Economics 150: Chapter 2
Economics 150: Chapter 2 Econ 150-12
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This 6 page Class Notes was uploaded by Suzannah Hudson on Wednesday April 27, 2016. The Class Notes belongs to Econ 150-12 at Brigham Young University - Idaho taught by Hirschi, Rick L. in Spring 2016. Since its upload, it has received 17 views. For similar materials see Econ Principles & Problems Micro in Economcs at Brigham Young University - Idaho.
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Date Created: 04/27/16
Chapter 2 Notes Lesson 1: Economic System: A particular set of institutional arrangements and a coordinating mechanism for solving the economizing problem; a method of organizing an economy, of which the market system and the command system are the two general types. Economic systems differ for two different reasons; (1) who owns the production and factors and (2) the method used to motivate, coordinate, and direct economic activity. Economics systems can be classified by the degree to which they rely upon decentralized decision making based upon markets and prices or centralized government control based upon orders and mandates Laissez-faire Capitalism: Government intervention is at a very minimum and markets and prices are allowed to direct nearly all economic activity. Sometimes referred to as “pure capitalism.” In Laissez-faire capitalism, the government’s role would be limited to protecting private properties from theft and aggression and establishing a legal environment in which people could interact n markets to buy and sell goods. Laissez-faire: French for “let it be,” or “hands free.” Proponents of laissez-faire capitalism believe that government interference reduces human welfare, that government should restrict itself and only allowing control over preventing individuals and firms from coercing (threating) each other. Who knows better what people want than the people themselves? NO society has every employed a laissez-fair system. Thus it should be thought of as a hypothetical system that is viewed by the proponents as ideal. Command System: Government owns most property resources and economic decision making is set by a central economic plan created and enforced by the government. This is also known as Socialism or Communism. Laissez-faire Capitalism and Command System are the two extreme sides of the Economic Systems. The division of output between capital and consumer goods is centrally decided, and capital goods are allocated among industries on the basis of the central planning board's long-term priorities. North Korea and Cuba are the last prominent remaining examples of largely centrally planned economies. Market System: This is the majority of the world’s economies, which is also known as Capitalism or Mixed Economy. A system in which individuals own most of the economic resources and in which markets and prices serve as the dominant coordinating mechanism used to allocate those resources. The market system is characterized by the mixture of centralized government and decentralized actions taken by individuals and firms. Individuals and businesses seek to achieve their economic goals through their own decisions regarding work, consumption, or production. The result is competition among independently acting buyers and sellers of each product and resource and an economic system in which decision making is widely dispersed. The government, however, is not the dominant economic force in deciding what to produce, how to produce it, and who will get it. That force is the market. Lesson 2: Characteristics of a Market System Private Property: The right of private persons and firms to obtain, own, control, employ, dispose of, and bequeath land, capital, and other property. The most important consequence of property rights is that they encourage people to cooperate by helping to ensure that only MUTUALLY AGREEABLE economic transactions take place. Encourages investment, innovation, exchange, maintenance of property, and economic growth. Allow intellectual property through copyrights and trademarks. Also facilitates exchange. Freedom of Enterprise: ensures that entrepreneurs and private businesses are free to obtain and use economic resources to produce their choice of goods and services and to sell them in their chosen markets. Freedom of Choice: enables owners to employ or dispose of their property and money as they see fit. Also allows workers to try to enter any line of work for which they are qualified. It ensures that consumers are free to buy the goods and services that best satisfy their wants. These choices are free, but only within broad legal limitations, of course. Self-Interest: That which each firm, property owner, worker, and consumer believes is best for itself and seeks to obtain. It is the motivating force of the various economic units as they express their free choices. The motive of self-interest gives direction and consistency to what might otherwise be a chaotic economy. Competition: the effort and striving between two or more independent rivals to secure the business of one or more third parties by offering the best possible terms. Competition among buyers and sellers diffuses economic power within the businesses and households that make up the economy. They cannot control the price because someone can cut it down. The freedom of an industry to expand proved the economy with the flexibility it needs. The diffusion of economic power inherent in competition limits the potential abuse of that power. Market: any institution or mechanism that brings together buyers (demanders) and sellers (suppliers) of a particular good or service. Market and Prices are key components of the market system. A market system conveys the decisions made by buyers and sellers of products and resources. It is an elaborate communication network through which innumerable individual free choices are recorded, summarized, and balanced. The market system encourages extensive use and rapid development of capital goods that can encourage competition, freedom of choice, self- interest and personal rewards. Examples: tools, machinery, factories, communication, transportation, etc. Advanced technology and capital goods are important because the most direct methods of production are often the least efficient. More efficient production means much more abundant output. Specialization: The use of resources of an individual, a firm, a region, or a nation to concentrate production on one or a small number of goods and services. The majority of consumers produce virtually none of the goods and services they consume, and they consume little or nothing of the items they produce. Division of Labor: Another term for human specialization – the separation of the work required to produce a product into a number of different tasks that are performed by different workers; specialization of workers. Specialization makes use of differences in abilities, fosters learning by doing individual tasks, and saves time. Specialization increases the total output society derives from their limited resources. Medium of Exchange: Any item sellers generally accept and buyers generally use to pay for a good or service. Barter: swapping of goods for goods. The exchange of items with no medium. Requires a coincidence of wants between the buyer and seller, where the buyer must want what the seller has at the exact same time the seller wants what the buyer has. Money: a convenient means of exchanging goods and services without engaging in barter. It makes trade easier. To serve as money it must be generally acceptable to sellers in exchange for their goods and services. There are markets in which currencies are bought and sold, which makes it easier for people living in different countries to exchange goods and services without having to barter. The final characteristic of market systems is an active, but limited, government. There can be “market failures,” in which the government can make up for, but there can be “government failures,” as well. Lesson 3: The 5 fundamental questions of market economies: What goods and services will be produced? How will the goods and services be produced? Who will get the goods and services? How will the system accommodate change? And how will the system promote progress? What will be produced? The goods and services that can be produced at a continuing profit will be produced, while those whose production generates a continuing loss will be discontinued. Total Revenue – Explicit Cost = Accounting Profit…..Accounting Profit – Implicit Cost = Economic Profit. Economic Profit = above opportunity cost. Consumer Sovereignty: The determination by consumers of the types and quantities of goods and services that will be produced with the scarce resources of the economy. Dollar Votes: The “votes” that consumers cast for the production of preferred products when they purchase those products, rather than the alternatives that were also available. Where consumers spend their income on the goods they are most willing and able to buy. How will the Goods and Services be produced? In combinations and ways that minimize the cost per unit of output. Any firm wishing to maximize profits will make great efforts to minimize production costs. Competition eliminates high-cost producers. Who will get the output? Any product will be distributed to consumers on the basis of their ability and willingness to pay its existing market price. Their amount of income depends on (1) the quantities of the property and human resources they supply and (2) the prices of those resources commanded in the resource market. How will the system accommodate change? Through changes in prices and profits, it communicates changes in such basic matters as consumer tastes and elicits appropriate responses from businesses and resource suppliers. How will the system promote progress? Through the encouragement of technological advancement and capital accumulation, the market system provides a strong incentive for entrepreneurs and firms to move towards economic growth (greater output) and higher standards of living (greater output per person). Creative Destruction: The hypothesis that the creation of new products and production methods destroys the market power and existing monopolies. Most technological advances require additional capital goods. Who counts the dollar votes for capital goods? Entrepreneurs and business owners. Lesson 4: Invisible Hand: the tendency of competition to cause individuals and firms to unintentionally, but quite effectively, promote the interests of society even when each individual or firm is only attempting to pursue its own interests. The invisible hand ensures that when firms maximize their profits and resources suppliers maximize their incomes, these groups also help maximize society’s output and income. The market system promotes efficiency, encourages incentives, and emphasizes on personal freedom. Laissez-faire market is like God’s plan for us. He gives us agency to choose while guiding us and controlling aspects every now and then. Command markets are like Satan’s plan for us. He promises that everything will be perfect and ours, but we have no choice in the matter, because he wants to take away our agency. Lesson 5: Circular Flow Diagram: An illustration showing the flow of resources from households to firms and of products from firms to households. These flows are accompanied by reverse flows of money from firm to households and from households to firms. An illustration in which there is no government. Households: one or more persons occupying a housing unit. Households buy the goods and services that businesses make available in the produce market. They then obtain the income needed to buy those products by selling resources in the resource market. Businesses: commercial establishments that attempt to earn profits for their owners by offering goods and services for sale. They fall into 3 main categories: sole proprietorship, partnership, and corporation. Sole Proprietorship: a business owned and managed by a single person. Partnership: two or more individuals agree to own and operate a business together. Corporation: an independent legal entity that can – on its own behalf – acquire resources, own assets, produce and sell products, incur debts, extend credit, and otherwise engage in any legal business activity. Product Market: a market in which products are sold by firms and bought by households. Resource Market: a market in which households sell and firms buy resources or the services of resources. The circular flow model depicts a complex web of economic activity in which businesses and households are both buyers and sellers. Lesson 6: Producing goods and services is a risk. There can be numerous reasons why taking the risk can go wrong, such as sudden rises of input shortages and a sudden change in consumer preferences. In the market system and economic system, they try to maximize the potential of risk and develop methods and ways for managing it. They do so by showing the business owners their financial consequences and try to manage their risks. Risk falls to those who are acting as the entrepreneurs for that firm of business. Profit System: the entrepreneurs who must deal with risk and uncertainty gain profits if they choose wisely but suffer losses if they choose poorly. In a command system, they deal with risk very poorly because the central planners don’t accrue and loss if risk management goes well or poorly. They get paid either way. When dealing with risks for a business owner, they supply contracts for their employees, and suppliers supply contracts for the owners, guaranteeing that they will get payed, whether that business is making money or losing profit. Insurance promotes economic growth and investment by transferring risk from those who have a low tolerance for risk to those who have a high tolerance for risk. The two major benefits that arise from the market system’s restriction of business risk to owners and investors: Attracting Inputs and Focusing Attention. Attracting Inputs: This is when employees and suppliers are confident in lending their resources to the business because of the restriction of risk in that business. They don’t have to worry about the profitability of that firm, but can be rest assured that they will receive their own profits back. Focusing Attention: The amount of risk is shielded from the employees and suppliers, because all of the attention is focused on the business owner. If anything were to happen because of a poor decision with risk, the owner is held responsible. In a command system, the risk is spread out through all different layers of government so that not one person is responsible for the bad outcomes.