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What is Economics
What is economics and why is the study of economics important?
Economics is the study of how humans make decisions in the face of scarcity. These can be individual decisions, family decisions, business decisions or societal decisions.
● Scarcity means that human wants for goods, services and resources exceed what is available.
Division of Labor – the way in which different workers divide required tasks to produce a good or service.
Division of Labor Increases Production
Dividing and subdividing the tasks involved with producing a good or service, produces a greater quantity of output.
● Specialization – when workers or firms focus on particular tasks for which they are well-suited within the overall production process.
• Specialization allows businesses to take advantage of economies of scale, which means that for many goods, as
the level of production increases, the average cost of producing each individual unit declines.
Economics is concerned with the well-being of all people, including those with jobs and those without jobs, as well as those with high incomes and those with low incomes.
● Microeconomics focuses on the actions of individual agents within the economy, like households, workers, and businesses.
● Macroeconomics is the branch of economics that focuses on broad issues such as growth, unemployment, inflation, and trade balance.
Monetary policy – policy that involves altering the level of interest rates, the availability of credit in the economy, and the extent of borrowing.
• Determined by a nation’s central bank
Fiscal policy – economic policies that involve government spending and taxes.
• Determined by a nation’s legislative body
One of the most influential economists in modern times was John Maynard Keynes.
● Keynes thought that economics teaches you how to think, not what to think.
Economic Theories and Models
A theory is a simplified representation of how two or more variables interact with each other.
• A good theory is simple enough to understand, while complex enough to capture the key features of the object or situation you are studying.
● Economists use models to test theories, but for this course we will use the terms model and theory interchangeably.
The circular flow diagram shows how households and firms interact in the goods and services market, and in the labor market.
○ The direction of the arrows shows that in the goods and services market, households receive goods and services and pay firms for them.
○ In the labor market, households provide labor and receive payment from firms through wages, salaries, and benefits.
There are at least three ways that societies organize an economy:
● 1) Traditional economy – typically an agricultural economy where things are done the same as they have always been done.
• Oldest economic system
• Used in parts of Asia, Africa, and South America
• Occupations tend to stay in the family
• What you produce is what you consume
• Little economic progress or development
2) Command economy – an economy where economic decisions are passed down from government authority and where the government owns the resources.
• Government decides what goods and services will be produced and what prices it will charge for them.
• The government decides what methods of production to use and sets wages for workers.
• The government provides many necessities like healthcare and education for free.
Examples of command economy:
○ Ancient Egypt
○ Medieval manor life
○ Currently, Cuba and North Korea
3) Market economy – an economy where economic decisions are decentralized, private individuals own
resources, and businesses supply goods and services based on demand.
● Market – interaction between potential buyers and sellers; a combination of demand and supply.
● Private enterprise – system where private individuals or groups of private individuals own and operate the means of production (resources and businesses).
Most economies in the real world are mixed. They combine elements of command, traditional, and market systems.
● The U.S. economy is positioned toward the market-oriented end of the spectrum.
● Many countries in Europe and Latin America, while primarily market-oriented, have a greater degree of government involvement in economic decisions than the U.S. economy.
● China and Russia, while they have moved more in the direction of having a market-oriented system, remain closer to the command economy end of the spectrum.
There is no such thing as an absolutely free market.
● Regulations always define the “rules of the game” in the economy.
● Economies that are primarily market-oriented have fewer regulations—ideally just enough to maintain an even playing field for participants.
● Heavily regulated economies often have underground economies (or black markets), which are markets where the buyers and sellers make transactions without the government’s approval.
Rise of Globalization
Globalization – the trend in which buying and selling in markets have increasingly crossed national borders.
● Exports – the goods and services that a nation produces domestically and sells abroad.
● Imports – the goods and services that are produced abroad and then sold domestically.
● Gross domestic product (GDP)- measures the size of total production in an economy.
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Economics 102 – Principles of Macroeconomics