Economics Chapter 4

What is a subsidy or "bail-out"?

A subsidy is a payment from the government to prevent the institution from falling into bankruptcy. A bailout is an act of giving financial assistance to a failing business or economy to save it from collapse. They're basically the same thing.

Law of Supply

As the price of a good rises, business people want to see more. As the price of a good falls, business people want to sell less. Ex: If coffee could only be sold for $2.00, the many sellers wouldn't consider it a profitable market, but rather marginal. If coffee could be sold for $5.00 and they'd get away with it, it becomes profitable, and more people want to sell. Thus the curve moves outward.

What is the solution in a Capitalist society if a firm is losing so much money that is failing?

Capitalists say that bankruptcy is more beneficial for an individual than a bail out. Attending a bankruptcy court and being closed out to have their debts handled is better than getting bailed out over and over, never learning your lesson. It's like the "F" grade in a class. Also refer to the carrot-stick metaphor. If you want a donkey to obey you, hold a carrot in its face (money) and swat it's rear end with a stick (bankruptcy), it'll listen eventually.

What is entrepreneurship?

Describes someone who organizes, manages, and assumes the risks of the firm, taking a new idea or a new product and turning it into a successful business.

Who produces the output? Who consumes it? Where do the households get the income to pay for the output?

Firms supply (produce), households demand (consumes). Households get income to pay for the output from input markets (land, labor, capital).

What is land?

Households supply land or other real property in exchange for rent.

What is capital?

Households supply their savings, for interest or for claims to future profits, to firms that demand funds to buy capital goods.

What is labor?

Households supply work for wages to firms that demand labor.

Law of Demand

If the price of a good decreases, people will want to buy more of it. If the price of a good increases, people will want to buy less of it. If the "good" is not a good for a specific persona, the law of demand does not apply. Ex: Tom doesn't like ties, so whether the price rises or not, it doesn't really matter. The further to the right the demand curve shifts, the more in demand the good is.

What are inputs in the production process?

Inputs in the production process are also called factors of production. In input markets, households supply the resources.

What are the major factors of production?

Land, labor, capital, and entrepreneurship.

What are product or output markets?

Markets in which goods and services are exchanged.

Does pure capitalism approve of this?

No. Pure capitalism does not approve of a "bail-out". Instead, they believe bankruptcy - which implies that someone or a company cannot pay their contracted for bills or the total debt is more than the total revenue - is the best way to go.

Can the output and income for a country be larger than the other?

One can be larger than the other and it would be a shortage or a surplus. Equilibrium must be found to create the ideal profitable experience for buyers and sellers. (Firms and households) Goods for which demand goes up when income is higher and for which demand goes down when income is lower is called normal goods. Movie tickets, restaurant meals, telephone calls, and shirts are all normal goods. Goods for which demand tends to fall when income rises are called inferior goods.

What is Profit, and how is it defined?

Profit is the difference between revenues (gains) and costs [Revenue - Costs = Profits]. Recall the Blackberry example from class. $10 million minus $8 million is a $2 million profit, but 7 million minus $8 million is a -$1 profit or no profit. Supply is likely to react to changes in revenues (gains) and changes in production costs. The amount of revenue a firm earns depends on what the price of its product in the market is and on how much it sells. Costs of production depend on factors such as: the kinds of inputs needed to produce the product, the amount of each input required, and the prices of inputs.

What are the negative aspects of using the price mechanism?

Referring back to the auction, the quantity demanded falls as buyers dropout of the market and perhaps choose a substitute.

Equilibrium Price

Refers to a particular price that brings the desires of buyers and sellers into equality. Equilibrium is achieved when there are no shortages, no surpluses, and no pressure on the price to change.

What is consumer sovereignty?

Refers to the freedom for an individual to choose to purchase a good or services at a price determined in a free, unfettered market. At any time the producer can hike up a price to make a profit, or the consumer can decide not to buy a product because of the price. It's all about personal preference.

Are Socialist firms required to make a profit?

Socialists firms aren't required to make a profit, because they have the government to bail them out if they don't. Like the post office has lost $20 billion dollars in the past 4 years, but the government can always bail them out, or ultimately let the government owned postal service die out and let private firms take over that business instead.

Why do Socialists often oppose bankruptcy of firms and insist that the government subsidize the firm?

Socialists would rather the government bailing out failing companies be an obligation and die a slow, painful death, rather than letting the companies spare themselves.

How are output and income for a country related?

The amount of output increases when there is an increase in income and vice versa.

What factors cause profit to rise or fall?

The same factors that would affect demand or supply, affect profit. Tastes and preferences, income and wealth, expectations, and prices of other products.

What are the positive aspects of using the price mechanism to determine the output of goods and services VS. centrally planning the decisions in government?

Using a price mechanism, such as an auction, gives buyers and sellers more freedom to determine both what they want to offer and what they are willing to pay for a product. If the government centrally planned decisions such as these, prices would be set and people wouldn't be able to make their own decisions as to what they believe is profitable. The quantity supplied increases as farmers find themselves receiving a higher price for their product and shift additional acres into soybean production.

What is a shortage?

When you have less than what you can supply. The demand will be high, but your supply will be low.

What is a surplus?

When you have more than what you need to supply. The demand will be low or marginal, but your supply will be high.