Author: John Bouman

Introduction

What’s in This Chapter? In this unit, we define economics and describe fundamental economic concepts. We study economics to explain important economic relationships and to determine how to best improve a nation’s standard of living and citizens’ happiness. In this definition, improving a nation’s standard of living includes increasing tangible (cars, houses, food), as well as intangible goods and services (protection from violence, clean air, entertainment, leisure time). The production possibilities curve in this unit shows us the production choices we face given a certain amount of resources. No matter how abundant our resources are, they are limited, and we have to make choices regarding what and how much we want to produce and for whom. In section 4, we look at the circular flow model. This model paints a picture of the main economic activities and groups in a country. In free market economies, the decision as to what and how much to produce is made by the buyers and sellers of the products. Governments in free market economies play an important role in setting certain rules and protecting people and private properties, but exert relatively little control over prices of products and factors of production. Section 5 discusses the three main economic systems, which reflect the various degrees of government involvement: capitalism, socialism, and communism. Section 6 defines and explains important fundamental economic concepts, such as the...

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Section 1: Economics

The Definition of Economics What is economics? Is it the study of money? Is it about trade-offs and scarce resources? Is it about inflation, unemployment, and government budget deficits? Is it about eliminating poverty? All of the above are important topics in the study of economics, but the main objective of economics is its ability to explain how we can most optimally achieve the highest standard of living and citizens’ happiness. Therefore: Economics is the study of how we can best increase a nation’s standard of living and citizens’ happiness with the resources that we have available to us. Standard of living in this definition includes tangible products, such as cars and houses, as well as intangible products, such as more leisure time, access to health care, and cleaner air. How Can We Best Increase Our Nation’s Standard of Living? There is substantial disagreement over how a country can best achieve the optimum standard of living. Some economists support considerable government involvement, price controls, and government rules and regulations. Others believe that government involvement should be minimal and limited to tasks including the provision of a legal system, military, police and fire protection, and providing certain public goods. Many believe that a combination of moderate government involvement and private initiative works best. Controversial issues in economics include the role of profits, income and wealth distribution, unions, and government stimulus...

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Section 2: The Production Possibilities Curve

Production Choices When we study how a country can best increase its standard of living, we must look at its production behavior. In order to produce, a country must use its resources, including land, labor, capital, and raw materials. A production possibilities curve represents production combinations that can be produced with a given amount of resources. Let’s say that a very small hypothetical country uses 100 acres of land, 20 machines, and 50 workers, and is able to produce two products: guns and roses. You can think of “guns” as representing the category of military products. “Roses” represents all consumer products. This country has some choices (possibilities) regarding how it uses its resources. It can produce 500 units of guns and 350 units of roses (point C on the graph below). However, it can also, with the same resources, produce 400 units of guns and 500 units of roses (point B). Or it can produce 300 units of guns and 580 units of roses (point A). Numerous other combinations (for example, points D, E, G or points in-between), are possible.           A production possibilities curve represents outcome or production combinations that can be produced with a given amount of resources. Points on the Curve and Trade-offs If an economy is operating at a point on the production possibilities curve, it is operating at full employment....

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Section 3: Economic Growth

Causes of Economic Growth Economic growth occurs when the economy realizes greater production levels. In the graph below, the production possibilities curve shifts outward to the right (for instance, through point F), so that the country’s production capacity level rises. For the curve to shift outward, resources (land, labor, capital, and raw materials) must increase, or we must improve the way we use these resources (technology). Therefore, economic growth is made possible by advances in technology and/or increases in resources, such as natural resources (land, oil, trees, etc.), workers, and capital goods, including machinery, equipment, assembly lines, office buildings, factories, roads, highways, and airports. How does a country increase its capital goods, and how does it achieve advances in technology? Let’s take a look at increases in capital goods first. Increases in Capital Goods Capital goods are produced just like other goods, such as cars or food. If a country is producing at full employment (operating on the curve), more capital goods can be produced only if the country produces fewer consumption goods. Looking at the diagram in the previous section, this is reflected by a move from a point on the curve from the lower right to the upper left (for example, from point D to point A, or from point B to point C). A government can encourage more production of capital goods by, for example, providing...

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Section 4: The Circular Flow

The Simple Circular Flow Model In its simplest form, an economy consists of buyers and sellers. Sellers are businesses that buy resources, including land, labor, capital goods, and raw materials and use these to produce and sell goods and services. Households provide (sell) their labor to businesses, and use the income to buy products. Households also may own land, capital (money), capital goods, and raw materials which can be used for production. In the graph below, a simple circular flow diagram shows the economic interactions between households and businesses. This paints a simplified picture of how our economy works. The Circular Flow with Government and Foreign Markets A more realistic picture of our economy also incorporates the economic interactions of two other main participants in our economy: a government and foreign markets. This is illustrated in the diagram below. Governments provide services to businesses, households, and foreign markets, and collect taxes to pay for these. Foreign markets buy and sell goods and services to and from our households, businesses, and governments. So a typical economy consists of four main groups: households, businesses, governments, and foreign markets. The circular flow model illustrates the interactions between these four groups. For a video explanation of the circular flow, please watch the...

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