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 Capital-the tools used to produce goods.

Human Capital-the 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 risk-takers 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• I could buy myself what I want. ($4.50) That

would leave only $.50 for Anita.– Option #2• 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– In each of the alternatives there is a trade-off.

• Trade-off-is the act of giving up one thing of value to gain another thing of value.– 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. (Trade-off 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

• Specialization is the devotion of resources to a specific task.

• In a business workers may focus on a specific task.– Division of Labor

• 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 Government

In 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.

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.

Governments resolve market failures They regulate the economy to prevent an economic crisis and to restore

prosperity. Current ways our government regulates the economy

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 All factors of production that go into producing a good or

service Outputs

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.

Interest-money paid to the investor for the use of their money.

Capital Investment 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.