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The Basic Economic Problem Essay Sample

The Basic Economic Problem Pages
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Economics is a social science that studies the allocation of scarce resources Scarcity – an unlimited demand for limited resources
There simply isn’t enough to go around
What are some of the resources that you have?
Economic Roles
In the economy, there are two roles that are played out
PRODUCER – also called manufacturers, suppliers, or sellers. CONSUMER – also called buyers or users
Which are you?
From the Producers’ Perspective
How do we decide who will get the limited stuff that we have? Allocation Methods –
Price
Random Selection
Personal Characteristics
Queuing
Violence
From the Consumer’s Perspective
From the Consumer’s Perspective
How do consumers get what they want?
Cost – having to give up something in order to get what you want. Cost does NOT equal price
Price always involves money, costs can be anything
Types of Costs
External Cost – a cost that someone else creates, but you have to pay for it. Sunk – a cost that you cannot get back
Marginal – the added cost of doing an additional thing
Opportunity – the value of the greatest sacrificed alternative Production Possibilities
Opportunity cost
Marginal Opportunity Cost
Per-Unit Opportunity Cost
Growth
Marginal Analysis
Marginal Cost – the added cost of doing an additional thing Marginal Benefit – the added benefit from doing an additional thing Law of Increasing Marginal Cost – as units of production are increased, the marginal cost of doing additional work will also increase Law of Diminishing Marginal Returns – as units of production increase, the benefit derived from additional work will decrease. Demand

Demand – the amount of a good or a service that consumers are willing and able to buy [at every available price.] Quantity Demanded (Qd) – the amount of a good or a service that consumers are willing and able to buy at a specific price. Demand schedule – a list of various prices and quantities demanded The Law of Demand – as the price of a product rises, the quantity demanded will fall and vice versa The Price Effect – A change in the price of a product will only affect Qd, not demand. Changes in demand

Ceteris paribus – “all other things held constant”
When the ceteris paribus assumption is dropped, movement no longer occurs along the demand curb. Rather, the entire demand curve shifts. A shift means that at the same prices, more people are willing and able to purchase that good. Changes in price don’t shift the curb

5 Shifters (Determinates) of Demand:
1. Tastes and Preferences
2. Number of Consumers
3. Price of Related Goods
a) Substitute
b) Compliments
4. Income
5. Future Expectations
Prices of Related Goods
Substitutes are goods used in place of one another
If the price of one increases, the demand for the other will decrease and vice versa Compliments are two goods that are bought and used together
If the price of one increase, the demand for the other will fall Income
1. Normal Goods
As income increases, demand increases
As income falls, demand falls
2. Inferior Goods
As income increases, demand falls
As income falls, demand increased
Elasticity of Demand
Elasticity refers to how sensitive quantity is to change in price. The Law of Demand tells us how a change in price will affect Qd, elasticity tells us how much it will affect it. For a producer, it is a matter of knowing which strategy will produce greater revenue. Raising the price or lowering the price? Elastic Demand

The percentage change in quantity demanded is greater than the percentage change in price Products are considered luxuries are generally elastic.
Expensive products are generally more elastic.
What pricing strategy would bring out greater revenue?
Inelastic Demand
The percentage change in quantity demanded is less than the percentage change in price Products that are considered necessities are generally inelastic. Cheaper products are generally more inelastic.

If ER1.0 – Elastic
If ER=1.0 – Unit Elasticity
Total Revenue Method – compare what happens to price with what happens to Total Revenue Supply Determinants
Remember, a change in price only changes the Qs, not the supply, so these are things that will change the supply curve without changing the price. Change in natural phenomenon
Change in costs of production
Change in government regulation
Change in technology
Change in the number of suppliers in the market
Explicit vs. Implicit Costs
Explicit costs are monetary payements for resources used to conduct business Implicit costs are opportunity costs given up to operate the business

Profit Definitions
Accounting profit takes into account only explicit costs
Economic profit also accounts for implicit costs.
Cost Definitions
Fixed Cost – not dependent upon production
1. Rent
2. Salaries
3. Insurance
4. Depreciation
Variable Cost – Change depending upon production
1. Raw Materials
2. Wages
3. Utilities
4. Materials
Total Cost = FC+VC
Average Fixed Cost = FC/Units
Average Variable Cost = VC/Units
Average Total Cost = TC/Units
Marginal Cost = Change in TC/Change in Units
Competition Continuum
Perfect Competition
1. Many, Many sellers
2. No Control over price – “price takers”
3. Identical Products
Commodities
No differentiation
4. No barriers to entry
Entry/Exit is very easy
Entry/Exit won’t affect market
5. MR=AR=P=D
6. Demand is perfectly elastic – straight horizontal line. 7. Profit
maximization
8. Most efficient market
Allocative efficiency
Productive efficiency

Monopolistic Competition
Oligopoly
Pure Monopoly
Single seller – No competition
Unique product – No close substitutes
Price maker
High barriers to entry
Patents
Copyrights
Licenses
Start-up costs
Economies of scale
Natural Monopolies
In certain cases, a monopoly is more effective at supplying a good or service. The monopolies are allowed to exist, but are generally regulated by a government entity. Water company
AT&T
Electricity
Market Comparisons
1. Perfect Competition
a. Many, many sellers
b. No control over price
c. Products are identical
d. No barriers to entry
2. Pure Monopoly
a. Single seller
b. Unique product
c. Complete control over price (supply)
d. High barriers to entry
3. Monopolistic Competition
a. Many sellers
b. Some control over price
c. Come barriers
d. Products are similar, but different
4. Oligopoly
a. Only a few competitors
b. Control of price depends upon how the competitors act.
c. Products are similar, but different
d. Barriers can be high
Monopolistic Competition
Most common form of competitive market
Each company has some element that makes them “unique” among competitors Gives each company some level of “monopolistic” capacity Non-price competition is common
Location
Quality
Service
Advertising is key.
Oligopolies
If the few sellers compete, they are known only as an oligopoly. Their graph will be similar to a monopolistic competitor.
If they collude, (agree to act as one) they are called a cartel. OPEC (the Organization of Petroleum Exporting Countries)
Columbian drug cartel

Mutual Interdependence
In an oligopoly, the actions of each competitor depends upon the actions of other competitors

Financing a Business
Generally, there are two ways to finance a business.
From the owners’ pocket.
Loan
For a corporation, it is the same way
Stock sales – represent ownership
Bonds – represent loan
Corporate Finance
Stock – stock certificates are used by corporations to raise capital (money). Because they represent ownership, the holder is entitled to the benefits of being an owner Portion of the profits (dividends)

A “say” in running the business (vote)
Stockholders may be interested in the long run investment or the short run speculative investment strategy Bonds
A bond is a loan that has to be repaid to the lender
A Corporation will sell bonds to raise money without giving away more ownership rights The bond will have three components
A face value
Money and Banking
Money – Anything that is generally accepted in exchange for goods and services Functions of Money
Medium of exchange
Store of value
Measure of Worth
Power
Characteristics of Money
Portability
Divisibility
Durability
Uniformity
Limited Supply
Acceptability
The Beginnings of Banking
In the beginning were goldsmiths who kept their gold in a “safe” place. When others acquired some gold, they would deposit it with the goldsmith to keep it safe When they needed some gold, they could go and show a receipt to withdraw the proper amount for their purchase. Eventually, the receipts were traded, instead of gold.

Goldsmiths soon realized they could lend out some of the gold and charge interest for their trouble. The number of receipts in circulation did not match the amount of gold in the “safe.” Inflation was a problem.

Banking
Banks are really “money stores” where money is bought and sold Banks “buy” money by taking in deposits and paying depositors interest Banks “sell” money by making loans and charging interest Interest is the “price” of money

Simple Interest = P x R x T
P=Principle – the original amount of money
R=Interest Rate – expressed as a decimal
T=Time – expressed in years.
The Federal Reserve System
After several banking “panics” at the turn of the 20th Century, President Woodrow Wilson created the Federal Reserve to be the National Banking System of the United States. Officially created in 1913

Commonly called the FED
How the FED is structured
12 FED banks and Districts
Each district is managed by the FED bank in that area
The board of governors regulates the system
7 members
Appointed by President and approved by Congress
Serve a single term (neutral politically)
14 years (stability)
Staggers appointments
Current chairwoman
Janet Yellen
Former president of the San Francisco FED
Began term as Vice Chairwoman in 2010
Took over as Chairwoman in 2014
Term ends in 2024
Professor of Economics as UC Berkley
Functions of the FED
Bank of US
Regulate of banking
Regulate money supply
Tools of monetary policy
Reserve requirement
Discount rate/ federal funds
Open market groups
Regulating the Money Supply
Called “monetary policy.”
By regulating the money supply, they can control the “price” of money The Tools of Monetary Policy
The money creation process.
Banks create money through the lending process.
A loan is actually future money being brought into the present. Once ii is spent, it is now real money in the present.
When loans are paid back, the process balances out.
Is more loans are made than are paid back, the money supply increases. If more money is paid back than is lent out, the money supply shrinks.

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