Introduction to FRED

Data is very important in economics because it describes and measures the issues and problems that economics seeks to understand. A variety of government agencies publish economic and social data. For this course, we will generally use data from the St. Louis Federal Reserve Bank’s FRED database. FRED is very user friendly. It allows you to display data in tables or charts, and you can easily download it into spreadsheet form if you want to use the data for other purposes. The FRED website includes data on nearly 400,000 domestic and international variables over time, in the following broad categories:

• Money, Banking & Finance
• Population, Employment, & Labor Markets (including Income Distribution)
• National Accounts (Gross Domestic Product & its components), Flow of Funds, and International Accounts
• Production & Business Activity (including Business Cycles)
• Prices & Inflation (including the Consumer Price Index, the Producer Price Index, and the Employment Cost Index)
• International Data from other nations
• U.S. Regional Data
• Academic Data (including Penn World Tables & NBER Macrohistory database)

For more information about how to use FRED, see the variety of videos on YouTube starting with this introduction.

Scarcity is the condition of having insufficient resources to satisfy unlimited wants and needs. It is a fundamental problem in economics that forces people to make choices and tradeoffs. Think about all the things you consume: food, shelter, clothing, transportation, healthcare, and entertainment. 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. If you do not, someone else does on your behalf. Yet most of us never have enough income to buy all the things we want. This is because of scarcity. So how do we solve it?

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’t enough money in the budget to do everything. How do we use our limited resources the best way possible—that is, to obtain the most goods and services we can? There are a couple of options. First, we could each produce everything we each consume. Alternatively, we could each produce some of what we want to consume, and “trade” for the rest of what we want.

Let’s also explore these options. Why do we not each just produce all of the things we consume? 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 all—or any—of those things, but it is not because we could not learn. 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 1.3) in his book The Wealth of Nations.

Figure 1.3 Adam Smith. Adam Smith introduced the idea of dividing labor into discrete tasks. (Credit: Wikimedia Commons)

The Division of and Specialization of Labor

The formal study of economics began when Adam Smith (1723–1790) 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 concept of division of labor, which means that the way one produces a good or service is divided into a number of tasks that different workers perform, instead of all the tasks being done by the same person.

To illustrate 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 different people performed—all for a pin, believe it or not!

Modern businesses divide tasks as well. Even a relatively simple business like a restaurant divides the task of serving meals into a range of jobs like top chef, sous chefs, less-skilled kitchen help, servers to wait on the tables, a greeter at the door, janitors to clean up, and a business manager to handle paychecks and bills—not 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 a shoe factory (Figure 1.4), or a hospital can have hundreds of job classifications.

Why the Division of Labor Increases Production

When we divide and subdivide the tasks involved with producing a good or service, workers and businesses can produce a greater quantity of output. In his observations of pin factories, Smith noticed 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 complete two or three of the 18 tasks involved with pin-making), could make 48,000 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, geography affects specialization. For example, it 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 effective 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 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 50,000 cars each year, then it can set up an assembly line with huge machines and workers performing specialized tasks, and the average cost of production 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 his or her 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 music—you just buy an iPod or MP3 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 jacket—you just buy the jacket and wear it. You do not need to know anything about internal combustion engines to operate a car—you 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?

There are many interesting reasons to study economics, whether you are a high school or a college student. Here are some of them:

Economics helps you understand the world around you. Economics is a broad discipline that helps us understand historical trends, interpret today’s headlines, and make predictions about the coming years. It enables people to understand people, businesses, markets, and governments, and therefore better respond to the threats and opportunities that emerge when things change.

Economics develops your critical-thinking and problem-solving skills. Economics, at its core, is the study of how to evaluate alternatives and make better choices. It teaches you how to use logic, data, and evidence to support your arguments and decisions. It also challenges you to question your assumptions and consider different perspectives.

Economics gives you a competitive edge in the job market. Economics is a versatile and valuable major that can prepare you for a wide range of careers in the public and private sectors. Economics majors have high earning potential and low unemployment rates compared to other majors.⁴ They can work as analysts, consultants, managers, researchers, teachers, journalists, lawyers, policymakers, and more.

Economics is fun and fascinating. Economics can be enjoyable and engaging because it relates to your everyday life and experiences. You can use economics to analyze anything from sports to music to movies to social media. You can also learn from interesting stories and examples of how economics affects people and societies around the world.

These are just some of the reasons why studying economics can be rewarding and exciting. If you are curious about how the world works and how you can make a difference in it, economics might be the right choice for you.

1. https://economics.gmu.edu/prospective/prospective-undergraduate-students/why-should-i-study-economics
2. https://economics.appstate.edu/node/245
3. https://www.afterschoolafrica.com/60276/importance-of-economics/
4. https://online.hbs.edu/blog/post/5-reasons-why-you-should-study-economics
5. https://economics.northwestern.edu/undergraduate/why-economics/index.html

1.2 Microeconomics and Macroeconomics

Learning Objectives

By the end of this section, you will be able to:

• Describe microeconomics
• Describe macroeconomics
• Contrast monetary policy and fiscal policy

 

Economics is concerned with the well-being 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 the production of useful goods and services can create problems of environmental 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 considerable ground. We can divide that ground into two parts: Microeconomics focuses on the actions of individual agents within the economy, like households, workers, and businesses. Macroeconomics looks at the economy as a whole. It focuses on broad issues such as growth of production, the number of unemployed people, the inflationary increase in prices, government deficits, and levels of exports and imports. Microeconomics and macroeconomics are not separate subjects, but rather complementary perspectives on the overall subject of the economy.

To understand why both microeconomic and macroeconomic 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 lake’s ecosystem 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 microeconomics and macroeconomics study the same economy, but each has a different viewpoint.

Whether you are scrutinizing 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 understand 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 influenced by whether the macroeconomy is healthy. For example, firms will be more likely to hire workers if the overall economy is growing. In turn, the macroeconomy’s performance ultimately depends on the microeconomic decisions that individual households and businesses make.

Microeconomics

Microeconomics is the study of human action and interaction. It focuses on the role consumers and businesses play in the economy, with specific attention paid to how these two groups make decisions. These decisions include when a consumer purchases a good and for how much, or how a business determines the price it will charge for its product. To accomplish this analysis, microeconomists consider questions like, “what determines how much a consumer will save?” and “how much should a firm produce, given the strategies their competitors are using?” and “why do people buy both insurance and lottery tickets?”

In the microeconomics part of this book, we will learn about the theory of consumer behavior, the theory of the firm, how markets for labor and other resources work, and how markets sometimes fail to work properly.

Macroeconomics

Macroeconomics is the branch of economics that deals with the structure, performance, behavior, and decision-making of the whole, or aggregate, economy. It analyzes an economy through a wide lens and includes looking at variables like unemployment, GDP, and inflation. Macroeconomists develop models explaining the relationships between these factors. The Federal Reserve closely examines macroeconomics because its goals—maximum sustainable employment and stable inflation—are measured and achieved on an economy-wide level.

We can determine an economy’s macroeconomic health by examining a number of goals: growth in the standard of living, low unemployment, and low inflation, to name the most important. How can we use government macroeconomic policy to pursue these goals? A nation’s central bank conducts monetary policy, which involves policies that affect bank lending, interest rates, and financial capital markets. For the United States, this is the Federal Reserve. A nation’s legislative body determines fiscal policy, which involves government spending and taxes. For the United States, this is the Congress and the executive branch, which originates the federal budget. These are the government’s main tools. 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 we will explore in the macroeconomic chapters of this book.

 

1.3 How Economists Use Theories and Models to Understand Economic Issues

Learning Objectives

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 1.5 John Maynard Keynes. One of the most influential economists in modern times was John Maynard Keynes. (Credit: Wikimedia Commons)

John Maynard Keynes (1883–1946), 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 (Figure 1.5) famously wrote in the introduction to a fellow economist’s book: “[Economics] is a method rather than a doctrine, an apparatus of the mind, a technique of thinking, which helps its possessor to draw correct conclusions.” In other words, economics teaches you how to think, not what to think.

Link It Up

Watch this video about John Maynard Keynes and his influence on economics.

The circular flow diagram is a model that shows how money, goods, and services flow through an economy. It has two main parts: households and firms.

Households are the people who live in an economy. They provide the factors of production (land, labor, and capital) to firms in exchange for income.
Firms are the businesses that produce goods and services. They use the factors of production provided by households to produce goods and services, which they then sell to households in exchange for money.

The circular flow diagram can be used to show how the economy works in a simple way. For example, let’s say that a household in Louisiana owns a farm. The household provides the land, labor, and capital (such as tractors and equipment) to the farm in exchange for income. The farm uses these factors of production to produce crops, which it then sells to other households in Louisiana. The households then use the money they earn from buying the crops to pay the farm for its products.

The circular flow diagram can also be used to show how the economy can be affected by changes in different factors. For example, if the government decides to increase taxes on businesses, the businesses will have less money to pay their workers. This will lead to a decrease in the amount of income that households earn, which will lead to a decrease in the demand for goods and services. This, in turn, will lead to a decrease in the amount of output produced by firms, and so on.

Figure 1.6 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.

Firms produce and sell goods and services to households in the market for goods and services (or product market). Arrow “A” indicates this. Households pay for goods and services, which becomes the revenues to firms. Arrow “B” indicates this. Arrows A and B represent the two sides of the product market. Where do households obtain the income to buy goods and services? They provide the labor and other resources (e.g. land, capital, raw materials) firms need to produce goods and services in the market for inputs (or factors of production). Arrow “C” indicates this. In return, firms pay for the inputs (or resources) they use in the form of wages and other factor payments. Arrow “D” indicates this. Arrows “C” and “D” represent the two sides of the factor market.

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. The outer circle shows this, and represents the two sides of the product market (for example, the market for goods and services) in which households demand and firms supply. Households sell their labor as workers to firms in return for wages, salaries, and benefits. The inner circle shows this and represents the two sides of the labor market in which households supply and firms demand.

This version of the circular flow 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 real-world elements, like financial markets, governments, and interactions with the rest of the globe (imports and exports).

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. Economists express theories 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 problems that you will need to graph to solve. We explain both micro and macroeconomics in terms of theories and models. The most well-known theories are probably those of supply and demand, but you will learn a number of others.

Link it Up

Watch this video to see the flow of goods services and the factors of production in a market economy. See how households exchange scarce resources with firms in the resource market.

 

1.4 How To Organize Economies: An Overview of Economic Systems

Learning Objectives

By the end of this section, you will be able to:

• Contrast traditional economies, command economies, and market economies
• Explain gross domestic product (GDP)
• Assess the importance and effects of globalization

 

Think 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 ensures that, for example, the number of televisions a society provides is the same as the amount it needs and wants? Who ensures that the right number of employees work in the electronics industry? Who ensures that televisions are produced in the best way possible? How does it all get done?

There are at least three ways that societies organize an economy. The first is the traditional economy, which is the oldest economic system and is used in parts of Asia, Africa, and South America. Traditional economies organize their economic affairs the way they have always done (i.e., tradition). Occupations stay in the family. Most families are farmers who grow the crops using traditional methods. What you produce is what you consume. Because tradition drives the way of life, there is little economic progress or development.

Figure 1.7 A Command Economy. Ancient Egypt was an example of a command economy. (Credit: Jay Bergesen/Flickr Creative Commons)

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 in Figure 1.7, 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 lord’s bidding. In the last century, communism emphasized command economies.

In a command economy, the government decides what goods and services will be produced and what prices it will charge for them. The government decides what methods of production to use and sets wages for workers. The government provides many necessities like healthcare and education for free. Currently, Cuba and North Korea have command economies.

Figure 1.8 A Market Economy. Nothing says “market” more than the New York Stock Exchange. (Credit: Erik Drost/Flickr 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 (Figure 1.8) is a prime example of a market that brings buyers and sellers together. In a market economy, decision-making is decentralized. Market economies are based on private enterprise: the private individuals or groups of private individuals own and operate the means of production (resources and businesses). Businesses supply goods and services based on demand. (In a command economy, by contrast, the government owns resources and businesses.) Supply of goods and services depends on what the demands are. A person’s income is based on his or her ability to convert resources (especially labor) into something that society values. The more society values the person’s output, the higher the income (think Lady Gaga or LeBron James). In this scenario, market forces, not governments, determine economic decisions.

Most economies in the real world are mixed. They combine elements of command and market (and even traditional) systems. The U.S. economy is positioned toward the market-oriented end of the spectrum. Many countries in Europe and Latin America, while primarily market-oriented, have a greater degree of government involvement in economic decisions than the U.S. economy. China and Russia, while over the past several decades have moved more in the direction of having a market-oriented system, remain closer to the command economy end of the spectrum. The Heritage Foundation provides perspective on countries’ economic freedom, as the following Clear It Up feature discusses.

Clear It Up

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 businesses 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 Street Journal look at 50 different categories of economic freedom for countries around the world.

According to the Heritage Foundation’s Index of Economic Freedom, economic freedom is the fundamental right of every human to control his or her own labor and property.^1,2 The index measures 12 factors of economic freedom, grouped into four categories: rule of law, government size, regulatory efficiency, and open markets.² The index assigns a score to each country based on these factors, ranging from 0 (least free) to 100 (most free).

In 2023, Singapore is noted as having an economic freedom score of 83.9, ranking it number one in the world 1. This means that Singapore has a very high level of economic freedom, with strong property rights, low corruption, efficient regulation, and open trade and investment policies. Singapore’s score has decreased slightly by 0.5 points from the previous year, mainly due to a decline in fiscal health. In comparison, the U.S. earned an economic freedom score of 70.6 in 2023, placing it in 25th place of world rankings 1. This means that the U.S. has a moderately high level of economic freedom, but faces some challenges such as high government spending, complex taxation, and regulatory burdens. The U.S.’s score has increased by 0.4 points from the previous year, mainly due to an improvement in trade freedom.

Note that while the Heritage Foundation/WSJ index is widely cited by an array of scholars and publications, it should be regarded as only one viewpoint. Some experts indicate that the index’s category choices and scores are politically biased. However, the index and others like it provide a useful resource for critical discussion of economic freedom.

The 2016 Heritage Foundation’s Index of Economic Freedom report ranked 178 countries around the world: Table 1.1 lists some examples of the most free and the least free countries. Although technically not a separate country, Hong Kong has been granted a degree of autonomy such that, for purposes of measuring economic statistics, it is often treated as a separate country. Several additional countries were not ranked because of extreme instability that made judgments about economic freedom impossible. These countries include Afghanistan, Iraq, Libya, Syria, Somalia, and Yemen.

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
1. Hong Kong	167. Timor-Leste
2. Singapore	168. Democratic Republic of Congo
3. New Zealand	169. Argentina
4. Switzerland	170. Equatorial Guinea
5. Australia	171. Iran
6. Canada	172. Republic of Congo
7. Chile	173. Eritrea
8. Ireland	174. Turkmenistan
9. Estonia	175. Zimbabwe
10. United Kingdom	176. Venezuela
11. United States	177. Cuba
12. Denmark	178. North Korea

Table 1.1 Economic Freedoms, 2016 (Source: The Heritage Foundation, 2016 Index of Economic Freedom, Country Rankings, http://www.heritage.org/index/ranking)

1. https://www.heritage.org/index/
2. https://www.heritage.org/index/about

 

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 market-oriented have fewer regulations—ideally 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 collecting taxes. Conversely, even the most command-oriented economies operate using markets. How else would buying and selling occur? The government heavily regulates decisions of what to produce and prices to charge. Heavily regulated economies often have underground economies (or black markets), which are markets where the buyers and sellers make transactions without the government’s approval.

The question of how to organize economic institutions is typically not a black-or-white choice between all market or all government, but instead involves a balancing act over the appropriate combination of market freedom and government rules.

Figure 1.9 Globalization. Cargo ships are one mode of transportation for shipping goods in the global economy. (Credit: Raul Valdez/Flickr 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 borders—in other words, international trade and financial capital flows. The World Bank classifies countries into four income groups: low-income economies, lower-middle-income economies, upper-middle-income economies, and high-income economies.

Globalization has occurred for a number of reasons. Improvements in shipping, as illustrated by the container ship in Figure 1.9, and air cargo have driven down transportation costs. Innovations in computing and telecommunications have made it easier and cheaper to manage long-distance economic connections of production and sales. Many valuable products and services in the modern economy can take the form of information—for example: computer software; financial advice; travel planning; music, books and movies; and blueprints for designing a building. These products and many others can be transported over telephones and computer networks at ever-lower costs. Finally, international agreements and treaties between countries have encouraged greater trade. What’s Louisiana’s contribution to the U.S. GDP? According to the Bureau of Economic Analysis (BEA), Louisiana’s GDP was $255.3 billion in 2021, representing 1.11% of US GDP and ranking 26th among the states.

Table 1.2 presents one measure of globalization. It shows the percentage of domestic economic production that was exported for a selection of countries from 2010 to 2015, according to an entity known as the World Bank. Exports are the goods and services that one produces domestically and sells abroad. Imports are the goods and services that one produces abroad and then sells domestically. Gross domestic product (GDP) measures the size of total production in an economy. Thus, the ratio of exports divided by GDP measures what share of a country’s total economic production is sold in other countries.

Country	2010	2011	2012	2013	2014	2015	2020
Higher Income Countries
United States	12.4	13.6	13.6	13.5	13.5	12.6	11.3
Belgium	76.2	81.4	82.2	82.8	84.0	84.4	83.9
Canada	29.1	30.7	30.0	30.1	31.7	31.5	31.37
France	26.0	27.8	28.1	28.3	29.0	30.0	30.2
Middle Income Countries
Brazil	10.9	11.9	12.6	12.6	11.2	13.0	12.8
Mexico	29.9	31.2	32.6	31.7	32.3	35.3	38.2
South Korea	49.4	55.7	56.3	53.9	50.3	45.9	37.4
Lower Income Countries
Chad	36.8	38.9	36.9	32.2	34.2	29.8	56.6
China	29.4	28.5	27.3	26.4	23.9	22.4	56.6
India	22.0	23.9	24.0	24.8	22.9	–	19.1
Nigeria	25.3	31.3	31.4	18.0	18.4	–	10.07

Table 1.2 The Extent of Globalization (exports/GDP) (Source: http://databank.worldbank.org/data/)

In recent decades, the export/GDP ratio has generally risen, both worldwide and for the U.S. economy. Interestingly, the share of U.S. exports in proportion to the U.S. 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, specialization, and economies of scale. In this sense, the enormous U.S. economy is less affected by globalization than most other countries.

Table 1.2 indicates 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.

Despite the rise in globalization over the last few decades, in recent years we’ve seen significant pushback against globalization from people across the world concerned about loss of jobs, loss of political sovereignty, and increased economic inequality. Prominent examples of this pushback include the 2016 vote in Great Britain to exit the European Union (i.e. Brexit), and the election of Donald J. Trump for President of the United States.

Hopefully, you now have an idea about economics. 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.

Bring It Home

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 1970s, the Farmer’s Almanac, along with the Weather Bureau of the U.S. 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 Channel. 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, influencing decision-making. However, according to Pew Research Center, in 2021, 69% of adults in the US use Facebook, 40% use Instagram, 31% use Pinterest, 24% use LinkedIn and 23% use Twitter. This social media forum posts topics ranging from the National Basketball Association, to celebrity singers and performers, to farmers.

Information helps us make decisions as simple as what to wear today to how many reporters the media should send to cover a crash. Each of these decisions is an economic decision. After all, resources are scarce. If the media send ten reporters to cover an accident, they are not available to cover other stories or complete other tasks. Information provides the necessary knowledge to make the best possible decisions on how to utilize scarce resources. Welcome to the world of economics!

End of the Chapter Review

Key Terms

circular flow diagram

a diagram that views the economy as consisting of households and firms interacting in a goods and services market and a labor market

command economy

an economy where economic decisions are passed down from government authority and where the government owns the resources

division of labor

the way in which different workers divide required tasks to produce a good or service

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

exports

products (goods and services) made domestically and sold abroad

fiscal policy

economic policies that involve government spending and taxes

globalization

the trend in which buying and selling in markets have increasingly crossed national borders

goods and services market

a market in which firms are sellers of what they produce and households are buyers

gross domestic product (GDP)

measure of the size of total production in an economy

imports

products (goods and services) made abroad and then sold domestically

labor market

the market in which households sell their labor as workers to business firms or other employers

macroeconomics

the branch of economics that focuses on broad issues such as growth, unemployment, inflation, and trade balance

market

interaction between potential buyers and sellers; a combination of demand and supply

market economy

an economy where economic decisions are decentralized, private individuals own resources, and businesses supply goods and services based on demand

microeconomics

the branch of economics that focuses on actions of particular agents within the economy, like households, workers, and business firms

model

see theory

monetary policy

policy that involves altering the level of interest rates, the availability of credit in the economy, and the extent of borrowing

private enterprise

system where private individuals or groups of private individuals own and operate the means of production (resources and businesses)

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 well-suited within the overall production process

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

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

Key Concepts and Summary

1.1 What Is Economics, and Why Is It Important?

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; b) It encourages the agents to learn and invent; c) 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 well-rounded thinker.

1.2 Microeconomics and Macroeconomics

Microeconomics and macroeconomics are two different perspectives on the economy. The microeconomic perspective focuses on parts of the economy: individuals, firms, and industries. The macroeconomic perspective looks at the economy as a whole, focusing on goals like growth in the standard of living, unemployment, and inflation. Macroeconomics has two types of policies for pursuing these goals: monetary policy and fiscal policy.

1.3 How Economists Use Theories and Models to Understand Economic Issues

Economists analyze problems differently than do other disciplinary experts. The main tools economists 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.

1.4 How To Organize Economies: An Overview of Economic Systems

We can organize societies as traditional, command, or market-oriented 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.

Self-Check Questions (answers can be located at the end of the book)

1. What is scarcity? Can you think of two causes of scarcity?
2. Residents of the town of Smithfield 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?
3. 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?
4. A computer systems engineer could paint his house, but it makes more sense for him to hire a painter to do it. Explain why.
5. What would be another example of a “system” in the real world that could serve as a metaphor for micro and macroeconomics?
6. Suppose we extend the circular flow model to add imports and exports. Copy the circular flow diagram onto a sheet of paper and then add a foreign country as a third agent. Draw a rough sketch of the flows of imports, exports, and the payments for each on your diagram.
7. What is an example of a problem in the world today, not mentioned in the chapter, that has an economic dimension?
8. The chapter defines private enterprise as a characteristic of market-oriented economies. What would public enterprise be? Hint: It is a characteristic of command economies.
9. Why might Belgium, France, Italy, and Sweden have a higher export to GDP ratio than the United States?