Edexcel Economics (A) A-level Theme 1: Introduction to Markets and Market Failure 1.1 Nature of Economics Detailed Notes

Flashcards generated from Edexcel Economics A-level Theme 1 lecture notes to aid in exam preparation.

What is the role of models in economics?

To explain how the economy works, such as theories of supply and demand or the circular flow of income.

What is the difference between a theory and a model in economics?

The words “theory” and “model” can be used interchangeably. Theories can often be expressed in words whilst models, because they require greater precision, are expressed in mathematical terms.

What does 'ceteris paribus' mean?

'All other things remaining equal'; economists use it to simplify problems when developing models and theories.

Why is it difficult to set up experiments to test hypotheses in economics?

Economics is a social science, and economists have to gather data in the ordinary, everyday world, where other variables are always changing.

What is a positive economic statement?

A statement which is objective and made without any obvious value judgements or emotions, and can be tested to be proven or disproven.

What is a normative economic statement?

A statement that is subjective and based on opinion, so cannot be proven or disproven; often includes words such as ought, maybe, unwise, should etc.

How do economists use positive statements?

They use positive statements to back up normative statements.

What is the basic economic problem?

Scarcity; people have infinite wants, but resources are finite and limited.

What are the three basic questions economies try to solve?

What to produce, how to produce it, and for whom production should take place.

What is a renewable resource?

A resource of economic value that can be replenished or replaced on a level equal to consumption.

What is a non-renewable resource?

A resource of economic value that cannot be readily replaced by natural means on a level equal to consumption.

What is opportunity cost?

The cost of one thing in terms of the next best option which has been given up.

What does the Production Possibility Frontier (PPF) show?

The maximum possible combinations of capital and consumer goods that the economy can produce with its current resources and technology.

How is the PPF used to determine opportunity cost?

By measuring the trade-off between producing different goods; the amount of one good that must be given up to produce more of another.

How can economic growth or decline be represented on a PPF?

Economic growth is shown by an outward shift of the PPF, while decline is shown by an inward shift.

What does economic efficiency mean in the context of a PPF?

Economic efficiency is achieved when resources are used for their best use. At all points on the PPF, resources are allocated efficiently.

What does a movement along the PPF curve indicate?

A change in the combination of goods produced as the same amount of resources are allocated amongst the two goods differently.

What does a shift of the PPF curve indicate?

A change in the productive potential of the economy, due to a change in the number of resources and/or the technology available to the country.

What are capital goods?

Capital goods are goods that are produced in order to aid the production of consumer goods in the future.

What is specialisation?

The production of a limited range of goods by a company/individual/country.

What is division of labour?

When labour becomes specialised in a particular part of the production process.

Who stated the concept of specialisation and the division of labour?

Adam Smith.

What are the advantages of the division of labour?

Increased labour productivity, higher quality of goods and services, more cost effective to develop specialist tools, reduction of time wasted moving between jobs, and workers only need to be trained to do one specific task.

What are the disadvantages of the division of labour?

Work can become very boring leading to poor quality of work, reduction of craftsmanship and standardised product, delay in one process can stop every other task, and workforce doesn't have wide industrial training and could therefore suffer from structural unemployment.

What does the theory of comparative advantage state?

Countries should specialise in producing those goods where they have a lower opportunity cost, and so they are relatively best at producing.

What are the advantages of trade?

The theory of comparative advantage states countries should specialise in producing those goods where they have a lower opportunity cost, and so they are relatively best at producing. This will help them boost their economy. On the whole, there is greater output globally.

What are the disadvantages of trade?

Countries may become over-dependent on one particular export and if this fails their economy may collapse. Other countries specialise in non-renewable resources and these could run out, which will result in a huge loss of income for that country. There will be high interdependence and this will cause problems if trade is prevented.

What are the four key functions of money?

A medium of exchange, a measure of value, a store of value, and a method for deferred payment.

What is a free market economy?

An economy where individuals are free to make their own choices and own the factors of production without government interference; resources are allocated through the price mechanism.

What is a command economy?

An economy where all factors of production, except labour, is owned by the state and labour is directed by the state; resource allocation is carried out by the government, rather than the price mechanism.

What is a mixed economy?

An economy where both the free market mechanism and the government planning process allocate a significant amount of the total resources in the country.

What are the advantages of a free market economy?

The system is automatic due to the invisible hand; resources are moved out of production of a good when people stop wanting it or costs are too high. Consumers have freedom of choice, called consumer sovereignty. There is high motivation as people know working hard could lead to high potential rewards, creating conditions where initiative and enterprise flourish. There is political freedom. Because firms are in competition, they will produce goods at the lowest cost they can, ensuring productive efficiency. In general, freer market economies tend to have higher growth.

What are the disadvantages of a free market economy?

There tends to be high levels of inequality, since the rich own more factors of production and so can grow richer. There may be a lack of merit goods (goods considered as intrinsically good) and little control of demerit goods (intrinsically bad). Resources could be wasted on unproductive expenses such as advertising, switching the factors of production and providing competitive services. If competition disappears then there may be monopolies, who charge high prices and offer low quality of service. There is the problem of externalities.

What are the disadvantages of a command economy?

It is impossible for the state to make so many decisions correctly, which could lead to over or under supply and a waste of resources. Decision making will be slow as it has to go through various stages and there could be an increase in bribery and corruption (an increase in bureaucracy). As everyone receives the same wage, there is less motivation and efficiency because people know that working harder will not increase their standard of living. Consumers lose their freedom and it is often led by dictators.

What are the advantages of a command economy?

The state provides a minimum standard of living , ensuring no one is extremely poor as there is less inequality. There is less wastage of resources as there is no need for competitive services nor advertising, which is very expensive.Long term planning means that the industry doesn’t have to keep changing and shifting resources. Standardised products means that they are produced cost effectively. As the government, who are generally motivated by the wellbeing of the country, rather than the companies, who are motivated by profit, decide resource allocation, objectives other than profit can be followed: merit goods are encouraged and increased whilst demerit goods aren’t produced.

What is the government's role in a mixed economy?

Creating a framework of rules, supplements and modifies the price system, redistributes income, and stabilises the economy.