econ theme 1

what is economics

• social science

• production/consumption/distribution of goods + services

• allocation of scarce resources to provide for unlimited human wants

what are economic agents

groups of people involved in a transaction

what are the three economic agents

consumer

producer

government

what does ceteris paribus mean

all other things remaining equal

• all variables held constant

why is economics considered a social science

• unable to carry out scientific experiments

• uses scientific methods of data collection and observing human behaviours

• makes models using assumptions to explain economic interactions

how are economic models built

• identify variables to study

• make assumptions

• simplify complex human behaviours

what is the purpose of economic models

• explain tendencies

• simplify observations

why is ceteris paribus needed for economic models

• helps simplify observations

• people are complex and always changing

• impossible to consider all variables

what is positive economics

• objective statements on how a market/economy works

• can be proven/tested with real data

what is normative economics

• value judgement on hypothetical economic solutions/policies

• cannot be proven

• shoulds/worlds

what is value judgement

evaluative statement on how good/bad you think idea is

how does value judgement influence economic decisions

individuals/businesses/governments use value judgement

what is the basic economic problem

limited resources but unlimited human wants

why does the economic problem exist

• there is scarcity

• economic agents are forced to make choice because of this

what is scarcity in economics

limited resources

how does scarcity affect prices in a free market

scarcer resources have higher prices due to higher demand

how does scarcity affect economic decision-making

choices have to be made about best use of limited resources

what is opportunity cost

value of next best alternative that is foregone when making decision

what are renewable resources in economics

• can be replenished

• no opportunity cost

what are non-renewable resources in economics

• available in limited quantities and cannot be replenished in a human lifespan

• diminish with use

• have opportunity cost

what are factors of production

• resources used in production of goods/services

• measured in quantity/quality

what are the four factors or production

• capital

• land

• labour

• enterprise

what is capital

manmade/physical assets used to produce goods/services

what is land

natural resources used to produce goods/services

what is labour

workers needed to produce goods/services

what is enterprise

risk takers who combine other FOP to produce goods/services

what is production possibility frontier

• economic model showing maximum production of two goods/services

• shows idea of opportunity cost

what does PPF curve represent

full/efficient use of FOP

how is opportunity cost shown on PPF

downwards sloping curve

amount of one good that is foregone to produce more of other good

what causes outward shift of PPF

economic growth and increase in quantity/quality of FOP

what does point inside PPF curve represent

insufficient production and use of resources/FOP

what does point outside PPF curve represent

unattainable production given level of FOP

what are consumer goods

tangible products sold to consumer to satisfy current needs/wants

what does an inward/left shift of ppf show

• decrease in quantity or quality of FOP

• economic decline

possible reasons for left shift

• war

• natural disaster

• aging population/retirement rate increases

• emigration (Human Capital flight)

• resource depletion

• deforestation

what does an outward/right shift of ppf show

• increase in quantity or quality of FOP

• economic growth

possible reasons for outward/right shift of ppf

• increase in education

• increase in training/development

• increase in trade

• immigration

• tax breaks

• increased birth rate

• grants/subsidies

• increase in minimum wage

what does a linear PPF graph show

constant opportunity cost

what does a ppf shift in one good show

investment in FOP favouring one good over the other

what is specialisation

when a individual/firm/country focuses on producing goods/services in which they are advantageous in

what is division of labour

dividing up tasks into smaller units of work so specialisation can take place

what are the benefits of the specialisation and division of labour

• increased productivity

• increased quality of produce + labour

• less time spent on moving between tasks

• becoming expert

• higher output

• low labour costs per unit

• reduction in average costs → firm is price competitive

• increased profits

what are the drawback of the specialisation and division of labour

• boredom from repetitive tasks → decrease in productivity

• loss of skills once specialised

• if one stage of production breaks, production may stop

• lack of variety in goods

what are the macro benefits of the specialisation and division of labour

• high economic growth

• more choice as country can trade

• low price due to economies of scale

what are the macro drawbacks of the specialisation and division of labour

• economic growth is not sustainable as it’s dependent on external factors

• domestic producers may not be able to compete against imported goods/services

• price fluctuations

what is economies of scale

the more you produce the cost per unit is cheaper so is sold at lower cost

what is the impact of specialisation on FOP

• increase in quantity and quality of labour

• output increases

define production

number of outputs

define productivity

number of outputs per given time

what is the objective of firms

profit maximise

what is the objective of consumers

maximise utilities (satisfaction)

what is the objective of govt

maximise social welfare

what are the three main economic questions

• what to produce?

• who to produce for?

• how to produce?

what is a free market system

• market forces determine allocation of scarce resources

• controlled by invisible hand

• run on price mechanism (resources allocated based on price + supply/demand)

what are the features of free market

• motive for production is profit

• freedom of choice for producers and consumers

• no government intervention

• right to private ownership

how does competition affect free market

• better quality of goods/services

• lower prices

• encourages innovation

• more choice

what are the advantages of free market

• consumer sovereignty

• efficiency → profit motive encourages producers to reduce cost and increase profit

• no bureaucracy nor planners needed to allocate resources

• greater economic growth from increased outputs

what is consumer sovereignty

consumers in market economies determine what is to be produced via their purchasing decisions

what are the disadvantages of free market

• unequal distribution of income/wealth

• booms and slumps - macroeconomic instability

• external costs → market failure

• lower provision of public and merit goods

• producer sovereignty → monopolies

• consumer exploitation

what is a command economy system

• govt determines how all resources are allocated according to common good

• no price mechanism

• no markets

what are features of command economy system

• FOP belong to govt

• central plan on how to allocate resources established by govt

• no enterprise unless permitted by govt

• complete govt intervention

what are advantages of a command economy system

• equality

• macroeconomic stability

• fewer externalities

• full employment

what are disadvantages of a command economy system

• inefficiency as no profit motive and equal wages

• lack of incentives and creativity

• less choice

• shortages and surpluses

what is mixed economy

• combines features of planned and free market economies

• govt supply public and merit goods

what are features of mixed economy

• more even distribution of income

• ownership/production and resource allocation by state and individuals

• businesses compete with each other for FOP

• freedom of choice

• prices regulated by state in public sector

• prices regulated by market forces in private sector

• motive of production (public sector maximises social welfare while private maximises profit)

how does govt intervene in mixed economy

• taxes

• govt spending

• regulation to redistribute income

• discourage production of less desirable goods/services

what are advantages of mixed economy

• freedom of choice

• more competition

• more creativity

• more economic growth

• less social + external costs

• provision of public and merit goods

what are the disadvantages of mixed economy

• some inequality

• govt failure

• difficult to control power of govt

same drawbacks as the other two

what are the functions of money

• medium of exchange

• unit of account

• store of value

• standard of deferred payment

what is medium of exchange

• facilitates business transactions

• allows economic agents to exchange for goods/services

• addresses double coincidence of wants in barter system

what is barter system

exchange of goods/services for other goods/services without using money

what is unit of account

money allows economic agents to compare prices and keep account

what is store of value

allows economic agents to save for future use

what is standard of deferred payment

allows economic agents to buy now and pay later

• eg. credit cards

what is one precaution with function of money

inflation erodes value of money

what is the classic economic theory

economic agents make rational decision

what is the assumption of rational decision making

economic agents select the choice with the highest benefit

what does utility mean

amount of satisfaction gained from consuming good/service

what is total utility

total satisfaction consumer gets from consumption of units of good within period of time

what is marginal utility

additional utility gained from each additional unit of consumption

what is diminishing marginal utility

as more units are consumed the additional units will provide less additional satisfaction

how are producers able to profit maximise

• produce goods/services desired by consumers

• produce at lowest cost while gaining as much revenue as possible

what is the formula for profit

total revenue - total costs

what is revenue

• money received from sales (income)

• price x quantity

how do workers act rationally

maximise welfare at work

how do workers maximise welfare

consider pay, working conditions, benefits, commute, cost of finding alternative employment

what is the issue with pay for workers

conflict of objectives

what is the issue with benefits for workers

raises cost of business

how do govt act rationally

maximise welfare

what is the effect of irrationality on markets

• distorts market

• produces different outcomes to economic agents acting rationally

list the steps of the rational decision cycle

• define objective

• identify criteria

• weight criteria

• develop alternatives

• score each option against criteria

• select best alternative

how do humans short cut this cycle

deciding on convenience (heuristics)

what does satisficing mean

humans satisfy need to work conveniently but in turn sacrifice utility

what is demand

amount consumers are willing and able to buy at given price

what is effective demand

when consumer is both willing and able to purchase good and service

what is the law of demand

inverse relationship between price and quantity

what is the income effect

• price of goods rises while real income falls leading to purchasing power falling

• people feel poorer and buy less

what is the substitution effect

price of good is more expensive relative to another good so consumer switches to cheaper good

what is the effect of price on demand curve

only a movement along curve

list the conditions of demand (PASIFIC)

Population

Advertising

Substitutes

Income

Fashion/trends

Interest rates

Complementary goods