Econ theme 1

what is economics?

The study of how groups of individuals make decisions about the allocation of scarce resources, it is a social science.

social science

The study of societies and human behaviour using a variety of methods including the scientific method.​

scientific method

A method of acquiring knowledge through proposing and testing ideas.​ The method involves generating abstract models to help explain how a complex, real world operates.​

steps of the scientific method

1\. Postulate a theory or model (put forward a hypothesis, capable of refutation).​ 2. Gather evidence to support or refute the theory.​ 3. Accept, modify or refute the theory.

the role of assumptions

Make the world easier to understand.​ Assumptions allow Economists to make models to answer different questions.

Ceteris paribus

Latin phrase meaning ‘all other things remaining equal’.​ An important assumption in economics because in the real world it is usually hard to isolate all the different variables.​

pros of using models

Forecast activities and help future analysis/ policy. ​ Gives a clear and mathematical representation of the data.​ helps broaden understanding.​ Simplifies otherwise complex data. ​ answers become accessible.​ Quickens the pace of analysis.​ Helps to isolate the effect of a variable.​ looks at causality (helps to consider which factors are relevant and irrelevant).

cons of using models

The bias of the creator of the model will then bias the results.​ Assumptions may not be valid in different settings.​ Models assume complete rationality however individuals have bounded rationality.​ Humans may not act in different ways despite the predictions of the model.​ Output quality is determined by input quality.​ Data and analysis may be overly simplified.​ Incorrect results.​

difficulties in conducting scientific experiments in economics

1) lack of sterile environment 2) ethical objections 3) No universal laws of human behaviour exist

positive economics statements defenition + role

A factual/objective statement which can be proved true or false (‘What is’) ​ Positive economics deals with objective explanation and the testing and rejection of theories, i.e. provable causal relationships​ Identifies relationships between economic variables, which can be verified by referring to data (you can be positive about a positive statement)​

normative economics statements defenition + role

Value judgements which cannot be proved true or false (‘What ought to be’)​ Often concerned with ethical issues such as ‘fairness’​ Indicated by words such as ‘should’, ‘ought to’, etc. Often used when considering policy options ​

Human needs

the minimum that is necessary for human survival- finite

Human wants

desires for non-essential consumption. INFINITE

the basic economic problem

SCARCITY (there aren’t enough resources to meet everyone’s wants)

3 fundamental choices that must be answered to solve the economic problem

WHAT is to be produced?​ HOW is production to be organised?​ FOR WHOM is production to take place?

opportunity cost

The benefit lost from the next best alternative forgone.​

opportunity cost assumption

Available choices can be ranked in terms of the benefits to be gained. One choice will be the “best” and the others are given up.​

economic good

A good which has an opportunity cost.​

free good

where there is no opportunity cost. This as there is zero degree of scarcity, but abundance. Free goods cannot be traded because nobody would ever pay for them– there is no point. (air, wind, sea).​ Nothing must be foregone to consume them.​

factors of production defenition

the resources used in the production of goods and services aka factor inputs, inputs, resouces

4 factors of production

land- raw materials used to make goods capital- man made resources used in the production of other g&s. financial capital refers to money that will be used by a firm to purchase resources later on. labour- human input into the production process (skilled,unskilled,educsted,uneducated) enterprise- providing the initial ideas and taking risks with their own money

renewable vs non-renewable

Non-Renewable: a natural resource which cannot be replenished (produced, grown or generated) E.g. include Coal, Oil, Gold, Gas and Copper​ Renewable: resources replaced by natural processes consequently they can be used and replaced. E.g. fish, forests, wind, solar power​

fixed capital vs working capital

Fixed Capital: Includes factories, offices, machinery. Fixed in the sense that it will not be transformed into a final product Working Capital: Includes raw materials, semi-manufactured and finished goods waiting to be sold.

factor incomes defenition

The income derived from selling the services of the factors of production​

the 4 factor incomes

Rents: Income from selling/leasing natural resources​ Interest: Income generated by the use of capital​ Wages: Income as a reward for labour​ Dividends: Income that goes to the entrepreneurs​

factor intensity

Capital intensive: Firms which use a higher proportion of capital than labour​ Labour intensive: Firms which use a higher proportion of labour than capital​ ​

PPF

curve showing the max. potential ouput level of one good for a given level of production of another,for the current state of technology

Role of PPF's in economics

Allow us to show all the combinations of goods that can be produced if an economy's factors of production are fully employed and used at their maximum efficiency

consumption goods

g&s used by people to satisfy their needs and wants

capital goods

g&s used in the production of other goods

why does the PPF have a negative slope?

when all resources are employed at their most efficient, increasing the production of 1 good requires resources to be freed from producing another good.

why does opportunity cost vary along the ppf

resources are not equally efficient at producing both types of goods/services. ie factor inputs are not perfectly substitutable

what does a straight line ppf indicate

perfect factor substitutability of resources between the 2 goods. OC is constant

potential econ growth

an increase in an economy's productive potential. production of both goods can now be increased without having to cut production of the other

causes of potential econ growth

increase in quality/quantity of FoP

actual econ growth

An increase in the actual (value of) output of the economy

causes of actual econ growth

utilising mor FoPs , or using them more productively

Negative actual econ growth

a decrease in the actual (value of) output of the economy

causes of negative actual econ growth

utilising fewer resources for production or using them less productively

Negative potential econ growth aka hysteresis

a reduction in an economy's productive potential. max production of both goods is decreased

causes of negative potential econ growth

decrease in quality/quantity of FoP

shift of the PPF in one good

horizontal/vertical stretching of the PPF; an outward shift on one axis in the production possibility frontier.

causes of the shift of ppf in one good

changes in technology/ increases in factor inputs that can only be used in one of two goods.

productive efficiency

when each unit of output uses the fewest number of resources possible for that unit. this occurs anywhere on the ppf curve

Pareto efficiency

where it is impossible to make one person better off without making another worse off. anywhere on the ppf curve

allocative efficiency

production of those goods and services that are most desired by society in the quantity that they desire. point on ppf depends on preferences of population

inefficient

combinations of output where there are unemployed resources or when resources are not used to their full potential. we could increase the total ouput of g&s by moving towards the PPF. producing more of both goods with the same resources represents an improvement in welfare and a gain in allocative efficiency.

unattainable

combinations that require increased resources/productivity to achieve. these exist outside the ppf

specialisatioin

When economic agents are not self-sufficient but concentrate their factors of production on a task to produce specific goods or services and trade the surplus with others. ​

division of labour

The specialisation of labour. Production is broken down into many separate tasks which are divided up among the workers

pin factory- adam smith

The pin making process can be split into 18 distinct steps, including the packaging the pins​ Adam Smith visited a pin factory employing 10 men who produced 48,000 pins per day​ If these workers did every step themselves, he reckoned they could each produce 10-20 pins per day. ​ The specialisation replaces up to 4,800 pin makers!​ Labour productivity (output per person per day) in the factory is almost 500 times that of individual pin makers!​ ​

DoL advantages

increased output per worker: Improved productivity through “Learning by doing”.​ Lower cost per unit Increases business profits.​ Lower prices for consumers: Increased international Trade: ​

DoL disadvantages

less productivity Absenteeism-workers less puncutal High worker turnover little training-workers may struggle to get new jobs over-reliance low choice- lack of variety for customers due to mass production of certain goofs

why does specialisation require trade

People can only specialise in the production of one good or service if they can exchange/trade their good or service to fulfil their needs and wants for the goods and services they do not produce.​ If people can’t trade their output they won’t have a very good quality of life – most will die!

bartering

Trading goods and services through swapping one good for another.​ But: This is costly as you must spend time searching for people willing to exchange with you

why has money developed?

To reduce the costs of exchange/trade from bartering, and thus by encouraging trade it has allowed greater specialisation.​

money

Any item which fulfils the following four functions:​ A Medium Of Exchange. ​ A Measure Of Value/Unit Of Account. ​ A Store Of Value. ​ A Method Of Deferred Payment. ​ ​

a medium of exchange

Money can be used to buy goods and services ​ Eliminates the requirement of a double coincidence of wants. ​ People accept payment in money because they know that they will be able to use that money to buy other goods and services.​

a measure of value/unit of account

Money allows the value of something to be expressed in an understandable way, and in a way that allows the value of items to be compared. ​

a store of value

his can refer to any asset whose “value” can be used now or used in the future. This means that people can save now to fund spending at a later date. ​ Assets that deteriorate would not make good money​

a method of deferred payment

Money is a unit of account across time, expressing the value of a debt.​

rational choice theory

a framework for understanding and formally modelling social and economic behaviour based on the assumption that economic agents act rationally

rational

in accordance with reason/logic

net benefit

the sum of all the benefits of an outcome minus all the costs. each economic agent maximises a different net benefit. consumers maximise benefit workers maximise welfare at work firm maximise profit (= revenue-costs) governments maximise welfare of their citizens

rational consumers

try to maximise their utility ( constrained by income). behaviour is rational if it is goal oriented, reflective and consistent ( across time and different choice situations)

Homo economicus

a hypothetical model of humans who are infinitely rational and immensly intelligent, an emotionless being who can do cost analysis instantly, and is never ever wrong.

utility

the satisfaction derived from the use of a good or service

unit of utility

the util- an 'ordinal' measure used to rank the net benefits of different outcomes

total utility

the total satisfaction an economic agent gains from all the units of a good consumed within a given time period

marginal utility

the additional satisfaction gained from consuming one extra unit within a given time period

diminishing marginal utility

as more units are consumed, additional units add less to satisfaction than previous units.

when does max TU occur?

where MU=0, any more consumption and TU will start to fall

relationship between MU and TU

MU gives the rate of change of TU. MU is the differential of TU equation: MU= dTU/dQ

behavioural economics

economic theory that tries to augment/replace traditional ideas of economic rationality from rational choice theory (homo economicus) with decision making models borrowed from psychology. it attempts to explain why people apparently make rational decisions

homo sapiens

most of us are not infinitely rational but face 'bounded rationality' with people adopting simple,intuitive rules of thumb ' (heuristics) instead of calculating optimal solutions for every decision they make. we are open to influences outside of those covered in standard utility theory

Failures of RCT

computational weaknesses habitual behaviour social/external influences

computational weaknesses

problems recognising and defining the true net benefit of a choice

Habitual behaviour

choices are made automatically based on routine rather than consideration of net benefts

social/ external influences

factors that influence a decision outside the power of an economic agent

Demand

The quantity of a given good or service consumers are willing and able to buy at a given price. Every person has an individual demand for particular goods and services and our demand at each price reflects the value that we place on a product, linked usually to the expected utility we get from consuming the product

Latent demand

Latent demand exists when there is willingness to buy among people for a good or service, but it does not take into account whether the consumer has the purchasing power to be able to afford the product.

Effective demand

Demand is different to desire! Effective demand is when a desire to buy a product is backed up by an ability to pay for it

Market Demand

The sum of all consumers’ individual effective demands

The law of demand

as the price of a good increases (↑), quantity demanded decreases (↓); conversely, as the price of a good decreases (↓), quantity demanded increases (↑)

The demand curve

a graph depicting the relationship between the price of a certain commodity (the y-axis) and the quantity of that commodity that is demanded at that price (the x-axis)

Demand as a function

Quantity demanded can be thought of as a function of price, as well as several other factors Qd=f(P,K1,K2,...)

Movements along the demand curve

Change in price

Shift of the demand curve

Changes to any other determining factor

Why do we buy less at higher prices & more at lower prices?

* the income effect
* Substitution effect
* Diminishing marginal utility

The income effect

At lower price, consumers can increase their consumption for the same expenditure, meaning that the real value of their income has risen. Provided that the good is ‘normal’ (in economics this simply means that we consume more of it as we get richer), some of the resulting rise in real income will used to buy more of the product.

The substitution effect

At a higher price, consumers will find cheaper products more attractive and may choose to buy these instead When the price of a product falls however, some consumers switch their spending from an alternative as the product is now relatively cheaper

Diminishing marginal Utility

marginal utility of a good or service consumed will decrease as we consume more therefore our willingness to pay falls too

Determinants of Demand

* price of good
* Consumer income
* Prices of other G&S
* Consumer tastes or fashion
* Other factors

The price of the good (p)

If the price of an ordinary G/S increases, demand for that product will decrease If the price of an ordinary G/S decreases, demand for that product will increase Exceptions: products that people consume more of as the price rises and vice versa, violating the basic law of demand – i.e. upward sloping demand curves!

Veblen goods

Veblen goods have a ‘snob effect’ where people consume more of certain products as their price increased. This is ‘conspicuous consumption’ AKA paying for clout



**E.g.** Fancy cars, Supreme

Giffen Goods

Giffen goods are goods that are goods that tend to be very basic necessities. When the price of these goods rise, it represents a large fall in the purchasing power of consumer’s income, so they cut back on more luxurious items and double down on the very basic necessities even though they are more expensive. 

Consumer income (y)

Most goods are ‘normal goods’, as the income of consumers increases demand for normal goods will increase



This is shown by a shift to the right of the demand curve when income rises



However, some goods are ‘inferior goods’, where demand decreases as incomes increase



This is shown by a shift to the left of the demand curve when income rises



Giffen goods are very strongly inferior (their price rise represents a fall in real income as they are such a large part of their consumers’ expenditure)

Prices of other G&S

These will have a major impact on the quantity demanded of a product



**Substitute products:** are those that act as an alternative for consumers



A substitute acts as an alternative, therefore creating competition. If the price of good A increases, the demand for good B will increase 



Good B’s demand curve shift’s to the right



**E.g.** Coca-Cola and Pepsi Cola



**Complementary products** are those that are often bought together



A complement is bought alongside a good or service. If the price of good A increases, the demand for good B will decrease



Good B’s demand curve shift’s to the left



**E.g**. fish and chips

Consumer tastes or fashion

People’s tastes change over time and demand for fashionable products changes regularly, often manipulated by advertising

As some products become more fashionable there is an increase in demand

Just as quickly demand can disappear as tastes and fashion change. Eg fidget spinners

Other factors

A variety of other factors will have an impact on the quantity demanded of a good or service including:



Population changes



Advertising



The level of competition in the market



Etc.