prep year econ midterms ALL

3 basic economic problems

What to produce, how to produce, for whom to produce

Planned economy

Based on a centralized govt’s public ownership of resources

Gov’t decision-making and planning to coordinate choices that allocate resources and distribute income / output

Characteristics of a planned economy

Public ownership of productive resources

Centralized decision-making

Non-price rationing

Merits of a planned economy

Some objectives (eg. rapid economic growth and development) can be achieved more easily through direct administration and centralized govt planning

Easier to achieve a more equal distribution of income

Social services provided by govt can ease problem of poverty

Demerits of a planned economy

Inefficiency in production and resource allocation

Incentives tend to be distorted

Consumers’ preferences unlikely to be addressed

Limited freedom of choice for consumers and producers

Demerits of a planned economy - inefficiency in production and resource allocation

Large no. of decisions, information to be collected and analysed, factors of production to be allocated lead to difficulty in central planning

Production, investment, trade, consumption too complicated to plan efficiently

Difficulty of forecasting future changes in the economy / world

Bureaucracy implies inefficient use of resources

Free market economy

Based on private ownership of resources and decision making

Relies on price systems to allocate resources and distribute income / output

Features of free market economy

Private ownership of resources (institution of private property established and enforced by govt)

Decentralized decision-making

Reliance on price system (free competition, prices determined by demand and supply - rationing signal and incentive to distribute to those who can afford)

Private property rights

Exclusive right to use the property

Exclusive right to the income generated from the property

Right to transfer ownership

Merits of market economy

Invisible hand (coordination of resource and product markets is achieved by individual decisions based on self-interest)

Productive efficiency

Allocative efficiency

Economic growth (pursuit of self-interest)

Drawbacks of a pure market economy

Market may not provide or under-provide merit goods

Market may provide or over-provide demerit goods

Resources may be depleted and the environment may be polluted due to firms aiming at profit and cost minimization

Monopolies may arise and limit competition

Lack of social security net to protect some members of society, eg. long-term unemployed

Cannot operate effectively without govt’s definition of private property rights and legal framework

Assumptions for PPC

Only 2 goods or services

Resources employed fully and efficiently

Technology given

Points on the PPC

Maximum amounts of the 2 goods that can be produced with current resources and technology

Points outside the PPC

Unattainable with current resources and technology

Points inside the PPC

Under-utilisation of resources

Underemployment of resources and/or inefficient production

Scarcity on a PPC

Limited resources and state of technology available → production points outside the PPC are unattainable

Choice on a PPC

Many points exist along the PPC → economy has to make a choice on the combination of goods to be produced

Opportunity cost

Slope of the PPC represents the opportunity cost of producing one more unit of X in terms of Y

Increasing opportunity cost as more X is produced

PPC is concave to the origin

Increasing |m| as more X is produced

Resources will be diverted from the production of Y when the production of X increases. However, the resources more suited to the production of X will be used first, while the resources more suited to the production of Y will be used later.

Causes of economic growth

Increase in quality, eg. worker productivity

Increase in quantity of factors of production, eg. land, capital, labour (manpower)

Causes of potential economic growth

Improvement in quality/quantity of resources/technology (eg. labour, capital goods, natural resources - discovery of precious metal deposits)

Potential economic growth without actual economic growth

Discovery of new resources, technology etc. that is not utilised by the economy to increase output

Actual economic growth without potential economic growth

An economy that initially doesn’t fully utilise its resources utilises its resources more fully

Simple division of labour

A worker specializes in providing one particular product or service

Complex division of labour

Different workers specialize in a particular production stage of a good or service

Regional/territorial division of labour

A region or country specializes in producing a good or a particular production stage

Advantages of division of labour

• Increases labour productivity

  • Practice makes perfect

  • Choosing the most suitable person for a job

  • Economy of time

  • Stimulus to mechanization

  • Economy in the use of capital, if capital saved is devoted to the production of other capital goods

• Wider choice of goods and services

Disadvantages of division of labour

Work becomes dull and monotonous

Greater degree of interdependence between production stages

Greater risk of unemployment

Decline in quality of craftsmanship

Limitations of division of labour

Nature of production - cannot be applied to work requiring individuality

Size of the market - if the market is small and demand is low enough, division of labour is not needed

Possibility of trade - trade barriers limit division of labour

Factors affecting total supply of labour

Size of population

Proportion of population that works

No. of working hours (eg. less public holidays)

Factors leading to a higher proportion of the population that works

Higher legal retirement age

Lower minimum working age

More childcare services

Factors affecting productivity of labour

Education and training

Quantity and quality of labour

Methods of organizing labour

Working conditions and other welfare measures

Health conditions of labour

Factors affecting occupational mobility

Monetary rewards

Non-monetary rewards

Skills of workers

Restrictions of trade unions and professional associations

Age of workers

Availbility of market information

Factors affecting geographical mobility

Transport

Political status of home country

Economic status of home country

Economic status of foreign countries

Social factors (racial discrimination, differences in culture, customs, and language)

Restrictions on immigration and emigration

Availability of market information

Costs of capital

Tradeoff between production of capital and consumer goods (present and future consumption) due to scarcity

Economic roles of an entrepeneur

Risk-bearing (face uncertainties about returns due to owning business)

Decision-making (3 economic problems, ability to innovate, seek new opportunities)

Management (organize other factors of production, take on risks of success/failure)

Effects of profit as return for entrepeneurship

Encourages entrepeneurs to take risks to invest

Provides additional fund for investment and innovation

Encourages efficient use of available resources

Product-output curves

MP is the slope of TP

At TP’s inflection point, MP is at maximum

At max TP, MP is 0

MP cuts AP from above at its maximum

Cost-output curves

TC and TFC start at the same nonzero point. TFC remains constant

TC and TVC are “parallel”, with TC above TVC, which starts at 0

MC first decreases, the n increases, cutting AVC and AFC at their minima

ATC is the vertical sum of AVC and AFC

The gap between ATC and AVC, AFC, gradually decreases

AFC decreases steadily, approaching 0 as Q approaches infinity

Cost curves and product curves

Maximum MC = minimum MP

Maximum AP = minimum AVC, ATC

Economies of scale (list only)

Specialisation of labour and management

Indivisibilities of capital equipment and efficient processes

Marketing

Purchasing

R&D

Financial

Economies of scale

Specialisation of labour and management (possibility for wider scope of division of labour, more experts in management can be hired for more efficient management)

Indivisibilities of capital equipment and efficient processes (machines used more fully, mass production assembly lines: all inputs used in proportionately smaller quantities)

Marketing (advertising costs shared among larger outputs)

Purchasing (bulk purchase, discounts)

R&D (shared over larger outputs, can afford to spend on R&D, new cost-saving production techniques)

Financial (easier to raise capital with lower interest rate due to goodwill, big size)

Diseconomies of scale (list only)

Management

Poor motivation of workers

Marketing

Diseconomies of scale

Management (difficulty of coordination and monitoring, communication becomes a time-consuming process, leading to growing inefficiency)

Poor motivation of workers (lose sense of belongingand become unmotivated leading to lower efficiency)

Marketing (saturated market, cannot find sufficient demand, advertising costs have limited effects on sales)

Reasons for vertical supply curve

Not enough time to produce more

Impossible to produce more

Functions of price in a market (list only)

Price rationing and resource allocation

Price as a signal

Price as an incentive

Functions of price in a market

Price rationing and resource allocation (to those who can pay, invisible hand)

Price as a signal (communicate information to decision-makers; reflect consumer preference and ability, supply of goods in a market)

Price as an incentive (respond to information communicated, address economic problems for highest profit, find best product with lowest prices, make choices on what and how much to buy)

Factors affecting demand

Availability and closeness of substitutes - competitive demand

Complements - joint demand

Change in consumer taste/preference

Superior goods

Inferior goods

Changes in price expectation of consumers

Change in no. of consumers/size of population

Derived demand

Factors affecting supply

Change in no. of firms

Change in seller’s expectation of price movement

Price of goods in joint supply (Qs of A, S of B)

Price of goods in competitive supply (Qs of A, S of B)

Change in technology

Change in prices of inputs/factors of production

Supply shocks (adverse/beneficial)

Supply and demand both increase

Price indeterminate, Qt increases

D inc > S inc, P inc

D inc = S inc, P unchanged

D inc < S inc, P dec

Supply and demand both decrease

Price indeterminate, Qt decreases

D dec > S dec, P dec

D dec = S dec, P unchanged

D dec < S dec, P inc

Supply decreases, demand increases

Price increases, Qt indeterminate

D inc > S dec, Qt inc

D inc = S dec, Qt unchanged

D inc < S dec, Qt dec

Supply increases, demand decreases

Price decreases, Qt indeterminate

D dec > S inc, Qt dec

D dec = S inc, Qt unchanged

D dec < S inc, Qt inc

Elastic demand

PED > 1

Qd > P

Increase TR by lowering P

Inelastic demand

PED < 1

Qd < P

Increase TR by increasing P

Factors affecting PED

Availability and closeness of substitutes - elastic

Degree of necessity - inelastic

Proportion of expenditure in total expenditure - elastic

Length of time required to make the purchase - elastic

Primary commodities and PED

Tend to have lower PED, high price fluctuation from supply fluctuation

Manufactured products

High PED, low price fluctuation from supply fluctuation

Scarcity (of choice)

Inadequate supply of resources to satisfy unlimited human wants

Choice

People consider what to buy and what to give up on an individual level; a firm or society decides based on the 3 basic economic problems

Study of economics

Study of how human beings make decisions to solve the problem of scarcity and how people in a society interact with each other, and the study of rationing systems

Rationing systems

How scarce resources are allocated to fulfill the unlimited wants of human beings

Opportunity cost

Cost expressed in terms of the next best alternative foregone

Time cost

Next best alternative use of time

Implicit cost

Costs that involve no explicit outlay, but there are genuine opportunities to be foregone

Explicit cost

Costs that involve a transfer of funds from one to other parties

Interest

Cost of earlier availability of goods or resources to the borrower and the compensation for deferring consumption of goods or the use of resources to the lender

Firm

Basic unit of production that employs factors of production, responsible for making decisions concerning production

Household

Basic unit of consumption that supplies the firm with their factors of production for an imcome, responsible for making decisions concerning consumption

Microeconomics

Study of the behaviour of individual markets

Macroeconomics

Study of how the economy as a whole works using aggregates

Positive economics

Descriptive statements, propositions and predictions about the world with no value judgement

Normative economics

Statements of what ought to be that involve value judgement and cannot be proved

Productive efficiency

Output is produced by the use of the least/lowest possible resources/costs

Allocative efficiency

Making the best possible use of scarce resources to produce the combination of goods and services that are optimum for society

PPC

Shows the maximum combinations of goods and services that can be produced by an economy in a given period of time if all the resources in the economy are being employed fully and efficiently and the state of technology is fixed

Economic growth

An increase in the volume of output produced (per person)

Potential economic growth

An economy has a greater production capacity

Actual economic growth

An economy produces a greater output

Economic development

Improvements in the general living standard of the people

Production

The process of combining inputs for creating outputs

Primary production

All activities that directly utilize natural resources in production or the extraction of resources from nature

Secondary production

The process of turning raw materials into semi-finished and finished goods

Tertiary production

Provision of services

Good

Anything providing utility to at least one person; also used in a general sense to include goods, services, and resources

Utility

A measure of usefulness and pleasure that can be derived from goods

Free goods

Goods available in sufficient quantity to satisfy all our wants, hence it is not scarce and more is not preferred. There is no opportunity cost involved, so the price is zero.

Economic goods

Goods with inadequate quantity to satisfy all our wants, hence it is scarce and more is preferred. There is opportunity cost involved in its production or usage, so the price is nonzero.

Capital goods or producer goods

Goods produced for the production of other goods

Consumer goods or final goods

Goods produced for direct consumption

Private good

A good that is rivalrous and excludable in consumption

Public good

A good that is non-rivalrous and non-excludable in consumption

Quasi- or impure public goods

Goods whose nature is between public and private goods

Merit goods

Goods considered desirable for people (society), but are underprovided by the free market and so underconsumed

Demerit goods

Goods considered to be undesirable for people (society), but are overprovided by the free market and so overconsumed

Bad

Less of it is preferred

Division of labour

The separation of production processes into a number of sub-processes, where each is performed by different persons or production units

Specialization

Division of labour that also refers to other factors of production instead of only labour

Factors of production

Resources or inputs used to produce goods or services

Labour

Human effort, mental and physical, used in production