The nature of Economics - 1.1

Ceteris Paribus

The assumption that all other variables are the same/constant

Positive statements

Objective statements based on evidence or facts, which can be proved or disproved.

Normative statements

Subjective statements based on value judgements, which can’t be proved/ disproved

Scarcity

Resources are finite while wants are infinite

Basic economic problem

The challenge of allocating scarce resource to unlimited wants

• What to produce/how much to produce?

• How should the good/services be produced?

• For whom are the goods and services produced?

What are the factors of production?

• Land

• Labour

• Capital

• Enterprise

Land

includes all natural resources, raw materials, resources found in the sea, fertility of soil

Labour

Those involved in the production of goods/ services, includes all human effort.

Capital

Any man made aid to production including factory buildings, offices, IT, machinery used to make other goods/services

Enterprise

The entrepreneur Performs two essential functions:

• Bringing together other factors of production so that goods/services can be produced and

• Taking risks involved in production

Renewable resources

Those whose stock level can be maintained at a certain level

Non-renewable resources

Those which will eventually be completely depleted

Opportunity costs

The next best alternative that is foregone when a choice is made

Economic goods

Goods created from resources that are limited in supply, so are scarce. consequently has a price

Free goods

Goods unlimited in supply such as sunlight or sand on a beach. Consumption by one doesn’t limit consumption of others, therefore has no opportunity cost.

Production possibility frontier

Illustrates the maximum potential output of an economy when all resources are fully employed

Capital goods

Goods used to make other goods (e.g machinery)

Consumer goods

Goods that give satisfaction (or utility) to consumers, E.g phones, food, cars.

Economic growth

An increase in the productive capacity of the economy, indicating an increase in real output.

Economic decline

A decrease in the productive capacity of an economy, indicating a decrease in real output.

Marginal analysis

The impact of additions or subtractions from the current situation.

The rational decision maker will only make a decision if the marginal benefit outweighs the marginal cost

The PPF diagram

• All points along a PPF indicates the maximum productive potential of an economy and that resources are being used efficiently

• Points inside the PPF indicate that resources aren’t being allocated efficiently (workers unemployed, machinery may be unused)

• Points outside the PPF are unobtainable, and only possible withe conomic growth.

The increased difference in opportunity cost as you move along a ppf diagram is caused by what?

Some resources are more suited for the production of consumer goods (or capital goods) than they are for capital goods (or consumer goods)

How allocation of resources cause economic growth on the PPF

If there is a reallocation of resources so that more capital goods are produced, it would mean an initial decrease in the standard of living, although it means in the long run there will be economic growth because the extra capital goods will cause an increase in the productive capacity of an economy, meaning a rightward shift of the PPF

Limited economic growth on the PPF

Resources being reallocated from Capital goods to consumer goods would decrease production capacity as there are less capital goods, in turn resulting in a limit to potential economic growth

Movement along a PPF

• A result in the changes of the two goods being produced

Outward shift in the PPF

• Discovery of natural resources (e.g oil)

• Development of new methods of production

• Advances in technology

• Improvements in education (increases productivity)

• Anything that increases a size of the workforce (Immigration, increasing retirement age.)

Inward shift in the PPF

• Natural disasters

• Depletion of natural resources

• Emigration

• Recession

Division of labour

Occurs when the work is split up into small tasks

Adam Smith and the division of labour

Set out the view that economic growth could be achieved through increasing the division of labour. This is involves breaking down a job into small tasks, making workers more specialised, therefore increasing productivity

Advantages in the division of labour

• Workers specialise in tasks best suited for them

• Lower training costs (only 1 task needs to be trained)

• Faster (no movement from one task to another)

• Enables a production line methods to be employed, allowing increase in machinery used

• In turn helping productivity, and reducing COS

Disadvantages in the division of labour

• Boredom for workers (may decrease productivity)

• Loss of skills (they’re only trained for 1 task)

• A strike by one group of workers can bring production to standstill

• Lack of variety, all goods produced are identical

Specialisation to trade - Advantages

Increased output:

• Countries specialise in goods, which have low opportunity costs, and goods that are more efficient to produce.

Increased choice:

• Countries can now consume beyond than what they produce domestically, since they trade, so more goods and services are available to consumers.

Lower prices:

• More efficient production means that G/S are produced with lower costs, which can be passed onto consumers with lower prices

Specialisation to trade- disadvantages

• Country may become over dependant on imported G/S

• If it’s G/S become uncompetitive, it leads to unemployment

• This results in imports being worth more than exports

• Resource depletion is now faster if own country resources are used

Limits to the division of labour

• The size of the market - If there is only a small market, it will be harder to specialise because less G/S are produced, so less work is needed

• Type of product - Designer fashion goods are made in small quantities, and are not standardised, they’re unique so won’t suit it

• Transport costs - If these are high, then large scale production and division of labour may not be possible

Money

Anything that is used as a means of exchange for goods/services

4 functions of money

• A medium of exchange

• A store of value

• A measure of value

• A means of deferred payments

A medium of exchange

Exchanging money earned from doing a specialist job for goods/services the person wants to buy.

• It basically means money is used to buy and sell goods/services

• Before money, people had to barter, and this was a problem because the buyer must WANT your goods in order to exchange.

A store of value

Enables people to save in order to buy goods in the future.

• People can hold money and use it later. it lets you save wealth and spend it later.

• It’s good because goods (like fruits) can be perishable, so they can’t be saved.

• Simply put, money holds its value over time (of course, with the limitations of inflation)

A measure of value

Enables people to assess the value of different goods/services.

• Without money it’d be hard to compare goods

• Allows consumers and producers to make decisions in their best interest

• Allows for easier exchange - without it it would be harder to agree on an exchange

A means of deferred payments

Enables people to buy goods and pay for them on credit.

It essentially allows for borrowing, and paying later.

Free market economy

Where market forces (supply and demand) determine prices

• It is not under the control of the government

Adam Smiths arguement

When individuals pursue self interest in a free market, the economy becomes efficient and organised automatically, meaning limited government intervention is needed

Characteristics of a free market economy

• Private ownership of resources

• Market forces determine prices

• Producers aim to maximise profits

• Consumers aim to maximise satisfaction

• Resources are allocated by the price mechanism

Command economy

Where a government controls the allocation of resources

Characteristics of a command economy

• Public (state) ownership of resources

• Price is determined by the state

• Producers aim to reach production targets set by the state

• Resources are allocated by the state

• More equality of wealth and income than a free market

Mixed economy

A mixture between a free market economy and a command economy

Most economies are mixed

Advantages of free market economy

• Flexibility - the free market system can respond quickly to changes in consumer wants

• Increased choice

• Economic/ political freedom for producers and consumers to own resources

• Consumer sovereignty - this implies that consumers spending decisions determine what is produced

Disadvantages of a free market economy

• Inequality - those who own resources are likely to be richer than those who dont

• Trade cycles - May suffer from instability in the form of booms/slumps

• Monopolies - One firm may become the sole supplier of a product then exploit customers by charging higher prices than the FM equilibrium (theres no gov intervention to stop this)

• Externalities - costs to third parties which aren’t considered

• Imperfect information: Consumers need perfect information to make rational choices, and if not they make the wrong decisions

Advantages of a command economy

• Greater equality - state can ensure everyone has a minimum standard of living

• Macroeconomic stability - booms, slumps are smoothed out

• Externalities - these are taken into consideration when planning production

• No exploitation of workers (because firms aren’t aiming to maximise profits)

• Full employment (becuase government contros production, so workers can be allocated to them)

Disadvantages of a command economy

• Inefficiency - Absence of profit motivation may lead to an inefficient allocation of resources

• Lack of incentives to take risk - absense of profit may reduce incentives for investment

• Restriction of freedom of choice - people directed into jobs needed by the state

• Shortages and surpluses - state may miscalculate supply/ demand

Frederich Hayek’s defence of the free market

That if the government attempts to answer the problem of scarcity, it would fail because the government cannot know all the information within an economy. He argues that state planning would also require force, and restrictions on freedom

Karl Marx’s arguement

The argument that capitalism is unstable because workers are exploited by the owners of the factors of production,