ECON 208 Chapter Notes - Chapter 1: Barter, Marginal Cost, Comparative Advantage

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Chapter 1 Economic Issues and Concepts
Sept.11.12
Complexity of the modern economy:
- Economic transactions
- Economy is a complex system
- Individuals provide the goods and services other individuals desire
- Self-organizing economy: interaction of self-interested people creates social
order (foundation of economic order)
- Efficient organization: the spontaneous social order is relatively efficient
- Adam smith (1723-1790) “an economy organized by free markets behaves
almost as if it were guided by an invisible hand”
- Efficiency refers to organizing available resources to produce the goods and
services that people need/wants and by using the fewest possible resources
to do so
- Aiming to satisfy unlimited human wants and needs with scarce resources
Main characteristics of market economies:
- Self-interest guides individuals (buy/sell what’s best for them)
- Individuals respond to incentives (sell more with high prices, buy more with
low prices)
- Prices and quantities are set in relatively free markets in which individuals
trade voluntarily
- Institutions created by the state protect private property and enforce
contractual obligations (fair trade and exchange in the economy)
- Self-interest and incentives determine market prices and quantities produced
- This occurs within an institutional framework
Scarcity, choice, and opportunity cost:
- Land, labor, capital
- Resources = factors of production
- Outputs = goods and services (tangible and intangible)
- Scarcity means need for choice leading to opportunity cost
- Opportunity cost: benefit given up by not using resources in the best
alternative way
Key economic problems:
1. What is produced and how
- resource allocation determines the quantities of goods that are produced
- what combination of civilian and military goods will be chosen
- will the economy be inside the PPB curve (efficient or inefficient)
2. What is consumed and by whom
- what determines how economies distribute total output
- if and why are there inequalities with distribution
- is there a surplus or deficit of goods/services
- are there idle resources and should the government be concerned (i.e. high
unemployment rates)
3. Why are resources sometimes idle
4. Is the productive capacity (PPB) growing
- growth = outward shift
- efficiency = production on the curve
Who makes the choices and how:
- Individuals own factors of production and sell to producers
Flow of income and expenditure:
- Individuals own FOP, sell services (in factor markets) of the factors to
producers and receive payments in return (incomes)
- Distribution of income = how the nation’s total income is distributed among
its citizens, determined by the price that each type of factor service receives
in factor markets
- Maximizing decisions: consumers/producers are the basic decision makers,
assumption that everyone tries to do as best as possible for themselves (i.e.
profit maximizers)
- Marginal decisions: firms/consumers who are trying to maximize need to
weigh the costs/benefits of their decisions at the margin, buy a good only if
you think the benefit to you in terms of extra utility exceeds the marginal
cost
Complexity of production:
- Specialization and division of labor
- Allocation of different jobs to different people, more efficient than self-
sufficiency, individuals have different abilities (comparative advantage),
repetition = better production
- Division of labor = more levels of specialization
- Specialization must be accompanied by trade
- Money eliminates the system of barter by separating the transaction involved
in the exchange of productions
- Mass production: work is divided into highly specialized tasks by using
specialized machinery
- Artisans and flexible manufacturing: individual artisans have reappeared in
some lines of production, responding to the demand for individually crafted
goods, many manufacturing operations are being reorganized into lean
production/flexible manufacturing
Globalization:
- Development of new technologies: change market economies
- International trade today: globalization in manufacturers
- Possible due to: reduction of transport costs and a revolution in IT
- Consequences: consumer tastes become more universal and producers
become transnational companies (TNCs)
- Anti-globalization activists: increase global income inequality
- Defenders of globalization: way to reduce poverty
- Globalization and poverty: empirical findings show links, gain unequally
distributed among society
Alternative to the market economy:
Types of economic systems
- Traditional
- long-established traditions
- unchanging environment
- inherited jobs
- i.e. feudal system
- Command/planned
- central planner
- fully integrated plan
- very difficult to organize
- Free-market
- decentralized decisions
- coordinated by a price system
- Mixed economy
- combines significant elements of all three systems
The Great Debate:
- 1776 Adam Smith analyzed the operation of markets
- Stressed the relative efficiency for free-market economies
- Karl Marx argued that free market economies would be successful in
producing high levels of output but they can’t ensure output would be evenly
distributed
- Marx argued the benefits of a centrally planned system where the
government can more evenly distribute of output
- 1920 Soviet Union, Eastern Europe, China, and other nations adopted central
planning systems