Fundamental Economic Concepts Fundamental Economic Concepts
Fundamental Economic Concepts
Fundamental Economic Concepts
Explain why limited productive resources and unlimited wants result in scarcity, opportunity costs and trade offs for individuals, businesses and governments. Wants are unlimited, the total resources of a society including natural resources, human resources, capital goods and entrepreneurship are limited resulting in scarcity. All wants cannot be filled, trade-offs are inevitable when deciding what to produce. Define scarcity as a basic condition which exists when unlimited wants exceed limited productive resources Scarcity exists because human wants exceed the capacity of available resources. This basic problem of scarcity is faced by all individuals, organizations, businesses and governments. Define and give examples of productive resources (Factors of Production) as land (natural), labor (human), capital (capital goods), entrepreneurship Land = natural resources; Labor = people with their education, skills and abilities; Capital = the goods and services used to make other consumer goods and services; Entrepreneurs = individuals who take the risk and combine the productive resources (factors of production) to produce goods and services and profit by selling these to consumers. Identify strategies for allocating scarce resources See Chart. The different strategies include, price, contests, force, sharing, lottery, command, 1st come 1st served, personal characteristics. Define opportunity cost as the next best alternative given up when individuals, businesses and governments confront scarcity by making choices. Opportunity cost is what you give up to obtain something else, one good or service for another. Governments often have to decide on one good or service at the expense of another. Trade-off is giving up one benefit or advantage in order to gain another one that may be better. Provide examples of how rational decision making entails comparing the marginal benefits and the marginal costs of an action. We make choices to satisfy needs or to seek happiness! We look at the options, compare costs, benefits, and the trade-offs involved with each choice and reach a decision. Marginal Cost = the additional cost of producing one more unit. Marginal Benefit = the additional satisfaction or utility of consuming one more unit. Illustrate by means of a production possibilities curve the trade-offs between two options Production Possibilities Curve
A table or graph that shows the full employment capacity of an economy in the form of possible combinations of two goods, or two bundles of goods, that could be produced with a given amount of productive resources and level of technology.
Moving from point B to C indicates that this society now prefers to build more consumer goods and less capital goods. This is the trade-off when choosing a different combination of goods Explain that rational decisions occur when the marginal benefits of an action equal or exceed the marginal costs. Economic decisions are made on the basis of comparing marginal costs and marginal benefits. There are not many all or none decisions. Almost all decisions are marginal, we don’t typically make a decision between studying all day or watching TV all day, we choose between studying a little more and watching a little less TV or vice versa. Explain how specialization and voluntary exchange between buyers and sellers increase the satisfaction of both parties. Provide examples of how individuals and businesses specialize Division of Labor refers to the practice of dividing the work to make something into separate tasks. Workers become specialized in different tasks. We earn a living by doing tasks, taking our wages to purchase goods and services from other workers. Division of Labor and Specialization is the basis for an economy to exist. 3 benefits are doing it better, no time required to switch tasks, create more effective ways to do the task. Explain that both parties gain as a result of voluntary, non-fraudulent exchange. We don’t make all of our electronic devices, countries do not make all of the goods and services they need. Specialization is the basis of trade and interdependence among individuals, businesses, cities, regions and countries. Wisconsin = dairy Florida = oranges. Compare and contrast different economic systems, and explain how they answer the three basic economic questions of what to produce, how to produce and for whom to produce. Every society must contend with the problem of scarcity. Every society, regardless of its political structure, must develop an economic system to determine how to use its limited productive resources to answer the three basic economic questions.
What goods and services will be produced?
How will goods and services be produced?
Who will consume the goods and services?
The way a society answers these questions determines its economic system.
Three types of economic systems exist to answer these questions.
Traditional – In a traditional economy, economic decisions are based on custom and historical precedent.
Command – In a centralized command economy, government planning groups make the basic economic decisions. They determine such things as which goods and services to produce, their prices, and wage rates.
Market – In a decentralized market economy, economic decisions are guided by the changes in prices that occur as individual buyers and sellers interact in the market place (which it is also referred to as a price system). Other names for market systems are free enterprise, capitalism, and laissez-faire.
Compare command, market, and mixed economic systems with regard to private ownership, profit motive, consumer sovereignty, competition, government regulation Economic systems are characterized by how they answer the three basic economic questions Command (centralized) Economy – the issues of production and distribution are resolved through central planning and control Market (decentralized) Economy – market prices are determined by consumers and producers, all pursuing their own self-interest. Mixed Economy – there are no pure market or command economies, most economies today contain both command and market characteristics Profit Motive – the desire to make money causes people to work hard to produce goods and services. Consumer Sovereignty – people are free to choose without government interference or regulation Competition – consumers compete with other consumers for goods and services, producers compete with other producers for consumers. Governmental Regulation – the government intervention in the decisions of consumer and producers in the market. Evaluate how well each type of system answers the three economic questions and meets the broad social and economic goals of freedom, security, equity, growth, efficiency and stability Economic Freedom – freedom of choice by consumers and producers. Economic Security – protection against some risks as consumers and producers Economic Equity – Fairness? Right or wrong? Equal opportunity? Equal distribution of wealth and income? Economic Growth – an increase in the production of goods and services over time, measured by real GDP, 3 to 4 % is a reasonable and sustainable yearly growth rate. Economic Efficiency – allocation of resources so that no one is hurt at the expense of someone else gaining, lower costs to produce. Economic Stability – maintain stable prices, full employment and economic growth Describe the roles of government in a market economy. Government establishes the rules of the game, gov’t involved in the market, public goods, gov’t as a business (national defense), environmental concerns, monetary system. Explain why government provides public goods and services, redistributes income, protects property rights and resolves market failures. Public Goods and Services – Those goods and services that cannot be easily be restricted to those who pay for them. Shared consumption and non-exclusion determine what a public good is. Income Redistribution – The re-allocation of wealth and income, 3/4ths of national income is wages. Property Rights – legal ownership of resources, government’s role is to protect property rights. Market Failures – private police or military, imperfect information in the market, pollution costs. Provide examples of government regulation and deregulation and their effects on consumers and producers. Comparing the expected costs of a new policy or a change in an existing policy to the expected benefits. Explain how productivity, economic growth and future standards of living are influenced by investment in factories, machinery, new technology and the health, education and training of people. Define productivity as the relationship of inputs to outputs The quantity of output per unit of input, an increase in productivity can be more goods and services created with the same amount of resources or the same amount of goods and services with less resources. More productive workers lead to a higher standard of living. Provide illustrations of investment in equipment and technology and explain their relationship to economic growth Improvements in education, experience, skill level of the workforce (human capital), greater amounts of physical capital, improved technology. Provide examples of how investment in education can lead to a higher standard of living High investments in education, physical and human capital equals higher productivity, low inflation, political stability and free trade.
Describe how households, businesses, and governments are interdependent and interact through flows of goods, services, and money. Illustrate by means of a circular flow diagram, the Product market; the Resource (factor) market; the real flow of goods and services between and among businesses, households, and government; and the flow of money.
b. Explain the role of money as a medium of exchange and how it facilitates exchange.
Money – anything used to buy and sell goods and services. 3 functions of money:
Medium of exchange – generally accepted as a form of payment.
Store of value – retains value over time.
Unit of account – value is measured in units of money.
Explain how the Law of Demand, the Law of Supply, prices, and profits work to determine production and distribution in a market economy. Define the Law of Supply and the Law of Demand. Law of Supply – all other factors being equal, as the price of a good or service increases, the quantity of goods and services offered by suppliers increases and vice versa. Law of Demand – all other factors being equal, as the price of a good or service increases the quantities consumers demand for the good or service will decrease and vice versa. Describe the role of buyers and sellers in determining market clearing price. The market clearing price (equilibrium) results in neither shortages or surpluses. Transactions in a market economy are voluntary so they must benefit both buyers and sellers.
c. Illustrate on a graph how supply and demand determine equilibrium price and quantity.
d. Explain how prices serve as incentives in a market economy.
a. The price and quantity exchanged are determined by supply and demand, prices provide incentives for both buyers and sellers. Prices provide information to consumers and producers about market conditions on supply and demand.
Explain how markets, prices, and competition influence economic behavior. Identify and illustrate on a graph factors that cause changes in market supply and demand. Factors that cause changes in market supply – explain how they affect supply Cost of inputs Productivity Technology Taxes and Subsidies Expectations Government regulations Change in the number of sellers Weather/natural disasters
Increase in Supply Decrease in Supply
Factors that cause changes in market demand – explain how they affect demand Consumer income/wealth Consumer tastes and preferences (advertising) Change in the price of substitute goods Change in the price of complementary goods Change in expectations Change in number of consumers
Increase in Demand Decrease in Demand
b. Explain and illustrate on a graph how price floors create surpluses and price ceilings create shortages.
Price floor – a legally established minimum priced – examples are farm products and minimum wage laws. Too much milk produced, too many workers seeking a higher minimum wage. Designed to help suppliers, some will not be able to sell their goods because of lack of demand.
Price ceiling – legally established maximum price, an example would be rent control. Too many renters, not enough apartments. Designed to help consumers, the quantity demanded tends to exceed the quantity supplied.
c. Define price elasticity of demand and supply.
Price elasticity of demand – a way of measuring how much quantity demanded will change in response to a change in price.
Price elasticity of supply – a way of measuring how much quantity supplied will change in response to change in price.
Explain the organization and role of business and analyze the four types of market structures in the U.S. economy. Compare and contrast three forms of business organization—sole proprietorship, partnership, and corporation. Sole proprietorship – a business owned by one person. Advantages- ease of start-up, ease of management, owner gets all profits, full control, easy to stop, business itself is exempt from tax on income. Disadvantages- unlimited liability, difficulty in raising financial capital, amount of work, limited life. Partnership – a business jointly owned by two or more people. Advantages- ease of start-up, each partner brings a skill, larger pool of capital, lack of special taxes on partnerships. Disadvantages- each partner is responsible for the business, unlimited liability (unless LLP or limited liability partnership), limited life, potential for conflict. Corporation – a business organization that is owned by stock holders and recognized by law as a separate legal entity having all the rights of an individual. Advantages- ease of raising financial capital thru the sale of stock or bonds, limited liability of owners, unlimited life, ease of transferring ownership. Disadvantages- difficult to start, owners/shareholders often have little or no power to run the corporation, more legal requirements, double taxation.
b. Explain the role of profit as an incentive for entrepreneurs.
Entrepreneurs are willing to risk their resources in order to sell them for financial gain or profit, and are successful when providing goods and services valued by consumers. Successful entrepreneurs are willing to assume risk, have unique skills, discipline to work long and hard to earn income, learn skills valued by others.
Identify the basic characteristics of monopoly, oligopoly, monopolistic competition, and pure competition. Monopoly – a market structure in which there is a single supplier of a good or service that there is no close substitute for. Example – public water. Oligopoly – a market structure in which a few, relatively large firms account for all or most of the production or sale of a good or service in a market, barriers to new producers are high. Examples are cars, airlines, and movie studios. Monopolistic competition – a market structure where slightly different products are sold by a large number of relatively small producers, barriers to new firms are low. An example would be jeans and gas stations. Pure competition – a market structure theory in which a large number of relatively small firms produce and sell identical products, there are no barriers to enter the market and it is easy to exit from the market, the best example would be agricultural products like wheat.
Illustrate the means by which economic activity is measured.
Explain that overall levels of income, employment, and prices are determined by the spending and production decisions of households, businesses, government, and net exports.
Define Gross 29. Domestic Product (GDP), economic growth, unemployment, Consumer Price Index (CPI), inflation, stagflation, and aggregate supply and aggregate demand.
Gross Domestic Product (GDP) – the market value of all goods and services produced in a calendar year. Economic Growth – an increase in real output as measured by real GDP or per capita real GDP Unemployment – the number of people in the civilian workforce over the age of 16 without jobs who are actively seeking work. Consumer Price Index (CPI) – a price index that measures the cost of a fixed basket of consumer goods and services, compares the costs from other time periods and is used to measure inflation. Inflation – a rise in the general or average price level of all goods and services in an economy, (caused by demand-pull or cost-push) Stagflation – a decline in real GDP combined with a rise in the average price level Aggregate Supply (AS) – the value of output (real GDP) that would be produced at different price levels in a nation’s economy.
Aggregate Demand (AD) – the value of output (real GDP) that would be demanded at different price levels in a nation’s economy. Explain how economic growth, inflation, and unemployment are calculated. Economic growth is measured by GDP, Inflation is measured by CPI, the polling of 50,000 households to create an unemployment rate (total unemployed divided by the total workforce) Bureau of Economic Analysis- www.bea.gov (economic growth)
Bureau of Labor Statistics- www.bls.gov (inflation, unemployment)
Identify structural, cyclical, and frictional unemployment. Structural Unemployment – skills of workers do not match up with the skills required by employers. Cyclical Unemployment – caused by the fluctuations in the overall rate of economic activity or a phase in the business cycle. Frictional Unemployment – some are always unemployed, often it is the choice of the worker for a variety of reasons. Define the stages of the business cycle, include peak, contraction, trough, recovery, expansion as well as recession and depression. Business cycle – changes in the overall rate of national economic activity with alternating periods of expansion and contraction, varying in duration and severity and measured by real GDP Peak – the height of economic expansion, real GDP stops rising. Contraction – a period of economic Decline Marked by falling GDP. Trough – the lowest point in an
Economic contraction, real GDP
Recovery – the period following a
recession during which real
Expansion – a period of economic growth
as measured by a rise in real GDP.
Recession – a decline in national economic activity, measured by a decline in real GDP for at least two consecutive quarters (6 months). Depression – a severe and prolonged economic contraction. Describe the difference between the national debt and government deficits. National Debt – the public debt, all of the annual budgets deficits added together. Government Deficits – the government spends more money (expenditures) in a fiscal year than it takes in (revenue) during that time. Explain the role and functions of the Federal Reserve System. Describe the organization of the Federal Reserve System.
Chairman, Board of governors, FOMC, 12 district banks.
Define monetary policy.
Monetary Policy – changes in the money supply, availability and cost of credit set by the Fed to promote economic growth, price stability and full employment.
Describe how the Federal Reserve uses the tools of monetary policy to promote price stability, full employment, and economic growth. Open Market Operations – the buying and selling of government securities (T-bonds, T-notes- T-bills) by the Fed, to increase money supply – buy back bonds, to decrease money supply – sell bonds. Discount Rate – the interest rate the Fed charges banks that borrow money from the Fed. Federal Funds Rate – the overnight lending interest rate between banks utilizing federal funds (funds on reserve in a bank). Reserve Requirements – the fraction of bank deposits required by the Fed to be kept on hand. Banks must have this money (federal funds) available in their vault. Explain how the government uses fiscal policy to promote price stability, full employment, and economic growth. Define fiscal policy. Fiscal Policy – the spending (expenditures) and tax collection (revenue) of the government to influence economic activity. Explain the government’s taxing and spending decisions. Government taxation – revenue raised through taxes to pay for expenditures. Government expenditures – goods and services purchased by the government with tax revenues or borrowed money.
Fundamental Economic Concepts
Explain how specialization and voluntary exchange between buyers and sellers increase the satisfaction of both parties. *Provide examples of how individuals and businesses specialize Division of Labor refers to the practice of dividing the work to make something into separate tasks. Workers become specialized in different tasks. We earn a living by doing tasks, taking our wages to purchase goods and services from other workers. Division of Labor and Specialization is the basis for an economy to exist. 3 benefits are doing it better, no time required to switch tasks, create more effective ways to do the task. Explain that both parties gain as a result of voluntary, non-fraudulent exchange. We don’t make all of our electronic devices, countries do not make all of the goods and services they need. Specialization is the basis of trade and interdependence among individuals, businesses, cities, regions and countries. Wisconsin = dairy Florida = oranges.
Explain why individuals, businesses and governments trade goods and services. Define and distinguish between absolute advantage and comparative advantage Comparative Advantage – the ability to produce a good or service at a lower opportunity cost than some other producer (the economic basis for specialization and trade) Absolute Advantage –. the ability to produce more units of a good or service than some other producer, using the same quantity of resources. Explain that most trade takes place because of comparative advantage in the production of a good or service COMPARATIVE ADVANTAGE – every country should produce and trade the good in which it has a comparative advantage. The good or service in which the opportunity cost is lowest. Staying with comparative advantage yields the biggest gains in trade BENEFITS OF TRADE – international trade equals increased competition, increased variety of goods available to consumers, spreads new technology and production methods, helps low-income countries. Explain the difference between balance of trade and balance of payments Balance of Trade – a comparison of imports and exports of goods and services. Balance of Payments – the record of all transactions in trading good and services between countries and is expressed in monetary terms (dollars) Explain why countries sometimes erect trade barriers and sometimes advocate free trade define trade barriers as tariffs, quotas, embargoes, standards and subsidies Tariff – a tax on imported goods and services. Quotas – a limit on the quantity of a product that may be imported or exported. Embargoes – to impose certain conditions before granting consent to import a good or service. Standards – expectations of minimal levels of quality that must be met or extra safety standards. Subsidies – financial assistance from government to an enterprise or business, often considered to be beneficial to the public. Identify costs and benefits of trade barriers over time Designed to prevent imports and protect domestic industries and producers, protectionism is an attempt to protect a nation’s economy, trade barriers may save jobs in one area and at the same time destroy jobs in another area. List specific examples of trade barriers Tariffs, import quotas, non-tariff barriers like additional administrative requirements, regulations or unnecessary procedures. List specific examples of trading blocks such as the EU, NAFTA, ASEAN
EU – European Union
NAFTA – North American Free Trade Agreement [US/Canada/Mexico
ASEAN – Association of Southeast Nations
MERCOSUR – Common Market of the South [Latin America]
Other players on the world stage:
BRIC – Brazil, Russia, India, China
GATT – General Agreement of Tariffs and Trade
WTO – World Trade Organization
IMF – International Monetary Fund
Evaluate arguments for and against free trade. The arguments most often heard AGAINST free trade…
Keep jobs in America, keep our money in our country, national security, other nations treat their workers unfairly, other nations dump cheap stuff in our country, other countries keep our products from being sold in their country.
The argument FOR free trade….
Lower prices for goods, more variety in goods and services, higher standard of living because of increased income as a result of lower prices.
Explain how changes in exchange rates can impact the purchasing power of individuals in the United States and in other countries.
Exchange rate is the amount of one country’s currency that is equal to one unit of another country’s currency (Dollar vs. yen). Exchange rates are determined by supply and demand. All countries typically want to be paid in their country’s currency.
Define exchange rate as the price of one nation’s currency in terms of another nation’s currency
Exchange Rate – the price of one nation’s currency in terms of another nation’s currency.
Locate information on exchange rates – process skill
Rate at which one currency may be converted into another. The exchange rate is used when simply converting one currency to another (such as for the purposes of travel to another country), or for engaging in speculation or trading in the foreign exchange market. There are a wide variety of factors which influence the exchange rate, such as interest rates, inflation, and the state of politics and the economy in each country – also called rate of exchange or foreign exchange rate or currency exchange rate.
Interpret exchange rate tables – process skill
1 to 1
Explain why, when exchange rates change, some groups benefit and others lose.
When demand for a country’s currency rises faster than the supply of its currency, the value of the currency will rise
Personal Finance Concepts
Apply rational decision making to personal spending and savings choices.
Decision making – rational consumers seeking their own happiness or utility will make choices, everyday consumers consider their options and trade-offs and try to make the choice that brings them the greatest satisfaction.
Explain that people respond to positive and negative incentives in predictable ways
Incentives are costs and benefits that motivate a decision or action by consumers, workers or firms in an economy. Incentives matter in each and every decision. Concerns like higher and lower prices, wages and interest rates.
Use a rational decision making model to select one option over another
P – What is the PROBLEM?
What decision are you trying to make? What is the issue at hand?
A – What are the ALTERNATIVES?
What actions are you considering? What options are available to you in this decision?
C – What are the CRITERIA important to the decision?
What goals do you hope to accomplish in making your
What characteristics are you looking for in your result? Which criteria are more important than others? How do
you rank them?
E – EVALUATE each alternative.
Evaluate each alternative on the basis of each criterion. Give each alternative a plus (+) or a minus (-) according
to how well it meets each criterion.
D – Make a DECISION.
Calculate the net value of each alternative; which alternative
best meets your highest-ranking criteria?
What do you gain with each alternative? What do you give up with each alternative? Decision-Making Grid
A graph-like form into which people may enter notations about the costs and benefits of various alternatives; used for assistance in making decisions.
Using the decision grid below, evaluate each option and then decide which choice you would have made.
Evaluate each alternative as:
+ = Greater benefit than cost
? = Equal or questionable benefit and cost
– = Greater cost than benefit
Using the decision grid, rank the candidates in order of preference
Create a savings or financial investment plan for a future goal.
Spend or Save? Saving and investing go together, postponing current consumption or rewards for greater future benefits. Real investment is critical to economic growth in a society or country.
Explain that banks and other financial institutions are businesses which channel funds from savers to investors. compare services offered by different financial institutions –
ATM’s , interest rates, checking and saving accounts loans, credit and debit cards.
explain reasons for the spread between interest charged and interest earned
The difference between interest charged to borrowers and the interest paid to depositors is profit.
give examples of the direct relationship between risk and return
Risk = good or bad outcomes. The greater the risk usually requires a promise of a greater return to get investors. If it is too good to be true, it probably is.
Evaluate a variety of savings and investment options, including stocks, bonds and mutual funds. Stock – an ownership share or shares of ownership in a corporation. Bond – a certificate of indebtedness issued by a government or publicly owned corporation, promising to repay borrowed money to the lender at a fixed rate of interest and at a specified time. Mutual Fund – a pool of money used by a company to produce a variety of stocks, bonds or money market instruments. Provides diversification and professional management of their investment for investors. Explain how changes in monetary and fiscal policy can impact an individual’s spending and savings choices. Provide examples of who benefits and who loses from inflation
Inflation or an increase in prices across the economy benefit borrowers, and hurts those who loan money. Inflation hurts those who are on fixed incomes (retirees) and negatively impacts savings accounts.
Define progressive, regressive and proportional taxes
Progressive Tax – a tax that takes a larger percentage of income from people in higher-income groups than from people in lower-income groups. An example is the federal income tax.
Regressive Tax – a tax that takes a larger percentage of income from people in lower-income groups than higher-income groups. An example would be sales tax or gas tax.
Proportional Tax – a tax that takes the same percentage of income from people in all income groups. An example would be social security which takes 6.2 % from everyone up to 106,800 in 2009.
explain how an increase in sales tax affects different income groups.
Sales Tax – a regressive tax that requires lower-income groups to pay a higher percentage of their income than higher income groups.
Evaluate the costs and benefits of using credit List factors that affect credit worthiness
Are you suitable to receive credit? A person must show the ability and willingness to carry the cost of borrowing and be able to pay back the loan to the lender.
Compare interest rates on loans and credit cards from different institutions
Financial institutions attempt to earn a profit, people should shop around for the best interest rates on credit cards and loans.
A bank offers 3% interest on savings accounts, and 9% interest on car loans, the bank makes a profit on the 6% difference in interest rates.
Explain the difference between simple and compound interest rates.
Simple Interest – Year 1 – $100 at 10% interest = $10 in interest earned.