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This lesson will present an overview of the central features of the American economy.

We will discuss the circular flow of goods and services, factors of production and the individual economic choices that are made by people every day.

You will also be asked to apply your outstanding social science skills to the following real life economic problem: the cutting of the old-growth forests.

Let us continue our economic journey.

A new ECONOMIC APPLICATION TOOL, the Circular Flow of Goods And Services, combines many of terms and concepts that you have learned over the previous lessons.

Thus far we have studied the American Economic system including a determination as to how our economy answers the three basic economic questions.

In this lesson we will begin an examination of the concept the circular flow of goods and services.

This lesson provides the opportunity to apply some of the economic concepts that you learned in the previous lessons. We will also cover some important information on economic theory.

CIRCULAR FLOW OF THE ECONOMY

This simplified circular flow model of pure capitalism shows how a free enterprise economic system answers the questions of what to produce and how to produce.

People from households go to the market as consumers to buy, and they go to the market as suppliers of the factors of production to sell.

Businesses must also go to the market to sell their production, but they must first go to the market as buyers to get the factors of production necessary to produce the goods.

The inner arrows show the flow of money payments. The outer arrows show the flow of economic resources; that is, production and factors of production.

The flow of money thus determines the allocation of scarce resources. We will discuss the circular flow of goods and services in other lessons including the information on microeconomics.

As the mid-1970s approached, public confidence in economists probably reached a new low because they had failed to forecast the seriousness of a double-digit inflation.

Many of the economic terms, theories, and laws were difficult to understand for the general public.

Economists often do not agree with each other, which causes confusion among the general public.

TIME OUT FOR A REVIEW!

The apparent disagreements among economists tend to obscure the fact that they basically agree on thousands of facts, concepts, and principles.

Just as physicians may disagree on the treatment to give a patient, economists will disagree on the means for controlling a problem. Nevertheless, usually everyone will agree that the problem exists and should be solved.

Some economists have foolishly made predictions that have been very specific.

Many government officials, business leaders and consumers rely upon the economic forecast, expecting them to be exact.

Instead, these forecasts should be viewed as approximations, and users of the forecasts should be aware of the assumptions upon which they are based.

Economists cannot forecast weather conditions, such as a hard freeze in Florida that devastates the citrus crop or a hurricane that destroys the sugar cane crop.

In addition, economic forecasts can also be affected by political events in foreign countries, such as the Iraqi invasion of Kuwait that led to the Gulf War.

If economists cannot make accurate predictions about the future, what good are they?

To answer this question let us first identify three types of economics; "pure" economics, economic ethics and applied economics.

Pure economics addresses the question, "What exists?"

Economic ethics asks, "What ought to be?"

Applied economics deals with the question, "How can we, by applying the principles and tools of pure economics, achieve the goals that economic ethics have established?"

In other words, in the use of our economic resources, where are we now as a nation, where should we be, and how do we get there?

These economic questions that face our society will be answered in the manner in which we use the resources of the United States and how we spend our money.

Remember, this is the same thing nations and people have been doing for centuries.

Many economists, although differing in their ideological viewpoints, usually find themselves to be allies in discussions with other social scientists.

One does not have to spend much time around economists to recognize that there is an economic way of thinking.

That common ground is economic theory, developed from observing human behavior.

Economic theory has a reputation for being abstract and difficult, but this need not be the case.

Economic theory, like a road map or a guidebook, establishes reference points indicating what to look for, and how economic issues are interrelated.

As a road map, economic theory helps us understand the relationship among complex and often seemingly unrelated events in the real world.

A better understanding of these cause-and-effect relationships will enhance our ability to accurately predict the likely consequences of alternative policy choices.

Economics has often been called the "science of common sense."

After all, common sense is nothing more than a set of beliefs based on sound theories that have been tested over a long period of time and found to be accurate.

You must develop the economic way of thinking, focusing your thought processes on a few simple economic concepts or guideposts.

There are guideposts that characterize economic thinking that are essential to the understanding of the economic approach.

You already know how to do this.

The economic way of thinking should not be new to you. Over the first nine lessons we have identified many ECONOMIC APPLICATION TOOLS that have enabled you to become an expert economic thinker.

In addition, your outstanding Social Science skills provide you with the expertise to gain an understanding of all of the economic, social and political consequences of answering the three basic economic questions.

You will now have the opportunity to apply all of your economic knowledge and address a question that was raised in an earlier lesson.

Let us reconsider the economic impact of the cutting down of old-growth forests.

What is your view of this proposal as an anthropologist, sociologist, political scientist and geographer?

What will be the secondary effects of cutting down the trees in these forests that are over 200 years old?

What will we lose as a country - as a people?

Consider the fact that almost all of the old growth forests in the United States have either been cut down or are now a part of the National Park System and are not available to private companies.

The cutting of the old-growth forests may lead to water pollution because the run-off from the spring rains will go into the streams and rivers.

This runoff will eventually affect the water supply of major cities downstream.

Cities will now have to use money that would have been devoted to repairing roads, improving schools, or other project for the people to the expansion of the water treatment plant.

The decision not to cut the old-growth forests will also have a devastating economic impact on the logging industry.

Thousands of logging jobs will be lost, affecting families that must now seek assistance from the government.

Entire towns will be literally wiped out overnight. People who are not working do not have extra money to spend. Many businesses that need the employees of the logging company to survive may close.

Property tax receipts will also go down, meaning the government will have to cut back on services to the people.

Once again, there are many sides of the economic problem to consider. It will be very difficult to get everyone to agree on a solution to this or any economic problem.

Do you recall the testimony before the Senate Finance Committee on technology in a previous lesson? Apply the logic from this lesson to the previous statement.

This is not just an economic question. It also involves...

...Anthropology - the old-growth forests are a link to our past.

...Sociology - how it will impact the people?

...Political Science - how will government officials have to reallocate their resources?

...Geography - what will be the effect on the land?

...Economics - how will this affect the economy and the use of scarce resources?

This is a problem of opportunity cost. The choice to do one thing will cause secondary effects.

How does the concept of opportunity cost affect your personal economic decisions?

What is the highest valued benefit that must be sacrificed as a result of choosing an alternative?

An unpleasant fact of economics is that the choice to do one thing is at the same time a choice not to do something else.

Your choice to spend time watching your favorite television show is a choice not to play basketball with your friends, go to a movie, or study for a semester exam.

Remember, the cost of a decision exists in the mind of the decision-maker. Is real-life decision-making influenced by opportunity cost?

Real Life Economics 101

Let us go back to your decision to watch television to help us understand the concept of opportunity cost.

What is the difference in the cost of not being able to play basketball with your friends, go to a movie, or study for a semester exam?

What is the opportunity cost of your time that you would devote to each of these activities, and what do you stand to lose if you were unable to participate in these activities?

Which one of these activities will cost you the most in the long run?

By not studying for the exam, you might risk getting a lower grade.

Remember, in the economic way of thinking, you must consider the secondary effects of this lower grade.

If you get a low grade, you might flunk the class, lowering your grade point average enough to take you out of consideration for the scholarship you needed and now you will have to attend summer school to complete the required credits to get into college.

Now you won't be able to work this summer to earn the money for your car, etc.

By now you have the idea. Choosing one thing means giving up others things or opportunities that might have been chosen.

Opportunity cost is the highest valued option sacrificed as the result of choosing an alternative.

Law of Comparative Advantage: This principle states that individuals, firms, regions or nations can gain by specializing in the production of goods that they can produce cheaply at the lowest opportunity cost. These goods may be exchanged for other desired goods for which they are high opportunity cost producers.

What do you do best? You are playing basketball with your friends. Who do you want to take the three pointer to win the game?

Do you choose the best player or your best friend who can't hit the side of a barn?

The law of comparative advantage was initially developed in the early 1800s by the great English economist David Ricardo.

(Do you remember him from lesson 8?)

The law of comparative advantage states that the total output of a group of individuals, and entire economy, or a group of nations will be greatest when the output of each good is produced by the person (or business) with the lowest opportunity cost.

Take the Wheel!

You and four other students in your U. S. History class have been given an assignment to do a report on the Battle of Midway. Midway was a World War II naval battle that was fought 6 months after Pearl Harbor in June of 1942.

The assignment involves the following tasks:

(a) research,

(b) typing,

(c) an oral presentation,

(d) writing

(e) creating a visual display using computer graphics.

Please complete the steps listed on the next page.

(1) Randomly choose four students from the class you in are in right now, or choose four of your classmates.

(2) Write down your name and the names of these four students on a piece of notebook paper.

(3) Determine the specialization of each person in the group. (What can each person do better than anyone else?)

4. Beside each of the names, write down the task that you feel each of the persons in your group would be best qualified to complete in your World War II assignment. (Please refer to the previous page.)

Point to Ponder!

Why did you choose the person to do the computer graphics? Try to think of at least three reasons why you chose the computer person.

Congratulations!

You have just obeyed the law of comparative advantage by determining the proper division of labor and the areas of specialization for your group.

The law of comparative advantage leads to interdependence.

If the United States specializes in the production of farm products and the Middle East countries specialize in the production of oil, the countries become interdependent (meaning they depend on each other) for the products they need. In other words they depend on each other for the goods the other country produces.

If Florida specializes in the production of oranges and Oregon specializes in the production of lumber, they are interdependent on each other.

Problems develop when a political event or a natural disaster disrupts the interdependence (freeze in Florida, forest fire in Oregon).

Consider your interdependence on the other students in your group on the World War II project.

What if the person doing the computer graphics that were needed for the oral report watched a television show (remember opportunity cost) instead of completing the assignment?

What are the secondary effects of this decision to watch the television show?

The grade of the group drops significantly, because the computer graphics (20% of the grade) were not there to use during the oral report (another 20% of the grade).

What have your learned from this group project?

Interdependence can be painful!

This concludes our discussion of this lesson.

We are ready to move on to the review and presentation of economic research skills and topics in lesson 11.