Economics Unit 2

Why Did Communism Collapse?Capstone Lesson 6 The Collapse of communism in the USSR

was one of the most important events in the 20th Century

We want to apply economic reasoning to try to explain why

Visual 1 What was the position of the former Soviet Union

for much of the 20th century? The Soviet Union was regarded as one of the two

superpowers. How was the Soviet Union Opposed? In the Cold War and certain “proxy wars,”

including the war in Vietnam, the US and other nations opposed the expansion of communism

What is the Mystery? Why did the Soviet Union collapse?

Visual 2 Speculate as to whether or not these questions are true or false Now Read Activity 1 Now Let’s look back at visual 2 and answer the questions A. True For much of the twentieth century, nearly one-third of

the world’s population lived under communism or socialism B. True The USSR worked form the premise that only

government planners could provide for the overall economic well being of Soviet Society

C. True In a market economy, prices send important information to producers and consumers regarding the relative value of goods and services

D. True In command economies, prices are controlled by the government

Solve the Mystery Soviet authorities assumed that government planners had

superior information, enabling them to make better economic decisions that those made by individuals acting on their own behalf. But it was nearly impossible for government planners to understand local circumstances related to the production and consumption of goods and services. Principle 4.

The Rules of the soviet economic system abolished the incentives that ordinarily encourage producers to respond to consumers. First, most private ownership was abolished. Individuals were no longer allowed to benefit economically from the property they owned or worked. Second, under communism, the government owned businesses, and government managers managed businesses to meet government goals, not to make profits. This discouraged managers from responding to the interests of consumers. Principles 3 and 4

Solve the Mystery continued In any economic system, prices send valuable

messages to individuals and business owners. In a communist system, prices set by the government distorted the information sent to individuals and businesses. As a result, people often made poor decisions, causing waste and environmental damage. Principles 3 and 4

Visual 3

Visual 4 Basic characteristics of a market economy Private Property- Private individuals and groups are

the owners of the means of production including factories, farms, and their own labor.

Freedom of Choice- Businesses are free to decide what products to produce, and they may purchase what they need from suppliers of their choice. Consumers are free to spend or save their income in ways they choose.

Self Interest- People make choices they judge to be in their own interest. Adam Smith argued that in making such decisions people are led by an “invisible hand” to promote the good of society as a whole

Profit Motive- Businesses are free to earn profits. Profits are viewed as rewards earned by those who take the risks involved in producing goods and services for consumers

Markets and Prices- Most exchanges are handled through markets-local, regional, national or international. Market prices are established through the interaction of buyers and sellers. Prices are used to allocate goods and services in the economy.

Competition- Market systems depend on competition to restrain participants as they engage in self-interested behavior. In competitive systems, no one business can control market prices.

Limited Government- Market systems require a limited role for government. The government’s regulatory role is restricted by constitutional or other legal limits. Defining and enacting property rights, however is an important obligation of government in a market system.

Visual 5 Basic characteristics of a command economy Public Ownership- The government is the

owner of the means of production, including factories, farms and so forth.

Centralized Decision Making- A central authority such as a bureau, legislature, or government official makes the fundamental decisions about what and how much will be produced.

Economic Planning- National economic goals are often an important focus. Objectives are established for each sector of the economy. Objectives are fine tuned to provide instructions for each farm, factory or mine.

Allocation by Command- A central authority such as a bureau, legislature or government official makes the fundamental decisions about how goods and services are distributed. Raw materials and labor are assigned to factories, farms and other units of production according to priorities established by government.

Why did communism collapse? Under communism, government was thought to have

superior information, enabling it to make better economic decisions than individuals might make acting on their own behalf. The rules of the economic system abolished the incentives (including private ownership and the profit motive) that encourage producers to respond to consumers. Prices and quantities set by the government distorted the information sent to individuals and businesses.

Markets A place or service that enables buyers and

sellers to exchange goods and services Farmer’s Market, Supermarket, Flea Market

Barter Direct exchange of goods and services

without the use of money In order for barter to work you have to have

what the other wants. If I have an item that I want to trade to you

for another item, you must want what I have

Double coincidence of wants The situation that exists when A has what

B wants and B has what A wants

Transaction Costs The costs involved in making an exchange If we just were to concentrate on making

exchanges through barter without money, we would have very high transaction costs

Relative Price The price of one good expressed in terms of the

price of another good. When people agree to trade or exchange, they must

establish a rate of exchange or a price For example, if a plumber and a doctor agreed to

exchange services they would have to establish the value of one compared to the other. In this case they might agree that one hour of the doctor’s services are equal to three hours of the plumber’s services

Demand The amount of a product that people are

willing and able to purchase at each possible price during a given period of time, everything else held constant

This is what people are willing and able to buy.

Quantity Demanded The amount of a product that people are

willing and able to purchase at a specific price

Key difference demand refers to every price, quantity demanded refers to specific price

Law of Demand The quantity of a well-defined good or service

that people are willing and able to purchase during a particular period of time decreases as the price of that good or service rises and increases as the price falls, everything else held constant.

This states that people are going to demand more at a lower price and demand less at a higher price as long as everything else stays constant.

Demand Schedule A table or list of the

prices and the corresponding quantities demanded of a particular good or service

PriceQuantityDemanded

5 10

4 17

3 26

2 38

1 53

Demand Curve A graph of a demand schedule that

measures price on the vertical axis and quantity demanded on the horizontal axis

Demand Curve All demand curves slope down because of the

law of demand: as price falls, quantity demanded increases vice versa. Everything held constant (with this statement we are assuming that tastes don’t change)

Market Demand Is the sum total of all individual demands

for a particular product. We add together the quantity demanded at

each price not the dollars to determine market demand

Changes in Demand A number of factors may influence the

demand for a product, and changes in one or more of those factors may cause a shift in the demand curve

An increase in demand is shown by a shift of the demand curve up and to the right

A decrease in demand is down by a shift of the demand curve down and to the left.

Increase Decrease

Determinants of Demand Factors other than the price of the good

that influence demand-income, tastes, prices of related goods and services, expectations, and number of buyers.

Income Demand for any good or service depends

on income

Normal Good Goods for which demand increases as income

increases.

Inferior Goods Goods for which demand decreases as income

increases, Ex. Bankruptcy Services, Inexpensive Goods

and Services

Tastes Individual Tastes and preferences have an

effect on demand.

Price of Related Goods If goods that are similar to the ones you sell

go up or down in price, quality etc. that will have an effect on the demand for your goods.

Example. Taco Bell finds that it’s lettuce has e coli poisoning. More people eat at McDonalds

Substitute Goods Goods that can be used in place of each

other; as the price of one rises, the demand for the other rises.

Ex. Fords and Chevy’s, Coal and Oil, Steak and Chicken etc.

Complementary Goods - Goods that are used together as the price

of one rises, the demand for the other falls. Ex. CD players and CDs, DVD players and

DVD’s etc

Future Expectations Future expectations can have an effect on

demand today. What you think you might earn at a later date or if you think an item’s price will rise in the future

Number of Buyers When there are more buyers in a market

place- demand will rise

Changes in Quantity Demanded When the price of a good is the only thing

that changes the quantity demanded changes but the demand curve does not shift.

Supply The amount of a good or service that

producers are willing and able to offer for sale at each possible price during a period of time, everything else held constant.

Quantity Supplied The amount sellers are willing and able to

offer at a given price during a particular period of time, everything else held constant.

Law of Supply The quantity of a well-defined good or

service that producers are willing and able to offer for sale during a particular period of time increases as the price of that good or service increases and decreases as the price decreases, everything else held constant.

Supply Schedule A table or list of

prices and corresponding quantities supplied of a particular good or service

PriceQuantitySupplied

1 12

2 28

3 42

4 52

5 60

Supply Curve A graph of a supply schedule that measures

price on the vertical axis and quantity supplied on the horizontal axis

Market Supply The quantities that each producer supplies at

each price are added together to determine market supply.

Changes in Supply A number of factors may influence the supply

for a product, and changes in one or more of those factors may cause a shift in the supply curve

An increase in supply is shown by a shift of the supply curve down and to the right

A decrease in supply is shown by a shift of the supply curve up and to the left.

Increase Decrease

Determinants of Supply Factors other than the price of the good

that influence supply-prices of resources, technology and productivity, expectations of producers, number of producers, and the prices of related goods and services.

Prices of Resources If labor decreases, one of the resources used

in producing goods, then supply will decrease and vice versa.

Technology and Productivity If resources are used more efficiently in

production, then more of that good can be supplied for the same cost.

Productivity- The quantity of output produced per unit of resource.

Number of Producers When more people produce the supply

increases (supply curve shifts to the right)

Prices of Related Goods and Services If goods that are similar to the ones you

produce change their price your supply will be affected.

McDonalds Burger King

Changes in Quantity Supplied When the price of a good is the only thing

that changes the quantity supplied changes but the supply curve does not shift.

Equilibrium The price where quantity demanded and

quantity supplied are equal.

Disequilibrium A point at which quantity demanded and

quantity supplied are not equal at a particular price

Surplus A quantity supplied that is larger than the quantity

demanded at a given price; it occurs whenever the price is greater than the equilibrium price.

Whenever the price is greater than the equilibrium price, a surplus arises.

Shortage A quantity supplied that is smaller than the quantity demanded at a

given price; it occurs whenever the price is less than the equilibrium price.

Whenever the price is below the equilibrium price, the quantity demanded is greater than the quantity supplied and there is a shortage

Changes in the Equilibrium Price: Demand Shifts This occurs only when the determinants of demand change. If say taste results in a increase in demand, the demand curve will shift to

the right, resulting in a higher equilibrium price and quantity. The opposite could occur as well, an decrease in demand would result in a

lower equilibrium price and quantity.

Changes in Equilibrium Price: Supply Shifts Again focused on changes in the Determinants of Supply The decrease in supply is represented by the leftward shift of the supply

curve. A decrease in supply with no change in demand results in a higher price and a lower quantity. Conversely, an increase in supply would be represented as a rightward shift of the supply curve. An increase in supply with no change in demand would result in a lower price and a higher quantity.

Equilibrium in Reality If not in equilibrium the price and quantities

demanded and supplied change until equilibrium is established.

All items may not reach equilibrium. Ex. Sale items in a store

Price Floor is a situation in which the price is not

allowed to decrease below a certain level. A price floor keeps the price from falling not

rising.

Price Ceiling A situation in which the price is not allowed to rise above a certain

level. Whenever a price ceiling exists a shortage results. A price ceiling is only

effective if it is set below equilibrium price.

Round 1, 2, 3 Visual 1 will help you Sellers must report the price to me Make as many deals as you can in the time

permitted. You can take a loss in order to get a new

transaction card Visual 1 contains useful information

Post Simulation At what price was the silver most frequently sold at

each round? Look at your class tally sheet In which round did the greatest spread in prices

occur? Why did the prices become more clustered in later

rounds? Did Buyers or Sellers determine the final market

price for silver? How did competition within both buyers and sellers

influence price?

Consumer surplus and producer surplus are the main reasons why market economies work better than command economies. In a voluntary market, both buyers and sellers gain.

Complete Activity 3 Use the graph provided to plot your points

and answer the questions provided Visual 2 Review Answers to Activity 3

Answers to Activity 3 A. The lower the price, the more silver people want to buy. The

higher the price, the less silver people want to buy. This is called the law of demand.

B. The lower the price, the less silver people want to sell. The higher the price, the more silver people want to sell. This is called the law of supply.

C. $4.30, 24 ounces D. Hopefully, yes E. Markets don’t work that way. Equilibrium is a tendency.

When there is a temporary surplus, prices fall, when there is a temporary shortage, prices rise. Buyers and sellers are constantly interacting as prices constantly change.

F. Prices were closer to equilibrium as buyers and sellers reacted to their experiences and the information displayed

Review In a market who or what determines the

equilibrium price? The interaction of buyers and sellers Who gains and who loses when people trade

in a market? Both buyers and sellers gain. There are

consumer surpluses and producer surpluses

DemandCapstone Lesson 8 DO NOT COPY JUST LISTEN One day you are shopping with your friends, and you walk

into a small greeting card shop close to school to buy a birthday card for one of your relatives. While you are checking out the cards, you overhear the owner complaining that a certain style of card is not selling, and the display of that card is taking up precious space in the small store. “Unfortunately, I bought these cards up front and they cannot be returned,” he says. “I guess I will just throw them away and use the space for something that has a better chance of selling.” As the store owner looks over to you and your friends, he continues: “I learned in my economics class in high school that a person shouldn’t cry over spilt milk or let costs incurred in the past influence future choices, right?” It becomes obvious that the owner is soliciting a response from you.

Do you support the owner’s view or do you suggest an alternative course of action Possible Answers: The owner is right Lower the price of the cards Put them in a better place in the store Donate the cards to charity Advertise Recycle them

SALE Why do businesses put items on sale? To sell more merchandise To reduce surplus merchandise Avoid throwing items away that may still

have value Increase consumer demand* *Remember a change in price does not

change demand

If the owner puts the cards that weren’t selling on sale, will that be a good way for him to begin solving his problem? Yes, Although the owner can’t change his

decision to buy the cards in the first place, getting something for the cards now is better than getting nothing, so at the very least the decision minimizes loses

SALE When business people put products on sale, they are

attempting to predict consumer behavior. They are predicting that the number of products bought will increase at lower prices. That is not the only possible way to increase sales, of course. If the owner could change his customers’ perception of value for the cards, the customers also would buy more. Changing customers’ perceptions is one of the purposes of marketing through advertising.

Experiment I want to conduct an experiment to see whether these

predictions of consumer behavior are correct. I have a candy bar that I put in my lunch today but

I’ve decided to cut out sugar from my diet starting today.

I don’t want to waste it and think that somebody in here might find some value in consuming it.

I only have one so I want to make sure that the consumer who values it the most gets it, so I am going to conduct an auction

Visual 1

Results Did anyone choose not to bid on the candy bar? Some may see no value others that might not want the candy may just bid

low to sell it. What goes through your mind before a bid is made? A calculation of the value of ownership in comparison to the cost of

buying it-my opportunity cost. Why does a higher price reduce the number of items demanded? Higher prices increase the number and value of alternative uses for the

money. The alternatives may provide more satisfaction for some, and they will stop bidding. Higher prices also reduce an individual’s total purchasing power.

Once a price is established in the market, do you think it stays the same for long periods?

Generally not, because consumer preferences as well as other key variables change, and such changes influence demand. These changing variables actually shift the demand schedule and create a new price quantity relationship.

Graph We can graph this information Visual 2 (Everybody gets a copy) Write Price near the Vertical Axis Write Quantity near the Horizontal axis Enter the quantities demanded Use the demand schedule to plot the points on the

chart Connect the dots Compare yours to mine

Summary of Graph As the price rose, the quantity people were

willing and able to buy declined. As the price fell, the quantity people were

willing and able to buy increased

Demand Sometimes demand for products actually

changes when certain variables change Consumers are influenced by outside factors

such as income, tastes and preferences, price of related products, expectations, and number of buyers

These are the determinants of demand

Change in Demand To show this we are going to have a second auction. I found another candy bar Also I have read a study that says people’s risk of

getting cancer and having a heart attack gets reduced by eating this candy bar.

Also if you don’t have the money you can pay with an IOU

Visual 1

Second Auction Everybody gets a new copy of Graph Look at new schedule and plot your graph How did your buying decision change after you

learned more about chocolate and had an IOU option More students interested, both new variables

increased demand How do the two graphs compare? Different but the relationship will be the same. This

is because a change in the determinants of demand tastes and preferences, price of related goods and income

Shifts in Demand Raise your right hand if demand in this scenario will shift to

the right Raise your left hand if demand in this scenario will shift to

the left The demand for cars when people get a tax refund Right The demand for gasoline today when people expect prices to

fall tomorrow. Left The demand for Ice Cream when the price of Ice Cream

drops. No hands up-this is a change in quantity demanded, not a

demand change

SupplyCapstone Lesson 9 DO NOT COPY LISTEN The owner of a local fast food restaurant is having

trouble hiring workers for the closing shift. Although the closers have a few more responsibilities than other workers, including cleaning, the closing shift often fits best with students’ schedules. The owner of the restaurant doesn’t know what to do. He is angry. He says that “ Young people today are just plain lazy and maybe spoiled too.”

Is the owner right? Are there other explanations of why young

people might not choose to work as closers in the fast food restaurant?

The difficulty of the task Value of other ways to spend time Hanging out with friends Holding better jobs

Being a bat boy might be a better job

Producer Why do producers offer goods and services

for sale? Producers wish to earn money Take pride in producing a good or service Price goes up producers want to sell more,

and vice versa

Law of Supply To understand this better look at yourself as a

producer You produce labor You can sell your labor at the price and to

who you want You probably would want to sell your labor at

a higher price?

Experiment Activity 1 Complete Activity 1 Visual 1 4-5 volunteers What patterns do you observe in the responses on Visual 1? At low rates of pay, the quantity supplied is low. As the rates of pay increase, the

quantity of supplied increases Several students chose not to supply labor at any wage rate. Why? Low wages turn some away, but some value other alternatives so highly that they

refuse to work even at the $100 pay. Some might choose to work less at the $100 pay because they can earn a considerable amount of money at that rate in a short time

What influences your decision to work or not to work? Expected benefits must be equal to or greater than the next best use of my time Why does a higher wage usually increase the number of hours people are willing

to work? Higher wages provide positive incentives to work. These positive incentives

generate benefits greater than the expected value of the next-best alternative Would you predict that a different group of people would fill out the questionnaire

differently People value things differently and consequently make different choices

Graph Record Information on Activity 1 can be

graphed Visual 2 (Everybody Gets one) Place Price on the Vertical Axis Place Quantity on the Horizontal Axis Graph, plot points, draw line (curve)

Law of supply Higher prices higher quantity supplied, lower

prices lower quantity supplied

Determinants of Supply Variables other than price that can shift the supply curve which include

input prices, technology, expectations, number of sellers Activity 2 Why did so many farmers leave farming to go into other

careers? Better alternatives, low market prices for crops, increased

competition from foreign producers, high equipment costs, taxes

When many producers leave a market, what is likely to happen to the quantity produced at any given price?

The quantity will fall, the falling quantity is pictured by a supply curve that has shifted to the left. The supply curve moves on the graph. This shift occurs because one of the determinants of supply has changed. Number of sellers. When a determinant changes the who supply changes

Shifts in Supply Shift to the left raise left hand Shift to the right raise right hand The supply of cars when open trade agreements bring in new

producers. Right The supply of coffee when freezing temperatures hit the

major coffee producing regions in Brazil and Costa Rica Left The supply of lumber when a new computerized saw reduces

the cost of lumber producers Right

EquilibriumCapstone Lesson 10 Is a state of balance between opposing forces It occurs because everywhere else there is a state of imbalance or

disequilibrium Ball in Yankee Stadium Visual 1 What if the market price were $4 There would be a surplus of 800 yo-yos because the quantity demanded is

600 and the quantity supplied is 1,400 How would sellers get rid of the surplus? They would lower the price until all the yo-yos offered for sale were sold.

The lower price is an incentive that increases the quantity demanded but decreases the quantity supplied. All the yo-yos would be sold at $3, the equilibrium price

What if the market price were $2 There would be a shortage of 800 yo-yos. Buyers would demand 800

more yo-yos than sellers are willing to offer at that price

Equilibrium Which buyers will get the yo-yos? The ones who will pay more. The higher price is an incentive

that increases the quantity offered for sale. Once Again, at $3 the number of yo-yos offered for sale in a time period is equal to the number of yo-yos consumers are willing and able to buy.

Only at a price of $3 is the number of yo-yos sellers are willing and able to sell equal to the number consumers are willing and able to buy.

This is why equilibrium price is $3 and equilibrium quantity is 1,000

This is a process where prices, incentives, shortages and surpluses determine an equilibrium or resting place

Prices in equilibrium may not remain so for long. Any change in underlying conditions leads to a new equilibrium

Activity 1 Complete parts A-E Visual 2 (Answers) A. Under these conditions, competitive market forces would tend to establish an

equilibrium price of $3 per Frisbee and an equilibrium quantity of 200 million Frisbees

B. If the price currently prevailing on the market is $4 per Frisbee, buyers would want to buy 150 million Frisbees and sellers would want to sell 250 million Frisbees. Under these conditions, there would be a surplus of 100 million Frisbee. Competitive market forces would tend to cause the price to decrease to a price of $3 per Frisbee.

C. At this new price, buyers would now want to buy 200 million Frisbees, and sellers would now want to sell 200 million Frisbees. Because of this change in price, the quantity demanded changed by 50 million Frisbees, and the quantity supplied changed by 50 million Frisbees.

D. If the price currently prevailing on the market is $2 per Frisbee, buyers would be wiling to buy 250 million Frisbees and sellers would want to sell 150 million Frisbees. Under these conditions, there would be a shortage of 100 million Frisbees. Competitive market forces would tend to cause the price to increase to a price of $3 per Frisbee.

Activity 1 E. At this new price, buyers would now want to buy 200 million Frisbees,

and sellers would now want to sell 200 million Frisbees. Because of this change in price, the quantity demanded change by 50 million Frisbees, and the quantity supplied changed by 50 million Frisbees

F. Under these conditions, competitive market forces would tend to establish an equilibrium price of $4 per Frisbee and an equilibrium quantity of 150 million Frisbees. Compared to the equilibrium price in question A, we say that, because of this change in underlying conditions, the supply changed, and both the equilibrium price and the equilibrium quantity changed. The equilibrium price increased and the equilibrium quantity decreased.

G. Under these conditions, with the supply schedule S1 competitive market forces would tend to establish an equilibrium price of $3 per Frisbee and an equilibrium quantity of 100 million Frisbees. Compared to the equilibrium price in question F, because of this change in underlying conditions, the demand changed. The equilibrium price decreased and the equilibrium quantity decreased.

*Underlying conditions = determinants

Review Why does the price decrease if it is above equilibrium? The quantity for sale is greater than the quantity demanded, so sellers

have an incentive to lower the price. Why does the price increase if it is below equilibrium? At a price below equilibrium, the quantity demanded exceeds the quantity

supplied. Buyers have an incentive to offer a higher price if they want the good.

For each of the following predict the change in equilibrium price of turkeys and explain your prediction

Turkey is called a health food by the US Surgeon General Price increases for Turkey because demand increases and shifts right New technology helps turkeys breed faster Price increases for Turkey because supply increases and shifts right Thanksgiving is abolished Price decreases for Turkey because demand decreases and shifts left