Economics comes from the Greek word “oikonemikos” meaning household managementOikos= meaning householdNem= meaning management

Economics is the study of how society manages its scarce resources. Economists study how people make decisions: how much they work, what they buy, how much they save, and how they invest their savings.We have limitless wants and needs, and we have limited resources to fill those wants and needs.

Economics is about solving the problem of scarcity.

Macroeconomics: the study of the economy-wide phenomena, including inflation, unemployment, and economic growth

Microeconomics: the study of how households and firms make decisions and how they interact in markets

Everything involves choices. There is not a situation where we HAD to do something. In the reading, a boy misses the bus so he Had to come in late… Being late is a choice. You could set two alarms, you could force your parents to take you, or you could camp out at school, or stay up all night to make sure you were on time.

Not that you should, but there are many options for your decisions. And everything is just that… a decision or a choice.

If you don’t something, you must have thought the costs don’t outweigh the benefits.

We have to look at the cost of something.Economists look at the opportunity cost: an individual’s second best choice.

We also have to look at incentives. People respond to incentives in predictable ways. (Monetary and personal satisfaction)

In the reading, it’s not that the price of Babysitting is so high because the teenagers are Greedy. Kids do a lot more after school than ever before; they have more options than babysitting. Parents have to give incentives that would attract teenagers to baby-sit. The incentives have to be adequate enough to compensate teenagers for the opportunity costs.

People also take in their consideration the consequences for their choices.

Opportunity cost: you forgo the opportunity of something elseBecause resources are scarce, not everyone can have an endless supply of everything. We have to weight the costs and the benefits of alternative choices in a course of action.

The cost of something is the benefits of the next best option.

The cost of going to college after high school is the amount of potential salary that would have been earned if directly entering the work force.

Opportunity cost is the value we place on leisure time that we incur when we devote our time to work, that is why some firms pay large wages as an incentive for us to devote time to work-related activities

TANSTAAFL: There ain’t no such thing as a free lunchNothing is free. The cost of it is the opportunity cost.

Opportunity Cost/Scarcity T-Chart

We have to made decisions based on the marginThe marginal cost, of an extra something or additional cost

1. Should you attend school for another year or not?2. Should you add fries to that fast-food meal?3. Should a firm increase or decrease output?4. Should government increase or decrease military spending?

Introduction to PPF CurvesProduction Possibilities Frontier Curve (PPF or PPC)

The PPF Curve shows combinations of output that the economy can possibly produce. It shows alternative ways to use an economy’s resources.

Resources: Factors of Production (land, labor and capital, and entrepreneurs)The economy can produce any combination on or inside the frontier. Points outside the frontier are not feasible given the economy’s resources.

Here is a classic example of the different types of combinations that government can choose from when deciding on funding national security or domestic programs.

Guns vs. ButterPPF Curves also show opportunity cost as a quantity of goods lost.

(Lined notebook page)

Any point on the line represents a point at which the country is using all of its resources to produce a maximum combination of those two products

EXAMPLE:Lets say cookies and cake call for the exact same ingredients

Points on the line are possible with the amount of resources in the economy. Points on the PPF represent the economy working at its most efficient (using resources in such a way as to maximize the production of goods and services) level of production.

Points outside the frontier are not possible because resources are scarce. The economy does not have enough factors of production to support that level of output.

Points inside the curve, not on the line itself, are indications of underutilization of resources in the economy. This means that we using fewer resources that the economy is capable of using. It is a waste of resources. It is inefficient.

Remember: The slope (steepness) of the Production Possibilities Frontier shows opportunity cost in numerical terms.

There are also different shapes of PPF Curves that reflect different opportunity cost: constant, increasing, and zero.

Law of increasing OP: the more of a product that is produced, the greater the opportunity cost

The PPF Curve reflects the country’s current production possibilities as if the country’s resources were frozen.

Ceteris Paribus (“all else equal” in Latin) this is the possible production.

If the quality or quantity of resources changes then the PPF curve will change.

Lets say that we have a production possibilities curve that shows the possible output of computers and cars. If there is an economic advance in the computer industry (say a robot that can make computers faster) the PPF Curve will shift outwards.

Increasing the number of computers and cars the economy can produce.

If you can make computers faster you are going to produce more. But the whole curve is not going to shift outward, just the computer side. It’s going to rotate. When the curve shifts, the economy can make more computers for any given number of cars

Because of this economic growth, society might move production from point A to point E.

Vice versa, lets say that the country’s capacity decreases because of decrease of the quality or quantity of resources, the curve shifts leftward.

EXAMPLE:There is a huge plague and half of a society’s population dies. There is less labor to employ and therefore less production.

Unlike our last problem where only computers where only computers shifted, since this plague effected everyone, the whole society is effected, shifting the entire PPF Curve to the left.

Land, Labor, Capital, and Entrepreneurship

These are resources a society uses to produce goods and services. They are the inputs used to produce goods and services (which are the outputs).Land can be exactly that or it can be the space for rent in a strip center. Someone owns that land and is renting it out to firms. Labor is the people.Capital is the equipment and structures used to produce goods and services.

Example: a FarmThe Factors of Production or inputs or resources are:Land: the farmland itselfLabor: the people who work the farmlandCapital: the Tractors, Mills, the crop dusters rakes, shovels, hoes, whatever equipment is used.Entrepreneurship: the People or person that pays for all the inputs, invests in the farm.

Today we are going to be talking about another model. The past few days we have been talking about the Production Possibilities Frontier Curve, but today we are going to study the Circular Flow Model.

To understand how the economy works, we must find some ways to simplify our thinking about all these activities.

Trade, Exchange, and InterdependenceDivision of Labor and Specialization

The division of labor refers to the practice that the tasks of producing a good or service are divided up into separate tasks. When workers focus on performing separate tasks, specialization occurs.

Within a company, for example, there are typically workers who specialize in buying supplies, different aspects of production, future planning, paying bills and taxes, collecting sales revenue, hiring and managing workers, and many other categories.

Within the economy as a whole, the division of labor explains why even if you make your own bread, you typically don’t grow your own wheat, grind it into flour, build your own oven, and make your own bread pans and so on.

Instead people specialized in a few skills and then take the wages that they earn from those skills to purchase the other goods and services that they desire from other specialists. In this way, the division of labor and specialization is the basis for an economy to exist.

Adam Smith started the Wealth of Nations with a discussion of the division of labor as the basis for understanding how an economy works. He identified 3 reasons why the division of labor increases output:

1. Workers who specialize on one job become much better at doing it2. With specialization, the time that it would take to switch between jobs is eliminated3. Workers who specialize on one job often invent more effective ways or new machines for doing

the job.

But as Adam Smith makes clear, specialization is possible only when people are able to coordinate their production and consumption decisions with each other.

And before Adam Smith, Plato said that people are naturally unequal to one another because of1. The social class/status you are born in2. Ability

Because of this there are specialization and the division of labor.

People do what they are good at and rely on other people to provide their needs.

This binds people in a mutual interdependence

BENEFITS OF TRADE; COMPARATIVE ADVANTAGE

On Friday we talked about specialization. Specialization occurs when producers-either individuals or nations-decide to produce only certain goods and services, rather than producing all the goods and services they need. Specialization is determined by a nation’s natural resources and by its human and physical capital (or basically its factors of production).

But what if you lived in a country with an abundance of resources, including a rich natural environment, a well-educated work force, and the latest technology?

In theory, it sounds like this type of country could produce almost all that it needs by itself.

Although, self-sufficiency may sound appealing, it actually is better for countries to specialize in some products and trade for others.

In the video it spoke about comparative advantage. But to understand comparative advantage we must understand absolute advantage.

Absolute advantage: is when a person or nation can produce more of a given product using a given amount of resources.

T-Shirts per Hour Chairs per HourDavid 6 2John 1 1

David has an absolute advantage over John in producing both goods. Would David be better off if he specialized in either T-Shirts or Chairs? What should John produce: T-shirts, Chairs, or both?

The answer to these questions lies with the concept of comparative advantage.

Early in the 19th century, David Richardo argued that the key to determining which country should produce which goods is opportunity cost.

The nation that has the lower opportunity cost in producing a certain good has a comparative advantage in producing that good.

A country has a Comparative Advantage in the product that it can produce most efficiently given all the products it could choose to produce.

The Law of Comparative Advantage states: a nation is better off when it produces goods and services for which it has a comparative advantage.

So let’s look at the opportunity cost for David and John. In an hour, David can make either 6 t-shirts or 2 chairs. Therefore he sacrifices 3 t-shirts for every Chair he produces. In other words, the opportunity cost of a Chair is 3 t-shirts he could have produced instead. Conversely, the opportunity cost of a T-shirt is 1/3 of a Chair.

John sacrifices only 1 t-shirt for every Chair. His opportunity cost for a Chair is the 1 t-shirt that he could have produced instead.

Each person should produce the good for which he or she has a comparative advantage: that is, a lower opportunity cost than another person.

Opportunity cost of a T-shirt

Opportunity cost of a Chair

David 1/3 Chair 3 T-shirtsJohn 1 Chair 1 t-shirt

Who has the lowest opportunity cost for T-shirts? David does with only 1/3 of a chair.Who has the lowest opportunity cost for Chairs? John does with only 1 T-shirt.

Knowing that, David should Specialize in T-shirts and John should specialize in Chairs because they have a lower opportunity cost than the other in that product.

Here is another Example:Tiger Woods spends a lot of time walking around on grass. One of the most talented golfers of all time, he can hit a drive and sink a putt in a way that most casual golfers only dream of doing. Most likely, he is talented at other activities too. For example, let’s imagine that Woods can mow his lawn faster than anyone else. But just because he can mow his lawn fast, does that mean he should?

To answer this question, we can use the concepts of opportunity cost and comparative advantage. Let’s say that Woods can mow his lawn in 2 hours. In that same 2 hours, he could film a television commercial for Nike and earn $10,000. By contrast, Forest Gump, the boy next door, can mow Wood’s lawn in 4 hours. In that same 4 hours, he could work at McDonald’s and earn $20.

Hours to mow a lawn Money made during that timeTiger Woods 2 $10,000Forest Gump 4 $20

In this example, Woods opportunity cost of mowing the lawn in $10,000 and Forrest’s opportunity cost is $20. Woods has an absolute advantage in mowing lawns because he can do the work in less time. Yet Forrest has a comparative advantage in mowing lawns because he has the lower opportunity cost.

The gains from trade in this example are tremendous. Rather than mowing his own lawn, Woods should make the commercial and hire Forrest to mow the lawn.

Many people often think that trade is a zero-sum game: for every winner there must be a loser. The beauty of trade, and one of the most important points to get across is economics, is that trade is a win-win situation. Both parties involved must stand to gain, or they would not engage in voluntary trade.

An example of involuntary trade would be paying taxes. Most people rather not. Involuntary trade hints at some forced situation… like jail time if you don’t pay taxes… or a mob guy taking a bat to your knees if you don’t pay. That would be involuntary trade.

Economic reasoning required that people weigh costs and benefits of actions when they make decisions.

This next activity enables you guys to discover the benefits of specializing according to comparative advantage and to apply these concepts to international trade. You will also be able to evaluate why a

person with absolute advantage in producing 2 services can nonetheless benefit from voluntary trade. Lastly, you will be able to identify winners and losers from free trade and restricted trade.

Many people argue that governments should regulate trade in order to protect certain industries and jobs from foreign competition. Most countries have some form of trade barriers that hinder free trade.

Trade Barriers: or trade restriction, is a means of preventing a foreign product or service form freely entering a nation’s territory. There are 3 common trade barriers:

1. Import Quotas:a. An import quota is a limit on the amount of a good that can be importedb. Example: the U.S. limits the amount of raw (unprocessed) cotton coming into the country

from other nations to protect the cotton industry here.2. Voluntary Export Restraints:

a. Or VER is a self imposed limitation on the number of products that are shipped to a particular country.

b. Under a VER, a country voluntarily decreases its exports in an attempt to reduce the chances that the importing country will set up trade barriers.

3. Tariffs:a. A tax on imported goods like foreign steel and foreign-made cars

i. Like a customs duty, some stores are “duty free”

There are obviously some effects of trade barriers on a nation’s economy, some negative some positive.1. Increased prices for foreign goods (because of these tariffs)2. Trade wars: a cycle of increasing trade restrictions

a. When one country restricts imports, its trading partner may impose its own restrictions against the first country. Trade wars often lead to substantial decrease in trade for both countries. This hurts both trading partners.

b. Some tariffs that lead to trade wars that have negatively affected the U.S. economy are:i. Smoot-Hawley Tariff of 1930ii. Chicken Tariff of 1963

iii. Pasta Tariff of 1985iv. Beef War of 1999

So why do countries have trade barriers if it can end up hurting the economy? PROTECTIONISMProtectionism is the use to trade barriers to protect a nation’s industries from foreign competition. These include protecting worker’s jobs, protecting infant industries (which is just a nickname for a new industry), and safeguarding national security.

Many economists argue that free trade is the best way to pursue comparative advantage, raise general living standards, and further international peace. Recent trends favor lowering trade barriers and increasing free trade.

In increase free trade, a number of international free trade agreements have been developed.An international free trade agreement is an agreement that results from cooperation between at least 2 countries to reduce trade barriers and tariffs and to trade with each other.

In 1948, GATT, the General Agreement on Tariffs and Trade, was established to recue tariffs and expand world trade. The World Trade Organization (WTO) was founded in 1995 to ensure compliance with GATT, to negotiate new trade agreements, and to resolve trade dispute.

The WTO is a worldwide organization whose goal is freer global trade and lower tariffs.

The WTO also acts as a referee, enforcing the rules agreed upon by the member countries.

The European Union (EU): a regional trade organization make up of European nationsThis is a custom union that agrees to abolish tariffs and trade restrictions among union members and to adopt uniform tariffs for nonmember countries.

In 2002, 11 members of EU replaced their individual currencies with a single currency called the Euro

In other parts of the world, countries have developed free-trade zones.Free-trade zones: is a region where a group of countries agrees to reduce or eliminate trade

barriers.NAFTA is an example of that.

NAFTA (the North American Free Trade Agreement) will eliminate all tariffs and other trade barriers between Canada, Mexico, and the United States by 2009. The resulting free-trade zone is the largest in the world.

There has always been a great deal of controversy surrounding NAFTA.Opponents worry that American factories would relocate to Mexico, where wages were lower and government regulation, such as environmental controls, were less strict. The result would be a loss of jobs in the US.

Supporters of NAFTA claimed that the measure would instead create more jobs in the US as a result of increased exports to Mexico and Canada.

The result is that some jobs were created but an almost equal number of jobs had been eliminated. On the other hand, trade between Mexico, the US, and Canada had increased significantly.

Exchange rate is the value of a foreign nation’s currency in terms of the home nation’s currency.When the value of a currency increases it is called appreciation.When the value of a currency decreases it is called depreciation.

A country can have a fixed exchange rate system or a flexible exchange rate system1. Fixed exchange rate: a currency system in which governments try to keep the values of their

currencies constant against one another.2. Flexible exchange rate: a currency system that allows the exchange rate to be determined by

supply and demand of the currency.Balance of Trade:

The relationship between a nation’s imports and its exports 1. Trade Surplus: the result of a nation exporting more than it imports2. Trade Deficit: the result of a nation importing more than it exports

a. We have had a trade deficit since the mid 1970’s (because OPEC was formed and raised the price of oil)

DEMAND:Okay, let’s look at the quantity demanded of a particular good: ice cream

The quantity demanded of any good is the amount of the good that buyers are willing and able to purchase. Many things determine the quantity demanded of any good, but when analyzing how markets work, one determinate plays a central role- the price of a good.

If you went to cold stone and a scoop of ice cream cost $20 you would buy less ice cream. You might buy go to TCBY and buy frozen yogurt instead. If the price of a scoop then fell to 50 cents per scoop you’d buy more.

Because the quantity demanded falls as the price rises and rises as the price falls. We say that the quantity demanded is negatively related to the price

The price of a good and the quantity demanded of a good is negatively correlated or inversely related.

This relationship is true for most goods This relationship is so persuasive that economists call it the law of demand, saying: Ceteris Paribus, or other things equal, when the price of a good rises, the quantity demanded of the good falls, when the price falls, the quantity demanded rises.

Here is a Demand Schedule for Ice Cream

A demand schedule: a table that shows the relationship between the price of a good and the quantity demanded.The demand curves illustrates the information that the demand schedule showsThe demand curve is a graph of the relationship between the price of a good and the quantity demanded.

A downward-sloping line

Price of Ice-Cream Cone

Quantity of Cones Demanded

$0.00 12$0.50 10$1.00 8$1.50 6$2.00 4$2.50 2$3.00 0

So when the ice cream is free, a person will demand 12 cones. The reason the quantity demanded is 12 and not an infinite amount is because our stomachs will only hold so many ice cream cones.

When the price is 50 cents, 10 cones will be demanded.

Plot these points on a graph.

This shows an individual’s demand for ice cream. Some people might like ice cream more than others and will demand a higher quantity at every price.

But to analyze how markets work, we need to determine the Market Demand: which is the sum of all individual demands for a particular good or service.

So far our discussion of demand was qualitative, not quantitative. We’ve discussed the direction in which the quantity demanded moves, but not the size of the change.

To measure how much consumers respond to changes in these variables, economists use the concept of elasticity.

Elasticity: is a measure of the responsiveness of quantity demanded or the measure of how consumers react to a change in price.

Demand for a good is said to be elastic if the quantity demanded responds substantially to changes in price.

Demand for a good is said to be inelastic if the quantity demanded responds only slightly to changes in the price.

The price elasticity of demand for any good measures how willing consumers are to move away from the good as its price rises

There are several factors that can determine the price elasticity of demand of a product1. Availability of Close Substitutes:

a. Goods with close substitutes tend to have more elastic demand b/c it is easier for consumers to switch from that good to others.

i. Example: butter and margarine2. Necessities versus Luxuries

a. Necessities tend to have an inelastic demand, where as luxuries have elastic demand.

i. Necessities like insulin (if you are diabetic) are still needed at any priceii. Luxuries like Starbucks, Sailboats, IMAX movies are not needed and the as

the prices of these things rises the quantity demanded for them falls substantially.

3. Taxes/Subsidiesa. A government can reduce the supply of a good by placing certain taxes on the

item (like an excise tax)b. A government can also increase the supply of a good by subsiding (a government

payment or loan) that supports a certain firm.i. This happens a lot to farmers

4. Definition of the Marketa. Narrowly defined markets (specific markets) tend to be more elastic than broadly

defined marketsi. Example: Food, a very broad market, lots of goods fall under the title of

“food”, has an inelastic demand because there are no good substitutes for food. But, Vanilla Ice Cream, a very narrow category has a very elastic demand because other flavors of ice cream are almost perfect substitutes for vanilla.

5. Time Horizon: Goods tend to have more elastic demand over long time periods.a. When the price of gas rises, the Quantity of gas demanded falls slightly in the first

few months… But in the long run people tend to buy more fuel efficient cars,

move closer to work, and switch to public transportation and therefore in several years the quantity of gas demanded falls substantially.

Price elasticity of demand: a measure of how much the quantity demanded of a good responds to a change in the price of that good;The price elasticity of demand is equal to the percentage change in quantity demanded over the percentage change in price.

Price elasticity of demand = Percentage change in quantity demandedPercentage change in price

To Calculate Percentage change = Original number – new number x 100 Original Number

EXAMPLE: Suppose that a 10% increase in the price of an ice cream cone causes the amount of ice cream you buy to fall by 20%. We calculate your elasticity of demand as

20 percent/10 percent = 2There is also income elasticity of demand: which measures how the quantity demanded changes as consumers income changes. Income Elasticity of Demand = % change in QD / % change in income

When Price Elasticity= 0Perfectly Inelastic Demand

When Price Elasticity = less than 1Inelastic Demand

When Price Elasticity = 1Unit Elastic Demand

When Price Elasticity = Greater than 1Elastic Demand

When Price Elasticity = InfinityPerfectly Elastic Demand

So far we’ve only been focusing on the Demand curve of the Supply and Demand Graph and examining the behavior of consumers.Today we are going to turn our attention to the other side of the market and examine the behavior of sellers.

We know what quantity demanded is… let’s look at quantity supplied.

Quantity Supplied is the amount of a good that sellers are willing and able to sell.There are many factors that determine the quantity supplied, but once again price plays a special

role.

When the price of ice cream is high, selling ice cream is profitable, and so the quantity supplied is large.

When the price of ice cream is low, selling ice cream is less profitable, and so sellers produce less ice cream.

Because the Quantity supplied rises as price rises and falls as the price falls, we say that the quantity supplied is positively related to the price of the good.

This relationship is called the Law of Supply: ceteris paribus, other things equal, when the price of a good rises, the quantity supplied of the good also rises, and when the price falls, the quantity supplied falls as well.

Let’s look at a supply schedule: a table that shows the relationship between the price of a good and the quantity supplied.

When you graph the information on the supply schedule, it’s called the supply curve: a graph of the relationship between the price of a good and the quantity supplied.

Price of Ice Cream Cone

Quantity of Cones Demanded from

Sellers$0.00 0 $0.50 0$1.00 1$1.50 2$2.00 3$2.50 4$3.00 5

Graph it using graph paper projected onto the white board… This upward sloping curve is called the supply curve.At the prices of free and 50 cents there aren’t going to be any ice cream sellers because they aren’t making any profit from selling ice cream. But as the price rises, the sellers are going to be incised from the increase of profit and demand ice cream so they can “get in on the ice cream action”Also, like demand, Market supply is the sum of individual’s supplies.

And also like demand, there are factors that can Shift the Supply Curve:1. Input Prices

a. In the ice cream selling business, sellers need inputs like cream, sugar, ice, ice cream machines, a building or ice cream truck, labor.

b. If one or more of the prices of inputs rises, producing ice cream becomes less profitable and firms supply less ice cream.

i. If inputs rise too much, then a firm might shut down, producing no ice cream at all

2. Technologya. If a machine comes out that reduces the amount of labor required, this will reduce

the firm’s costs since they had to pay labor wages, and they don’t have to pay the robot any wages.

b. This advance in technology raises the supply of ice cream3. Expectations

a. If a firm expects the prices of ice cream to rise in the future, it will put some of its current production into storage and supply less to the market today.

4. Number of Sellersa. If there are a lot of sellers, then a lot of supplyIf there are very little sellers, then very little supply

Price Elasticity of Supply is a measure of how much the quantity supplied of a good responds to a change in the price of that good, computed as

Price Elasticity of Supply = Percentage Change in Quantity SuppliedPercentage Change in Price

Remember thatTo Calculate Percentage change = Original number – new number x 100

Original Number

The labels elastic, inelastic, and unitary elastic represent the same values of elasticity of supply as those of elasticity of demand.

Where supply of a good is said to be elastic if the quantity supplied responds substantially to changes in price.

And where Supply of a good is said to be inelastic if the quantity supplied responds only slightly to changes in price.

Examples of inelastic supply: Beachfront land because it is almost impossible to produce more of itExamples of elastic supply: Books, Cars, and Televisions because the firms that produce them can run their factories longer in response to a higher price.

Supply is more elastic in the long run because firms cannot easily change the size of their factories to make more or less of a good. Therefore, in the short run quantity supplied is not very responsive to the price of a good.

Elasticity = 0 (perfectly inelastic)

Elasticity < 1 (Inelastic Supply)

Elasticity = 1 (Unit Elastic)

Elasticity > 1 (Elastic)

Elasticity = infinity (Perfectly elastic)

So using what we know lets Combine Supply and Demand onto one graph.The Demand Curve is negatively sloping.The Supply Curve is positively slopingPrice goes on the Y-axisQuantity goes on the X-axisWith 0 at the origin

All graphs that you draw need to be properly labeled all the time or it is wrong, you need to get in the habit now, because the next exam will not be all multiple-choice like the last one was.

Where the Demand Curve and the Supply curve intersect is called the Equilibrium.

Equilibrium: a situation in which the price has reached the level where the quantity supplied equals the quantity demanded. (Noted by an *)

Equilibrium Price: the price that balances quantity demanded and quantity supplied.Equilibrium Quantity: the quantity supplied and the quantity demanded at the equilibrium price.

At the equilibrium price, the quantity of goods that buyers are willing and able to buy exactly balances the quantity that sellers are willing and able to sell.

Here the equilibrium price is $2: At this price, 7 ice cream cones are supplied and 7 ice cream cones are demanded.

P

2.00

7 Q

When the price is above the equilibrium price it creates a surplusWhen the price is below the equilibrium price it creates a shortage

The law of supply and demand states that the price of any good adjusts to bring the quantity supplied and the quantity demanded for that good into balance.

So far all of our examples of supply and demand, we have been talking about a purely competitive market where there is no government intervention in economics. That doesn’t mean that there is no government, only that the government doesn’t intervene in the economy. Everything is being lead by the invisible hands (purely competitive).

In a democratic economy we have government intervention. One way that government intervenes is when they control prices by setting them in the market.

Because buyers of any good want a lower price while sellers want a higher price, the interests of the two groups’ conflict. Therefore the government comes in and sets prices.

The government can impose a price ceiling or a price floor.

A price ceiling is a legal maximum on the price at which a good can be sold.A good or service cannot be sold at a price that is higher than the price ceiling.

A price floor is a legal minimum on the price at which a good can be sold.A good or service cannot be sold at a price that is lower than the price floor.

Price Ceiling is not binding if set above the equilibrium. Because the forces of supply and demand balances supply and demand at the equilibrium.. The ceiling will have no effect if set above the equilibrium.

When the equilibrium price is above the Price Ceiling, the ceiling is a binding constraint on the market. The forces of supply and demand tend to move the price toward the equilibrium price, but when the market price hits the ceiling, it can rise no further. Therefore a Price Ceiling that is binding is set below the Equilibrium price.

When the government imposes a binding price ceiling on a competitive market, a shortage of the good arises, and sellers must ration the scarce goods among the large number of potential buyers.

The government places price ceilings on some goods that are considered “essential” and might become too expensive for some consumers w/o ceilings.

Example: Rent Control: a price ceiling on rentIt keeps the prices of rent down so that low income families can afford apartment living. It creates a shortage of apartments

Rent control helps some people but it also creates a housing market with fewer, less desirable homes b/c landlords have difficulty earning profit.

If Price Ceilings are set below the equilibrium price, then Price Floors are set above the equilibrium price.

An example of a Price Ceiling is Minimum wage: which sets a minimum price that an employer can pay a worker for an hour of labor.

If the minimum wage is below the equilibrium rate, it will have no effect b/c employers would have to pay at least the equilibrium rate anyways to find workers.If the minimum wage is set above the market equilibrium wage rate, the result is a decrease in employment.With a price floor, like minimum wage, there is an excess of workers looking for work than there are employers willing and able to hire.

We’ve been talking about choices, well a society makes choices every day. Society makes choices because resources are scarce.

Because resources are limited, every society must answer three key economic questions:

1. What goods and services should be produced?1. When looking at our PPF curve.. What goods should be produced? Guns or

butter? Should we produce domestic goods or devote our resources to national defense?

2. How should these goods and services be produced?1. What kind of energy should be used to produce our goods and services. Should

it be the mom and pop stores or the large corporate chains? How much capital should we use? Labor? Land?

3. Who consumes these goods and services?1. Who gets to eat a steak and who has to eat ramin noodles? Who gets to drive a

Ferrari and who gets to drive the Pinto? Who gets to have a 60 inch plasma TV and who gets to have a black and white TV that turns on with a knob? Who gets to have the new iphone, and who has to use the payphone?

Another choice that we have to answer, and is different to everyone, is where should we sit on the Economic Spectrum? (4th Period: We talked about this on Friday)

Ever heard of someone saying “left wing” and “right wing”?

This spectrum is what they are referring to:Where Left is Pure Command Government Answers QuestionsWhere Right is Pure Markets Forces Answers Questions

The US system:Democrats and liberals are LeftRepublicans and Conservatives are Right

There are different economic systems around the world, some in use, some not. These different systems reflect the different prioritization of economic goals.These different types of economic systems are reflecting different answers to the 3 Economic Questions.

1. Traditional economy: an economic system that relies on habit, custom, or ritual to decide questions of production and consumption of goods and services.

1. This revolves around the family. Work is usually divided on gender lines. Boys will follow in their fathers footsteps and girls, their mother's.

2. This system usually stays in communities that are rather small than large.3. Agriculture and hunting practices usually lie at the heart of the people's lives,

laws, and religious beliefs. 4. Slow to adopt new technology and ideas, lack modern conveniences, and have a

low standard of living.

2. Market Economies: Economic system in which decisions on production and consumption of goods and services are based on voluntary exchange in markets.

1. Free markets, capitalism 

3. Command Economies: and Economic system in which the central government makes all decisions on the production and consumption of goods and services.

1. The centrally planned government alone makes all the decisions on how to answer all three key economic questions

4. Mixed economies: Market-based economic system with limited government involvement.

Most Economies today are some form of Mixed Economies,

Economies that are either one side of the spectrum or another usually do not last. Positive statement: claims that attempt to describe the world as it is.

Free EnterpriseDemocraticSocialism

Authoritative SocialismCommunism

They are descriptive statements. Making a claim about how the world works. Speaking like a scientist. Example: Minimum-wage laws cause unemployment.Speaking in an objective way using Facts

Normative statement: claims that attempt to prescribe how the world should be.Making a claim about how the world ought to be. Speaking like a policy advisor.

Example: The government should raise minimum-wage.Using words like “should” or “shouldn’t” or “ought to” or “not ought to”Speaking in a subjective way using opinions

Let’s Switch Gears:

Yesterday we talked about Free Enterprise, being on the far right of the economic spectrum where Pure Market Forces answer the questions of “what, how, and who”

There is no government involvement.

The Leader in Free Enterprise was a man named Adam Smith, who lived from 1723-1790. If you asked anybody who knows anything about Economics “who is the father of modern economics” they are probably going to say Adam Smith. He wrote a little book called An Inquiry into the Nature and Causes of the Wealth of Nations. Which is usually just called “The Wealth of Nations” It was published in 1776.

Does the year 1776 ring a bell?1776 is the same year that American Revolutionaries signed the Declaration of

Independence. The two documents share the same view of the government role. Both believed that individuals are usually best left to their own devices, w/o the heavy hand of government guiding their actions

Adam Smith called for restricting the role of the government in the economy. He believed in the policy of “laissez faire” meaning let it be or let them do as they please. Individuals left alone to try to better themselves will produce a multiplication or riches: more jobs and more goods and services.

Adam Smith coined the term “invisible hand” He observed that Households and Firms interacting in markets act as if they are guided by an “invisible hand” that leads them to desirable market outcomes.

He said the invisible hand guides a nation’s resources to their most productive use.

No government interaction. The forces of the invisible hand, meaning the natural course that the markets will run, is the best action.

A firm will stay in business if the firm is needed, if not then not, and that is as simple as that.

Adam Smith was an advocate of Free Enterprise.

The 4 Pillars of Free Enterprise are:

1. Private property- this includes labor and all other resources2. Free pricing - no controls, no government intervention, supply and demand determine

(market determines price)3. Entrepreneurship - few barriers such as license fees, etc. to entice people to be risky4. Competition- firms competing with each other for customers… this competition results in

lower prices for us