4.1.1 Microeconomics - Economic Methodology and the Economic Problem

ceteris paribus

all other things held constant

What is a social science ?

studies human behaviour as individuals + parts of organisations and their use of scarce resources

What are similar methodologies between natural sciences and other sciences?

• develop theories + create models

• test theories + models against known facts

• use empirical data + use economics models

What are different methodologies between natural sciences and other sciences?

no controlled lab experiments where only one variable changed at a time

eg. trying to examine whether price of cheese changes demand for it won’t factor in a change in consumer income

Positive statement

A statement including facts, which can easily be proved / disproved

e.g. Raising tax will lead to increase in tax revenue

normative statements

A value-based judgement, based on an opinion, that can not be easily proved / disproved

e.g. The free market is the best way to allocate resources

What are 4 ways economic decisions could be made?

Normative statements - opinions

Moral views and value judgements - eg. people shouldn’t be poor so share wealth

Political judgements - eg. lowering taxes wins government votes

Short term positive consequence - ⬇tax ➔ win election ➔ ⬇government income ➔ public spending cuts

The fundamental economic problem

How to allocate scarce resources given unlimited wants, forcing choices to be made

- e.g. Water scarcity, food scarcity

Central purpose of economic activity

Production of goods and services to satisfy the needs and wants of society

What are the key economic decisions?

• What to produce?

• How to produce it?

• Who is to benefit from the goods and services produced.

Why is choice central to the basic economic problem

all economic decisions incur an opportunity cost

Utility

the satisfaction or benefit that you obtain from consuming a good or service

Opportunity cost

The cost of giving up the next best alternative

Law of opportunity cost

As more of a good is produced, more of another good has to be sacrificed in production

Absolute advantage

Fewer resources are used in production

Comparative Advantage

When one can perform an activity at a lower opportunity cost than anyone else

Law of comparative advantage

Trade can benefit countries if they specialise in goods in which they have a comparative advantage + lower opportunity cost

Marginal cost

The cost of doing / buying one extra thing

The factors of production

Land, labor, capital and enterprise

Land

The natural resources, agriculture, water, fuel, energy

Labour

All human resources which contribute to output to produce goods

Enterprise

Creativity and initiative needed to start a business

Capital

Types of property such as machinery and tools that are used to produce goods

Why is the environment a scarce resource?

aren’t enough natural resources to satisfy everyone demands

How does land affect businesses?

The quality of the land can impact the cost and feasibility of using the land

Reward : Rent

How does labour affect businesses?

The quality and skills of the work force can influence productivity, efficiency and output of the product

Reward: Wages

How does capital affect businesses?

Better capital can improve production capability and technological advancement

Reward: interest from investment

How does enterprise affect businesses?

Enterprise can lead to business growth, as it can lead to better profits, as the entrepreneur is willing to take risk

Reward: Profit

Scarcity

A lack of resources

What does scarcity require?

Choices on the careful allocation of scarce resources

renewable resource

A resource that is produced at a faster rate that it is consumed

non-renewable

a finite resource, produced at a slower rate than when it is used up, so it runs out

Commodity

Something tradeable - gold, silver

Sustainable development

Meets the needs of the present, without damaging the future

PPF

A graph to show the various combinations of 2 goods/services that can be produced with given factors of production

A & B - productively efficent

C & D - productively inefficient

E - not attainable

How do PPFs show opportunity cost

A move to increase consumer goods has an opportunity cost of the drop in capital goods

Concave PPF

(Bows outwards)

increasing opportunity cost, as workers may be differently skilled

Some resources are more specialised that others

Would a fall in unemployment shift a PPF

No, we would move closer to the line, as we are not produce at productive capacity

Convex PPF

decreasing opportunity cost, as making first product is hard, but gets easier

Straight line PPF

Constant opportunity cost

All points on the PPF curve are

Productively efficient but not necessarily allocatively efficient

Production

the output of goods and services

Productivity

the output per unit of input

Economic welfare

A measure of progress in improving people's lives

Economic growth

An increase in the real value of goods and services produced, measured by the change in GDP

Economic good

Something that is scarce, as their use has an opportunity cost

They are created from scarce resources, so command a price

Intermediate goods

Goods used in the production of other goods

Free good

Something that is not scarce and everyone should have access to

Have no opportunity cost

e.g. Air

Zero-priced good

Socially needed, hard to value, set by government

e.g. Healthcare, Parks

Capital good

machinery used - indirect satisfaction

Consumer good

What the consumer buys - direct satisfaction

three types of efficiency

Productive, Allocative, Pareto

3 economic agents

1. Consumer

2. Producer

3. Government

Public sector

government

Private sector

part of the economy involving private ownership of businesses

Buffer stock scheme

A scheme intended to stabilise the price of a commodity by purchasing excess in supply when supply is high, and selling commodity reserves when supply is lowP

Productively efficient

When maximum output is produced from the available Factor of productions

Any point on the PPF curve is productively efficient, as the economy is producing at full current capacity

Pareto Efficiency

Nothing can be made better off without making something else worse off

Allocative efficiency

When factors of production are used to produce the combination of goods and services that maximise society's welfare (meets needs)

What are PPF used to illustrate?

different features of the fundamental economic problem, such as: resource allocation, opportunity cost and trade-offs, unemployment of economic resources, economic growth.

What is a trade off?

Have to choose between conflicting objectives because you can’t achieve all objectives at same time.

Involves compromising & aiming to achieve each objective a bit

Why are all points on the boundary productively efficient but not all points on the boundary allocatively efficient?

Not all points will reflect the production of goods that people want or need

Whats a movement along the PPF

reallocation of resources

How can you shift a PPF?

increase the quality and quantity of the factors of production

What does an increase in the production of capital goods on a PPF indicate?

lower living standards

What does an outward shift of the PPF show?

Economic growth

Outward shift of PPF caused by:

-Technological improvement = higher productivity / efficiency

- Changes that increase working population (Immigration, raise in retirement age)

- Improvement in education / training

- Innovation of new product / discovery of new resources

Inward shift of PPF caused by:

- Damaging effect of natural disaster

- Large scale labour migration

- Loss of factor inputs

- Wars

- Prolonged recession

- Global warming / climate change

Economic decision-makers are primarily concerned with

maximising their welfare

Economic resources

Those which can contribute to increased production