1.1-1.2 The Nature of Economics

What is scarcity?

When wants are unlimited, but the resources available to satisfy them are finite.

Economics definition.

Economics is the study of how individuals, firms and governments make choices about allocating scarce resources to satisfy unlimited wants.

Rational behaviour definition.

Acting to maximise your own benefit.

Economic policy definition.

Actions taken by a government to influence the economy taxes, spending, regulation and interest rates.

Social science definition.

A subject that studies human behaviour and society using scientific methods.

Ceteris Paribus definition.

‘all other things being equal’

• changing one variable while assuming everything else stays the same

Hypothesis definition.

A testable prediction.

What makes a statement positive?

It can be tested against evidence and shown to be true or false.

What is a value judgement?

• based on beliefs rather than facts

• opinion

Factors of production definition.

The resources used to produce goods and services.

Economic agents definition.

The decision-makers in an economy

Productive potential definition.

The maximum output an economy can produce with its current resources and technology the PPF itself.

Economic growth definition.

An increase in an economy's productive potential, shown by an outward shift of the PPF.

Opportunity cost definition.

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

What does PPF stand for?

Production possibility frontier

What is a PPF?

A curve showing the maximum combinations of two goods an economy can produce when all resources are fully and efficiently used.

What does a shift on a PPF show?

A change in productive potential caused by a change in the quantity or quality of factors of production or technology.

What is productive efficiency?

Producing on the PPF: it is impossible to make more of one good without making less of the other.

What does a movement along the PPF show?

A change in the combination of goods produced using the same resources — a reallocation.

What are Capital goods? (+ example)

Capital goods are used to produce other goods

• (machines, factories)

What are Consumer goods?

Consumer goods are bought and used by the final consumer.

What is an economic model?

A simplified representation of how part of the economy works, used to explain and predict behaviour.

Why would you use an economic model?

• The real economy has millions of people making it impossible to describe in full.

• Model strips away detail to isolate cause an effect

What assumptions economists make for models?

1. Rational behaviour

• consumers maximise satisfaction (utility)

• firms maximise profit

2. People have the full information - know the price and quality of what they buy

3. Ceteris Paribus

Why do we use Ceteris Paribus when making economic models?

• allows us to isolate the effect of something

• makes models workable - one cause, one effect

• lets economists make clear, testable predictions

What are the limitations of Ceteris Paribus?

In the real world other things are unlikely to stay equal, so predictions can fail

• sales may increase despite price increase

• then economist must ask ‘what else changed’

Why can economists not run scientific experiments?

• other things never stay constant - the economy never stands still

• practical and ethical limits

• people learn, anticipate and may change their behaviour because they know a policy is being tested

• you cannot re-run historical events (e.g. economic crisis) and run it with a different policy to compare incomes

What do economists do instead of running scientific tests?

• observe and analyse data

• natural experiments - comparing similar places with different policies (e.g. neighbouring regions with different minimum wages)

• build models, test predictions, accept economists will disagree and forecasts carry uncertainty

What two things do you need for Policy decision?

Positive economics + Value judgements.

What is positive economics?

Tells us what is and what will happen if we act

What are Value judgements?

Tell us what we want to happen and what counts as ‘better'.

What is Policy decision?

Combines evidence and values to get an action.