling my stomach the most important thing to me?
 Is pleasing Anita the most important?
 Is not feeling selfish a priority?
 I decide that I am not going to be selfish and am going
to please Anita.
Economic Decision Making Model
(Step Four)
•
Evaluate the Alternatives
–
•
Trade-off-is the act of giving up one thing of value to
gain another thing of value.
–
–
•
In each of the alternatives there is a trade-off.
I value being full and satisfied, my wife being satisfied and
feeling good about myself, but I cannot have all three.
Trade-offs bring about opportunity costs.
Opportunity cost-the values of the alternative option
that is lost when an individual, business, or government
makes a decision.
Economic Decision Making Model
(Step Four Cont.)
•
Evaluating the alternatives with trade-offs and
opportunity costs in mind.
–
–
–
If I choose to fill myself the trade-off is the food I should
have gotten Anita and my opportunity cost is her being
happy with me.
If I buy her nachos and a coke my trade-off is the food I
could have bought myself and my opportunity cost is a full
stomach.
If I choose the middle road my trade-off is some of the food
I could have bought Anita and part of what I could have
gotten for myself and my opportunity cost is feeling totally
full and totally pleasing Anita.
Economic Decision Making Model
(Step Five)
•
Making a rational decision.
–
In determining a rational decision a person, business, or government must
determine that the marginal benefit of a an action is equal to or
exceeds the marginal costs of the decision.
•
•
–
–
•
Marginal benefit-is the amount of benefit a person, business or government
receives once the cost of the decision is considered.
Marginal cost-is the cost of the decision once weighed against the benefits.
If the benefits are greater than the costs, then it is a rational economic
decision.
If the costs are greater than the benefits, then it is an unwise or irrational
decision
What should he do?
–
The second option is the most rational choice; but Coach Theiss is not
always rational.
Production Possibilities and Trade-offs
Production possibilities
curves represent all the
possible combinations
of goods and services
that an economy is
able to produce with a
fixed amount of
resources.
The bow curve
represent the amount
of units of good Y and
good X that a society
can produce. More of
good X cannot be
produced unless less of
good y is produced.
Production Possibilities and Trade-offs
A movement from point b
to point c means that less
of good X is able to be
produced. This frees up
resources to produce
more of good Y and
allows for a shift from
point d to point e on the Y
Axis.
Both are maximum
combinations but both
involve a choice of what
will be produced. (Tradeoff and Opportunity Cost)
Specialization and Division of Labor
•
In order to maximize their profits a company may
try to reduce their costs of production, while at the
same time trying to sell their goods at as high a
price as consumers are willing to pay.
–
In order to do this a producer needs to reduce their
costs.
•
•
To reduce costs a company tries to increase productivity.
Productivity is the ability to turn an input into an output in a
certain amount of time.
Specialization and Division of Labor
Cont.
•
Ways to increase productivity.
–
Specialization of Labor
•
•
–
Division of Labor
•
–
Specialization is the devotion of resources to a specific task.
In a business workers may focus on a specific task.
The act of splitting up work into smaller and more specialized
tasks is division of labor.
By combining Specialization and Division of Labor a
company becomes more efficient in production.
Voluntary Exchange and its Benefits
•
Voluntary exchange is evident in the U.S. economy because
individuals and businesses freely choose to exchange goods,
services, resources, etc…for something else of value
(money).
–
–
–
Consumers and producers decide together what is produced and
what is purchased.
Consumers decide what they want; entreprenuers pursue profits
by producing (supplying) what is wanted (demanded) by
consumers.
A voluntary exchange occurs when a consumer finds what they
want at a price they are willing to pay and for which a producer
is willing to give them the product.
Voluntary Exchange and its Benefits
Cont.

Benefits of Voluntary Exchange
 It
encourages increased productivity and efficiency.
 It encourages technological inventions and innovations
to help in productivity and efficiency.
Economic Systems and the Three Basic
Economic Questions


There are four basic types of economic systems:
traditional, command, market and mixed.
Each of these systems must answer the three basic
economic questions to better allocate their
resources.
Three Basic Economic Questions

What will be produced?
 The
type of economy will determine what is produced.
 In a market economy like ours, businesses produce what
is demanded by consumers.
 We have also converted from a manufacturing society
into one that thrives off of service jobs.
 Because
service jobs require more education, more people
are enrolling in college.
 Factories have closed and been replaced by office
buildings.
Three Basic Economic Questions Cont.

How will it be produced?
 There
are two possible answers to this question: Private
Businesses or the Government.
 Private companies
 In
the U.S. private companies produce the majority of our
goods and services.
 The
 In
Government
socialist countries (command economies), the government
produces goods and services and everyone works for the
government.
Three Basic Economic Questions Cont.

For whom will it be produced?
 The
answer to this question can give us an idea of the
breakdown of wealth in a country.
 If
most goods are luxury goods then wealth is controlled by
a small group of people, and the poor are creating goods
they themselves cannot afford.
 In industrialized nations, the majority of people are in the
middle income group.


There are rich people and poor people but they are less
numerous than those in the middle.
The majority of goods and services are produced by the middle
class and for the middle class.
Economic Systems

Traditional Economies
They are based on the premise, if something works for one
generation, it can work for the next.
 They produce at a subsistence level (they make what they
need for survival and nothing more).
 A person’s status is inherited from their parents and one very
wealthy class controls the means of production, so
advancement in society is very difficult.
 Productivity is motivated by the need to survive and a sense
of purpose.
 Very few of these exist anymore .

Economic Systems Cont.

Command Economies
 The
Government controls all markets and answers the
basic economic questions.

A Centralized planning committee takes into account all the resources
of a country and sets up a system of production.
 The
government is supposed to provide for the citizens
because they control everything.


Everything is supposed to be distributed equally to the people.
This could work in a small society but not on a large scale.
Economic Systems Cont.

Command Economies Cont.

Because there is not private ownership, the people have
very little incentive to produce.




Because the government controls everything, personal liberties and freedoms are not
as great as they are in a Market Economy.
There is very little profit motive.
There is also very little innovation because the Government, not the producers and
consumers, set the economic conditions.
Command Economies often produce a set of goods and services that is different from
what the population really wants.


This leads to shortages of needed goods and surpluses of others.
The former USSR is an example of a Command Economy.

Because the USSR collapsed economically, economists question the long term viability
of Command Economies.
Economic Systems Cont.

Market Economies


These are also called capitalistic or free market systems.
Private individuals and firms control all resources and the price and
quantity of all goods are determined by supply and demand in
unrestricted, open markets.



Producers and consumers working together answer the three basic economic questions.
There is motive for both producers (profit) and consumers/laborers (wages).
Ownership of property and goods is determined by the private sector.



The government does virtually nothing to interfere in the market.
The system relies on the belief that a market system naturally leads to efficient results
through the “invisible hand”.
This “hand” theoretically corrects any inequalities in resource allocation; supply and
demand working together.
Economic Systems Cont.

Market Economies Cont.

Adam Smith wrote the Wealth of Nations in 1776

This book introduced the term “invisible hand”.

His theories outlined in the book are still relevant today.

He also talked about Laissez-faire economics


This means “hands-off” meaning that the government leaves businesses and economics alone.
The U.S. economy is market oriented but is not a purely capitalistic
society.

The government intervenes so there is a mechanism to help the poor.

A downside to this type of system is that some people may become very rich while
others remain very poor.
Economic Systems Cont.

Mixed Economies
In the real world most economies are a blend of two or even
all three of these together.
 China



They are considered a Command Economy but have begun to
incorporate many aspects of the market system into their economy.
The U.S.

We are considered a Market Economy but our government does
intervene in some markets.
Role of the Government in our Market
Economy


Governments need to provide public goods and services.
Governments sometimes also redistribute income.



Governments resolve market failures


They regulate the economy to prevent an economic crisis and to restore
prosperity.
Current ways our government regulates the economy


This is when money is taken from citizens who have it (taxes) and given to citizens
who do not (normally through welfare programs).
This is done to maintain stability and keep the poor from becoming disgruntled.
Tariffs (to protect industry), subsidies (money given to a company to make up for
their losses), actions of the Federal Reserve, environmental regulations,
workplace safety guidelines, and consumer protection laws.
The government may also deregulate the economy in order to encourage
competition and increase product quality.
Investment

Investment in Productivity
If a country is productive there are more goods and services
available to buyers and more financial rewards for
laborers.
 Inputs



Outputs


All factors of production that go into producing a good or service
The amount of a good or service produced
In order to be productive, the inputs in a business must
produce enough output to make more money than was put
into the products.
Impact of Investment

Investment-using resources that could bring immediate benefits for
the purpose of gaining greater benefits at a later time.

Interest is the main way investors make money.


Capital Investment



Interest-money paid to the investor for the use of their money.
This is spending money on Capital goods (products used to make other
goods or provide services).
By investing in new machinery a company can increase productivity.
Human Capital-investment in people


A company can improve its business by investing money, time and resources
to improve their employee’s life and skills.
Laborers may invest in themselves by gaining training or education
Impact of Investment

Investments in human capital can lead to a higher standard of
living.


An educated worker can make more money and can afford more things
than a less educated worker.
There are trade-offs and opportunity costs to investments for a
company.



Machines must be paid off before you see the increase in profits.
Time spent on education may slow down production before it increases
it.
Investments are made for long-term purposes.