Principles of Microeconomics Scarcity and Social Provisioning Chapter 1 Welcome to Economics!

CHAPTER . WELCOME TO ECONOMICS ! INTRODUCTION PRINCIPLES OF ECONOMICS Figure . Do You Use Facebook ?

Economics is greatly impacted by how well information travels through society . Today , social media giants Twitter , Facebook , and Instagram are major forces on the information super highway . Credit Johan ) DECISIONS DECISIONS IN THE SOCIAL MEDIA AGE To post or not to post ?

Every day we are faced with a myriad of decisions , from what to have for breakfast , to which route to take to class , to the more Should I double major and add possibly another semester of study to my education ?

Our response to these choices depends on the information we have available at any given moment information economists call imperfect because we rarely have all the data we need to make perfect decisions . Despite the lack of perfect tion , we still make hundreds of decisions a day . And now , we have another avenue in which to gather media . Outlets like Facebook and Twitter are altering the process by which we make choices , how we spend our time , which movies we see , which products we buy , and more . How many of you chose a university without checking out its Facebook page or Twitter stream first for information and feedback ?

As you will see in this course , what happens in economics is affected by how well and how fast information is disseminated through a society , such as how quickly information travels through Facebook . Economists love nothing better than when deep and liquid markets operate under conditions of perfect information , says Jessica , National Economics Editor for News Corp Australia . This leads us to the topic of this chapter , an introduction to the world of making decisions , processing information , and

ERIK DEAN , JUSTIN , MITCH GREEN , BENJAMIN WILSON , AND SEBASTIAN BERGER understanding behavior in markets World of economics . Each chapter in this book Will start with a discussion about current ( or sometimes past ) events and revisit it at chapter bring home the concepts in play . Introduction In this chapter , you will learn about What Is Economics , and Why Is It Important ?

and How Economists Use Theories and Models to Understand Economic Issues How Economies Can Be Organized An Overview of Economic Systems hat is economics and why should you spend your time learning it ?

After all , there are other disciplines you could be studying , and other ways you could be spending your time . As the Bring it Home feature just mentioned , making choices is at the heart of what economists study , and your decision to take this course is as much as economic decision as anything else . Economics is probably not What you think . It is not primarily about money or finance . It is not about business . It is not mathematics . What is it then ?

It is both a subject area and a way of Viewing the world .

WHAT IS ECONOMICS , AND WHY IS IT IMPORTANT ?

LEARNING OBJECTIVES By the end of this section , you will be able to Discuss the importance of studying economics Explain the relationship between production and division of labor Evaluate the significance of scarcity is the study of how humans make decisions in the face of scarcity . These can be vidual decisions , family decisions , business decisions or societal decisions . If you look around carefully , you will see that scarcity is a fact of life . Scarcity means that human wants for goods , services and resources exceed what is available . Resources , such as labor , tools , land , and raw als are necessary to produce the goods and services we want but they exist in limited supply . Of course , the ultimate scarce resource is everyone , rich or poor , has just 24 hours in the day to try to acquire the goods they want . At any point in time , there is only a finite amount of resources able . Think about it this way In 2015 the labor force in the United States contained over million workers , according to the Bureau of Labor Statistics . Similarly , the total area of the United States is square miles . These are large numbers for such crucial resources , however , they are . Because these resources are limited , so are the numbers of goods and services we produce with them . Combine this with the fact that human wants seem to be virtually infinite , and you can see why scarcity is a problem . If you still do not believe that scarcity is a problem , consider the following Does everyone need food to eat ?

Does everyone need a decent place to live ?

Does everyone have access to healthcare ?

In every country in the world , there are people who are hungry , homeless ( for example , those who call park benches their beds , as shown in Figure ) and in need of healthcare , just to focus on a few cal goods and services . Why is this the case ?

It is because of scarcity . Let delve into the concept of scarcity a little deeper , because it is crucial to understanding economics . THE PROBLEM OF SCARCITY Think about all the things you consume food , shelter , clothing , transportation , healthcare , and . How do you acquire those items ?

You do not produce them yourself . You buy them . How do you afford the things you buy ?

You work for pay . Or if you do not , someone else does on your behalf .

ERIK DEAN , JUSTIN , MITCH GREEN , BENJAMIN WILSON , AND SEBASTIAN BERGER Figure . Scarcity of Resources . Homeless people are a stark reminder that scarcity of resources is real . Credit Creative Commons ) Yet most of us never have enough to buy all the things we want . This is because of scarcity . So how do we solve it ?

Visit this website to read about how the United States is dealing with scarcity in resources . conga ' I . i Every society , at every level , must make choices about how to use its resources . Families must decide whether to spend their money on a new car or a fancy vacation . Towns must choose whether to put more of the budget into police and fire protection or into the school system . Nations must decide whether to devote more funds to national defense or to protecting the environment . In most cases , there just isn enough money in the budget to do everything . So why do we not each just produce all of the things we consume ?

The simple answer is most of us do not know how , but that is not the main reason . hen you study economics , you will discover that the obvious choice is not always the right at least the complete answer . Studying economics teaches you to think in a different of way . Think back to pioneer days , when individuals knew how to do so much more than we do today , from building their homes , to growing their crops , to hunting for food , to repairing their equipment . Most of us do not know how to do those things . It is not because we could not learn .

PRINCIPLES OF ECONOMICS Rather , we do not have to . The reason why is something called the division and specialization of labor , a production innovation first put forth by Adam Smith , Figure , in his book , The Wealth of Nations . Figure . Adam Smith . Adam Smith introduced the idea of dividing labor into discrete tasks . Credit Commons ) THE DIVISION OF AND SPECIALIZATION OF LABOR The formal study of economics began when Adam Smith ( published his famous book The Wealth of Nations in 1776 . Many authors had written on economics in the centuries before Smith , but he was the first to address the subject in a comprehensive way . In the first chapter , Smith introduces the division of labor , which means that the way a good or service is produced is divided into a ber of tasks that are performed by different workers , instead of all the tasks being done by the same person . To illustrate the division of labor , Smith counted how many tasks went into making a pin drawing out a piece of wire , cutting it to the right length , straightening it , putting a head on one end and a point on the other , and packaging pins for sale , to name just a few . Smith counted 18 distinct tasks that were often done by different for a pin , believe it or not ! Modern businesses divide tasks as well . Even a relatively simple business like a restaurant divides up the task of serving meals into a range of jobs like top chef , sous chefs , kitchen help , servers to wait on the tables , a greeter at the door , janitors to clean up , and a business manager to handle checks and to mention the economic connections a restaurant has with suppliers of food , furniture , kitchen equipment , and the building where it is located . A complex business like a large manufacturing factory , such as the shoe factory shown in Figure , or a hospital can have hundreds of job classifications .

ERIK DEAN , JUSTIN , MITCH GREEN , BENJAMIN WILSON , AND SEBASTIAN BERGER Figure . Division of Labor . Workers on an assembly line are an example of the divisions of labor . Credit Nina Creative Commons ) WHY THE DIVISION OF LABOR INCREASES PRODUCTION When the tasks involved with producing a good or service are divided and subdivided , workers and businesses can produce a greater quantity of output . In his observations of pin factories , Smith observed that one worker alone might make 20 pins in a day , but that a small business of 10 workers ( some of whom would need to do two or three of the 18 tasks involved with ) could make pins in a day . How can a group of workers , each specializing in certain tasks , produce so much more than the same number of workers who try to produce the entire good or service by themselves ?

Smith offered three reasons . First , specialization in a particular small job allows workers to focus on the parts of the production process where they have an advantage . In later chapters , we will develop this idea by discussing comparative advantage . People have different skills , talents , and interests , so they will be better at some jobs than at others . The particular advantages may be based on educational choices , which are in turn shaped by interests and talents . Only those with medical degrees qualify to become doctors , for instance . For some goods , specialization will be affected by is easier to be a wheat farmer in North Dakota than in Florida , but easier to run a tourist hotel in Florida than in North Dakota . If you live in or near a big city , it is easier to attract enough customers to operate a successful dry cleaning business or movie theater than if you live in a sparsely populated rural area . Whatever the reason , if people specialize in the production of what they do best , they will be more productive than if they produce a combination of things , some of which they are good at and some of which they are not . Second , workers who specialize in certain tasks often learn to produce more quickly and with higher quality . This pattern holds true for many workers , including assembly line laborers who build cars , stylists who cut hair , and doctors who perform heart surgery . In fact , specialized workers often know their jobs well enough to suggest innovative ways to do their work faster and better . A similar pattern often operates within businesses . In many cases , a business that focuses on one or a

PRINCIPLES or ECONOMICS few products ( sometimes called its core competency ) is more successful than firms that try to make a wide range of products . Third , specialization allows businesses to take advantage of economies of scale , which means that for many goods , as the level of production increases , the average cost of producing each individual unit declines . For example , if a factory produces only 100 cars per year , each car will be quite expensive to make on average . However , if a factory produces cars each year , then it can set up an line with huge machines and workers performing specialized tasks , and the average cost of duction per car will be lower . The ultimate result of workers who can focus on their preferences and talents , learn to do their specialized jobs better , and work in larger organizations is that society as a whole can produce and consume far more than if each person tried to produce all of their own goods and services . The division and specialization of labor has been a force against the problem of scarcity . TRADE AND MARKETS Specialization only makes sense , though , if workers can use the pay they receive for doing their jobs to purchase the other goods and services that they need . In short , specialization requires trade . You do not have to know anything about electronics or sound systems to play just buy an iPod or player , download the music and listen . You do not have to know anything about artificial fibers or the construction of sewing machines if you need a just buy the jacket and wear it . You do not need to know anything about internal combustion engines to operate a just get in and drive . Instead of trying to acquire all the knowledge and skills involved in producing all of the goods and services that you wish to consume , the market allows you to learn a specialized set of skills and then use the pay you receive to buy the goods and services you need or want . This is how our modern society has evolved into a strong economy . WHY STUDY ECONOMICS ?

Now that we have gotten an overview on what economics studies , let quickly discuss why you are right to study it . Economics is not primarily a collection of facts to be memorized , though there are plenty of important concepts to be learned . Instead , economics is better thought of as a collection of questions to be answered or puzzles to be worked out . Most important , economics provides the tools to work out those puzzles . If you have yet to be been bitten by the economics bug , there are other reasons why you should study economics . Virtually every major problem facing the world today , from global warming , to world poverty , to the conflicts in Syria , Afghanistan , and , has an economic dimension . If you are going to be part of solving those problems , you need to be able to understand them . Economics is crucial . It is hard to overstate the importance of economics to good citizenship . You need to be able to vote intelligently on budgets , regulations , and laws in general . When the government came close to a standstill at the end of 2012 due to the fiscal cliff , what were the issues involved ?

Did you know ?

A basic understanding of economics makes you a thinker . When you read articles about economic issues , you will understand and be able to evaluate the writers argument . When you hear classmates , or political candidates talking about ERIK DEAN , JUSTIN , MITCH GREEN , BENJAMIN WILSON , AND SEBASTIAN BERGER economics , you will be able to distinguish between common sense and nonsense . You will find new ways of thinking about current events and about personal and business decisions , as well as current events and politics . The study of economics does not dictate the answers , but it can illuminate the different choices . KEY CONCEPTS AND SUMMARY Economics seeks to solve the problem of scarcity , which is when human wants for goods and services exceed the available supply . A modern economy displays a division of labor , in which people earn income by specializing in what they produce and then use that income to purchase the products they need or want . The division of labor allows individuals and firms to specialize and to produce more for several reasons a ) It allows the agents to focus on areas of advantage due to natural factors and skill levels ) It encourages the agents to learn and invent ) It allows agents to take advantage of economies of scale . Division and specialization of labor only work when individuals can purchase what they do not produce in markets . Learning about economics helps you understand the major problems facing the world today , prepares you to be a good citizen , and helps you become a rounded thinker . SELF CHECK QUESTIONS . What is scarcity ?

Can you think of two causes of scarcity ?

Residents of the town of like to consume hams , but each ham requires 10 people to produce it and takes a month . If the town has a total of 100 people , what is the maximum amount of ham the residents can consume in a month ?

A A consultant works for 200 per hour . She likes to eat vegetables , but is not Very good at growing them . Why does it make more economic sense for her to spend her time at the consulting job and shop for her Vegetables ?

A computer systems engineer could paint his house , but it makes more sense for him to hire a painter to do it . Explain why . REVIEW QUESTIONS Give the three reasons that explain why the division of labor increases an economy level of production . A What are three reasons to study economics ?

CRITICAL THINKING QUESTIONS Suppose you have a team of two workers one is a baker and one is a chef . Explain why the kitchen can produce more meals in a given period of time if each worker specializes in what they do best than if each Worker tries to do everything from appetizer to dessert .

PRINCIPLES OF ECONOMICS . Why would division of labor without trade not Work ?

Can you think of any examples goods , that is , goods or services that are not scarce ?

REFERENCES Bureau of Labor Statistics , Department of Labor . 2015 . The Employment Accessed March 27 , Lisa . US Labor Market in Bureau of Labor Statistics . Accessed December , 20 art . division of labor the way in which the work required to produce a good or service is divided into tasks performed by different workers economics the study of how humans make choices under conditions of scarcity economies of scale when the average cost of producing each individual unit declines as total output increases scarcity when human Wants for goods and services exceed the available supply specialization when workers or firms focus on particular tasks for which they are within the overall production process SOLUTIONS Answers for Questions . Scarcity means human Wants for goods and services exceed the available supply . Supply is limited because resources are limited . Demand , however , is virtually unlimited . Whatever the supply , it seems human nature to want more . 100 people 10 people per ham a maximum of 10 hams per month if all residents produce ham . Since consumption is limited by production , the maximum number of hams residents could consume per month is 10 . She is very productive at her consulting job , but not very productive growing vegetables . Time spent consulting would produce far more income than it what she could save growing her vegetables using the same amount of time . So on purely economic grounds , it makes more sense for her to maximize her income by applying her labor to what she does best ( specialization of labor ) The engineer is better at computer science than at painting . Thus , his time is better spent Working for pay at his job and paying a painter to paint his house . Of course , this assumes he does not paint his house for fun !

AND LEARNING OBJECTIVES By the end of this section , you will be able to Describe Describe Contrast monetary policy and fiscal policy is concerned with the of all people , including those with jobs and those without jobs , as well as those with high incomes and those with low incomes . Economics acknowledges that production of useful goods and services can create problems of mental pollution . It explores the question of how investing in education helps to develop workers skills . It probes questions like how to tell when big businesses or big labor unions are operating in a way that benefits society as a whole and when they are operating in a way that benefits their owners or members at the expense of others . It looks at how government spending , taxes , and regulations affect decisions about production and consumption . It should be clear by now that economics covers a lot of ground . That ground can be divided into two parts focuses on the actions of individual agents within the economy , like households , workers , and businesses looks at the economy as a whole . It focuses on broad issues such as growth of production , the number of unemployed people , the ary increase in prices , government deficits , and levels of exports and imports . and are not separate subjects , but rather complementary perspectives on the overall of the economy . To understand why both and perspectives are useful , consider the problem of studying a biological ecosystem like a lake . One person who sets out to study the lake might focus on specific topics certain kinds of algae or plant life the characteristics of particular fish or snails or the trees surrounding the lake . Another person might take an overall View and instead consider the entire ecosystem of the lake from top to bottom what eats what , how the system stays in a rough balance , and what environmental stresses affect this balance . Both approaches are useful , and both examine the same lake , but the viewpoints are different . In a similar way , both and study the same economy , but each has a different viewpoint . Whether you are looking at lakes or economics , the micro and the macro insights should blend with each other . In studying a lake , the micro insights about particular plants and animals help to

PRINCIPLES or ECONOMICS 11 stand the overall food chain , while the macro insights about the overall food chain help to explain the environment in which individual plants and animals live . In economics , the micro decisions of individual businesses are by whether the economy is healthy for example , firms will be more likely to hire workers if the overall economy is growing . In turn , the performance of the ultimately depends on the decisions made by individual households and businesses . What determines how households and individuals spend their budgets ?

What combination of goods and services will best fit their needs and wants , given the budget they have to spend ?

How do people decide whether to work , and if so , whether to work full time or part time ?

How do people decide how much to save for the future , or whether they should borrow to spend beyond their current means ?

What determines the products , and how many of each , a firm will produce and sell ?

What determines what prices a firm will charge ?

What determines how a firm will produce its products ?

What mines how many workers it will hire ?

How will a firm finance its business ?

When will a firm decide to expand , downsize , or even close ?

In the part of this book , we will learn about the theory of consumer behavior and the theory of the firm . What determines the level of economic activity in a society ?

In other words , what determines how many goods and services a nation actually produces ?

What determines how many jobs are available in an economy ?

What determines a nation standard of living ?

What causes the economy to speed up or slow down ?

What causes firms to hire more workers or to lay workers off ?

Finally , what causes the economy to grow over the long term ?

An economy health can be defined by a number of goals growth in the standard of living , low unemployment , and low , to name the most important . How can nomic policy be used to pursue these goals ?

Monetary policy , which involves policies that affect bank lending , interest rates , and financial capital markets , is conducted by a nation central bank . For the United States , this is the Federal Reserve . Fiscal policy , which involves government spending and taxes , is determined by a nation legislative body . For the United States , this is the Congress and the executive branch , which originates the federal budget . These are the main tools the government has to work with . Americans tend to expect that government can fix whatever economic problems we encounter , but to what extent is that expectation realistic ?

These are just some of the issues that will be explored in the chapters of this book . KEY CONCEPTS AND SUMMARY and are two different perspectives on the economy . The economic perspective focuses on parts of the economy individuals , firms , and industries . The economic perspective looks at the economy as a whole , focusing on goals like growth in the standard of living , unemployment , and . has two types of policies for pursuing these goals monetary policy and fiscal policy .

12 ERIK DEAN , JUSTIN , MITCH GREEN , BENJAMIN WILSON , AND SEBASTIAN BERGER SELF ' QUESTIONS What would be another example of a system in the real world that could serve as a metaphor for micro and economics ?

QUESTIONS What is the difference between and ?

What are examples of individual economic agents ?

What are the three main goals of ?

CRITICAL THINKING QUESTIONS A balanced federal budget and a balance of trade are considered secondary goals of , While growth in the standard of living ( for example ) is considered a primary goal . Why do you think that is so ?

is an aggregate of what happens at the level . Would it be possible for what happens at the macro level to differ from how economic agents would react to some stimulus at the micro level ?

Hint Think about the behavior of crowds . fiscal policy economic policies that involve government spending and taxes the branch of economics that focuses on broad issues such as growth , unemployment , and trade balance . the branch of economics that focuses on actions of particular agents within the economy , like households , workers , and business firms monetary policy policy that involves altering the level of interest rates , the availability of credit in the economy , and the extent of borrowing SOLUTIONS Answers to Questions There are many physical systems that would work , for example , the study of planets ( micro ) in the solar system ( macro ) or solar systems ( micro ) in the galaxy ( macro )

HOW ECONOMISTS USE THEORIES AND MODELS TO UNDERSTAND ECONOMIC ISSUES LEARNING OB By the end of this section , you will be able to Interpret a circular flow diagram Explain the importance of economic theories and models Describe goods and services markets and labor markets Figure . ohn Maynard Keynes . One of the most influential economists in modern times was john Maynard Keynes . Credit Commons ) ohn Maynard Keynes ( one of the greatest economists of the twentieth century , pointed out that economics is not just a subject area but also a way of thinking . Keynes , shown in Figure , famously wrote in the introduction to a fellow economist book Economics is a method rather than a doctrine , an apparatus of the mind , a technique of thinking , which helps its to draw correct In other Words , economics teaches you how to think , not What to think .

14 ERIK DEAN , JUSTIN , MITCH GREEN , BENJAMIN WILSON , AND SEBASTIAN BERGER Watch this video Maynard Keynes and his on economics . Economists see the world through a different lens than anthropologists , biologists , or of any other discipline . They analyze issues and problems with economic theories that are based on particular assumptions about human behavior , that are different than the assumptions an anthropologist or psychologist might use . A theory is a simplified representation of how two or more variables interact with each other . The purpose of a theory is to take a complex , issue and simplify it down to its essentials . If done well , this enables the analyst to understand the issue and any problems around it . A good theory is simple enough to be understood , while complex enough to ture the key features of the object or situation being studied . Sometimes economists use the term model instead of theory . Strictly speaking , a theory is a more abstract representation , while a model is more applied or empirical representation . Models are used to test theories , but for this course we will use the terms interchangeably . For example , an architect who is planning a major office building will often build a physical model that sits on a tabletop to show how the entire city block will look after the new building is constructed . Companies often build models of their new products , which are more rough and unfinished than the final product will be , but can still demonstrate how the new product will work . A good model to start with in economics is the circular diagram , which is shown in Figure . It pictures the economy as consisting of two and interact in two the goods and services market in which firms sell and households buy and the labor market in which households sell labor to business firms or other employees . Of course , in the real world , there are many different markets for goods and services and markets for many different types of labor . The circular flow diagram simplifies this to make the picture easier to grasp . In the diagram , firms produce goods and services , which they sell to households in return for revenues . This is shown in the outer circle , and represents the two sides of the product market ( for example , the market for goods and services ) in which households demand and firms supply . holds sell their labor as workers to firms in return for wages , salaries and benefits . This is shown in the inner circle and represents the two sides of the labor market in which households supply and firms demand . This version of the circular model is stripped down to the essentials , but it has enough features to explain how the product and labor markets work in the economy . We could easily add details to this basic model if we wanted to introduce more elements , like financial markets , and interactions with the rest of the globe ( imports and exports )

PRINCIPLES OF ECONOMICS 15 90995 an . Figure . The Circular Flow Diagram . The circular flow diagram shows how households and firms interact in the goods and services market , and in the labor market . The direction of the arrows shows that in the goods and services market , households receive goods and services and pay firms for them . In the labor market , households provide labor and receive payment from firms through wages , salaries , and benefits . Economists carry a set of theories in their heads like a carpenter carries around a toolkit . When they see an economic issue or problem , they go through the theories they know to see if they can find one that fits . Then they use the theory to derive insights about the issue or problem . In economics , are expressed as diagrams , graphs , or even as mathematical equations . Do not worry . In this course , we will mostly use graphs . Economists do not figure out the answer to the problem first and then draw the graph to illustrate . Rather , they use the graph of the theory to help them figure out the answer . Although at the introductory level , you can sometimes figure out the right answer without applying a model , if you keep studying economics , before too long you will run into issues and that you will need to graph to solve . Both micro and are explained in terms of theories and models . The most theories are probably those of supply and demand , but you will learn a number of others . KEY CONCEPTS AND SUMMARY Economists analyze problems differently than do other disciplinary experts . The main tools mists use are economic theories or models . A theory is not an illustration of the answer to a problem . Rather , a theory is a tool for determining the answer . SELF CHECK QUESTIONS . Suppose we extend the circular model to add imports and exports . Copy the circular diagram

15 ERIK DEAN , JUSTIN , MITCH GREEN , BENJAMIN WILSON , AND SEBASTIAN BERGER onto a sheet of paper and then add a foreign country as a third agent . Draw a rough sketch of the of imports , exports , and the payments for each on your diagram . What is an example of a problem in the world today , not mentioned in the chapter , that has an economic dimension ?

REVIEW QUESTIONS How Maynard Keynes define economics ?

Are households primarily buyers or sellers in the goods and services market ?

In the labor market ?

Are firms primarily buyers or sellers in the goods and services market ?

In the labor market ?

CRITICAL THINKING QUESTIONS . Why is it unfair or meaningless to criticize a theory as unrealistic ?

Suppose , as an economist , you are asked to analyze an issue unlike anything you have ever done before . Also , suppose you do not have a specific model for analyzing that issue . What should you do ?

Him What would a carpenter do in a similar situation ?

circular diagram a diagram that views the economy as consisting of households and firms interacting in a goods and services market and a labor market goods and services market a market in which firms are sellers of what they produce and households are buyers labor market the market in which households sell their labor as workers to business firms or other employers model see theory theory a representation of an object or situation that is simplified while including enough of the key features to help us understand the object or situation SOLUTIONS Answers to Questions . Draw a box outside the original circular to represent the foreign country . Draw an arrow from the foreign country to firms , to represents imports . Draw an arrow in the reverse direction representing payments for imports . Draw an arrow from firms to the foreign country to represent exports . Draw an arrow in the reverse direction to represent payments for imports . There are many such problems . Consider the AIDS epidemic . Why are so few AIDS patients in Africa and

PRINCIPLES OF ECONOMICS 17 Southeast Asia treated with the same drugs that are effective in the United States and Europe ?

It is because neither those patients nor the countries in which they live have the resources to purchase the same drugs .

HOW ECONOMIES CAN BE ORGANIZED AN OVERVIEW OF ECONOMIC SYSTEMS LEARNING By the end of this section , you will be able to Contrast traditional economies , command economies , and market economies Explain gross domestic product ( Assess the importance and effects of globalization hink about what a complex system a modern economy is . It includes all production of goods and services , all buying and selling , all employment . The economic life of every individual is interrelated , at least to a small extent , with the economic lives of thousands or even millions of other individuals . Who organizes and coordinates this system ?

Who insures that , for example , the number of televisions a society provides is the same as the amount it needs and wants ?

Who insures that the right number of employees work in the electronics industry ?

Who insures that televisions are produced in the best way possible ?

How does it all get done ?

There are at least three ways societies have found to organize an economy . The first is the traditional economy , which is the oldest economic system and can be found in parts of Asia , Africa , and South America . Traditional economies organize their economic affairs the way they have always done ( tradition ) Occupations stay in the family . Most families are farmers who grow the crops they have always grown using traditional methods . What you produce is what you get to consume . Because things are driven by tradition , there is little economic progress or development . Command economies are very different . In a command economy , economic effort is devoted to goals passed down from a ruler or ruling class . Ancient Egypt was a good example a large part of economic life was devoted to building pyramids , like those shown in Figure , for the pharaohs . Medieval manor life is another example the lord provided the land for growing crops and protection in the event of war . In return , vassals provided labor and soldiers to do the lords bidding . In the last century , emphasized command economies . In a command economy , the government decides what goods and services will be produced and what prices will be charged for them . The government decides what methods of production will be used and how much workers will be paid . Many necessities like healthcare and education are provided for free . Currently , Cuba and North Korea have command economies .

PRINCIPLES or ECONOMICS 19 Figure . A Command Economy . Ancient Egypt was an example of a command economy . Creative Commons ) Figure . A Market Economy . Nothing says market more than The New York Stock Exchange . Credit Erik Creative Commons ) Although command economies have a very centralized structure for economic decisions , market economies have a very decentralized structure . A market is an institution that brings together buyers and sellers of goods or services , who may be either individuals or businesses . The New York Stock Exchange , shown in Figure , is a prime example of market in which buyers and sellers are brought together . In a market economy , is decentralized . Market economies are based on private enterprise the means of production ( resources and businesses ) are owned and operated by private individuals or groups of private individuals . Businesses supply goods and services based on demand . In a command economy , by contrast , resources and businesses are owned by the ment . What goods and services are supplied depends on What is demanded . A person income is based on his or her ability to convert resources ( especially labor ) into something that society

20 ERIK DEAN , JUSTIN , MITCH GREEN , BENJAMIN WILSON , AND SEBASTIAN BERGER . The more society values the persons output , the higher the income ( think Lady Gaga or LeBron James ) In this scenario , economic decisions are determined by market forces , not governments . Most economies in the real world are mixed they combine elements of command and market ( and even traditional ) systems . The economy is positioned toward the end of the spectrum . Many countries in Europe and Latin America , while primarily , have a greater degree of government involvement in economic decisions than does the economy . China and Russia , while they are closer to having a system now than several decades ago , remain closer to the command economy end of the spectrum . A rich resource of information about countries and their economies can be found on the Heritage Foundation website , as the following Clear It Up feature discusses . WHAT COUNTRIES ARE CONSIDERED ECONOMICALLY FREE ?

Who is in control of economic decisions ?

Are people free to do what they want and to work where they want ?

Are free to produce when they want and what they choose , and to hire and fire as they wish ?

Are banks free to choose who will receive loans ?

Or does the government control these kinds of choices ?

Each year , researchers at the Heritage Foundation and the Wall look at 50 different categories of economic freedom for countries around the world . They give each nation a score based on the extent of economic freedom in each category . The 2015 Heritage Foundation Index of Economic Freedom report ranked 178 countries around the world some of the most free and the least free countries are listed in Table . Several countries were not ranked because of extreme instability that made judgments about economic freedom impossible . These countries include Afghanistan , Iraq , Syria , and . The assigned rankings are inevitably based on estimates , yet even these rough measures can be useful for discerning trends . In 2015 , 101 of the 178 included countries shifted toward greater economic freedom , although 77 of the countries shifted toward less economic freedom . In recent decades , the overall trend has been a higher level of economic freedom around the world . Most Economic Freedom Least Economic Freedom . Hong Kong 167 . Singapore 168 . Democratic Republic of Congo . New Zealand 169 . Argentina . Australia 170 . Republic of Congo . Switzerland 171 . Iran . Canada 172 . Chile 173 . Equatorial Guinea . 174 . Ireland 175 . Zimbabwe 10 . 176 . Venezuela 11 . Denmark 177 . Cuba 12 . United States 178 . North Korea Table . Economic Freedoms , 2015 ( Source The Heritage Foundation , 2015 Index of Economic Freedom , Country Rankings , ranking )

PRINCIPLES OF ECONOMICS 21 REGULATIONS THE RULES OF THE GAME Markets and government regulations are always entangled . There is no such thing as an absolutely free market . Regulations always define the rules of the game in the economy . Economies that are primarily have fewer just enough to maintain an even playing field for participants . At a minimum , these laws govern matters like safeguarding private property against theft , protecting people from violence , enforcing legal contracts , preventing fraud , and taxes . Conversely , even the most economies operate using markets . How else would buying and selling occur ?

But the decisions of what will be produced and what prices will be charged are heavily regulated . Heavily regulated economies often have underground economies , which are markets where the buyers and sellers make transactions without the governments approval . The question of how to organize economic institutions is typically not a choice between all market or all government , but instead involves a balancing act over the appropriate bination of market freedom and government rules . Figure . Globalization . Cargo ships are one mode of transportation for shipping goods in the global economy . Credit Raul Creative Commons ) THE RISE OF GLOBALIZATION Recent decades have seen a trend toward globalization , which is the expanding cultural , political , and economic connections between people around the world . One measure of this is the increased buying and selling of goods , services , and assets across national other words , international trade and financial capital . Globalization has occurred for a number of reasons . Improvements in shipping , as illustrated by the container ship shown in Figure , and air cargo have driven down transportation costs . in computing and telecommunications have made it easier and cheaper to manage economic connections of production and sales . Many valuable products and services in the modern economy can take the form of example computer software financial advice travel planning music , books and movies and blueprints for designing a building . These products and many

22 ERIK DEAN , JUSTIN , MITCH GREEN , BENJAMIN WILSON , AND SEBASTIAN BERGER others can be transported over telephones and computer networks at costs . Finally , national agreements and treaties between countries have encouraged greater trade . Table presents one measure of globalization . It shows the percentage of domestic economic tion that was exported for a selection of countries from 2010 to 2013 , according to an entity known as The World Bank . Exports are the goods and services that are produced domestically and sold abroad . Imports are the goods and services that are produced abroad and then sold domestically . The size of total production in an economy is measured by the gross domestic product ( Thus , the ratio of exports divided by measures what share of a country total economic production is sold in other countries . Country 2010 2011 2012 2013 Higher Income Countries United States 135 Belgium 828 Canada 301 France 283 Middle Income Countries Brazil 126 Mexico 317 South Korea 539 Lower Income Countries Chad 322 China India 248 Table . The Extent of Globalization ( Source ( In recent decades , the ratio has generally risen , both worldwide and for the . the share of exports in proportion to the economy is well below the global average , in part because large economies like the United States can contain more of the division of labor inside their national borders . However , smaller economies like Belgium , Korea , and Canada need to trade across their borders with other countries to take full advantage of division of labor , and economies of scale . In this sense , the enormous economy is less affected by than most other countries . Table also shows that many medium and low income countries around the world , like Mexico and China , have also experienced a surge of globalization in recent decades . If an astronaut in orbit could put on special glasses that make all economic transactions visible as brightly colored lines and look down at Earth , the astronaut would see the planet covered with connections . So , hopefully , you now have an idea of what economics is about . Before you move to any other chapter of study , be sure to read the very important appendix to this chapter called The Use of Mathematics in Principles of Economics . It is essential that you learn more about how to read and use models in economics .

PRINCIPLES OF ECONOMICS 23 DECISIONS DECISIONS IN THE SOCIAL MEDIA AGE The world we live in today provides nearly instant access to a wealth of information . Consider that as recently as the late , the Farmers Almanac , along with the Weather Bureau of the Department of Agriculture , were the primary sources American farmers used to determine when to plant and harvest their crops . Today , farmers are more likely to access , online , weather forecasts from the National Oceanic and Atmospheric Administration or watch the Weather nel . After all , knowing the upcoming forecast could drive when to harvest crops . Consequently , knowing the upcoming weather could change the amount of crop harvested . Some relatively new information forums , such as Facebook , are rapidly changing how information is distributed hence , decision making . In 2014 , the Pew Research Center reported that 71 of online adults use Facebook . Facebook post topics range from the National Basketball Association , to celebrity singers and performers , to farmers . Information helps us make decisions . Decisions as simple as what to wear today to how many reporters should be sent to cover a crash . Each of these decisions is an economic decision . After all , resources are scarce . If ten reporters are sent to cover an accident , they are not available to cover other stories or complete other tasks . Information provides the edge needed to make the best possible decisions on how to utilize scarce resources . Welcome to the world of economics ! KEY CONCEPTS AND SUMMARY Societies can be organized as traditional , command , or economies . Most societies are a mix . The last few decades have seen globalization evolve as a result of growth in commercial and financial networks that cross national borders , making businesses and workers from different economies increasingly interdependent . QUESTIONS The chapter defines private enterprise as a characteristic of economies . What would public enterprise be ?

Hint It is a characteristic of command economies . Why might Belgium , France , Italy , and Sweden have a higher export to ratio than the United States ?

REVIEW QUESTIONS What are the three ways that societies can organize themselves economically ?

What is globalization ?

How do you think it might have affected the economy over the past decade ?

CRITICAL THINKING QUESTIONS Why do you think that most modern countries economies are a mix of command and market types ?

Can you think of ways that globalization has helped you economically ?

Can you think of ways that it has not ?

24 ERIK DEAN , JUSTIN , MITCH GREEN , BENJAMIN WILSON , AND SEBASTIAN BERGER REFERENCES The Heritage Foundation . 2015 . 2015 Index of Economic Accessed March 11 , ranking . Caleb . plane crash Reporting , emotions on social media , The San Francisco Chronicle . July , Jessica . Social Networking Sites are Factories of Modern The Sydney Morning Herald . November 25 , 201 . Pew Research Center . 2015 . Social Networking Fact Accessed March 11 , The World Bank Group . 2015 . World Data Accessed March 30 , command economy an economy where economic decisions are passed down from government authority and where resources are owned by the government exports products ( goods and services ) made domestically and sold abroad globalization the trend in which buying and selling in markets have increasingly crossed national borders gross domestic product ( measure of the size of total production in an economy imports products ( goods and services ) made abroad and then sold domestically market interaction between potential buyers and sellers a combination of demand and supply market economy an economy where economic decisions are decentralized , resources are owned by private individuals , and businesses supply goods and services based on demand private enterprise system where the means of production ( resources and businesses ) are owned and operated by private individuals or groups of private individuals traditional economy typically an agricultural economy where things are done the same as they have always been done underground economy a market where the buyers and sellers make transactions in violation of one or more government regulations SOLUTIONS Answers to Questions . Public enterprise means the factors of production ( resources and businesses ) are owned and operated by the government . The United States is a large country economically speaking , so it has less need to trade internationally than the other countries mentioned . This is the same reason that France and Italy have lower ratios than

PRINCIPLES OF ECONOMICS 25 Belgium or Sweden . One additional reason is that each of the other countries is a member of the European Union , Where trade between members occurs without barriers to trade , like tariffs and quotas .