• The term "economics" has three meanings:

# 1. As the logic behind decision making in the market place, economics focuses on the factors considered in making economic decisions.

# 2. As the unique set of institutions, processes, and economic culture that make up each separate economy, or better still, the pure capitalist system.

# 3. As the functioning of the market system, economics defines how the quantities transferred for the satisfaction of wants are determined.

ECONOMICS AS THE ECONOMY

# The economy is the larger domain where economic reasoning occurs, its operation comes from our notions about the pure capitalist system, the market system as ideally conceived in the mind of the first group of economic thinkers.

# This ideal capitalist system is called classical economics and is found in the writings of the first group of economic thinkers or classicists that existed from 1776-1871 about.

# Pure capitalism may not always correspond exactly with how the market system works in the day-to-day operations of the 21^st century; but as in all sciences, economics is based on a set of idea theories, the exceptions to these theories notwithstanding, we can only talk to each other based on certain broadly agreed norms, and principles.

# Because these exceptions to the rule do matter, it is important to understand why and how, that is, under what circumstances the ideal market may deviate from its norms, or to put it differently, where the ideal market fails to work as it is supposed to, hence, the analysis of these areas is termed, "market-failure analysis."

Capitalism is revolutionary because, unlike under its two immediate predecessors where wealth accumulation was restricted to just one or at most a few social groups, under capitalism all who work could own wealth.

Wealth Accumulation Under Comparative Economic Systems

# Pointing out these exceptions to the ideal market is the work of a new class of economics that emerged in the early 1870s and continues to the present. This sub-field is called neo-classical economics.

# Laissez-faire capitalism argues that the market system is at its best when not regulated by government.

# Adam Smith (1723-1790) is considered the god-father of laissez-faire capitalism.

# He was raving against the heavy handedness of feudal lords and mercantilist governments of his time.

# He argued that the interaction of the market forces of supply and demand do far a better job of allocating resources than human choices that are often corrupt.

# Because the market is supposedly self-correcting, it does not need the intervention of government, hence this model is called, "the minimalist-government" model.

# The second most important feature of pure capitalism is the claim that scarce resources are owned by private individual not by government as in socialist and communist political economies.

# If resources are privately owned, then they can be dispensed with as their lawful owners see fit.

# The combination of private ownership and freedom of choice gives the individual the right to enter into legal contracts, including the right to sell his labor to the highest bidder.

# The consumer is "king" because he is allowed to choose from a wide range of things, and together the total choice of consumers determines how much suppliers can produce.

# The dual freedom of ownership and choice is the basis of private enterprise: the legal right to own a business and to employ whatever resources you deem necessary to achieve your business goals.

# In the pure capitalist system, unrestricted competition determines who produces what, how, and how much.

# The four conditions for unrestricted competition are:

(a) a large number of buyers and sellers, who are all price-takers;

(b) freedom to enter and exit any industry; so production can continuously respond to prices;

(c) industry products are largely homogeneous, that is, easy substitutes for one another, so no producer can gain market power and control prices;

(d) producers and consumers have unrestricted information about the market, so producers can tailor their production levels not to exceed demand, and consumers can avoid those selling above the market price.

# A market is any mechanism that brings potential buyers and suppliers together.

# The wide range of markets is usually grouped into four: labor, capital, consumer and industrial markets, with different degrees of competition.

# Labor market competition is high and workers are vulnerable to manipulation by employers. Labor unions and government regulation attempt to minimize this danger.

# Capital or financial markets include individuals, corporations and government that invest in and borrow from a large number of intermediary institutions.

* Make sure you know a few examples of these intermediary institutions, P. 55.

# Because money is issued by the authority of the sovereign head of a country, this market is the most regulated of the four.

# The number of consumers is so large, the consumer market is the least organized.

# Because an unorganized group of consumers face off with suppliers who are fairly well organized and generally fixed prices, consumers end up on the losing end of the consumer market; often they don't look at all like kings.

# Competition is most fierce in the industrial market which operates on a survival of the fittest basis: the successful grow bigger, the weak are forced to quit.

Question: What does it take to remain competitive in the industrial market? p. 56.

# Prices standardize the value of goods and services and so reduce the cost of transactions.

# Prices determined the level of consumption, and hence, production.

# Without the benefit of prices, exchange can never be standardized given the high improbability of the double coincidence of independent buyers finding the right producers with the right prices.

# Specialization, the division of labor into a chain of easily repeated activities, accounts for much of the efficiency and progress of capitalist political economies.

# The business enterprise takes specialization a step further, by providing permanent linkages between different layers of specialization in an industry. Through this chain, it transforms initial products into finer products, thus adding value to these goods and services.

# Many of America's large corporations evolved from the technological and logistical demands of World War II. Others came on board in response to the huge demand for goods following the war.

# Multinational corporations advance the business logic onto the international stage. And as in most industrialized countries, the expansion of U.S. business abroad benefited from deliberate U.S. foreign economic policies after the war.

ECONOMICS AS ECONOMICS

# The second meaning of economics is as the behavior of the market forces or the functioning of the market system. It answers the question: How does the market system work?

# Adams Smith claimed that supply and demand interacts to set market prices, to determine the optimal (best possible) level of production.

# Because the selfish acts of numerous consumers and producers results in the best possible outcome for society, Smith regarded the free market as the perfect handiwork of an invisible hand.

# Demand can be both individual and aggregate (sum total).

# Aggregate demand represents a purchasing schedule showing the various amounts of a product consumers are willing and able to purchase at each specific price in a set of possible prices during some specific period of time.

# Demand is determined by many factors: availability of the product, the level of the money supply (chp. 9), individual taste, intelligence and ignorance, availability of substitutes, information and advertising.

# Supply is also a schedule of various alternative possibilities of amounts of a product producers are willing and capable of supplying to the market at specific prices in a set of possible prices during some specific period of time.

# Because both demand and supply are not specific quantities but a listing of the coincidence of two ranges of possibilities, both can be represented in the form of curves: the demand curve, the supply curve.

Question: Can you draw the demand and supply curves using the information given on p. 63?

# Market price is the price of a product when its supply is equal to its demand; this occurs at the point of equilibrium.

# Suppliers and consumers react differently to the demands of scarcity:

(a) consumers want to buy the highest value at the lowest possible price;

(b) suppliers want to sell the highest possible quantity at the highest possible price.

# Because aggregate (sum total) demand and aggregate supply move in opposite directions, market forces (supply, demand, prices) will move steadily towards equilibrium most of the time, even if for a while one exceeds the other.

# When demand exceeds supply, there is a shortage in the market which will exert an upward pressure on prices, and if it lasts for a long time, will encourage new suppliers to enter the industry.

# When supply is ahead of demand, there is a surplus in the market that will exert a downward pressure on prices, and if it lasts for a long time, will result in some suppliers being forced out of the market.

# Equilibrium is simply a recognition that, over the long term, suppliers cannot produce more to the market than consumers want to buy.

ECONOMICS AS ECONOMIC THINKING

# Economics as economic thinking or economic calculation starts with the reality that material wants are unlimited while economic resources are limited or scarce.

# The need to allocate or ration out resources arises in the conflict between the two.

# Whereas political constraint arises from our social milieu, economic constrain is between society or the individual's own competing needs.

# Whereas the solution of political conflict requires government intervention, the resolution of economic conflict is internal and needs no external intervention.

# Rationing is the method of allocating economic scarce resources.

# But rationing, whether political or economic, imposes painful choices or tradeoffs.

# The best alternative value we give up to enjoy our most preferred choice is the opportunity cost of our choice.

# But scarcity forces us to be efficient; either to do more with the same amount of resources, or to achieve previous records using less.

# Each consumer must ration his resources, chose and select from his range of wants the best combination that not simply matches, but maximizes his resources.

# The individual nature of economic choice is illustrated in the very different choices and tradeoffs made by Tom and Larry.

# The ordering of the individual's preferences is termed, his "preference schedule" which is very personal, reflecting each individuals ordering of values.

# Economists' claim that economic rationing is more efficient than political allocation is based on three assumptions:

(1) that economic rationing is rational, that is, based on a well-calculated analysis of costs and benefits;

(2) that economic rationing is not zero-sum;

(3) that economic exchange results in only net gains.

Question: So is economic allocation more efficient than political allocation?

# All three assumptions are true, but still does not make economic allocation any superior to political allocation.

# Economic reasoning is often but not always based on adequate information that allows for a careful cost/benefits analysis.

# Unlike the zero-sum outcomes of politics, Tom and Larry do not have to forgo any of their wants completely in order to satisfy their preferred values.

# Potentially, economic exchange leaves both traders better of, but only if there are no hidden costs, and often, there are many such hidden costs.

# For economic exchange to happen each partner must have a need and a value that match.

# Though we need others to solve our economic needs, it does not require the imposition of authority because exchange is peaceful, each trader looking after his selfish interest.

# Because economic rationing is so personal, the only efficiency question that arises is how well the individual or society distributes their scarce resources to maximize his preference schedule. This is the means-end test.

# As students, Larry's preference ordering maximizes his objective as a student more than Tom's.