1.1 economic methodology and the economic problem

why is economics a social science

uses scientific methodology to observe human behaviour and has laws and principles but cannot be tested in a lab

what is the economic problem?

unlimited wants and limited resources

what is a need?

necessary for human survival e.g. food, shelter

what is a want?

something desirable but not necessary for human survival

what does ceteris paribus mean?

all other variables held constant

economic agents behave rationally by...

maximising their own interest

What is a positive statement?

a statement of fact that is objective and can be tested against evidence

What is a normative statement?

a statement that includes a value judgement and cannot be refuted just by looking at the evidence - it focuses on what the economy 'should be'

what is choice?

Selecting one of multiple alternatives when deciding how to allocate scarce resources.

What is economic welfare?

The economic satisfaction/wellbeing of individuals/households/groups in an economy.

What is opportunity cost?

the value of the next best alternative that is forgone when an economic decision is made

what is a factor of production?

inputs of the production process

What are the factors of production?

Capital, Enterprise, Land, Labour (CELL)

what is capital?

man made, physical equipment used to make other goods and services e.g. machinery

what is enterprise?

when individuals take a business risk in combining the other three factors of production in order to produce a good or service e.g. Jeff Bezos - utilise FofP effectively

What is land?

all naturally occurring resources e.g. minerals, the sea

What is labour?

people involved in production, sometimes referred to as human capital e.g. teacher, farmer

what is the central purpose of economic activity?

The production of goods and services to satisfy needs and wants.

what are the key economic decisions?

what to produce, how to produce it and who is to benefit from the goods and services produced

why is scarcity a problem and how is it managed?

results from limited resources and unlimited wants. It means choices have to be made about how resources are allocated between different uses. These choices have an opportunity cost

what is a free market?

- markets allocate resources not govs

- gov. laissez faire, markets regulate themselves

- consumers and businesses make economic decisions

- e.g. Switzerland, USA, Singapore

what is a command economy?

- socialist and communist systems

- state allocates resources, sets production targets and growth rates

- market prices pay little or no role in decisions

- limited consumer choice

- e.g. China, North Korea, Sweden

What is a mixed economy?

- some resources owned by private sector, some owned by public sector

- state supplies public, quasicubic and merit goods, and intervenes in markets to correct perceived failure

- different mixes in different economies

- e.g. UK, France, Germany

free market advantages

- consumer sovereignty

- flexibility

- competition

- choice

- economic and political freedoms

free market disadvantages

- inequality (income and wealth)

- imperfect information

- externalities

- macroeconomic instability

- monopolies

command economy advantages

- equality

- full employment

- fewer externalities

- macroeconomic instability

command economy disadvantages

- inefficiency

- shortages and surpluses

- lack of incentives

- reduced choice

what are economic goods?

- require scarce resources to produce

- production has opportunity cost

- carries a price

- e.g. car, clothes, food

what are free goods?

- abundant in supply

- production doesn't deplete scarce resources

- doesn't command a price

- e.g. air, sunlight, seawater

what are finite resources?

Non-renewable resources that become increasingly scarce and will eventually run out

What are renewable resources?

restorable resources that can be replenished, infinite supply

what is a production possibility diagram?

shows the max. possible output combinations of two goods in an economy (macro) or firm (micro) assuming all resources (factors of production) are fully and efficiently employed

what is the law of diminishing returns?

at certain point, employing an additional FofP causes a relatively smaller increase in production - makes PPF concave to origin

explain what imperfect substitutes means

not all factor inputs are equally suited to producing items leading to lower productivity - land, labour and capital are imperfect substitutes

what does it mean if a PPF was a straight line?

any FofP was equally good at operating in any industry - perfectly substitutable i.e. worker equally good in computing and mining

what does it mean if a point lies on the PPF?

productively efficient

what does it mean if a point lies inside the PPF?

productively inefficient - i.e. not all resources fully utilised e.g. unemployment

What does it mean if a point lies outside the PPF?

point not yet attainable with current resources

what is productive efficiency?

when max. output is produced from the available FofPs and when its not possible to produce more of one good without producing less of another

what is allocative efficiency?

when economic resources (FofPs) are utilised to produce the combination of goods and services that maximise economic welfare

what is the allocative efficiency point?

one point that best reflects society's preferences for particular goods and services

what is allocative price function?

Prices allocate resources away from markets with excess supply to markets with excess demand.

What are capital goods?

good that are used to produce other goods e.g. factories

what are consumer goods?

goods and services that satisfy our needs and wants directly e.g. mobile phones

what causes movement along the PPF?

reallocation of existing resources from the production of one good to the production of another

what is short run economic growth on PPFs? (actual growth)

when the economy is employing available FofPs and employs them more efficiently - economy is becoming closer to being productively inefficient

what is long run economic growth on PPFs? (potential growth)

when a rise in the economy's productive capacity causes the PPF to shift outwards - this then allows increased supply of both goods

What is economic decline on a PPF?

when a decrease in the economy's productive capacity causes the PPF to shift inwards - this then causes a decreased supply of both goods

causes of outward shifts in PPF (growth)

- technological improvements

- discovery/extraction of new resources e.g. oil

- improvements in education and training

- demographic changes e.g. increase in immigration or increased retirement age

causes of inward shifts in PPF

- natural disasters e.g. earthquakes

- wars

- global warming/climate change - leads to loss of farmland, rising sea levels + extreme weather

- a prolonged recession, which may lead to permanent loss of productive capacity