Economic system and how it works.

Absolute and comparative advantage

• Absolute advantage is the ability to produce a good or service using fewer resources than another producer.
• Comparative advantage is the ability to produce a good or service at a lower opportunity cost than another producer.

The benefits of international trade come from specialization and the exploitation of comparative advantage. When countries specialize in producing the goods and services that they have a comparative advantage in, they can produce more of those goods and services and enjoy a higher standard of living.

The costs of international trade come from the loss of jobs in industries that are no longer competitive. However, the benefits of trade typically outweigh the costs, and international trade is generally considered to be a good thing for the economy.

Invisible hand

The invisible hand is a metaphor for the unintended consequences of individual self-interested actions. Adam Smith, the Scottish economist, first used the term in his book The Wealth of Nations to describe how the free market can lead to economic prosperity even though individuals are not acting with the intention of promoting the common good.

The invisible hand works because when individuals act in their own self-interest, they are also helping to promote the interests of others. For example, when a farmer produces food, he is not doing it to help other people; he is doing it to make a profit. However, by producing food, he is also helping to feed other people.

The invisible hand is not a perfect system, and there are times when it can lead to problems. However, it is generally considered to be a good thing for the economy, and it is one of the reasons why free markets are so successful.

Circular flow diagram

The circular flow diagram is a model of the economy that shows how money and goods flow between households, businesses, and the government. The diagram is divided into two loops: the product market loop and the factor market loop.

The product market loop shows how households buy goods and services from businesses. The factor market loop shows how businesses buy factors of production (land, labor, capital, and entrepreneurship) from households.

The government sector is also included in the circular flow diagram. The government collects taxes from households and businesses, and it uses those taxes to provide goods and services, such as education, healthcare, and national defense.

Production possibilities model

The production possibilities model is a model that shows the different combinations of goods and services that an economy can produce with its limited resources. The model is a curve that shows the maximum attainable output of two goods, given the economy’s resources and technology.

The production possibilities model illustrates the concept of opportunity cost. Opportunity cost is the cost of giving up one thing in order to get something else. In the production possibilities model, the opportunity cost of producing more of one good is giving up the production of some of the other good.

The production possibilities model is a useful tool for understanding the economic implications of choices. For example, if an economy decides to produce more of one good, it will have to give up the production of some of the other good. This is because the economy’s resources are limited, and it cannot produce more of everything.

Microeconomics and macroeconomics

Microeconomics is the study of individual economic units, such as households, firms, and markets. Macroeconomics is the study of the economy as a whole, such as the level of employment, the rate of inflation, and the growth rate of the economy.

Microeconomics and macroeconomics are two different but complementary branches of economics. Microeconomics provides the foundation for macroeconomics, and macroeconomics helps to understand the implications of microeconomic decisions for the economy as a whole.