Chapter 1 Five Foundations of Economics

Chapter 1: Five Foundations of Economics What is Economics? ● ● ● Economists study how decisions are made Scarcity: term used to describe the limited nature of society’s resources Economics: the study how individuals and societies allocate their limited resources to satisfy their practically unlimited wants Microeconomics and Macroeconomics ● ● ● Microeconomics: the study of the individual units that make up the economy, such as households and businesses Macroeconomics: study the overall aspects and workings of an economy such as inflation, growth, employment, interest rates, and productivity of the economy ○ Examine government policies regarding the federal budget and money supply, reasons for inflation and unemployment, economic growth, international trade, government borrowing Ex: worker who gets laid off and becomes unemployed ○ Worker and individual → micro ○ Employment is one of the broad areas of concern → macro ○ Because only one worker is laid off, it is a micro issue 5 Foundations of Economics ● ● ● ● ● Incentives Trade-offs Opportunity cost Marginal thinking Trade Creates Value Micro or Macro Issue? ● ● ● ● Statement: The national savings rate is less than 2% of income. ○ Answer: The national savings rate is a statistic based on the average amount each household saves as a percentage of income. As such, it is a broad measure of savings that describe a macroeconomic issue Statement: Maya was laid off from her job and is currently unemployed ○ Answer: Maya’s personal financial circumstances constitute a microeconomic issue, because she is an individual worker Statement: Apple decides to open 100 new stores ○ Answer: Even though Apple is a very large corporation and 100 new stores will create many new jobs, Apple’s decision is a microeconomic issue because it is best understood as part of an individual firm’s competitive strategy Statement: The government passes a job bill designed to stabilize the economy during a recession (an economic downturn) ○ Answer: You may be tempted to ask how many jobs are created, but that information is not relevant to answering this question. The key part of the statement refers to “stabilize the economy during a recession”, which is an example of the government taking an active role in managing the overall workings of the consumer economy. Therefore, it is a macroeconomic issue. Incentives ● ● ● ● ● ● ● In making a decision, you respond to incentives Incentives: factors that motivate you to act or exert effort Positive incentives: encourage action by offering rewards or payments Negative incentives: discourage action by providing undesirable consequences or punishments Direct incentives: ex: if a gas station lowers its price, it will get more customers ○ Easy to recognize ○ Ex: cut my grass and I’ll pay you $30 Indirect incentives: more difficult to recognize ○ When a situation creates an unintended safety net, like where assistance originally meant as a safety net could start to be seen as a permanent source of income Incentives and innovation: patent system and copyright laws guarantee inventors a specific period of time where they have the exclusive right to sell their work ○ Encourages innovation by creating a powerful financial reward for creativity Trade Offs ● ● ● Every decision incurs a cost Economists are the ones who ask: What are the trade offs? Thinking about trade offs mean that we will make more informed decisions about how to utilize our scarce resources Opportunity cost ● ● Trade offs are about having to give something up, and opportunity cost quantifies “what” or “how much” is being given up Opportunity cost: Highest value alternative that must be sacrificed to get something else Marginal Thinking ● ● ● ● Economic thinking: a purposeful evaluation of the available opportunities to make the best decision possible Economic thinkers use marginal analysis to break down decisions into smaller parts The choice is usually between doing more or less of something Marginal thinking requires decision makers to evaluate whether the benefit of one more unit of something is greater than its cost Trade ● ● ● ● Trade: the voluntary exchange of goods and services between 2 or more parties Markets bring buyers and sellers together to exchange goods and services As commerce spread, trade routes developed Circular flow diagram: shows how goods, services, and resources flow through the economy via commerce between households and firms ○ Households: made up of consumers ○ Firms: businesses ○ Households desire the goods and services produced by firms, but firms require the resources owned by households ○ Goods, services, and resources are paid for with funds ○ Resources go into the production of goods and services → sustaining households so they can continue to provide firms with resources ○ Funds are transferred from households’ bank accounts to firms’ accounts as payment ● for goods and services → households as payment for resources Trade creates value: voluntary trade among rational individuals creates value for everyone involved ○ Ex: You need to pick up milk on the way home from class, and you are in a hurry to study. You afre willing to pay up to $5 for the convenience of getting milk fast → at the store, you find that the price $4 and you happily purchase the milk. The ability to buy it for less makes an incentive. If the seller got the milk for $3 from supplier, and you’re willing to pay the $4, the store owner has an incentive to sell → both are better of ○ Comparative advantage: refers to the situation in which an individual, business, or country can produce at a lower opportunity cost than a competitor can ■ Uses the power of specialization ■ Ex: Starbucks specializes in coffee, Honda in cars. You don’t want coffee from Honda ○ By using specialization, global companies and economies create value through increased production and growth ○ Global trade controversy: people losing their jobs to foreigners because they can be highered at a lower cost