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Economics 101

The Social Science field Economics studies how people make choices. Economics deals with people's unlimited wants and limited resources; in other words, scarcity. How do people make choices to satisfy our unlimited wants with limited resources? How do people allocate limited resources to satisfy unlimited wants? How do people's behavior become affected with the choices other people make? Using general, simple, and abstract models and economic theories including the assumption ceteris paribus defined as holding other things constant or equal, Economics can help us live in a better place.

There are two general Economic fields which are Macroeconomics and Microeconomics. Macroeconomics deals with the economy as a whole or the aggregate; for example, the Gross Domestic Product and Interest Rates. Microeconomics deals with the specific economy or the units; for example, prices, consumer behavior, and surplus & shortages. I am going to mention some terms and concepts in Macroeconomics and Microeconomics including Supply and Demand. For Macroeconomics: Resources, Circular Flow, Business Cycle, and Inflation. For Microeconomics: Opportunity Cost, Tax System, Consumer Surplus, and Law of Diminishing Marginal Returns.

Supply and Demand

The supply and demand charts are the same from macroeconomics and microeconomics. The horizontal axis or X-axis is the quantity. The vertical axis or Y-axis is the price per quantity. The supply curve slopes upward or from bottom to top. The demand curve slopes downward or from top to bottom. If there is a change in price, then there is a movement along in the curve itself. If there is a change in quantity, then there is a shift in the curve moving either to the right for an increase in quantity or to the left for a decrease in quantity. The change in price and change in quantity applies to the supply curve and the demand curve.

Putting the supply curve and the demand curve together, their intersection is the equilibrium or market clearing. Equilibrium is the quantity supplied and quantity demanded equals. There is no excess supply or surplus and no excess demand or shortage. A price above equilibrium is a surplus. A price below equilibrium is a shortage.

If the supply curve shifts to the right and the demand curve is constant, then price decreases and quantity increases. If the supply curve shifts to the left and the demand curve is constant, then price increases and quantity decreases. If the demand curve shifts to the right and the supply curve is constant, then price increases and quantity increases. If the demand curve shifts to the left and the supply curve is constant, then price decreases and quantity decreases.

A shift in both supply curve and demand curve the outcome is indeterminate. It doesn't matter how much the shift. The outcome is unknown.

Click on the three links to download supply and demand chart sketches:
Supply and Demand 1 (135k)
Supply and Demand 2 (93k)
Supply and Demand 3 (80k)

Macroeconomics: Resources

There are four types of resources used to produce goods and services:

  • Land: Natural resources such as the forest, minerals, and water to produce goods and services.
  • Labor: The people with physical and/or mental abilities to produce goods and services.
  • Capital: The investment goods such as manufacturing equipment, storage facilities, transportation, pens, computers, etc. to produce goods and services.
  • Entrepreneurial: The human resource personal who combines land, labor, capital, and makes basic business decisions to start a company or business for producing goods and/or services.

Macroeconomics: Circular Flow

A basic circular flow chart shows how land, labor, capital, and entrepreneurial are combined to create a market of goods and services. Households provide land, labor, capital, and entrepreneurial to businesses and businesses provide incomes to households.

Macroeconomics: Business Cycle

The business cycle shows the "ups" and "downs" of economic activity. Output, employment, and price level are affected when the business cycle fluctuates. During the PEAK, the economy is at full employment and output is near capacity and the price level rises. After the PEAK is the RECESSION when output, income, and employment declines. A prolonged RECESSION is a DEPRESSION. The TROUGH is when output and employment reach the lowest levels; in other words, the lowest point of the business cycle. Finally, the RECOVERY is when output, employment, and income increase.

Throughout American History, America has experienced many "ups" and "downs" of economic activity. Starting with the Bull Market boom during the mid-1920s we experienced a peak, followed by the Great Depression in the 1930s we experienced a depression, World War II we experienced a recovery and peak, after World War II we experienced a recession, Korean War we experienced a peak, and so on.

Macroeconomics: Inflation

Inflation is when prices rise. Inflation is measured by the change in the Consumer Price Index which measures the general level of prices by subtracting last year's index from the current year's index, dividing the difference by last year's index, and multiplied by 100 to express as a percentage.

Economists recognize two causes of inflation: (1) the demand of goods and services exceeds the supply of goods and services available to meet the demand and (2) production costs rise causing lower availability of goods and services even when demand does not change.

When inflation hits the economy, the purchasing power of the dollar declines; in other words, since prices increase, a person needs more dollars to purchase goods and services. For example, one dollar can purchase two cans of soda. When inflation hits the economy, soda prices increase such that one dollar can purchase one can of soda.

Microeconomics: Opportunity Cost

Opportunity Cost is the next-best alternative choice sacrificed to attain something. When you choose something, you lose the next-best option you could have choose to do. For example, I have Saturday free. I can either go to San Francisco to visit Pier 39 or go to the Palace Of Fine Arts. Both places I like, but I can't go to both. If I choose San Francisco to visit Pier 39, my opportunity cost is going to the Palace Of Fine Arts.

Microeconomics: Tax System

Government raise revenues by taxation. All taxes fit into one of three categories: proportional which is a constant tax rate for all incomes; progressive which is a tax rate increasing when a person's income increase; and regressive which is a tax rate decreasing when a person's income increase.

The progressive tax purpose is to close the gap between the rich and the poor. The progressive tax equals the distribution of income between the rich and the poor. The regressive tax the rich pays more than the poor in terms of dollars paid, but as a percentage of income, the poor pays more than the rich. The regressive tax makes distribution of income less equal.

The Federal, State, and Local taxes are progressive. The sales tax, however, is regressive. Why is the sales tax regressive? The poor has a smaller income and the rich has a bigger income. When a poor person and a rich person purchase the same taxable goods, the sales tax takes a bigger percentage of income from the poor compared to the rich.

Microeconomics: Consumer Surplus

Consumer surplus is the maximum price a person will pay for a good or service minus the actual price. The maximum price a person will pay is determined from many factors such as necessity, want, preferences, etc. For example, a person is really thirsty and is willingly to pay $3.00 for a bottle of water. The person enters a store selling the bottle water for $1.00. The thirsty person's consumer surplus is $2.00 ($3.00 for the person willingly to pay minus $1.00 for the store selling the bottle water).

Microeconomics: Law of Diminishing Marginal Returns

The Law of Diminishing Marginal Returns is when more units of a variable factor of production is added to a fixed amount of fixed factors, the marginal product of the variable factor eventually declines. In other words, as more units are added to a production of goods or services, eventually the marginal returns or marginal output declines.

For example, a person has a warehouse full of dirt and must remove all the dirt.

  • The first hour, the person uses a bulldozer to remove the lose dirt. The person removes 70% of the dirt and cleans 50% of the warehouse.
  • The second hour, the person uses a broom to remove the dirt on the floor. The person removes 10% of the dirt totaling 80% of the dirt removed and cleans a total of 70% of the warehouse.
Notice that in the second hour, the marginal return declined (second hour 10% of the dirt was removed compared to the first hour 70% of the dirt was removed) even though the total return increased (in the second hour, a total of 70% of the total dirt was removed compared to the first hour a total of 50% of the total dirt was removed).
  • The third hour, the person uses a small brush to remove the dirt from the edges of the warehouse. The person removes 10% of the dirt totaling 90% of the dirt removed and cleans a total of 80% of the warehouse.
  • And so on . . .

Note sometimes as more units are added to a production of goods or services, the marginal returns or marginal output can increase at first, but eventually declines as more units are added.


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