Key Concepts and Summary

Key Terms

circular flow diagram a diagram that views the economy as consisting of households and firms interacting in a goods and services market and a labor market command economy an economy where economic decisions are passed down from government authority and where the government owns the resources division of labor the way in which different workers divide required tasks to produce a good or service economics the study of how humans make choices under conditions of scarcity economies of scale when the average cost of producing each individual unit declines as total output increases exports products (goods and services) made domestically and sold abroad fiscal policy economic policies that involve government spending and taxes globalization the trend in which buying and selling in markets have increasingly crossed national borders goods and services market a market in which firms are sellers of what they produce and households are buyers gross domestic product (GDP) measure of the size of total production in an economy imports products (goods and services) made abroad and then sold domestically labor market the market in which households sell their labor as workers to business firms or other employers macroeconomics the branch of economics that focuses on broad issues such as growth, unemployment, inflation, and trade balance market interaction between potential buyers and sellers; a combination of demand and supply market economy an economy where economic decisions are decentralized, private individuals own resources, and businesses supply goods and services based on demand microeconomics the branch of economics that focuses on actions of particular agents within the economy, like households, workers, and business firms model see theory monetary policy policy that involves altering the level of interest rates, the availability of credit in the economy, and the extent of borrowing private enterprise system where private individuals or groups of private individuals own and operate the means of production (resources and businesses) scarcity when human wants for goods and services exceed the available supply specialization when workers or firms focus on particular tasks for which they are well-suited within the overall production process theory a representation of an object or situation that is simplified while including enough of the key features to help us understand the object or situation traditional economy typically an agricultural economy where things are done the same as they have always been done underground economy a market where the buyers and sellers make transactions in violation of one or more government regulations

Key Concepts and Summary

1.1 What Is Economics, and Why Is It Important?

Economics seeks to solve the problem of scarcity, which is when human wants for goods and services exceed the available supply. A modern economy displays a division of labor, in which people earn income by specializing in what they produce and then use that income to purchase the products they need or want. The division of labor allows individuals and firms to specialize and to produce more for several reasons: a) It allows the agents to focus on areas of advantage due to natural factors and skill levels; b) It encourages the agents to learn and invent; c) It allows agents to take advantage of economies of scale. Division and specialization of labor only work when individuals can purchase what they do not produce in markets. Learning about economics helps you understand the major problems facing the world today, prepares you to be a good citizen, and helps you become a well-rounded thinker.

1.2 Microeconomics and Macroeconomics

Microeconomics and macroeconomics are two different perspectives on the economy. The microeconomic perspective focuses on parts of the economy: individuals, firms, and industries. The macroeconomic perspective looks at the economy as a whole, focusing on goals like growth in the standard of living, unemployment, and inflation. Macroeconomics has two types of policies for pursuing these goals: monetary policy and fiscal policy.

1.3 How Economists Use Theories and Models to Understand Economic Issues

Economists analyze problems differently than do other disciplinary experts. The main tools economists use are economic theories or models. A theory is not an illustration of the answer to a problem. Rather, a theory is a tool for determining the answer.

1.4 How To Organize Economies: An Overview of Economic Systems

We can organize societies as traditional, command, or market-oriented economies. Most societies are a mix. The last few decades have seen globalization evolve as a result of growth in commercial and financial networks that cross national borders, making businesses and workers from different economies increasingly interdependent.

Self-Check Questions

1 . What is scarcity? Can you think of two causes of scarcity? 2 . Residents of the town of Smithfield like to consume hams, but each ham requires 10 people to produce it and takes a month. If the town has a total of 100 people, what is the maximum amount of ham the residents can consume in a month? 3 . A consultant works for $200 per hour. She likes to eat vegetables, but is not very good at growing them. Why does it make more economic sense for her to spend her time at the consulting job and shop for her vegetables? 4 . A computer systems engineer could paint her house, but it makes more sense for her to hire a painter to do it. Explain why. 5 . What would be another example of a “system” in the real world that could serve as a metaphor for micro and macroeconomics? 6 . Suppose we extend the circular flow model to add imports and exports. Copy the circular flow diagram onto a sheet of paper and then add a foreign country as a third agent. Draw a rough sketch of the flows of imports, exports, and the payments for each on your diagram. 7 . What is an example of a problem in the world today, not mentioned in the chapter, that has an economic dimension? 8 . The chapter defines private enterprise as a characteristic of market-oriented economies. What would public enterprise be? Hint: It is a characteristic of command economies. 9 . Why might Belgium, France, Italy, and Sweden have a higher export to GDP ratio than the United States?

Review Questions

10 . Give the three reasons that explain why the division of labor increases an economy’s level of production. 11 . What are three reasons to study economics? 12 . What is the difference between microeconomics and macroeconomics? 13 . What are examples of individual economic agents?