Chapter 1 – Introduction

Economics

Economics is the social science that studies how humans make decisions in regards to scarcity. These can be the decisions of individuals, families, businesses, or entire societies.

Scarcity means that there is an imbalance between supply and demand. Humans want certain goods, services, and resources, but they exist only in limited supply.

Members of society at every level decide how to allocate resources (e.g., time and money). For example, a city council may have to decide between a school expansion or a new fleet of police cars.

Division of Labour

In The Wealth of Nations, Adam Smith introduced the concept of division of labour. In restaurants, some cooks prep, while others deep-fry or plate. When each contributor specializes in a certain task, they may specialize in a task where they have an advantage, creating economies of scale.

Micro and Macroeconomics

Microeconomics studies the actions of individual agents (households, workers, businesses, etc.) within an economy.

Macroeconomics focuses on the behaviour of the entire economy (see: gestalt), with broad issues such as production growth, unemployment, inflation, government deficits, and import/export.

• Monetary policy is controlled by a nation’s central bank, affecting lending, interest rates, and financial capital markets
• Fiscal policy is controlled by a nation’s legislative body, affecting government spending and taxation. Congress and the executive branch control the United States’ fiscal policy through the federal budget

Theories and Models

Theories are abstract representations of how certain aspects of an economy function, based on principles and assumptions.

Models are applied representations of theories. Models can be used to test theories.

Circular Flow Diagram

The circular flow diagram models the economy as consisting of households and firms.

Firms $\stackrel{\text{Goods and Services}}{\to }$ Households $\stackrel{\text{Payment for G\&S}}{\to }$ Firms $\to$ …

Firms $\stackrel{\text{Wages, Salaries, and Benefits}}{\to }$ Households $\stackrel{\text{Labour}}{\to }$ Firms $\to$ …

Economic Systems

	Supply	Demand	Example
Traditional	Determined by customs and resources; limited change	Guided by traditional and basic needs; limited choice	Agricultural settlements
Command	Production targets centrally planned by government	Determined by government; shortages or surpluses may occur	Historical communist states
Market	Driven by individual producers seeking profit; responsive to changes in price	Determined by consumers, reflecting preferences and price	Modern capitalist nations

Government Regulation

Market-oriented economies have fewer regulations. The minimum viable laws govern the protection of people and property, enforcing contracts, preventing fraud, and collecting taxes.

Command-oriented economies still utilize markets, however, production and prices are set by the government. Underground economies (black markets) often occur in heavily regulated economies as buyers and sellers may transact outside of the government’s approval.

Globalization

Due to improvements in transportation and international agreements, trade and financial capital is able to freely flow across borders.

Exports are goods and services produced domestically and sold abroad.

Imports are goods and services produced abroad and sold domestically.

Gross domestic product (GDP) is a monetary measure of the size of production in an economy. The ratio $\frac{\text{Exports}}{\text{GDP}}$ measures the share of a country’s economic production sold in other countries.