Unit 6 Free Market and Role of Government. The existence of competition in a free market

economy ensures individual choice.

Scarcity – The basic economic problem that arises because people have unlimited wants but resources are limited

The government can protect a free market economy by maintaining a stable currency, tax breaks to proprietorships, law and order…

51. How do individuals and governments utilize scarce resources?

Trade Off/Opportunity Costs – A benefit, profit, or value of something that must be given up to acquire or achieve something else.

Factors of Production – Resources required for the production process.Ex. Land, Labor, Capital, Enterprise

Economic Questions:1. What is to be produced? 2. How are the goods to be produced? 3. For whom are the goods produced.

Traditional Economic Systems• The economy is based on custom, the way things have always been done.• low technology development• the “village” takes care of each other• Often a leader and elders make decisions.

Command Economy

• The government controls the economy.• technology use varies according to the

economic system and the country• The government provides the goods and

services it chooses.

Market economy (free market, capitalism, free enterprise)

• The economy is based on supply (producers) and demand (consumers).

• medium to high technology use• Each individual takes care of him/herself• Government stays out of the economy (“laissez-faire)

Characteristics of a market economy• Laissez-faire – government leave business/free enterprise alone, “hands off”

• Invisible hand – the economy will be balanced by competition, profit motive and self interest

• Consumer sovereignty - the consumers and their demand are the driving forces in a market economy

• What consumers purchase is their private property, the goods/services belong to the consumers

Sole Proprietorship

• Sole Proprietorship– a business owned and operated by a single

individual

Advantages of a Sole Proprietorship

• Most popular type of business in the US (75% of businesses)

• Easy to start-up• Least-regulated form of business• Owner gets to keep all profits • Owner has full control of management of the

business

Disadvantages of Sole Proprietorships

• Unlimited Liability (unlimited losses)– Owners are fully and personally responsible for all

of firm’s debts• Limited Life– “dies” when the owner retires or closes the

business

Partnerships

• Partnership– A business owned and managed by two or more

people

Partnerships

• Advantages– Able to raise more

money than a sole proprietor

– Owners are able to specialize

• Disadvantages– Require articles of

partnership– Unlimited liability– (unlimited losses)– Potential for conflict

Corporations

• Corporation– A legal entity, owned by individual stockholders

who face limited liability for firm’s debts

“A legal entity…”

• To start a corporation, must create a legal charter to describe business

• Corporations have legal identities separate from that of their owners

• Corporations function in many ways like individuals– Pay taxes– Sign contracts– Can sue others and be sued

“…owned by individual stockholders…”

• Stock – certificate of ownership• Stockholder(s) are the owner(s)• Stockholder(s) elect leaders of the company• Money from stock is used to start-up and run

the corporation

“…who face limited liability for the firm’s debts.”

• Limited liability (limited losses/debts, can only lose what you put in, NOT personal assets, personal items)– Only the corporation, not the owners, is

responsible for any debt of the corporation• Stockholders can only lose the amount of

money they have invested in the business

Advantages of Corporations

• Limited liability for owners• Unlimited Life• Ability to raise financial capital through stock• Can grow very large

Disadvantages of Corporations

• Difficult to start-up• Owners/stockholders may have very little say

in management• More government regulation• Higher tax rates

Law of Demand

• When prices goes up the quantity demanded goes down.

• When the price goes down the quantity demanded goes up.

Demand Curve

• ..

Demand Shift Factors

1. Population – more people = more demand2. Income – more money = more demand3. Substitutes – higher price for butter decreases demand for butter

and increases the demand for margarine4. Complements – higher price for peanut butter usually reduces

demand for peanut butter and for jelly5. Tastes and Preferences – more popular = more demand

Demand Shifts

• rise in demand = rise in demand curve to the right. (high demand for turkeys before Thanksgiving)

• drop in demand – lower in demand curve to the left (little demand for turkeys after Thanksgiving).

Law of Supply

• Suppliers will offer more (higher quantity) of a good at a high price

• As price increases, quantity the supplier is willing to supply increases

• Price and quantity supplied go in same direction

Economics choices for the supplier (the producer)

• 1. fixed costs – a cost that will remain fairly constant; the price of rent,

• 2. variable costs – costs that will change, a producer will not pay the same every month; the electricity

• 3. total costs – the fixed costs + the variable costs• 4. marginal costs – the cost of adding one more unit

of production (what is the cost of producing just one more item, one more “baconator” if new employees/machinery must be included in the pricing?)

Supply shifts too!• Cost of Resources (input)• (also called factors of production)– If the price of resources used in production increase,

the supply will decrease– Price of resources decreases, supply increases

• Government Influence (taxation + regulation)– If government limits supply, the supply decreases– If government supports more supply, the supply

increases (ex/ farm subsidies)– If government regulations increase production costs

(environmental regulations EPA, or safety regulations OSHA), supply may decrease

When the supply and demand curves intersect, the market is in equilibrium

Surplus is when there is an excess supply of a product.

Shortage is when the quantity demanded is higher than the available supply

MonopolyHow does competition affect price and output?

1. Only one seller in the market2. Extremely difficult to enter the market3. Produces 1 product4. Doesn’t need to compete5. Full control over price• Examples– Duke Power– Pizza at Wake Forest

Monopolies

• Sometimes called a “market failure”• Full price control• Total market power• Should the government regulate monopolies?

OligopolyHow does competition affect price and output?

1. A few (2-4) sellers in the market2. Difficult to enter the market3. Similar products4. Compete with few other sellers5. Some control over price• Examples– Forsyth and Baptist Hospital– American Car Companies

Competitive MarketHow does competition affect price and output?

1. Large number of sellers2. Easy entry into the market3. Very similar products4. Highly competitive5. Very little price control• Examples– Pizza– Groceries

Monetary policy$$$$$$$$$$$$$$$$$$$$$$$$$$$

• Controlled by the Federal Reserve System• Discount rate– The rate the Federal Reserve Bank (a bank for the

banks) charges a member bank for a loan.• Open market operations– Buying and selling of government bonds

Monetary policy$$$$$$$$$$$$$$$$$$$$$$$

• Loose monetary policy (to help the business cycle expand)– Decrease the discount rate, decreases interest rates– Buy bonds – gives $ to bond holders

• Tight monetary policy (to help the business cycle contract)– Increase the discount rate – increases interest rates, fewer

customers/businesses will borrow $– Sell bonds – takes money from bond holders

Monetary policy$$$$$$$$$$$$$$$$$$$$$$$$$$$

• Loose monetary policy– Creates more money – Long term could cause inflation

• Tight monetary policy– Reduces the money available– Long term could cause unemployment if

consumers stop spending and businesses begin to lay off employees

Fiscal(freaking, federal, fiscal tax me and spend it on you policy)

• Government spending– Spending money on infrastructure (roads, bridges,

dams, flood gates…)– Military, education, Medicare, Social Security– Unemployment, health care

• Government taxes– Progressive income taxes– Excise taxes (gas, alcohol, cigarettes, tanning)

Fiscal(freaking, federal, fiscal tax me and spend it on you policy)

• Loose fiscal policy– Increase government spending– Decrease taxes

• Tight fiscal policy– Decrease government spending– Increase taxes

Fiscal(freaking, federal, fiscal tax me and spend it on you policy)

• Loose fiscal policy effects– More $ for consumers and businesses– Business cycle will expand

• Tight fiscal policy effects– Less $ for consumers and businesses– Business cycle will contract

the business cycle

• ...

trough

expansion

peak

contraction

trough

the business cycle• ...

peak

trough

recession, 6 months of declining GDP

depression, high unemployment, low GDP, low CPI

peak

peak

business cycles, examples

• ...

Two major indicators...

GDP = Gross domestic product= total dollar value of all final goods and services produced in a countryCPI = Consumer Price Index= measure of change in price over time of specific goods/services