Module 5 Review Guide

Transcription

1 Adam Smith: Adam Smith lived from , was a Scottish philosopher and professor, and authored The Wealth of Nations. As a supporter of Smith s theories you are most likely to feel the government should not drastically change its policies when faced with an economic crisis and that, eventually, the problems will resolve themselves through market forces (supply and demand). Karl Marx: Karl Marx was German, lived from , and authored many works. Probably the most significant for economics students is Das Kapital (Capital, in English). As a supporter of Marx s theories you are most likely to feel it is the government s job to make all the economic decisions to promote stability. You would likely think it unfair for the owners of a corporation to share the profits of their business without sharing them with everyone who works for the company. John Maynard Keynes: John Maynard Keynes was British and lived from He authored several works but his most significant, especially to economics students is his General Theory of Employment, Interest, and Money. As a supporter of Keynes theories you are most likely to support the government borrowing money and spending tax dollars on programs that will help put people to work and keep businesses in operation. Likely, you would also support government policies that put some restrictions on banks and other businesses to prevent major swings in the economy. Headline Government Takes Over Factory Amid Worker Strike Congress Calls for Eliminating Business Regulations President Approves Grant Program for Small Business Congress Plans to Open Ten New Federally-Run Auto Dealerships Congress Requests $50 Billion in Spending to Lower Unemployment Congress Refuses to Raise Minimum Wage; Says Supply and Demand Best Wage Determinants Economist Marx Smith Keynes Marx Keynes Smith

2 Type of Economy Traditional Command Characteristics Economy revolves around individual and family unit activity, usually agriculture or a trade like shoemaking. Local leaders are most significant in the village or town life. We call traditional economies subsistence economies as well Economy revolves around government decisions. The government chooses the goods and services to produce, production quantities, and prices to charge. Leaders also determine training, education, employment opportunities, and wages. Free Market Mixed Economy revolves around individuals and business firms, who determine the goods and services to provide. Individuals and business firms seek to earn profits. In a true market economy, the government would not involve itself in the economy in any way The majority of the world s countries are mixed economies somewhere between command and free market. These countries leaders seek to combine individual initiative and progress with the protection of government intervention. Countries organize their economies in different ways but most seek the goals of efficiency, security, freedom, growth, and equity.

3 National Goals and Economic Indicators National Goal Freedom Equity Growth Security Efficiency Definition Extent of personal choice, extent of ability to enter, compete, and exchange in markets, protection of personal property Extent to which citizens of a society have equal opportunities to share in the country s overall wealth Increasing overall output of the country s economic goods over time and increasing standard of living Extent to which citizens of a society are able to provide their own material well-being even in time of crisis Maximizing the use of resources in a society s production Related Economic Indicators Economic Freedom of the World Index Several attempts to measure economic freedom objectively, EFW index based on 42 components and has member research institutes contributing from around the world Income gap Difference in income between rich and poor Representation statistics Statistics showing similar representation proportions among various age, gender, or ethnic groups, like in higher education or career fields GDP Gross Domestic Product, a monetary value based on production of goods and services within a country s borders CPI Consumer Price Index, total price for a sample of consumer goods; changes in the CPI month to month indicate the rate of inflation Fluctuations in rates Changes in housing or motor vehicle sales Jobless claims Number of weekly applications for unemployment benefits Unemployment rate Percentage of workers over age 16 unable to find work Poverty rate Percentage of families earning less than the official poverty level Balance of trade A country s exports value minus imports value The United Nations divides countries into 3 groups based on their human development index: High human development countries have an HDI of 0.8 or above. These countries have an average life expectancy of 77 years and a GDP per capita of just over $23,000 U.S. Dollars. In the 2003 report, Australia had an HDI of Medium human development countries have a Human Development Index of 0.5 and 0.8. Their average life expectancy is 67 years and their average GDP per capita is about $4,000 U.S. Dollars. Low human development countries have HDIs lower than 0.5. Their average life expectancy is 49 years and their average GDP per capita is about $1,200 U.S. Dollars. 30 out of the 34 low development countries are in sub-saharan Africa. In the 2003 report Mozambique had an HDI of

4 Specialization (focusing on specific products for production in higher quantities) allows a country to produce higher quality products and potentially enter into trade agreements with other countries. Those countries, in turn, specialize in their own goods and services. Each country specializes in certain products and trade to obtain other products. Comparative advantage - when a country has a lower opportunity cost than another country to produce a particular good or service More on Comparative Advantage --- Using simple math When we look at what a country should focus on producing, we need to be thinking in terms of comparative and not absolute advantage. Remember, when we look at absolute advantage, we are looking at productivity. In other words, we are focusing on how many products a country can make and which country can make products at a better rate. On the other hand, when we look at comparative advantage, we are focusing on the opportunity costs for creating products. In other words, we are trying to come up with the best combination of goods produced for all countries involved, so that each country is producing the good or service that has the lowest opportunity cost for them. Sometimes we look at how many goods and services we can produce using our fixed resources, and sometimes we look at what resources must be used to produce the good or service. There are two methods for determining opportunity cost: the output method and the input method. The output method is used when you can determine the amount of output you get from a fixed set of resources or in a specific amount of time (the output is different for each nation using the same resources). Output example (how much of a product can be produced in 1 day): Country Wooden Chairs Corn (in pounds) United States ,000 Canada ,000 You can determine the opportunity cost by putting the number of chairs or corn produced over the number in the opposite column. This will allow you to correctly determine the opportunity cost of producing a product. When looking at these 2 goods, the United States has a comparative advantage for producing wooden chairs, and Canada has a comparative advantage for producing corn. In the case with wooden chairs, the United States has a lower opportunity cost (10,000/3,000 = 3.3) for producing chairs than Canada (4,000/1000 = 4). On the other hand, Canada has a lower opportunity cost (1,000/4,000 =.25) for producing corn than the United States (3,000/10,000 =.30).

5 The input method is a little different because we are looking at how many resources (usually focusing on time length) it takes to complete 1 activity (the output is the same for each nation). We will again look for opportunity cost, but this time the math is a little different. To determine opportunity cost when we are looking at inputs, we put the numbers in each column under the other number. Let s look at another example that focuses on comparing worker input instead of total output. Input Example (how many hours to produce a good): Number of Worker Hours to Produce One Ton of Iron Number of Worker Hours to Produce One Barrel of Crude Oil Country United States 4 9 Ecuador 7 10 To produce one additional barrel of crude oil instead of a ton of iron, Ecuador requires only three additional worker hours while the United States requires five more worker hours. Thus, according to our chart, Ecuador has a comparative advantage over the United States in crude oil production. We can verify this by using the input method --- in the case of producing crude oil, Ecuador (10/7 = 1.4) has a lower opportunity cost than the United States (9/4 = 2.25). When looking at producing iron, the United States (4/9 =.44) has a lower opportunity cost than Ecuador (7/10 =.77). Arguments to ban trade: 1. National Security - Avoid dependence on imports for items critical to defense 2. Prices - Avoid oversupply of cheap foreign products forcing domestic producers to lower prices 3. Domestic Businesses - Avoid competition of low pay for foreign workers or recognition of a foreign brand 4. Domestic Jobs - Avoid sweatshops, child labor, forced labor, and other undesirable working conditions that attract companies to employ foreign workers 5. Consumer Confidence - Avoid drops in market demand because of quality, safety, or ethical concerns arising from foreign products

6 Barriers to Trade Barrier Description Quota Tariff Regulation Impact Embargo, ban A quota sets a maximum amount of a product for import. With less product available, quantity supplied decreases and price increases. A tariff is a tax on imported goods. It is added onto the selling price when it enters the country and increases the price of import goods, thus decreasing the quantity demanded. In addition, it provides more tax revenue to the government. A regulation is a safety and quality standard. It may result in the ban of specific ingredients proven to be hazardous. If a product includes these ingredients, it is not allowed to enter the country. A regulation also serves as a standard for environmental or ethical impact. Impact limits consumer access to goods that are considered to be of poor quality or do not meet social expectations. An embargo is the complete refusal to import a good or even all goods from a particular country. It can create a black market for those goods and hurts the political relationship with the country that has been banned. It could also potentially hurt the economy of one or both countries. Balance of trade - the value of a country s exports minus the value of the country s imports Outsourced - purchasing the labor of another company to cut costs, typically referring to foreign companies Inflation - general rise in prices over time. Hyperinflation occurs when the rate of inflation rises quickly and faster than a rise in income. American economists view yearly inflation rates between two and four percent as acceptable. Consumer Price Index is a statistic comparing the cost of a market basket of goods and services American households normally purchase to the cost from a prior time. Calculating changes in the CPI produces the inflation rate. If the inflation rate is a negative number, that means overall prices are falling and we call this deflation. Though you might think this is a positive for the consumer, falling prices means businesses are losing profits and they may reduce worker pay. Rather than growing, the economy is shrinking. Exchange rate - rate at which people may trade one currency for another. When the United States has high inflation, then the value of the American dollar decreases. Foreign investors may turn to other countries with lower inflation to purchase similar products at a lower cost.

7 Globalization refers to the way that the individual nations of the world are becoming more connected to each other and in the process, interdependent. It makes it more likely that inflation in one country will affect another country. The US dollar is a floating currency. This means that the value of these currencies is determined by market forces: supply and demand rather than governments. Currency speculators are people or institutions that buy a particular currency and hope that its value will rise when they can sell it for a profit. For example, if you buy one Euro when it s worth one U.S. dollar and sell it a year later when it s worth $1.10 you can make ten percent profit. Its only ten cents when you re dealing with one dollar, but major banks and corporations are dealing with hundreds of millions of dollars.