Economics

1.1

What is the process of developing models in economics?

To be able to explain how the economy works and to predict economic outcomes.

eg: Law of demand, circular flow of income

Developed by putting forward a model, gather evidence then accept, change or disregard the model.

What is the distinction between theories and models?

Can be used interchangeably.

theories: often expressed in words

models: need greater precision, expressed in mathematical terms.

What’s the purpose of creating models/theories?

To explain why something is as it is.

Simplified to be able to be more useful.

What’s the need in making assumptions in Economics?

There are too many variables which can change within an economic model, assumptions must be made

What is ceteris paribus assumption?

"All other things being equal”

Allows scientists to simplify problems.

Analyse the relationship between variables without the complications of other influencing factors

eg change in income, demand will shift

Example of Ceteris Paribus?

• Law of demand:

Price of serve decreases

Quantity demanded increases

• Supply and price:

relationship between market price and the quantity supplied.

When to drop Ceteris Paribus?

• When considering multiple variables:

In some cases, essential to analyse how multiple variables interact simultaneously 

eg economic growth, government spending

• Behavioural economics:

impact of psychological social and emotional factors on economic decisions

capture the nuances of human behaviour

How valid is the Ceteris Paribus assumption?

Simplifies complex economic relationships, easier to analyse and understand, focus on specific cause and effect on relations.

Often challenging to hold all factors constant economic variables are interconnected.

What’s the difference between microeconomics and macroeconomics?

Microeconomics:

looks at prices and quantities of individuals goods and services

Macroeconomics:

looks at general price levels and total output of all goods and services eg GDP

Why is economics unable to make scientific experiments?

Economics is a social science, unlike natural science, difficult to set up experiments to test hypothesis 

variables always change in the ordinary everyday world 

economics come up with different conclusion for particular set of data

What’s the difference between positive and normative statements?

• positive statements:

objective, made without any obvious value judgements or emotions, can be proven or disproven

• normative statements:

subjective, based on opinion cannot be proven or disprove 

eg should, ought, maybe

What’s the role of value judgements in influencing economic decision making?

economists use positive statements to back up normative statements.

Value judgements can influence economic decision making.

(diff economics make diff judgements on same statistic)

What is the problem of scarcity?

basic problem in economics.

People have unlimited wants but limited resources. 

Scarcity - resources aren’t necessarily scarce in themselves but they are scarce in relation to the demand placed upon them.

eg scarcity in water in India.

How to solve the problem of scarcity?

Economies try working out what to produce, how to produce it and for whom production should take place.

What’s the difference between renewables and non-renewable?

• Renewable resource:

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

eg oxygen, solar power, fish

• Non-Renewable resource:

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

eg fossil fuels, coal, oil, gas

What’s the definition of opportunity cost?

the value of the next best alternative forgone when a choice is made.

What’s the importance of opportunity costs on economic agents?

consumer: make choice on how to use their limited income. high levels of satisfaction.

producer: choose what to do with their limited resources, decision based on profit.

government: make decisions on where they should spend limited tax revenues based on maximised social welfare 

What is the four factors of production?

• Land: 

Natural resources, natural materials that are used up in production (wood, gold)

Factor payment: Rent

• Labour:

human effort (mental and physical) (accountant, teacher)

FP: Labourers receive wages

• Capital:

man made resources, produce goods and services (phone, book)

FP: owners of capital receive interest on their land 

• Enterprise:

risk takers, organisers, combine 3 factors of production to make product or service

FP: Successful entrepreneurs earn profit from their activities

(different industries combine factors of production in different combination)

labour intensive (construction) land intensive (farming)

what are production possibility frontiers?

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

What is the distinction between capital goods and consumer goods?

• Consumer goods:

demanded and bought by households and individuals

• Capital goods:

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

(some goods can be both = computers)

Whats the difference between straight PPF and curved PPF?

• Straight PPF:

Factors equally successful at making both goods

constant opportunity cost

• Curved PPF:

Factors not equally successful at making both goods 

increasing opportunity cost

What is economic decline?

Resource depletion is where quantity of resource falls.

Resource depreciation is where resources are worn down.

What is economic growth?

comes from an increases in quantity, quality or productivity of factor of production.

Describe how to inefficiently allocate resources?

outside the curve is unobtainable production, beyond the PPF don’t have enough resources/tech to produce

Inside the curve is possible but inefficient as they are not producing within the curve (not maximising output)

How to efficiently allocate resources?

All points on the PPF curve are allocated efficiently

resources are produced at the lowest possible cost and optimise economic welfare.

What’s the distinction between movements and shifts in PPC? (Movements)

movements along the curve indicates a change in the combinations of goods produced

same amount of resources are allocated amongst the two goods differently.

(consumer ^ capital down) viseversa

What’s the distinction between movements and shifts in PPC?(Shifts)

shifts indicate a change in the productive potential of the economy

(consumer ^ capital ^)vise versa

a change in number of resources or technology available

What are the causes for a outward shift in a PPF?

• Increase in natural resources

(increase production capacity)

• technological advancement

(allows economy to produce more output with same resources)

• human capital government 

(better educated/more skilled workers can increase productivity)

What is division of labour?

When labour becomes specialised during production process so do a specific task in cooperation with other workers.

What is an advantage and disadvantage of specialisation?

• Advantage:

high productivity 

higher pay 

more profit/investment

lower prices

better use of scarce resources

• Disadvantage:

boring for workers 

difficult to monitor productivity 

workers have less pride in their work

less flexible

less synergy

less occupational mobility

What are the benefits of specialisations and division of labour in organising production?

Higher labour productivity rising business profits:

workers can be quicker, better and more efficient as they concentrate on one thing skills increase output per hour worked

Higher quality of goods and services:

creates surplus output that can be traded for mutual benefit, trade increases the range of products we can consume

Time is not wasted:

trained to do one specific task, rather than many, saving time ad money

What is specialisation?

process where individuals (Econ agents), firms or regions concentrate their efforts on producing a narrow range of goods in which they have a comparative advantage.

What is one of the functions of money? (medium of exchange)

earliest method (barter): enables trade to buy, sell goods and services, acceptable everywhere.

Problem: need a double coincidence of wants, (both parties want the good the other party offers)

What is one of the functions of money? (a measure of value)

compare the value of two goods, able to put a value on labour (how much its worth)

What is one of the functions of money? (a store of value)

able to keep its value and can be kept for a long time.

What is one of the functions of money? (method of deferred payment)

money can allow for debts to be formed, people can pay for things without having money present, pay for it later. Relies on money storing its value.

What’s an advantage of specialisation and production of goods to trade?

theory of comparative advantage:

countries should specialise in producing goods when low opportunity cost, so relatively best at producing. Help boost the economy, greater output globally.

What is a disadvantage of specialisation and production of goods to trade?

• Countries may become over dependent on one particular export and if this fails their economy may collapse.

• specialise in non-renewable, it could run out, result in a huge loss of income+resources

• increased specialisation means more competition to cut costs, wages will fall

Who was Adam Smith?

Stated the concept of specialisation and division of labour.

Showed how it can increase labour productivity (output per worker)

allowing firms to increase efficiency and lower cost of production.

Who was Friedrich Hayek?

Believed in the free market economy

argued that state control of the economy leads to the loss of freedom.

poor in free market countries better than in command economies as they have personal freedom.

Who was Karl Marx?

Believed in command economy, criticised capitalism.

Believed capitalists profit came from exploiting labour as they underpaid workers for the value they actually created.

Believed capitalism will collapse leading to communism.

What is a free market economy?

Individuals are free to make their own choices, own factors of production without government interference.

resources allocated through price mechanisms, consumer determines what is produced by their willingness to spend their money on a good.

makes desicions based on satisfaction, producers based on profit 

(no completely free market, gov interference to an extent)

Why is there no free markets in the world today?

government has to intervene at least to an extent:

issuing money, protecting property, rights and breaking up monopolies.

What are the advantages to a free market economy?

• System is automatic due to the invisible hand

(resource moved out of production of a good when people stop wanting it/costs to high)

• consumers have freedom of choice called consumer sovereignty

• high motivation (work har = high potential award)

• political freedom

• firms are in competition, produce goods at lowest costs they can, productive efficiency

In general, freer market economies tend to have higher growth

What’s a disadvantage to free market economy?

• High levels of inequality

(Rich have more factors of production can grow richer disparities in wealth)

• a lack of merit goods and little control of demerit goods (intrinsically bad)

• resources could be wasted on unproductive expenses

• if competition appears their may be monopolies who charge high prices and offer low quality service 

• problem of externalities (1.3) 

What is command economy?

• all factors of production, except labour, is owned by the government and labour is directed by the state.

• no private property, everyone is assumed to be selfless, working for a common good.

• Resource allocation is carried out by the government rather than price mechanism.

• Income distribution from government and all workers, no matter the job, get the same wages

• products are standardised and prices are limited causing excess demand and queueing 

• Planning is so complex some of decisions are left up to the consumer 

What are some advantage of the command economy?

• state provides a minimum standard of living (less inequality) no one is extremely poor.

• less wastage of resources, no need for competitive services. 

• long term planning, industry doesn’t keep changing and shifting resources.

• standardised products, produced cost effectively.

• government generally motived by wellbeing of country rather than companies.

What are some disadvantages of command economy?

• impossible for state to make so many decisions correctly

(over/under supply and waste of product)

• decision making will be slow 

• increase in bribery and corruption

• everyone will receive the same wages

less motivation, efficiency (working harder =! increase standard of living)

• consumers loose their freedom (led by dictators)

What is a mixed economy?

both free market mechanism and the government planning process allocate a significant amount of the total resources of the country (40-60%)

What’s the governments role in a mixed economy?

• creating a framework of rules:

prevent the abuse of monopolies (company with more than 25%)

that have higher prices/poorer service

• Supplements and modifies the price system:

produce public and merit goods eg emergency services and transport limit production of demerit goods like child pornography 

• redistribute income:

move income from one group of people to another (rich-poor)

income tax for those out of work/low income, prison for services for all like NHS and education

• Stabilises the economy:

government will attempt to manage the level of demand in the economy to prevent extreme high or low, they do this through fiscal, monetary policy.