Final Review!Final Review!

What is the study of What is the study of economics?economics? How to meet How to meet unlimited wantsunlimited wants with with

scarce resourcesscarce resources

Economists study how to meet Economists study how to meet people’s unlimited wants with people’s unlimited wants with scarce, available resourcesscarce, available resources

THE FACT THAT WE MUST DEAL THE FACT THAT WE MUST DEAL WITH SCARCITY FORCES US TO WITH SCARCITY FORCES US TO MAKE CHOICES CONSTANTLYMAKE CHOICES CONSTANTLY

Trade-off: the choice that one makes Trade-off: the choice that one makes whenever making economic decisionswhenever making economic decisions

Opportunity cost: the cost of the next Opportunity cost: the cost of the next best alternative when one choice is best alternative when one choice is made, ex) money, time, resources, made, ex) money, time, resources, etc).etc).

Production Production Possibilities FrontierPossibilities Frontier A graphical representation of how A graphical representation of how

an economy makes decisions on an economy makes decisions on what to produce.what to produce.

Production Possibilities Curve Production Possibilities Curve shows the choices a country can shows the choices a country can make with respect to its available make with respect to its available resources.resources.

Production Possibility Production Possibility FrontierFrontier

Production Possibility Production Possibility FrontierFrontier The PPF shows all efficient The PPF shows all efficient

combinations of output, when the combinations of output, when the factors of production are used to their factors of production are used to their full potential. full potential.

As more of one product is produced, As more of one product is produced, increasingly larger amounts of the increasingly larger amounts of the other product must be given up.other product must be given up.

the opportunity cost increases as one the opportunity cost increases as one moves toward either extreme on the moves toward either extreme on the curve of production possibilities.curve of production possibilities.

Tools economists useTools economists use

Economists demonstrate real-Economists demonstrate real-world relationships using world relationships using economic modelseconomic models

Economists use the term Economists use the term efficiencyefficiency to measure marginal to measure marginal costs, and the term costs, and the term productivitproductivity y to measure production levels.to measure production levels.

Know the different Know the different economic systemseconomic systems How do these systems answer the How do these systems answer the

basic economic questions?basic economic questions?

1) What to produce1) What to produce 2) How to produce it?2) How to produce it? 3) For whom to produce?3) For whom to produce?

Traditional EconomiesTraditional Economies 1) What to produce? Whatever 1) What to produce? Whatever

ritual, habit or custom dictatesritual, habit or custom dictates 2) How to produce? However ritual, 2) How to produce? However ritual,

habit or custom dictatehabit or custom dictate 3) For whom to produce? For 3) For whom to produce? For

whomever ritual, habit or custom whomever ritual, habit or custom dictatedictate

Examples: Australian aborigines, the Examples: Australian aborigines, the Mbuti of Central Africa, The InuitMbuti of Central Africa, The Inuit

Command EconomiesCommand Economies

1) What to produce? Whatever the 1) What to produce? Whatever the government says to producegovernment says to produce

2) How to produce? However the 2) How to produce? However the government tells you to producegovernment tells you to produce

3) For whom to produce? For whomever 3) For whom to produce? For whomever the government tells you to produce the government tells you to produce (ideally the entire society)(ideally the entire society)

Examples: Cuba, North KoreaExamples: Cuba, North Korea

Market EconomyMarket Economy Basic economic questions answered by Basic economic questions answered by

consumersconsumers Dollars=VotesDollars=Votes What to produce? Whatever consumers What to produce? Whatever consumers

want (demand)want (demand) How to produce? However business How to produce? However business

owners want, usually at maximum owners want, usually at maximum efficiency (production possibility frontier) efficiency (production possibility frontier) in order to maximize profitsin order to maximize profits

For whom to produce? For whomever will For whom to produce? For whomever will buy itbuy it

Examples of market Examples of market economieseconomies

The U.S. Canada, U.K., France, The U.S. Canada, U.K., France, Germany, etc.Germany, etc.

Remember these aren’t Remember these aren’t completely free market system. completely free market system. There is a level of government There is a level of government control and regulation, thereforecontrol and regulation, therefore: : these are these are MIXED ECONOMIC MIXED ECONOMIC SYSTEMS.SYSTEMS.

The 4 factors of The 4 factors of productionproduction LandLand: Gifts of the earth/Natural : Gifts of the earth/Natural

resources (oil, diamonds, etc.)resources (oil, diamonds, etc.) LaborLabor: people who work: people who work Capital (goods)Capital (goods): The things needed to : The things needed to

produce a good or service (sewing produce a good or service (sewing machine, oven, etc.)machine, oven, etc.)

EntrepreneurEntrepreneur: Risk-taking individual : Risk-taking individual who organizes the other 3 factors of who organizes the other 3 factors of production in order to make a profitproduction in order to make a profit

Law of SupplyLaw of Supply

As Price goes up, quantity will go As Price goes up, quantity will go upup

As Price goes down, quantity goes As Price goes down, quantity goes downdown

Supply Curve Supply Curve Illustrates the Law of Illustrates the Law of SupplySupply

Supply ElasticitySupply Elasticity

Supply can be: Supply can be:

1)1) ElasticElastic

2)2) InelasticInelastic

3)3) Unit ElasticUnit Elastic

Elasticity of SupplyElasticity of Supply Elastic: When price rises, quantity supplied Elastic: When price rises, quantity supplied

rises considerably. Ex: price rises 20% rises considerably. Ex: price rises 20% quantity supplied rises 50% quantity supplied rises 50%

Elasticity of SupplyElasticity of Supply InelasticInelastic: When price rises, quantity supplied : When price rises, quantity supplied

does not rise considerably. Ex: price rises 20% does not rise considerably. Ex: price rises 20% quantity supplied rises 5%quantity supplied rises 5%

Elasticity of SupplyElasticity of Supply

Unit ElasticUnit Elastic: : When price rises, When price rises, quantity supplied rises quantity supplied rises proportionally. Ex: price rises proportionally. Ex: price rises 20% quantity supplied rises 20% quantity supplied rises 20%20%

Law of DemandLaw of Demand

As the price of a product As the price of a product decreases, the demand for the decreases, the demand for the product will increase. This is an product will increase. This is an example of an inverse example of an inverse relationship.relationship.

Demand CurveDemand Curve

ElasticityElasticity

Elastic:Elastic:– As the price for a product decreases As the price for a product decreases

by half, the demand for the product by half, the demand for the product increases 100%. More than increases 100%. More than proportional!proportional!

ElasticityElasticity

InelasticInelastic– As the price for a product increases As the price for a product increases

by 25%, the demand for the product by 25%, the demand for the product decreases by 10%. Less than decreases by 10%. Less than proportional!proportional!

ElasticityElasticity

Unit ElasticUnit Elastic– As the price of the product triples, As the price of the product triples,

the demand for the product the demand for the product decreases by 300%. Proportional!decreases by 300%. Proportional!

If prices were to stay If prices were to stay the same, what then the same, what then

could change demand?could change demand?

ComplimentsCompliments

Compliments are goods that are Compliments are goods that are related. You need to have both in related. You need to have both in order to use themorder to use them

ComplimentsCompliments

If the price of DVD players If the price of DVD players goes down, then the goes down, then the demand for DVD’s goes updemand for DVD’s goes up

If the price of Gillette razor If the price of Gillette razor handles goes up, then the handles goes up, then the demand for the razor blades demand for the razor blades goes downgoes down

SubstitutesSubstitutes

The demand for a product tends The demand for a product tends to decrease if the price of its to decrease if the price of its substitute decreasessubstitute decreases

What are some substitute What are some substitute products? products?

SubstitutesSubstitutes

If the price of butter If the price of butter goes up, then the goes up, then the demand for demand for margarine will go margarine will go up.up.

If the price of sugar If the price of sugar goes up, then the goes up, then the demand for demand for Splenda© will go upSplenda© will go up

Utility & DemandUtility & Demand Utility: The usefulness or satisfaction Utility: The usefulness or satisfaction

one gets from consuming a good or one gets from consuming a good or service service (one slice of pizza is good)(one slice of pizza is good)

Marginal utility: The extra Marginal utility: The extra usefulness or satisfaction one gets usefulness or satisfaction one gets from consuming a good or service from consuming a good or service (two slices of pizza is better)(two slices of pizza is better)

Diminishing marginal utility: the Diminishing marginal utility: the more we consume of something, the more we consume of something, the less satisfying or useful it becomes less satisfying or useful it becomes (eating an entire pizza makes one (eating an entire pizza makes one feel sick)feel sick)

Supply & Demand Supply & Demand CurvesCurves

S1S1

ee

PricePrice D1D1

QuantityQuantity

PricePrice

Who gets to set prices in a Who gets to set prices in a market economy?market economy?– Consumers AND producers – prices Consumers AND producers – prices

are the result of competition are the result of competition between buyers and sellersbetween buyers and sellers

Circular Flow of Economic ActivityCircular Flow of Economic Activity

Factor Market

Producer

Product Market

Consumer

Goods &Services

LandLaborCapital

Land, Labor, Capital

Goods&Services

$$$$$

$$$$$$$

$$$$$

$$$$$$$$$

Businesses may be Businesses may be organized in a variety of organized in a variety of waysways 1) Sole Proprietorship1) Sole Proprietorship 2) Partnership2) Partnership 3) Corporation3) Corporation

Sole ProprietorshipsSole Proprietorships

The most common form of The most common form of business organization in the United business organization in the United States States

The most profitable of all business The most profitable of all business organizationsorganizations

This is a business owned and run This is a business owned and run by one personby one person

Smallest size of business Smallest size of business organizationorganization

PartnershipsPartnerships Types of partnershipsTypes of partnerships

– General General Partnerships:Partnerships: all all partners are partners are responsible for the responsible for the management and management and financial obligation financial obligation of the business of the business (most common form (most common form of partnership)of partnership)

– Limited PartnershipsLimited Partnerships: : at least one partner at least one partner is not active in the is not active in the daily running of the daily running of the businessbusiness

CorporationsCorporations Corporations Corporations

account for 1/5 of all account for 1/5 of all firms in the U.S. and firms in the U.S. and 90% of all sales90% of all sales

A corporation is a A corporation is a form of business form of business organization organization recognized by law as recognized by law as a separate legal a separate legal entity entity having all the having all the rights of an rights of an individualindividual

Forming a CorporationForming a Corporation

People must ask the government People must ask the government for permission to for permission to incorporateincorporate

This is done through a corporate This is done through a corporate charter charter which is a government which is a government document giving individuals the document giving individuals the right to incorporateright to incorporate

Corporate Formation…Corporate Formation…cont’cont’ A corporate charter specifies the A corporate charter specifies the

number of shares of number of shares of stockstock, or , or ownership certificates in the firmownership certificates in the firm

These shares are sold to investors who These shares are sold to investors who are called are called stockholdersstockholders or or shareholdersshareholders

If the company is successful, it will If the company is successful, it will issue a issue a dividenddividend a check representing a check representing a portion of corporate earnings to each a portion of corporate earnings to each stockholderstockholder

The Company $$$$$$$$$$ $$$$$$$$$$ $$$$$$$$$$ $$$$$$$$$$

(Stock ownership) $ 1/100th → $$$$$$$$$ $$$$$$$$$$ $$$$$$$$$$ $$$$$$$$$$ $$$$$$$$$$ $$$$$$$$$$

If a corporation has a total of 100 shares of stock, and if you could somehow divide the corporation into 100 equal parts, the owner of a single share of stock would own 1/100th of the corporation. A stockholder is someone who owns part of a company’s plant and equipment, and has a say in how the business is run

The Owners (The Shareholders) elect the…

Board of Directors who select the…

President who hires…

Vice President (Sales)

Vice President (Production)

Vice President (Finance)

Domestic

International

Quality Control

Research & Development

Payroll

The Role of GovernmentThe Role of Government 1) To 1) To protectprotect the consumer from the consumer from

dangerous products and unscrupulous dangerous products and unscrupulous businesspeople (USDA, FDA, OSHA, etc.)businesspeople (USDA, FDA, OSHA, etc.)

2) To 2) To provideprovide the consumer with goods the consumer with goods and services and to and services and to consumeconsume goods and goods and services from producers.services from producers.

Provider: streets, parks, education, buses, Provider: streets, parks, education, buses, garbage pickup, etc.garbage pickup, etc.

Consumer: the government is now the Consumer: the government is now the second largest consuming sector of second largest consuming sector of society, second only to the actual society, second only to the actual consumer sectorconsumer sector

Promoter of National Promoter of National GoalsGoals The government modifies the The government modifies the

economic systems to promote its economic systems to promote its goals. Social security, child labor goals. Social security, child labor laws, minimum wage laws, etc.laws, minimum wage laws, etc.

We live in a modified We live in a modified economic systemeconomic system

People carry on their People carry on their economic activity freely, economic activity freely, but are subject to some but are subject to some government intervention government intervention and regulationand regulation

This is not a laissez-faire This is not a laissez-faire economyeconomy

One form of government One form of government regulation is the Securities and regulation is the Securities and Exchange Commission (SEC)Exchange Commission (SEC)

SEC: The federal agency that SEC: The federal agency that regulates activity in the securities regulates activity in the securities markets, and protects the public markets, and protects the public against malpractice by broker-against malpractice by broker-dealers. dealers.

They regulate the stock marketThey regulate the stock market

Consumer vs. Capital Consumer vs. Capital GoodsGoods Consumer good: A good intended Consumer good: A good intended

for use by consumers, ex: car or for use by consumers, ex: car or telephonetelephone

Capital good: A good used by Capital good: A good used by businesses to produce other businesses to produce other goods, ex: robotic arm for car goods, ex: robotic arm for car factory, microchip for phonefactory, microchip for phone

Public GoodsPublic Goods

An economic good that is An economic good that is consumed by the public or consumed by the public or collectivelycollectively

1) National defense1) National defense 2)2) 3)3) 4)4)

Public GoodsPublic Goods

– Public goodsPublic goods are products are products everyone consumeseveryone consumes

– The market does not supply The market does not supply such goods because it produces such goods because it produces only items that can be withheld only items that can be withheld if people refuse to pay for themif people refuse to pay for them

– If public goods are to be If public goods are to be supplied, the government supplied, the government usually has to provide them.usually has to provide them.

PrivatizationPrivatization

Taking things that were public Taking things that were public goods and selling them to private goods and selling them to private companiescompanies

Market StructuresMarket Structures

PerfectPerfect Monopolistic Monopolistic Oligopolistic Oligopolistic Monopoly Monopoly

CompetitionCompetition Competition Competition Competition Competition

ElasticElastic Relatively Elastic Relatively Elastic Relatively Elastic Relatively ElasticInelasticInelastic

DemandDemand Demand Demand Demand Demand DemandDemand

Perfect CompetitionPerfect Competition

A large number of informed, A large number of informed, independent buyers and sellers independent buyers and sellers who exchange identical productswho exchange identical products– Ex) beef, oranges, applesEx) beef, oranges, apples

Monopolistic Monopolistic CompetitionCompetition many small firms, products many small firms, products

differentiated by brand names, differentiated by brand names, easy entry and exit, some price easy entry and exit, some price control through brand loyalty, control through brand loyalty, much advertising.much advertising.– Ex) shampoos, make-upEx) shampoos, make-up

OligopolyOligopoly

few large firms, more complex few large firms, more complex products, entry difficult due to products, entry difficult due to high capital costs, significant high capital costs, significant price control, much advertising.price control, much advertising.– Ex) McDonald’s, Burger King, Pepsi, Ex) McDonald’s, Burger King, Pepsi,

Coca ColaCoca Cola

MonopolyMonopoly

single large firm, single large firm, unique product, unique product, blocked entry, blocked entry, absolute price absolute price control.control.– Ex) utility Ex) utility

companies: National companies: National Fuel, National GridFuel, National Grid

Natural MonopoliesNatural Monopolies

Natural monopolies are legal in the Natural monopolies are legal in the United States, and are apparent in United States, and are apparent in all areas of the country. Some all areas of the country. Some examples include National Fuel examples include National Fuel and other utility companies.and other utility companies.

Natural monopolies only work Natural monopolies only work where the good involved has an where the good involved has an inelastic demand where people inelastic demand where people have to buy even if prices go up! have to buy even if prices go up!

What are the causes of What are the causes of Market Failures?Market Failures?

1)1) Inadequate informationInadequate information

2)2) Inadequate competitionInadequate competition

3)3) Immobile resourcesImmobile resources

4)4) Prices do not reflect the costs of Prices do not reflect the costs of productionproduction

What are What are externalities?externalities? An unintended side effect that An unintended side effect that

either benefits or harms a third either benefits or harms a third partyparty

Negative externalityNegative externality

An unintended side An unintended side effect that harms a effect that harms a third partythird party

Example new Example new airport built, airport built, people who live people who live near that airport near that airport are bothered by are bothered by the noise and the noise and traffic traffic

Positive externalityPositive externality

An unintended side An unintended side effect that benefits effect that benefits a third partya third party

Example new Example new airport built, airport built, restaurants and restaurants and hotels near that hotels near that airport see an airport see an increase in increase in businessbusiness

The cost of doing The cost of doing businessbusiness

Fixed costs/overhead: The costs Fixed costs/overhead: The costs businesses incur even when not businesses incur even when not producing anythingproducing anything

Examples: Rent, executive Examples: Rent, executive salaries, taxes and salaries, taxes and depreciationdepreciation (wear and tear on (wear and tear on capital goodscapital goods used in production)used in production)

Variable costVariable cost

A cost that changes with A cost that changes with business output, labor, raw business output, labor, raw materials, utilitiesmaterials, utilities

A factory wants to increase A factory wants to increase production, so they add a third production, so they add a third shift. How will their variable shift. How will their variable costs increase?costs increase?

The stages of The stages of productionproduction

Three Stages of Three Stages of ProductionProduction How many workers do How many workers do

you need to operate you need to operate at maximum at maximum efficiency?efficiency?

Stage I – Stage I – Increasing Increasing returnsreturns: first, there : first, there are more resources are more resources than workers than workers (inefficient), as more (inefficient), as more workers are hired, workers are hired, production becomes production becomes more and more more and more efficient (more efficient (more workers are added, workers are added, output increases)output increases)

Three Stages of Three Stages of ProductionProduction

How many workers How many workers do you need to do you need to operate at maximum operate at maximum efficiency?efficiency?

Stage II – Stage II – Diminishing Diminishing marginal returnsmarginal returns: : More workers are More workers are added, output added, output continues to continues to increase, but in increase, but in smaller incrementssmaller increments

Three Stages of Three Stages of ProductionProduction How many workers do How many workers do

you need to operate you need to operate at maximum at maximum efficiency?efficiency?

Stage III – Stage III – Diminishing Diminishing returnsreturns: In stage III too : In stage III too many workers have many workers have been hired and they been hired and they are no longer working are no longer working at maximum at maximum efficiency (more efficiency (more workers than workers than resources)resources)

# of # of WorkersWorkers

Total Total ProductProduct

Marginal Marginal ProductProduct

Stage of Stage of ProductionProduction

00 00 00 Stage 1Stage 1

Total Total Output Output RisesRises

11 55 55

22 1212 77

33 2121 99

44 3232 1111

55 4040 88 Stage 2Stage 2

Total Total Output Output SlowsSlows

66 4646 66

77 5050 44

88 5252 22

99 5050 -2-2 Stage 3Stage 3

Output Output DecreasesDecreases

1010 4747 -3-3

The Business CycleThe Business Cycle

InflationInflation

Rise in Rise in general general price levelsprice levels

RecessionRecession

Decline in Gross Decline in Gross Domestic Product Domestic Product lasting at least 6 lasting at least 6 months. months. Production slows Production slows down, workers are down, workers are laid off, etc.laid off, etc.

How does the FED try to How does the FED try to control inflation and control inflation and recession?recession?

1) Discount interest rate1) Discount interest rate

2) Fractional reserve requirement2) Fractional reserve requirement

Monetary Monetary policypolicy

Actions by the Actions by the FED to FED to expand or expand or contract the contract the money supplymoney supply

Monetary = Monetary = moneymoney

Discount Interest rateDiscount Interest rate

The FED loans money to banks at The FED loans money to banks at a percentage of interest, the bank a percentage of interest, the bank then loans consumers money at a then loans consumers money at a higher percentage to consumers. higher percentage to consumers. Example FED loans M&T money Example FED loans M&T money at 4%, M&T loans consumers at 4%, M&T loans consumers money at 6%.money at 6%.

Discount Interest RateDiscount Interest Rate

So, when times are bad So, when times are bad (recession, not enough money in (recession, not enough money in circulation), the FED lowers the circulation), the FED lowers the discount interest rate. That way, discount interest rate. That way, the bank lowers their interest the bank lowers their interest rate, then people borrow and rate, then people borrow and spend more moneyspend more money

Discount Interest RateDiscount Interest Rate

When times are too good When times are too good (inflation, too much money in (inflation, too much money in circulation) the FED raises the circulation) the FED raises the discount interest rate. That way, discount interest rate. That way, the bank raises their interest rate, the bank raises their interest rate, then people borrow and spend then people borrow and spend less moneyless money

Fractional Reserve Fractional Reserve RequirementRequirement The FED requires banks to keep a The FED requires banks to keep a

portion of their deposits on portion of their deposits on reserve.reserve.

For example, The Fed may For example, The Fed may require banks to keep 10% of require banks to keep 10% of their total deposits on reserve.their total deposits on reserve.

That means the bank can loan out That means the bank can loan out 90% of their money 90% of their money

Fractional Reserve Fractional Reserve RequirementRequirement During During inflationaryinflationary periods, there is too periods, there is too

much money in circulation, so the FED much money in circulation, so the FED raisesraises the Fractional reserve the Fractional reserve requirement so that banks have less requirement so that banks have less money to lend outmoney to lend out

During a During a recessionaryrecessionary period, there is period, there is too little money in circulation, so the too little money in circulation, so the FED FED lowerslowers the fractional reserve the fractional reserve requirement so that banks have more requirement so that banks have more money to lend out.money to lend out.

To freely trade or not To freely trade or not to freely trade?to freely trade? Free traderFree trader There should be There should be

no barriers to no barriers to trade between trade between nationsnations

ProtectionistProtectionist Countries should Countries should

use tools like use tools like tariffs and quotas tariffs and quotas to protect their to protect their farmers and farmers and producers from producers from cheap, foreign cheap, foreign goodsgoods

ProtectionismProtectionism

Tariff: A tax on foreign goods Tariff: A tax on foreign goods

Quota: A limit on the number of a Quota: A limit on the number of a particular foreign good that can particular foreign good that can be importedbe imported

Comparative Comparative AdvantageAdvantage International trade is based on International trade is based on

the idea of comparative the idea of comparative advantage.advantage.

Comparative advantage is the Comparative advantage is the idea that some places are better idea that some places are better at producing particular things at producing particular things than other placesthan other places

How much is the dollar How much is the dollar worth?worth? When the US dollar is compared When the US dollar is compared

to other countries’ currency, that to other countries’ currency, that is called the is called the foreign exchange foreign exchange raterate..

For example, one Euro (For example, one Euro (€) is €) is currently worth $1.4877currently worth $1.4877