Economics

What is economics?

• It studies how we allocate the limited resources to satisfy unlimited wants

American Free Market System

• Introduction

• Challenges in a free market

• Supply and Demand

• Economic systems

• The U.S. economy

• Factors of Production

• Business organizations

The Circular flow of Economics

• Resources, goods and services and money flow continuously among households, businesses and the government in the U.S. economy.

The Circular flow of Economics Continued…

• Individual households own the resources used in production; sell the resources and use the income to purchase products.

• Businesses (producers) buy resources used in production; sell the resources and use the income to purchase products. Businesses provide households with income and goods and services.

• Governments use tax revenue from individuals and businesses to provide public goods and services.

Households supply businesses with labor (workforce) and payments for goods and services

Businesses provides households with income and public goods and services.

The government supplies businesses with public goods and services and payments for products purchased.

Businesses provide the government with taxes and goods and services.

The government provides households with income and public goods and services.

Households provide the government with labor (workforce) and taxes

Production, Consumption and DistributionFour Questions all

Economic Systems must Address

Four Questions All Economic Systems must address…

What is produced?*Production*

• Goods and services must satisfy the consumers wants and desires

Four Questions All Economic Systems must address…

• HOW should these goods be produced?

*Factors of Production*1. Capital

2. Entrepreneurship3. Land4. Labor

Combine the factors of production to make or produce the goods and services

Four Questions All Economic Systems must address…

• For WHOM are the goods and services produced?

*Distribution* Getting the goods and services from

producer to consumer

Four Questions All Economic Systems must address…

• HOW MANY goods and services should be produced?

*Consumption*Make enough to have a large profit and still have

consumer demand. How many is determined by supply and demand.

Supply and Demand

Supply and Demand…• Scarcity is the inability to satisfy all

wants at the same time due to limited resources

• Choices must be made as to what to produce, how much to produce and who will receive what is produced.

• PRICE: Mechanism to decide who gets goods and services. The amount that satisfies both producers for profit and consumers for value.

Scarcity

Choices

Price

Supply and Demand determine price through their interaction

• DEMAND: is the amount of a good or service that consumers are willing and able to buy at a certain price

• SUPPLY: is the amount of a good or service that producers are willing and able to sell at a certain price.

LAW OF SUPPLY :Businesses will provide more products when they can sell them at higher prices

LAW OF DEMAND:Buyers will demand more productswhen they can buy them at lower prices

Incentives

• Incite or motivate• Change economic

behavior• Something that

spurs someone into action: sale, coupons, etc.

Resources, Scarcity & Opportunity Cost

Good• Anything that can be grown or

manufactured (made)• Food• Clothes• Cars

Service • Something a person does for

someone else in exchange for money or value.

• Doctor• Hairdresser• waiter

Resources • Natural • Human• Capital• Combine to make goods and services

Our Basic Economic Problem…

People have Unlimited Wants

• Food• Clothing• Shelter• Schools• Hospitals• Cars• Transportation

But Resources are Limited

• Land• Soil• Minerals• Fuels• People• Money• Technology

Scarcity• The inability to satisfy all

wants at the same time;• the NEEDS are greater than

the RESOURCES

Since resources are LIMITED consumers and producers must make CHOICES

• CHOICE: selecting from a set of alternatives

• OPPORTUNITY COST: what is given up when the choice is made.

*Scarcity forces us to choose which needs and wants to satisfy with available resources.

*Scarcity affects decisions concerning what and how much to produce, how goods and services will be produced and who will get

what is produced

Production: (sellers)

*Combining resources to make goods and services.

*Available resources and consumer preference determine what is produced

Consumption (buyers)

*Using goods and services

*Consumer preference and price determine what is purchased

SELLER Buyer

Challenges in a Free Market: Terms

ScarcityIn English

You can't have everything you want.

Lessons for lifeAcceptance of scarcity

will help you make more reasoned choices

AlternativesIn English

Different options from which you

can choose

Lessons for Life

There are many different ways to

allocate resources and to solve problems

Yes….these are generic converse!

Choice In English

Because you can't have everything

you want, you have to make choices

from a list of alternatives

Lessons for life When policy-makers decide on

a particular resource allocation, recognize that a choice had to be made due to scarcity. You may not

like the alternative chosen, you may question the

choice, but the villain is scarcity

Trade-off’s In English

• Choices involve giving up something to get something. All choices have consequences, both positive and negative

Lessons for Life

You are responsible for the consequences of your choices. Since you make choices, you can't be a victim.

Opportunity Cost In English

What is given up when a choice is made

Lessons for Life

All choices have opportunity costs. A good idea is only a good idea if its value is greater than the value of its opportunity cost. Voters must always identify the opportunity cost of a particular policy

Types of Economies

• Traditional economy:– Economic decisions are based on custom

and historical precedent.– People often perform the same type of

work as their parents and grandparents, regardless of ability or potential.

Command Economy • The central

government makes decisions and determines how resources will be used.

• The central government owns property and resources.

• Businesses are not run for profit.

• Businesses are not run for profit.

• No competition• Lack of consumer

choice• The government sets

the prices of goods and services.

• China, North Korea, Cuba

Economic Systems

Mixed Economy• Most common type of

economic system• Government and

individuals share the decision making process

• Individuals and businesses make decisions for the private sector

• Individuals own the means of production

• Government makes plans for the public sector

• Government guides and regulates production of goods and services offered.

• A greater government role than in a free market economy

• Most effective economy for providing goods and services

• U.S. and most Western European countries are mixed economies

Free Market Economy• Also known as

capitalism or free enterprise

• Private ownership of property and resources (owned by individuals)

• Individuals and businesses make profits

• Individuals and businesses compete

• Economic decisions are made by supply and demand

• Profit is a motivator for productivity

• No government involvement

• Consumer sovereignty: buyers determine what is produced

The U.S. economy is

a MIXED ECONOMY PRIVATE

PROPERTY

FREE MARKETS

PROFITCOMPETITION

CONSUMER SOVEREIGNTY

Markets are allowed to operate without undue interference from the government. Money, goods and services flow continuously among individual households, businesses and the government

Consumers determine what goods and services are produced by what they buy

Money left over after all business expenses have been paid.

Rivalry between businesses for the same customers; results in better quality Individuals can

own the means of production & property without undue government interference

Competition

• We compete for the use of limited resources

– 2 ways of competition – Price competition– Non price competition e.g. waiting,

examination, lucky draw, violence…

Factors of Production

anything that goes into the making of a good or service

Factors of ProductionCapital

• Ex: tools, machinery, money and technology

Entrepreneur

Business owner and risk taker combines the

factors of production

Factors of production cont…

Land

Natural Resources

Labor

Workers and their time and energy

Business OrganizationsThe 15 million businesses in the U.S.

fall into three categories: sole proprietorships, owned by a

single individual, partnerships, with more than one

owner sharing the risks and profits and

corporations, owned by their stockholders.

Sole Proprietorship 1 owner

• The owner takes all the risks• Supplies capital, hires help, pays

taxes• The owner makes all the profits• The owner is solely responsible for

losses

Partnership More than one owner (2+)

• Risks are shared amongst the owners• Profits are shared amongst the

owners• Often more successful than sole

proprietorships • Responsibilities are shared

Corporation Owned by stockholders

• Authorized to act as a legal person regardless of the number of owners

• Owners share the profits• Liability is limited to investment (you can

only loose as much as you put in)• Raise money by selling stocks• No one is responsible for corporation’s

debt if it fails

Making choices

• Which restaurant will you go for lunch?

• What would you like to study at university?

• What will you buy with $100? CD or dress ?

• Which girl (boy) will you marry?

Complimentary tickets

• Going to Busch Gardens instead of going to work

• Ticket : Free of charge• Money spent on food, transport..=$60• Income forgone = $50

• Full cost of going for day at Busch Gardens=$110

Choosing a CareerCost-Benefit Analysis

• Cost: Education• Benefit: Higher paying job

• Example: Cost of college for 4 years averages $36,000.

Average Annual Earnings—Different Levels of Education

• Professional Degree $109,600 • Doctoral Degree $89,400 • Master's Degree $62,300 • Bachelor's Degree $52,200 • Associate's Degree $38,200 • Some College $36,800 • High School Graduate $30,400 • Some High School $23,400 Average Annual Earnings—

Different Levels of Education.Source: U.S. Census Bureau, Current Population Surveys, March 1998, 1999, and 2000.

TaxationDefinition of taxation: In economic terms, wealth transfer from

businesses or households to the government occurs by use of taxation.

Let us now look at the four main purposes of taxation which are:1. Revenue: to raise money to spend on hospitals & schools,

roads and government functions like justice system.2. Redistribution: Transfer of wealth from richer sections of

society to poorer sections. This is controversial.3. Repricing: Taxes are imposed to influence society; taxation on

tobacco to discourage smoking.4. Representation: direct taxation results in higher degree of

accountability & better governance.

Types of Taxes

• Income• Sales• Self-employed businessperson or independentContractor• Business• Real estate• Utility• Lodging/Restaurant• Personal property

Personal Finances

• No one will make your life but you! • You cannot build a house without a

hammer. You cannot build a lifestyle without money.

Definitions

• Personal finance: the process of planning your spending, financing, and investing to optimize your financial situation

• Personal financial plan: a plan of your financial goals and describes the spending, financing, and investing plans that are intended to achieve those goals

How You Benefit From An Understanding of Personal Finance

• Make your own financial decisions– Every spending decision has an

opportunity cost

• Judge the advice of financial advisors– Make informed decisions

Components of a Financial Plan

• Budgeting and tax planning• Managing your cash• Financing your large purchases• Protecting your assets and income

(insurance)• Investing your money• Planning your retirement and estate

A Plan for Your Budgeting and Tax Planning

• Budget planning: The process of forecasting future expenses and savings

• Evaluate your current financial position– Assets: what you own (buying a house vs.

renting)– Liabilities: what you owe– Net worth: the value of what you own minus the

value of what you owe

Budgeting

• Identify sources of income.• Relate employee benefits to disposable income (Do

you have to buy insurance?)• Estimate income (gross pay versus net pay).• Estimate expenses.• Construct a budget/spending plan.

– Fixed expenses (rent/mortgage, insurance, electricity, water, gas, automobile, phone, cable)– Variable expenses (groceries, entertainment, taxes, etc.)

Budgeting and Tax Planning

A Plan to Manage Your Cash

• Credit management: decisions regarding how much credit to obtain to support your spending and which sources of credit to use– Credit cards-decrease credit score (score given people based on how you

use credit and available to bankers)

– Short term loans-increase credit score

– Mortgages-increase credit score, tax-deductible, build equity (equity is value held by bank but available to you as cash when you sell your home)

Managing Your Cash

Banking

• Checking-check card, checks, cash machine– Easy access, but with service fee

• Savings– Less access, rarely a fee

• Certificate of Deposit (CD)– Little access, they pay you interest!

Developing the Financial Plan

• Step 1. Establish Your Financial Goals– Types of goals

• Car, home, college, wealth, charity– Set realistic goals

• Stronger likelihood of reaching goals– Timing of goals

• Short term (within one year)• Intermediate (between 1–5 years)• Long term (beyond five years)

Developing the Financial Plan

• Step 2. Consider Your Current Financial Position– How your future financial position is tied to

your education• Consider your skills, interests, and career paths

– How your future financial position is tied to your career choice

• Choose a career that will be enjoyable and suit your skills, as well as one which helps you reach your financial goals

Integrating Key Concepts

A Plan for Your Financing

• Loans often needed for large expenditures– College tuition, car, house

• Managing loans– How much can you afford to borrow?– Determining maturity of the loan– Selecting a loan with a competitive interest

rate

Financing Your Large Purchases

Insurance

• Property-against fire, casualty• Liability-against lawsuit!• Automobile-This is a state law.• Health –medical costs are very

expensive!• Life-as gift to those you love

Investing

• Stocks• Bonds• Annuities• Mutual Funds• Property (Real Estate, Precious Metals,

Art, etc.)

A Plan for Your Investing

• Funds not needed for cash can be invested

• All investments have some level of risk

• Risk: uncertainty surrounding the potential return on an investment

Retirement

• Employee Benefits-not as common as it used to be!

• Social Security-A political issue. Do you want to count on this?

• Personal Savings-Your best bet!

A Plan for Your Retirement and Estate

• This includes insurance planning, retirement planning, and estate planning– Retirement planning: determining how much

money should be set aside each year for retirement and how those funds should be invested

– Estate planning: determining how your wealth will be distributed before or upon your death

• Your will

How to stay out of financial trouble

• Maintain a record-keeping system for credit purchases• Ensure safekeeping of credit and credit cards• Avoid late payment and other penalties-pay attention to deadlines, bills,

etc.• Debt payment plans-BUDGET!!• Warning signs of debt problems

– Default, Notices, Repossessions, Collection agencies, Liens, Garnishment, Foreclosure, Repossession, Eviction

• Credit counseling• Understanding bankruptcy: Chapter 7 (liquidation), Chapter 13

(repayment)• Rebuilding credit

-bank accounts-->credit cards-->short term loans-->mortgages

Miss Cheng could spend two hours at a concert orMiss Cheng could spend two hours at a concert ortutoring a student at $70 per hour. She could use the time tutoring a student at $70 per hour. She could use the time on painting instead and earn a total of $170. If the price of on painting instead and earn a total of $170. If the price of the concert ticket is $250, what is the opportunity cost of the concert ticket is $250, what is the opportunity cost of her choice of going to the concert?her choice of going to the concert?

A. $410A. $410 B. $420B. $420 C. $430C. $430 D $440D $440

No. of couponsNo. of coupons GiftsGifts

5515152020

CupCupBagBagCameraCamera

Mary has accumulated 20 Coupons.Mary has accumulated 20 Coupons.What is the opportunity cost to her What is the opportunity cost to her if she uses them to exchange for one if she uses them to exchange for one camera?camera?

A.Cup A.Cup B. BagB. Bag C. Cup and BagC. Cup and Bag D. Cup or BagD. Cup or Bag

Which of the following statementsabout scarcity is true?

A. Once a choice is made, the problem of scarcity is solved.

B. A good is scarce if not everyone has it.

C. Scarcity means unlimited human wants.

D. Both rich people and poor people face the problem

of scarcity.

Answer: D

Which of the following are opportunity costs of attending school?(1) Poor examination results(2) Income forgone(3) School fees(4) Expenditure on dinners

A. (1) and (4) only

B. (1) and (3) only

C. (2) and (3) onlyD. (2) and (4) onlyAnswer: C. (2) and (3) only