Agriculture Economics and the American Economy

Agriculture Economics and the American Economy Chapter 2

Objectives: • Define Economics. • Explain three major components of economics. • Discuss three basic economic questions. • Explain six types of economic systems. • Discuss economics from a historical perspective. • Discuss the role of government versus individuals in the economic system.

Objectives cont.’d • Describe the characteristics of the American economy. • Differentiate between macroeconomics and microeconomics. • Differentiate between positive and normative economics. • Explain agricultural economics.

Introduction Today’s world is complex and continually changing. The successful agribusiness manager must possess a basic understanding of economic principles to react to these changes. To understand agricultural economics, the agribusiness manager must first understand basic economic principles.

Definitions of Economics There are many definitions of economics. Consider each of the following definitions, look for key words and phrases, and then form your own definition. • Economics is the study of allocation of scarce resources among competing alternatives. • Economics is the study of how individuals and countries decide how to use scarce resources to fulfill their wants. • Economics is the “study of how society allocates scarce resources and goods.”

Economics is “the science of allocating scarce resources (land, labor, capital, and managements) among different and competing choices and utilizing them to best satisfy human wants. • Economics “is a study of how to get the most satisfaction for a given amount of money or to spend the least money for a given need or want.” • Economics is the study of how scarce resources are transformed into goods and services to satisfy our most pressing wants, and how these goods and services are distributed.

Economics is “the study of the decisions involved in producing, distributing, and consuming goods and services.” • Economics “is a social science that studies how consumers, producers, and societies choose among the alternative uses of scarce resources in the process of producing, exchanging, and consuming goods and services.” • Economics is “concerned with overcoming the effects of scarcity by improving the efficiency with which scarce resources are allocated among their many competing uses, so as to best satisfy human wants.”

Three major components of Economics Three key words or phrases can be drawn from each of these definitions: scarcity, types of resources, and wants and needs.

Scarcity Scarcity is the economic term for a situation in which there are not enough resources available to satisfy people’s needs or wants. Economics is the study of society’s allocation of scarce resources. These resources are considered scarce because of a society’s tendency to demand more resources than are available. A resource that is not scarce is called a free resource or good. However, economics is mainly concerned with scarce resources and goods. Scarcity is what motivates the study of how society allocates resources.

Shortage versus Scarcity Shortage and scarcity are not the same. Scarcity always exists because it relates to an unlimited or unsatisfied want, whereas shortages are always temporary. Shortages often exist after natural disasters destroy goods and property. Temporary shortages of products such as gasoline may be cause when imports are dramatically decreased for any reason.

Types of Resources Resources are the inputs that society uses to produce outputs. Traditionally, economists have classified resources as natural resources (land), human resources (labor), manufactured resources (capital), and entrepreneurship (management).

Natural Resources (Land) Land and the mineral deposits in it constitute a huge natural resource in the agricultural industry.

Human Resources (Labor) The services provided by laborers and managers for the production of goods and services are human resources and are also considered scarce.

Manufactured Resources (Capital) All the property people use to make other goods and services is capital. These resources take the form of machines, equipment, and structures.

Entrepreneurship (Management) • Entrepreneurship refers to the ability of individuals to start new businesses and to introduce new products and techniques. • Today the four resources just discussed are called the factors of production. They are used to produce goods and services. Goods are the items people buy. Services are the activities done for others for a fee.

Wants and Needs • Needs include things that are really crucial to daily living. Basic needs include enough food, clothing, and shelter to survive. Most of us would also consider a good education and adequate health are to be needs. Of course, there are other needs depending on your situation.

Wants are things that are not crucial to daily living. A basic tractor is a need to a farmer, but a tractor with a cab, air conditioner, and radio may be a want. The difference between needs and wants is not always clear. The tractor with an air conditioned may be a need if the operator has severe allergies.

Economists use the term insatiable (unlimited, unsatisfied) wants. This means that human wants cannot be satisfied no matter how much or how many goods we have. This human trait, in conjunction with scarcity of resources, creates economic problems. The efforts to solve these problems are the basis of the discipline of economics.

Three basic economic questions Because of the relationship between scarce resources and unlimited/unsatisfied wants, all societies have to answer some basic economic questions. These questions entail trying to decide what to sell, how to sell it, and who should receive the benefits. Therefore, all economic systems must solve the following three questions: • What goods should be produced, and how much of each? • How should these goods be produced? • Who should get what and how much?

What goods, and how much to produce. • This question is answered every time people buy goods. • How to produce goods. • This question is answered by agribusiness producers or manufacturers according to what will yield the greatest profits. • Who should get what? • This question refers to who will receive the benefits of the goods. The question is answered by determining who has the greatest needs, wants, and ability to pay

To simplify the economic questions, assume that all the goods and services in our society or represented by a pie. • What type of pie to produce? • What combination of ingredients to use? • How to divide the pie?

Each society answers the three basic questions (what, how, and for whom) according to its view of how best to satisfy the needs and wants of its people. The values and goals that a society sets for itself determine the kind of economic system it will have.

Economists have identified six types of economic systems: traditional, capitalism, fascism, socialism, command (communism), and mixed. These terms are often used to designate political systems as well as economic systems. The major distinction between these classifications is the degree of control by private individuals versus the group represented by government.

Traditional System A pure traditional economic system answers the three basic questions according to tradition. In a traditional system, things are done “the way they have always been done.” Economic decisions are based on customs, religious beliefs, and ways of doing things that have been passed from generation to generation. Today, traditional economic systems exist in very limited parts of Asia, Africa, the Middle East, and Latin America.

Capitalism In capitalism, individuals have free reign over their time and resources, and can determine exactly how to use those assets, with few legal controls by the government. It is a self-regulating system that excludes the government from economic decisions. What capitalism depends on is the will and desires of those involved in the system. Market forces determine prices, assign resources, and distribute income. Market prices indicate the value of resources and economic goods.

Socialism In sharp contrast to capitalism, the basis of socialism as an economic system is public ownership of all productive resources. Instead of little to no involvement in the system (as with capitalism), the government or “state” directs all decisions regarding the utilization of resources (both human and nonhuman) by the various sectors of the community. Decisions are therefore made on a centralized basis by government planners.

Fascism Fascism is an economic system in which productive property, though owned by individuals, is used to produce goods that reflect government or state preferences. Fascism suppresses opposition, censors criticism, and denies some freedoms to individuals. Although property is privately owned and businesses control production, the government controls labor, employers, and consumers.

Communism Communism is a totalitarian system of government in which a single, authoritarian political party or body controls government-owned means of production. In other words, the government has total control of economic matters and private individuals have none.

Economics – A historical perspective • The Father of Economics • England was the major center of intellectual activity during the 18th century and much current economic policy based on economic ideas presented during that period. Economic historians contend that all the ideas presented by Adam Smith had been introduced by other economists.

Adam Smith, like most economists of that time, was looking for new directions in economic policy to deal with the severe economic conditions he saw around him. He proposed a system completely opposite to the system operating in England and many other countries at that time. Several names have been coined for the system he proposed. The major ones include pure capitalism, free enterprise, and laissez-faire. All of these terms are used interchangeably, and they mean basically the same thing. The basic meaning is that individuals can control the economy without any government interference.

“What is the role of government versus the role of individuals?” Adam Smith said, “The government should provide a police force for internal and external protection and nothing else. Economic matters should be the sole responsibility of private individuals.” He said, “Let each individual seek his or her own personal gain,” and that society would be guided by an “invisible hand” in such a way that as a whole it would be better off than it would with government intervention. In other words, let each individual operate independently rather than having some government agency decide what should and should not be done.

Characteristics of the American Economy A common term for the U.S. economic system is the free enterprise system. It is the freedom of private businesses to organize and operate for profit in a competitive environment. Government interference is necessary only for regulation to protect the public interest and to keep the national economy in balance.

The American economy has six major characteristics: • Little or no government control • Freedom of enterprise • Freedom of choice • The right to own private property • Profit incentive • Competition

The six characteristics could be referred to as free enterprise with some regulations. Notice the influence of Adam Smith in these six characteristics, which are discussed in the following subsections.

Freedom of Enterprise Our economic system is also called the free enterprise system. This term emphasizes that individuals are free to own and make decisions about the factors of production.

Freedom of Choice Part of freedom of choice is the freedom to fail. Freedom of choice means that buyers make the decisions about what should be produced. The success or failure of a good or service in the marketplace depends on individuals freely choosing what they want.

Private property Private property is simply what is owned by individuals or groups rather than by the federal, state, or local government. You are free to buy whatever you can afford, whether it is land, an agribusiness, a home, or a car.

Profit Incentive • The desire to make a profit is called the profit incentive.

Macroeconomics versus Microeconomics The total body of economic knowledge today is too extensive for a person to be a general economist. The most common division of economics is into macroeconomics and microeconomics.

Macroeconomics The prefix macro means “large,” indicating that macroeconomics is the study of the economy on a large scale or nationally. Macroeconomics looks at the aggregate (total) performances of all the markets in the national economy and is concerned with the choices made by large subsectors of the economy.

Cont.’d • Gross domestic product – the GDP of a country is defined as the market value of all final goods and services produced within that country in a given period of time. • Aggregate supply – aggregate supply is the total supply of goods and services produced by a national economy during a specific time period. • Aggregate demand – aggregate demand is the total demand for goods and services in a national economy during a specific time period.

Unemployment rate – the unemployment rate is the number of unemployed workers divided by the total civilian labor force, which includes all those willing and able to work for pay – both unemployed and employed. • Inflation and deflation – inflation is a rise in the general level of prices, as measured against some baseline of purchasing power. Deflation is a decrease in the general price level, over a period of time.

Monetary policy – monetary policy is the government process of managing the money supply to achieve specific goals, such as constraining inflation, maintaining an exchange rate, and achieving full employment or economic growth. • Fiscal policy – fiscal policy determines changes in taxes, government spending on goods and services, and transfer payments that are intended to affect overall (aggregate) demand in the economy.

Microeconomics The prefix micro means “small,” indicating that microeconomics studies the economy on a small scale. Microeconomics considers the individual markets that make up the economy and is concerned with the decisions made by small economic units such as individuals, single firms, and individual government agencies such as the USDA and state governments.

Cont.’d • Market and prices – markets are institutions that enable buyers and sellers to exchange goods and services. The amount of money people pay in exchange for a good or service is the price of that good or service. • Supply and demand – supply is the different quantities of a resource, good, or service that will be offered to consumers at various prices during a certain amount of time. Demand is economic want backed up by purchasing power, expressing different amounts of product buyers are willing and able to buy at possible prices.

Competition and market structure – competition is determined by the number of buyers and sellers in a particular market. • Income distribution – there are two classifications of income distribution. The first is functional distribution, where the division of an economy’s total income goes into wages and salaries, rent, interest and profit. Income distribution also can be classified by personal distribution of income, which groups different populations by the number of people receiving various amounts of income.

Positive versus Normative Economics The media often contain statements about economic issues. These statements can be classified into “what is” and “what should be.” These two main categories are called positive and normative economics, respectively.

Positive Economics • Positive economics consists of objective statements dealing with matters of fact and questions about how things actually are. Positive statements do not contain obvious value judgments or emotional content. • Positive economics can be described as “what is, what was, and what probably will be” economics: emotion or social philosophy. Often these statements express a hypothesis that can be analyzed and evaluated. (continue to next slide)

…such as the following examples: • Higher interest rates will cause a rise in the exchange rate and an increase in the demand for imports. • Lower taxes may stimulate and increase in the active labor supply. • A nationwide minimum wage will probably cause a contraction in the demand for low-skilled labor.

Cost-benefit analysis “That person is hungry.” What is the cost of feeding that person? What benefit accrues to you or society if that person is not fed? What is the cost of not feeding that person? What is the benefit of not feeding that person? Positive economics tries to answer such questions objectively, by doing what is called cost-benefit analysis.

Agriculture Economics and the American Economy