The nature of Economics (1.1)

The economic problem

Scarcity - The fact that there are limited resources but unlimited wants

What the economic problem forces consumers to do

Make choices and decisions based on what is available

The Factors Of Production (F.O.P)

Capital

Enterprise

Land

Labour

Capital

Resources used to make consumer goods

Enterprise

The entrepreneurs and risk takers who utilise the F.O.P to gain profit

Land

Natural resources

Labour

Workers and the skills provided by them

The 3 economic agents

• Consumers

• Producers

• Government

What consumers do

Maximise utility

What producers do

Maximise profit

What government does

Maximise welfare

The 3 economic questions

• What do we produce?

• How do we produce?

• Whom do we produce for?

Opportunity cost

The value of the next best alternative foregone

Decisions made using opportunity cost

• Allocating F.O.P to alternative when opportunity cost is higher than the profit made in current decision

• Staying with current decision when opportunity cost is lower than profit made in current decision

Needs

Things that are essential for survival. e.g. food, water, shelter and clothing

Wants

Desires that are not essential for survival but can enhance quality of life

What is shown on a micro economic PPF graph

• The maximum possible production of 2 goods/services with given F.O.P

• The various combinations of 2 goods/ services that can be produced with given F.O.P

What is shown on a macro economics PPF graph

• The maximum possible production of all goods and services with given F.O.P

• The various combinations of all goods and services that can be produced with given F.O.P

A concave shaped PPF curve

Represents the law of increasing opportunity cost

Micro PPF graph

Macro PPF graph

Moving along the concave PPF curve

F.O.P become more suitable for the production of one thing than they are e for another thing, hence increasing opportunity cost

Linear PPF graph showing constant opportunity cost on a macro level

What is illustrated by a linear PPF curve

Constant opportunity cost

The 3 types of efficiency

• Productive efficiency

• Allocative efficiency

• Pareto efficiency

Productive efficiency

When goods and services are produced at the lowest possible cost, meaning that no resources are wasted and a firm is producing the maximum possible output with the least amount of input

Allocative efficiency

Resources being distributed to produce the goods and services that society most desires, leading to maximum social welfare

Pareto efficiency

A state in which resources are allocated so that it is impossible to make a one person better off without making someone else worse off

Point d

Productive inefficiency and pareto

Point d

Unemployment of labour or capital

What can be done to move from producing inside the PPF curve to on the curve

A business can employ all labour and idle capital

What can be done to move along the PPF curve

A business can reallocate F.O.P to specialise in one good by moving F.O.P away from producing the other good

In which direction would a business try and shift the PPF curve in order to increase production

Outward to the right

Shifting PPF curve to the right

One good/service does not need to be sacrificed for the production of the other. Instead more of both goods/services can be produced

How to shift the PPF curve to the right

A business can increase the quantity and/or quality of F.O.P

Graph showing increase in production favouring only one good

The change in quantity/quality of F.O.P suits the production of only one good

The economist who came up with the idea of specialisation and division of labour

Adam Smith

Advantages of specialisation

• Higher output leading to increased trade and growth

• Wider range of goods/services

• Greater allocative efficiency

• Higher productivity through better use of workers

• Quality improvements

Disadvantages of specialisation

• Finite resources

• Changes in fashion/trends

• De-industrialisation

• National interdependence

Division of labour

Breaking down a production process into separate tasks upon specialisation

Advantages of division of labour

• Workers are highly productive meaning that wages increase, time is saved, and a decrease in production costs and prices for consumers

• Specialist capital for workers

• Lower prices, higher quantity/choice and higher quality for consumers

Disadvantages of division of labour

• Demotivation of workers

• Higher worker turnover

• Risk of long term unemployment - workers become specialised in one thing causing them to find it hard to find other lines of work where they can transfer their skills

• Highly standardised goods/services

The functions of money

• Medium of exchange

• Store of value

• Measure of value

• Method of deferred payment

Medium of exchange

Money is accepted as a means of payment for goods and services, allowing transactions to take place without need for barter

Store of value

Money can be saved and used in the future because it maintains its value overtime, enabling