chpt 1 & 2 & 22

" Normative economics

" Normative economics is an analysis based on subjective value judgments. Normative statements express an individual or collective opinion on a subject and cannot be proven by facts to be true or false. Certain words or phrases, such as good, bad, need, should, and ought to, tell us clearly that we have entered the realm of normative economics.

Each economic system can be classified into one of three basic types:

(1) Traditional, (2) Command, or (3) Market.

. The market economy

. The market economy is an economic system that answers the What, How, and For Whom questions using prices determined by the interaction of the forces of supply and demand. One of the first people to explain the power of a market economy was the Scottish economist Adam Smith.

. Entrepreneurship is the creative ability of individuals to seek profits by taking risks and combining resources to produce innovative products.

An entrepreneur is a motivated person who seeks profits by undertaking risky activities such as starting new businesses, creating new products, or inventing new ways of accomplishing tasks.

association (or correlation) and causation

Another common error in reasoning is confusing association (or correlation) and causation between variables. Stated differently, you err when you read more into a relationship between variables than is actually there. A model is valid only when a cause-and-effect relationship is stable or dependable over time, rather than being an association that occurs by chance and eventually disappears.

Capital can be defined as a human-made good used to produce other goods and services; for example, capital includes the physical plants, machinery, and equipment used to produce other goods.

Capital can be privately or publicly owned. Private capital is owned by private companies and consists of factories, office buildings, warehouses, robots, trucks, and distribution facilities. Public (or social) capital, also known as infrastructure, is provided by government through taxes and is collectively owned. It consists of roads, bridges, dams, airports, harbors, and public universities and other government buildings. The term capital, as it is used in the study of economics, can be confusing. Economists know that capital in everyday conversations means money or the money value of paper assets, such as stocks, bonds, or a deed to a house. This is actually financial capital. In the study of economics, capital does not refer to money assets. Capital in economics means a factor of production, such as a factory or machinery. Stated simply, you must pay special attention to this point: Money is not capital and is, therefore, not a resource. Instead, money is used to purchase land, labor, or capital, as well as many consumer goods and services.

Capitalism

Capitalism is an economic system characterized by private ownership of resources and markets. Capitalism is also called the free enterprise system. Regardless of its political system, a capitalist economic system must possess two characteristics: private ownership of resources, and decentralized decision making using markets.

Three basic assumptions underlie the production possibilities curve model:

Fixed Resources. The quantities and qualities of all resource inputs remain unchanged during the time period. But the "rules of the game" do allow an economy to shift any resource from the production of one output to the production of another output. For example, an economy might shift workers from producing consumer goods to producing capital goods. Although the number of workers remains unchanged, this transfer of labor will produce fewer consumer goods and more capital goods. Fully Employed Resources. The economy operates with all its factors of production fully employed and producing the greatest output possible without waste or mismanagement. Technology Unchanged. Holding existing technology fixed creates limits, or constraints, on the amounts and types of goods any economy can produce. Technology is the body of knowledge applied to how goods are produced.

Land is a shorthand expression for any natural resource provided by nature that is used to produce a good or service.

Land includes those resources or raw materials that are gifts of nature available for use in the production process. Farming, building factories, and constructing oil refineries would be impossible without land. Land includes anything natural above or below the ground, such as forests, gold, diamonds, oil, coal, wind, and the ocean.

The Ideas of Karl Marx

Marx believed that private ownership and exploitation would produce a nation driven by a class struggle between a few "haves" and many "have-nots." As he stated in The Communist Manifesto, "The history of all existing society is the history of class struggle. Freeman and slave, patrician and plebeian, lord and serf, guildmaster and journeyman, in a word, oppressor and oppressed." In Marx's vision, capitalists were the modern-day oppressors, and the workers were the oppressed proletariat. Someday, Marx predicted, the workers would rise up in a spontaneous bloody revolution against a system benefiting only the owners of capital. Marx believed communism to be the ideal system, which would evolve in stages from capitalism through socialism. Communism is a stateless, classless economic system in which all the factors of production are owned by the workers and people share in production according to their needs. This is the highest form of socialism toward which the revolution should strive.

private ownership

Ownership of resources determines to a great degree who makes the What, How, and For Whom decisions. In a capitalist system, resources are primarily privately owned and controlled by individuals and firms, rather than having property rights be publicly held by government on behalf of society. In the United States, most capital resources are privately owned, but the term capitalism is somewhat confusing because it stresses private ownership of factories, raw materials, farms, and other forms of capital even though public ownership of land exists as well.

Positive economics

Positive economics is an analysis limited to statements that are verifiable. Positive statements can be proven either true or false. Often a positive statement is expressed: "If X, then Y." For example, if the national unemployment rate rises to 9 percent, then teenage unemployment exceeds 80 percent. This is a positive "if-then" prediction, which may or may not be correct. Accuracy is not the criterion for a statement to be positive. The key consideration is whether the statement is testable and not whether it is true or false.

Characteristics of Socialism

Public Ownership, Centralized Decision Making

Two broad categories of natural resources are renewable resources and nonrenewable resources.

Renewable resources are basic inputs that nature can automatically replace. Examples include crops, clean air, and the water and fish in lakes. Nonrenewable resources are basic inputs that nature cannot automatically replace. There is only so much coal, oil, and natural gas in the world. If these fossil fuels disappear, we must use substitutes.

Opportunity cost is the best alternative sacrificed for a chosen alternative.

Stated differently, it is the cost of not choosing the next best alternative. This principle states that some highly valued opportunity must be forgone in all economic decisions. The highest-valued good or use of time given up for the chosen good or use of time measures the opportunity cost.

Labor is the mental and physical capacity of workers to produce goods and services.

The services of farmers, assembly-line workers, lawyers, professional football players, and economists are all labor. The labor resource is measured both by the number of people available for work and by the skills or quality of workers.

. Marginal analysis examines the effects of additions to or subtractions from a current situation.

This is a very valuable tool in the economic way of thinking toolkit because it considers the "marginal" effects of change. The rational decision maker decides on an option only if the marginal benefit exceeds the marginal cost. buisnesses and farmers use this

Socialism's Strengths and Weaknesses

This is because government ownership of capital and other resources prevents a few individuals or groups from acquiring a disproportionate share of the nation's wealth. Also, supporters argue that rapid economic growth is achieved when planners have the power to direct more resources to producing capital goods and fewer resources to producing consumer goods (see Exhibit 5 in Chapter 2). proponents of such an economy can claim there is no unemployment because the government assigns all workers a job and allocates resources to complete their production goals. However, economic inefficiency results because the government often uses many workers to perform work requiring only one or two workers. Critics also point out that the absence of the profit motive discourages entrepreneurship and innovation and thus suppresses economic growth.

Three Fundamental Economic Questions

What products will be produced? How will they be produced? and For Whom will they be produced?

ISMS

What type of economic system will a society choose to answer the What, How, and For Whom questions? We could call most economies "mixed," but this would be too imprecise. In the real world, economic systems are labeled with various forms of the popular "isms"—capitalism, socialism, and communism, which are based on the basic types of systems.

Capitalism's Strengths and Weaknesses

\\\One of the major strengths of capitalism is its capacity to achieve economic efficiency because competition and the profit motive force production at the lowest cost. Another strength of pure capitalism is economic freedombecause economic power is widely dispersed. Individual consumers, producers, and workers are free to make decisions based on their own self-interest. Economist Milton Friedman makes a related point: Private ownership limits the power of government to deny goods, services, or jobs to its adversaries. . First, capitalism tends toward an unequal distribution of income. This inequality of income among citizens results for several reasons. Private ownership of capital and the other factors of production can cause these factors to become concentrated in the hands of a few individuals or firms. Also, people do not have equal labor skills, and the marketplace rewards those with greater skills. These inequalities may be perpetuated because the rich can provide better education, legal aid, political platforms, and wealth to their heirs. Second, private markets can fail to provide an adequate amount of public goods, like roads and national defense. Third, some critics believe capitalism inevitably leads to macroeconomic instability that can result in severe recessions or even depressions. Finally, pure capitalism is criticized for its failure to protect the environment. The pursuit of profit and self-interest can take precedence over damage or pollution to the air, rivers, lakes, and streams.

In a command economy,

a dictator or group of central planners makes economic decisions for society. In this system, the What, How, and For Whom questions are answered by a dictator or planners with central authority The principal feature of a command economy is the central planning board at the top, which transmits economic decisions down to the various producing and consuming units below. This process begins with an overall plan from a supreme planning board, such as the old Soviet Gosplan. The Gosplan established production targets and was the ultimate authority over a layer of specialized planning agencies, which authorized capital expansion, raw material purchases, prices, wages, and all other production decisions for individual producing units. Finally, the factories, farms, mines, and other producers distributed the specified output to consumers according to the approved master plan..

Resources

are the basic categories of inputs used to produce goods and services. Resources are also called factors of production. . Economists divide resources into three categories: land, labor, and capital

Society makes two broad levels of choices:

economy-wide, or macro choices, and individual, or micro choices. The prefixes macro and micro come from the Greek words meaning "large" and "small," respectively. Reflecting the macro and micro perspectives, economics consists of two main branches: macroeconomics and microeconomics.

. Two of the most common pitfalls to clear thinking are

failing to understand the ceteris paribus assumption. confusing association and causation.

scarcity

heart of economic way of thinking. wants are greater than available supply of time, goods, and resources.

Ceteris paribus

is a Latin phrase that means while certain variables change, "all other things remain unchanged."

. A mixed economy

is a system that answers the What, How, and For Whom questions through a mixture of traditional, command, and market systems.

Socialism

is an economic system characterized by government ownership of resources and centralized decision making. Socialism is also called command socialism. Under a socialist economy, a command system owns and controls in the public interest the major industries, such as steel, electricity, and agriculture. However, some free markets can exist in farming, retail trade, and certain service areas. Just as no pure capitalist system exists in the real world, none of the socialist countries in the world today practices pure socialism. In fact, there are as many variants of socialism as there are countries called socialist. Even in the United States, there are some elements of socialism. For example, the federal government owns and operates the Tennessee Valley Authority (TVA), the National Aeronautics and Space Administration (NASA), and the U.S. Postal Service, while at the same time allowing private utilities and mail service firms to operate.

Economic growth

is the ability of an economy to produce greater levels of output, represented by an outward shift of its production possibilities curve.

Investment

is the accumulation of capital, such as factories, machines, and inventories, used to produce goods and services.

Microeconomics

is the branch of economics that studies decision making by a single individual, household, firm, industry, or level of government. It applies a microscope to study specific parts of an economy, as one would examine cells in the body. The focus is on small economic units, such as economic decisions of particular groups of consumers and businesses.

. Consumer sovereignty

is the freedom of consumers to cast their dollar votes to buy, or not to buy, at prices determined in competitive markets. As a result, consumer spending determines what goods and services firms produce. In a capitalist system, most allocative decisions are coordinated by consumers and producers interacting through markets and making their own decisions guided by Adam Smith's "invisible hand." Friedrich Hayek, an Austrian economist who was a 1974 recipient of the Nobel Prize and author of The Road to Serfdom, argued that political and economic freedoms are inseparable.

Privatization

is the process of turning a government enterprise into a private enterprise. . It is the opposite of nationalization,

. Economics

is the study of how society chooses to allocate its scarce resources to satisfy unlimited wants.

The mental and physical capacity of workers to produce goods and services is known as:

labor

An economic system consists of the

organizations and methods used to determine what goods and services are produced, how they are produced, and for whom they are produced.

The production possibilities curve

shows the maximum combinations of two outputs that an economy can produce in a given period of time with its available resources and technology.

A model is a

simplified description of reality used to understand and predict the relationship between variables. The terms model and theory are interchangeable. A model emphasizes only those variables that are most important to explaining an event.

The traditional economy is a system

that answers the What, How, and For Whom questions the way they have always been answered. People in this type of society learn that copying the previous generation allows them to feel accepted. Anyone who changes ways of doing things asks for trouble from others. This is because people in such a society believe that what was good yesterday, and years ago, must still be a good idea today. The benefit of the traditional approach is that it minimizes friction among members because relatively little is disputed. Consequently, people in this system may cooperate more freely with one another.

nationalization,

which is the act of transforming a private enterprise's assets into government ownership. The motives for nationalization are political as well as economic.

macroeconomics,

which is the branch of economics that studies decision making for the economy as a whole. Macroeconomics applies an overview perspective to an economy by examining economy-wide variables, such as inflation, unemployment, economic growth, the money supply, and the national incomes of different countries. Macroeconomic decision making considers such "big picture" policies as the effect that federal tax cuts will have on unemployment and the effect that a change in the money supply will have on inflation.

law of increasing opportunity costs,

which states that the opportunity cost increases as production of one output expands.