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Chapter 1

Chapter 1 - ECON Reading.docx

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Queen's University
ECON 110
Ian James Cromb

Chapter 1 – ECON Reading o Economy: a system in which scarce resources are allocated among competing uses o Decisions must be made about which goods are produced and which are not; who works where and at what wage; and who consumes which goods at what times o The great insight of economists is that an economy based on free-market transactions is self- organizing o “Spontaneous Economic Order:” When individual consumers and producers act independently to pursue their own self-interests, responding to prices determined in open markets, the collective outcome is coordinated o Self-interest is the foundation of economic order o Spontaneously generated economic order is relatively efficient o Efficiency: the resources available to the nation are organized so as to produce all the goods and services that people want to purchase and to produce them with the least possible amount of resources o An economy organized by free markets behaves as if it were guided by “an invisible hand” – refers to the relatively efficient order that emerges spontaneously out of the many independent decisions made by those who produce, sell, and buy goods and services o Main Characteristics of Market Economies: - Self-Interests: individuals pursue their own self-interest, buying and selling what seems best for them and their families - Incentives: sellers usually want to sell more when prices are high; buyers usually want to buy more when prices are low - Market Prices and Quantities: would-be sellers compete to sell their products to would-be buyers - Institutions: governed by a set of institutions largely created by government  Private property  Freedom of contract  Rule of law o We live in a world of scarcity - Sufficient to produce only a small fraction of the goods and services that people desire - Gives rise to the basic economic problem of choice - Economics is the study of the use of scarce resources to satisfy unlimites human wants o Three Categories of Society’s Resources: - Land: includes all natural endowments (arable land, forests, lakes, crude oil, minerals) - Labour: includes all mental and physical human resources - Capital: includes all manufactured aids to production, such as tools, machinery, buildings o Factors of Production: resources used to produce goods and services; frequently divided into the basic categories of land, labour, and capital o We divide what is produced into goods and services o Goods: tangible commodities, such as cars or shoes o Services: intangible commodities; such as haircuts or medical care o Production: the act of making goods or services o Consumption: the act of using goods or services to satisfy wants o Resources are scarce relative to their desires o All societies face the problem of deciding what to produce and how much each person will consume o A decision to have more of something requires a decision to have less of something else o Scarcity implies that choices must be made; and making choices implies the existence of costs o Opportunity Cost: the cost of using resources for a certain purpose, measured by the benefit given up by not using them in their best alternative use - every time a choice is made, opportunity costs are incurred - example: resources that could have produced 20 km of road are best used instead to produce one hospital, the opportunity cost of a hospital is 20 km of road o Production Possibilities Boundary: a curve showing which alternative combinations of commodities can just be attained if all available resources are used efficiently; it’s the boundary between attainable and unattainable output combinations - A production possibilities boundary illustrates three concepts: scarcity, choice, opportunity cost o Concave Shape: indicates that the opportunity cost of either good increases as we increase the amount of it that is produced - Usually the way economists draw a country’s production possibilities boundary - Shape occurs because each factor of production is not equally useful in producing all goods o Straight Line Boundary: indicates that the opp. Cost of one good stays constant, no matter how much of it is produced o Four Key Economic Questions: - What is produced and how?  Resource Allocation: the allocation of an economy’s scarce resources of land, labour, and capital among alternative uses – determines the quantities of various goods that are produced  any economy must have some mechanism by which these decisions about resource allocation are made - What is consumed and by whom?  Questions relating to what is produced and how, and what is consumed and by whom, fall within the realm or microeconomics  Microeconomics: the study of the causes and consequences of the allocation of resources as it is affected by the workings of the price system and government policies that seek to influence it - Why are resources sometimes idle?  Resources – land, labour, factories – lie idle = the economy is operating inside its production possibilities boundary - Is productive capacity growing?  Represented by an outward shift of the production possibilities boundary  Combinations that are unattainable today will become attainable in the future  Questions relating to the idleness of resources and the growth of productive capacity fall within the realm of macroeconomics  Macroeconomics: the study of the determination of economic aggregates, such as total output, total employment, the price level, the rate of economic growth o The Flow of Income and Expenditure: - Individuals own factors of production. They sell the services of these factors to producers and receive payments in return = incomes - Producers use the factor services that they buy to make goods and services - They sell these to individuals, receiving payments in return = incomes of producers - Basic flows of income and expenditure pass through markets - Individuals sell the services of the factor that they own in what are collectively called factor markets - Producers sell their outputs of goods and services in what are collectively called goods markets - The prices that are determined in these markets determine the incomes that are earned - Distribution of Income: refers to how a nation’s total income is distributed among its citizens o Maximizing Decisions: - Consumers and producers are the basic decision makers in a market economy – also the government - Everyone tries to do as well as possible for himself/herself - People are assumed to be maximizers - They make choices designed to maximize their well-being, or utility - Producers make choices designed to maximize profits o Marginal Decisions: - at the margin - marginal cost - marginal benefit - consumers and producers who are maximizers make marginal decisions – whether to buy or sell a little bit or less of the many things that they buy nd sell o Specialization: - Specialization of Labour: the specialization of individual workers in the production of particular goods and serv
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