Chapter 2 Notes on Economics

Section 1 Objective: to identify and analyze the key questions of economics.

I. Answering Three Economic Questions

A. Three Key Questions
1. What goods and services should be produced?
a. Needs and Wants?
b. Guns and Butter?
c. What are the opportunity costs?
2. How should goods and services be produced?
a. Electricity --- should it be oil, solar, nuclear?
b. Manual /vs/ Mechanical Labor
3. Who consumes goods and services?
a. growing markets
b. Factor Payments – the income people receive for supplying
factors of production.
B. Economic Goals and Societal Values
1. Economic Efficiency
a. Most societies try to maximize what they can get for the
resources that they have to work with.
2. Economic Security and Predictability
a. Goods and services will be available when you need them.
b. Safety Net – set of government programs that protect people
experiencing unfavorable economic conditions, such as:
1. injuries
2. lay-offs
3. natural disasters
4. severe shortages
3. Economic Growth and Innovation
a. Standard of Living – level of economic prosperity.
 4. Economic Goals
a. Environmental Protection
b. Full Employment
c. Universal medical care

Section 2 Objective: to identify the free market and why it exists.

II. The Free Market

A. Why Markets Exist?!
1. Market – an arrangement that allows buyers and sellers to exchange things.
2. Specialization – concentration of the production efforts of individuals and
firms on a limited number of activities.
a. easier to learn one task very well.
B. Free Market Economy (FME)
1. FME – individuals and businesses own the factors of production, make
what they want, and buy what they want.
a. Household – is a person or a group of people living in the same
residence.
b. Firm – organization that uses resources to produce a product,
which it then sells.
2. Factor Market – firms purchase factors of production from households.
a. hire workers, pay wages, borrow money.
3. Product Market – goods and services that firms produce that are purchased
by households.
C. The Self-Regulating Nature of the Marketplace
1. Adam Smith (father of modern economics)
a. wrote The Wealth of Nations (1776)
b. Self-Interest – buyers and sellers own personal gain; it is the
motivating factor behind the economy.
 2. Competition – the struggle among producers for the dollars of consumers.
a. Firms (Businesses) Goals:
1. to increase sales
2. to make profits
b. Incentives – an expectation that encourages people to behave in
a certain way.
Example: offer a sale.
3. Invisible Hand
a. Adam Smith’s term to describe the self-regulating nature of the
marketplace.
D. Advantages of the Free Market
1. Economic Efficiency – a market economy responds quickly to
changing conditions
2. Economic Freedom – work where you want, buy what you
want, produce what you want.
3. Economic Growth – new ideas and innovations make money.
4. Additional Goals – consumers decide what gets produced.
a. Consumer Sovereignty – the power of the consumer to
decide what gets produced.

Section 3 Objective: to identify Centrally Planned Economies (CPE)

III. Centrally Planned Economies (CPE)
A. How is a CPE organized?
1. Government own both land and capital
a. government controls where you work and how much you earn (wages).
- farmers are told what to plant; manufacturers told what to make.
b. self-interest and competition do not exist in CPE’s.
2. Socialism /vs/ Communism (CPE)
a. Socialism – social and political belief that democratic means should be
used to distribute wealth evenly throughout society.
1. Government owns major industries, as well as utilities.
 b. Communism – CPE with all economic and political power in the hands
of the central government.
1. violent revolution
2. authoritarian – requires strict obedience to the government.
Usually takes the form of a dictator (Stalin, Castro)

Section 4 Objective: to identify what is a Mixed Economy.

IV. Modern Economies
A. Rise of Mixed Economies
1. The Limits of Laissez Faire
a. doctrine that states that government generally should not
intervene in the market place.
b. Laissez Faire doesn’t work in the modern economy.
Ex: National Defense, Roads/Highways, Education
c. Government Protects Business
Ex. Patents, Property rights, anti-monopoly, just compensation
2. Balancing Control and Freedom
a. Each nation must decide the opportunity costs of pursuing goals:
- army
- unemployment
- public education
- subsidize farms
B. Circular Flow Model of a Mixed Economy.
1. Page 42 in text
2. Profit motive – the force that encourages people and organizations to
improve their material well-being.
a. rewards innovation (allows for creative companies to grow).
b. Improves productivity – more efficient companies make more
money.
3. Open Opportunity – the concept that everyone can compete in the
marketplace.