MircoEconomics 1.1 Terms List

Terms List for spec point 1.1

Ceteris Paribus

All other things remaining the same

Models

A hypothesis which can be proven or tested by evidence - usually mathematical

Positive Statements

• objective statements

• dis/proved by testing with empirical/factual evidence

Normative Statements

• subjective statements

• based on value judgements and opinions

• cannot be dis/proven

Scarcity

• The shortage of resources in relation to the quantity of human wants

• due to scarcity, choice is necessary

• choices have to be made by individuals, firms and governments to answer the three questions:

  1. what?

  2. how?

  3. for whom to produce?

• what is scarce?

  1. labour

  2. entrepreneurs

  3. land

  4. capital

Factors of Production

1. Land - building, farming, etc.

2. Labour - workers

3. Capital - man-made, machines, etc.

4. Entrepreneurship - willingness to take risks, try something new, make decisions, organise, etc.

Renewable and Non-Renewable Resources

1. Renewable:

   • resources that do not run out

   • they can be replenished - so stock of resources can be maintained over a period of time

2. Non-Renewable:

   • resources that will run out

   • cannot be readily replenised or replaced at a level equal to consumption - demand is too high for supply to keep up with

   • stock level will decrease over time as they are consumed

Opportunity Cost

• the cost of any choice measured in terms of the next best alternative forgone (sacrificed)

• e.g. starbucks (£3) vs nescafe (£1)

• if u get starbucks - give up three cups of nescafe

• opportunity cost is the fact that you could’ve gotten 3 nescafes

• satisfying one objective more means satisfying other objectives less

Production Possibility Frontier (PPF)

• depicts the maximum productive potential of an economy

• uses a combination of two goods/services

• shows when these resources are fully and efficiently employed

• e.g. guns and butter - more guns means less butter

• illustrates scarcity, trade-offs and opportunity costs

• scarcity: limited availability of resources in relation to the unlimited wants and needs of a society

• opportunity costs: producing more of one good is the amount of the other good that has to be given up

• trade-offs: economies must make trade-offs when allocating resources - the shape of PPF depicts trade-off required when reallocating resources between two goods

• efficiency: PPF is the most effective option - points on the curve = most effective, points inside the curve are not - not fully utilising all available resources to produce goods and services

Capital Goods

• goods produced in order to aid the production of consumer goods in the future

• physical assets a company uses to produce goods and services for consumers - not the final product

• e.g. the machinery needed for an oven

Consumer Goods

• goods bought and demanded by households and individuals

• is the final product

• e.g. the oven

Specialisation

• when individuals/firms/regions concentrate their efforts on producing a narrow range of goods or services in which they have a comparative advantage

• comparative advantage: focus on producing goods or services that they are relatively more efficient at/have a lower opportunity cost compared to others

• they are able to then trade the surplus

• leads to various gains:

  • higher labour productivity which leads to increased business profits - specialisation = increased outputs (and therefore productivity) = lowered cost of goods/services = higher profit for businesses

  • surplus output created that can be traded for mutual benefit - industries/countries specialise in certain goods - therefore trade with each other - increased access to different goods/services for both parties

  • lower prices cause higher real income and GDP growth - lower prices = real purchasing power for customers, higher productivity = increased wages for workers, specialisation is key reason behind economic growth

Division of Labour

• one ‘whole’ job is split into multiple small jobs

• e.g. assembly-line production in cars - Ford

• raises output per person

Advantages:

• increased productive efficiency - shorter shift times mean more shifts take place

• higher output/person/hour worked - means decreased price of goods = higher demand

• specialisation increases skills - more efficient

• results in economies of scale - production quantities increase, average costs decrease, cost savings lead to higher profit for firms, more affordable products for consumers

Disadvantages:

• boredom + absenteeism of workers

• repetitive strain injuries

• repetitiveness - workers loose pride in work - quality suffers

• unrewarding - alienation, lower productivity

• mass-produced standardized goods lack vartiey

Adam Smith

• considered as the father of modern economics

• major advocate for free marekt economies

• The Theory of Moral Sentiments - moral ideas and actions are a direct product of out psychology - we will always choose what is best for all, not just ourselves

• created concept of GDP (gross domestic product)

• The Wealth of Nations - invisible hand theory (free amrkets are able to regulate themselves, people will inevitably choose what is best for everyone)

• division of labour - increased productivity, production assembly lines

Functions of Money

1. Medium of Exchange: facilitates transactions between buyer + seller

2. Store of Value: an asset that holds value over time

3. Measure of Value/Unit of Account: a nominal unit of measure used to value products/assets/debt/income/spending

4. Standard of Deferred Payment: each market’s accepted way of settling a debt

Free Market Economy

• an economy without any government intervention

• the price of goods and services is determined by consumers

• resources are allocated so consumers and producers are the ones who answer the three key questions

• pure capitalism

• Advantages:

  • economic freedom

  • invisible hand of the market

  • choice - price or quality - incentive to be efficient

  • dynamic - new ideas, consumer needs met

  • risk - well-rewarded

• Disadvantages:

  • few producers may dominate

  • potential loss of quality/price control

  • some goods/services may not be produced

  • inequality - high wealth gap, those w/ limited resources unsupported + struggle

  • environment - no regulation on the distruction/exploitation of it - therefore also unsustainable in the future

• how ‘free’ an economy is, is determined by the yearly economic freedom index

Command/Planned Economy

• all factors of production made by the government

• no role for price mechanism (system of resource allocation based on the free market movement of prices, determined by the supply and demand curves)

• pure communism

• Advantages:

  • co-operation between firms and workers can lead to high output - full resource allocation - point is on the PPF

  • less inequality - everyone gets an equal share

  • government can protect the environment

  • specific targets can be reached - e.g. production of vital goods and services like defence or healthcare can be guaranteed

• Disadvantages:

  • inefficient resource allocation - excess supply and shortages develop

  • lack of competition decreases efficiency

  • no motive/incentive to work hard - no ‘profit’ motive as will earn the same amount anyways

  • narrow range of choice of goods

Mixed Economy

• both the free market mechanism and government allocate resources

• all economies are mixed economies to some degree - cannot be ‘pure’

Friedrich Hayek

• one of the greatest critics of the socialist consensus

• strong advocate of free market economies

• The Road to Serfdom - concern about the view that fascism was a capitalist reaction to socialism - advocated for individualism and classical liberalism

• Won Nobel Prize w/ Mrydal in 1974 - work on theory of money and economic fluctuations

• aka how changing prices relay information that helps people determine their economic plan

• Austrian School of Economics

• a capitalist

Karl Marx

• Communist Manifesto

• Das Kapital

• Predicted capitalsim would destroy itself - inherent ineqaulity would cause working class to revolt and production would be turned over to them only

• aka capitalism would collapse into communism

• two flaws of capitalism - chaotic nature of free markets and extraction of surplus labour

• founder of Marxism

Labour Productivity

• measures hourly output of a country’s economy - amount of GDP produced by an hour of labour

• largely driven by investment in capital, technological progress and human capital development

• businesses and governments can increase labour productivity of workers by direct investing in or creating incentives for increases in technology and human/physical capital

Unit Costs

• average cost per unit produced, as measured over a particular time period (e.g. quarter, month, year, etc.)

• total production costs in period of time (£) /total output in period (units)

• useful - able to compare values with competition, can show demand for that particular good (lower cost = better)

• indicate the efficiency and productivity of a business