Basic Economic Principles

The Building Blocks of Economies

Economies depend on the availability of resources. These resources are known as the factors of production . The factors of production are

1. land and other natural resources

2. labor and other human resources

3. capital resources

GOODS AND SERVICES

Businesses use the factors of production to produce goods , which are items that are made by people, and services , which are actions that people perform for others.

How Economic Choices Are Made

Consumers must make economic choices about which things to produce or consume. They must consider supply and demand , or how much of something can be produced versus how much of it people want to buy.

BUSINESS DECISIONS

Business owners have to make decisions such as choosing one thing over another, which is called a trade-off. What they give up due to a decision is called an opportunity cost

COSTS OF RUNNING A BUSINESS

Fixed costs - These are costs that are always part of running a business.

Variable costs - These are costs that are determined by decisions about what to produce and what resources to use.

Marginal costs - These are costs that are determined by how an increase in production will affect a business.

MARGINAL ANALYSIS

Individuals can also employ something called marginal analysis when making economic choices. Marginal analysis involves comparing the additional benefits and the additional costs of an action.

Governments also use marginal analysis to make financial decisions. They stop spending on a program if its marginal benefit is no longer greater than its marginal cost.

Types of Economic Systems

Countries and governments must also make similar choices about economic systems. An economic system is a set of rules that governs how resources are used to produce goods and services. The set of rules answers these three questions:

• What to produce?

• How to produce it?

• For whom to produce it? (who gets it?)

Types of Economic Systems

• Traditional - People generally produce what they need to survive. Instead of using currency, people use a barter system, trading for the goods they need.

• Command - Resources and the means of production are controlled by the government

• Market - Supply and demand affect production, distribution, and investment decisions. Business owners choose what to produce, how to produce, and for whom to produce, which is a principle known as free enterprise. Consumers and producers are free to buy and sell what they wish, in a free market . These practices are linked to capitalism , a system in which private citizens control the means of production.

• Mixed - Most countries in the world use this system, a mix of market and command systems.

Principles of the Market Economy

Entrepreneurs take on financial risk when starting a business, which means that they may lose time and money if they fail. Their goal is to make a profit , or have money left over after expenses are paid

SUPPLY AND DEMAND

The law of supply and demand explains the relationship between the supply of a good and the demand for that same good. In general, when prices for a good are low, people will buy more of the good. This leads to a decline in supply. When the price of a good is high, people will buy less. This may lead to a surplus of the good, in which the quantity supplied is greater than the quantity demanded.

The point at which supply and demand are balanced, called the equilibrium , and it is usually where the price of the product is set. When too many buyers compete, there isn’t enough for everyone and is called a shortage , having a supply of resources that is less than the amount of demand.

The US Economic System

THE GOVERNMENT’S ROLE IN THE ECONOMY

In the United States, the government plays a few economic roles, such as enforcing laws against monopolies , which are businesses that hold sole control over the supply of a good or service.

FOUR FUNCTIONS OF GOVERNMENT IN THE US ECONOMY

• ensuring that the rules of fair business are followed

• collecting taxes

• using tax revenue to provide services to the public

• making payments to people who are entitled to receive them, such as Social Security

Drawbacks and Benefits of the US Market

Drawbacks - Lack of intervention can cause a severe economic downturn .

• Competition and the drive for profits can cause inequalities of wealth and resources.

Advantages - Economic incentives encourage people to work hard and be productive .

• Profitability inspires entrepreneurship .

• Competition sometimes leads to better and more innovative products

THE GROWTH OF AMERICAN BUSINESS

Motivated individuals start many successful new businesses. Some of these entrepreneurs are very successful. For example, industry leaders such as Microsoft cofounder Bill Gates.