Economics- 1.1 Nature of Economics

im so sad i dont wanna revise leave me alone

1.1.1 DEVELOPING MODELS

1.1.1 DEVELOPING MODELS

• economists develop models to explain how the economy works- they are built on assumptions used to simplify analysis but risk criticism for not being realistic enough.

1.1.1 THEORY VS MODEL

• there is no exact distinction between the two words.

• but theories can be expressed in words while models (because they require greater precision) are expressed in mathematical terms.

• purpose- to explain why something is as it is

• they’re simplified to make them more useful

1.1.1 ASSUMPTIONS

• assumptions are initial conditions made before a micro or macroeconomics analysis is built

• there are too many variables which can change within an economic model so assumptions must be made

1.1.1 CETERIS PARIBUS

• all sciences make assumptions when developing models and theories- allows them to simplify problems

• economists use the term ceteris paribus- latin to assume ‘all other things remain equal’ in an economic model

• economists will use this when looking at the relationship between 2 factors- assume only these 2 change and all other factors that would have an effect on any other variable remain the same

• helps them develop theories and models, and make predictions

1.1.1 SCIENTIFIC EXPERIMENTS

• economics is a social science (studies society and human behaviour) and so, unlike with natural science, it’s difficult to set up experiments to tests hypothesis.

• as the economist has to gather data in the everyday world, other variables are always changing it- difficult to decide whether evidence supports or disagrees with a hypothesis

• so they come up with different conclusions for a set of data

1.1.1 NOT SOCIAL SCIENCE?

(don’t know if you have to know this)

• some argue economics is not a social science bc it studies human behaviour and that cannot be reduced to scientific law.

• but groups of individuals are more predictable than 1 individual- economists deal more with groups

• laws can’t be definite bc we don’t know exactly what each individual will do

1.1.2 POSITIVE

• a statement which is objective and made without any obvious value judgements

• it can be tested to be proven or disproven and they’re often expressed in the form of a hypothesis

• statements of the future can be positive if they can proven or disproven in the future

• E.G.- “raising taxes will lead to an increase in tax revenue”

• important because they can be tested to see whether economic ideas are correct

1.1.2 NORMATIVE

• a statement which is subjective and based on value judgements, so can’t be proven or disproven.

• usually includes words like maybe, should etc. or says one action is better than another

• E.G.- “the government should increase taxes”

• important because value judgements influence decision-making and gov policy

1.1.2 VALUE JUDGEMENTS

• economists use positive statements to backup normative statements

• value judgements can influence economic decision making and policy- diff economists make diff judgements based on the same statistics

1.1.3 SCARCITY

• the worlds resources are finite so scarcity means that economic agents can only obtain a limited amount of resources

• scarce resources are called economic goods

• non-scarce resources are called free goods (e.g. air)

• BUT with destruction of rainforest and increasing pollution, the air we breathe may not remain a free good

• resources are not necessarily scarce in themselves but they are scarce in relation to the demands placed upon them.

1.1.3 THE PROBLEM OF SCARCITY

• People have finite needs, but infinite wants, as no one would choose to live at the level of basic human living standards if they can enjoy more

• because resources are limited, economies try to solve the basic economic problem by deciding what to produce, how to produce it and for whom production should take place

1.1.3 RENEWABLE RESOURCE

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

• E.G. oxygen, solar power and fish are renewable.

• as long as the rate of consumption is less than or equal to the rate of replenishment, the stock will not decrease.

1.1.3 NON-RENEWABLE RESOURCE

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

• E.G. fossil fuels

1.1.3 OPPORTUNITY COST

• the same resources cannot be used to produce different goods at the same time so decisions have to be made on how to use them, this leads to the opportunity cost.

• The opportunity cost is the value of the next best alternative forgone- i chose to buy flashcards with my £1 instead of chocolate

• consumers make choices on how to use their limited income based on what gives them the greatest level of satisfaction.

• producers choose what to do with their limited resources and their decisions will be based on profit

• the gov makes decisions on where they should spend their limited tax revenues based on what will maximise social welfare.

• no opportunity cost for free goods

1.1.3 FACTORS OF PRODUCTIONS

• LAND: all natural resources available for production

• LABOUR: quantity and quality of the human input available for production process

• CAPITAL: all man-made resources used to produce goods and services

• ENTERPRISE: willingness and ability to take risks of combining the other 3 factors to make goods and services. Successful entrepreneurs make profit

1.1.3 AUTOMATION

(don’t know if u have to know this but it was in the booklet)

• the production technique that uses capital machinery and new technologies to replace human labour- replacing labour is a process known as capital-labour substitution

1.1.4 WHAT IS PPF

• shows the maximum possible combinations of capital and consumer goods that the economy can produce with its current resources and technology

• usually a curve- means that when you move down along the PPF, as more resources are allocated towards Good Y, then the extra output created gets smaller.

• explained by the law of diminishing marginal returns- it occurs bc not all factor inputs are equally suited to producing different goods leading to lower productivity

1.1.4 MICROECONOMIC PPF

• looks at 2 products- business may reallocate their factor inputs towards one product

• this involves opportunity cost bc some output of the alternative good is sacrificed

1.1.4 MAX PRODUCTIVE POTENTIAL OF ECONOMY

• any point on the curve represents the max productive potential of the economy, the most that country can produce

• efficient allocation of resources

1.1.4 OPPORTUNITY COST THROUGH MARGINAL ANALYSIS (curve)

• straight line PPF is an indication of perfect sustainability of capital and labour inputs

• moving from A to B, the OC of producing an extra 15 consumer goods is 30 capital goods

• producing 60 capital goods (point A) the OC would be 20 consumer goods

1.1.4 OPPORTUNITY COST THROUGH MARGINAL ANALYSIS (straight)

• OC of producing 1 consumer good is 3 capital goods bc 600/200=3 (1 consumer good produced, 3 capital goods lost)

• OC of producing 1 capital good is 1/3 of a consumer good

1.1.4 ECONOMIC GROWTH OR DECLINE

• purple arrow show that the economy has grown bc it can produce more of both goods- growth may be achieved by increasing the quantity and/or quality of resources

• orange arrow show the economy is declining as it can produce less goods than previously- could be cause by no. of factors: natural disasters, natural resources ran out, decrease in quantity/quality of labour (due to migration or fall in education

1.1.4 EFFICIENT OR INEFFICIENT ALLOCATION OF RESOURCES/ UNOBTAINABLE PRODUCTION

• economic efficiency is achieved when resources are used for their best use.

• economy will aim to produce on the curve(mainly A)- POSSIBLE AND EFFICIENT

• B- POSSIBLE BUT INEFFICIENT, producing within the curve so not maximising output

• C- UNOBTANAIBLE- beyond the PPF so not enough resources/ technology to produce

• D and E are not likely- can only produce one good

1.1.4 CHANGE IN PRODUCTION (efficient)

• diagram shows increase in ability to produce consumer goods but not capital goods

• could be due to an improvement in technology that makes production of consumer goods more efficient

1.1.4 CHANGE IN PRODUCTION (inefficient)

• diagram shows a fall in capital production but not in consumer production

• shows a fall in efficiency or a change in resources that only affects capital good manufacture

1.1.4 PPF MOVEMENTS

• movement along curve indicates a change in the combination of goods produced

• more capital goods are produced and less consumer goods produced, or vice versa

• same amount of resources allocated amongst the 2 goods efficiently

1.1.4 PPF SHIFTS

• shift in curve indicates a change in the productive potential of the economy

• more consumer and capital goods can be produced or less consumer and capital goods can be produced

• there’s been a change in the no. of resources and/or the tech available to the country and so their potential output has changed

1.1.4 CAPITAL GOODS

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

• Some goods can be both consumer and capital goods, for example computers 

1.1.4 CONSUMER GOODS

• Goods that are demanded and bought by households and individuals 

1.1.4 INWARD SHIFT (L)

• A long-term fall in productivity of labour perhaps due to a decline in the quality of machinery

1.1.4 INWARD SHIFT (M)

• Large scale migration of people out of a country perhaps when there is high unemployment or a depression

1.1.4 INWARD SHIFT (N)

• The damaging effects of severe natural disasters such as tsunamis, earthquakes, floods, persistent drought and other extreme weather events many of which are now directly linked to the impact of climate change

1.1.4 INWARD SHIFT (W)

• The destruction caused by war and other types of conflict

1.1.4 OUTWARD SHIFT (L)

• Discovery of new natural resources (land)

  Discovery of commercially viable land drives higher extraction 

1.1.4 OUTWARD SHIFT (I)

• Innovation and invention of new products and resources

  Improved production processes help to lift efficiency so that we can get more outfit from given inputs

1.1.4 OUTWARD SHIFT (S)

• Increase in the stock of capital and labour supply

  From inward labour migration/increased capital investment

1.1.4 OUTWARD SHIFT (E)

• Higher productivity/efficiency of factor inputs

  This increases the output per unit of an input used in production 

1.1.4 OUTWARD SHIFT (M)

• Better management of factor inputs

  = Improved management reduces waste and improves quality 

1.1.5 SPECIALISATION

• specialisation is when we concentrate our scarce resources on a specific product or task

• the production of a limited range of goods by a company/individual/country which means that trade is essential as it is the only way they are able to access all they need

1.1.5 DIVISION OF LABOUR

• when labour becomes specialised in a particular part of the production process 

1.1.5 SPECIALISATION OF FOPs

• whilst some resources have many different uses, some may only have one use

• labour can differ greatly in terms of what they can do and what they are good at: some may be good at building things, whilst others may be good at designing computers

• so if a country wants to maximise the amount of goods and services it can produce they need to ensure that all factors of production, including workers, undertake the tasks that they are best at

1.1.5 ADAM SMITH- STATE

• He stated the concept of specialisation and the division of labour and showed how it can increase labour productivity (output per worker), allowing firms to increase efficiency and lower costs of production 

1.1.5 ADAM SMITH- DO

• he visited a factory and observed that the pin making process had been split into 18 different operations

• as a result, the company were able to produce 5,000 pins per person employed

• if the work had been carried out by workers making the whole pin from start to finish, it would have been less a few dozen

1.1.5 SPECIALISATION AND DOL IN ORGANISING PRODUCTION: ADVANTAGES

• The division of labour enables labour productivity to be increased- Workers will be quicker, better and more efficient as they are concentrating on one thing and so can quickly develop their skills. It also is likely they will have natural abilities or talents in their task

This may also lead to a higher quality of goods and services, since workers are more skilled at their jobs

• It is more cost effective to develop specialist tools, improving speed or quality

• time is not wasted moving between jobs and getting out tools etc.

• workers only need to be trained to do one specific task, rather than many, saving time and money

1.1.5 SPECIALISATION AND DOL IN ORGANISING PRODUCTION: DISADVANTAGES

• unrewarding, repetitive work can lower people’s motivation causing lower labour productivity

• workers may take less pride in their work and therefore quality of good and services suffers

• if production in one process is delayed, every other task has to stop until that problem is solved

• dissatisfied workers cause absenteeism rates to rise- increases costs for businesses- leads to high worker turnover

• mass produced standardised- goods lack variety for consumers

1.1.5 SPECIALISING IN THE PRODUCTION OF GOODS AND SERVICES TO TRADE

• if countries specialise, its essential that they trade in order to obtain all the goods and services that consumers demand

• trade has some disadvantages and advantages

1.1.5 SPECIALISING IN THE PRODUCTION OF GOODS AND SERVICES TO TRADE- ADVANTAGES

• the theory of comparative advantage states countries should specialise in producing those goods where they have a lower opportunity cost, and so they are relatively best at producing

• this will help them boost their economy

• on the whole, there is greater output globally

1.1.5 COMPARATIVE ADVANTAGE

• means that a country should focus on producing goods or services that it can produce more efficiently than others, even if it’s not the best in the world at making them

• what matters is that it has a lower opportunity cost, meaning it gives up less in producing those goods compared to other countries

• this way, each country focuses on what it does relatively best

1.1.5 COMPARATIVE ADVANTAGE- EXAMPLE

• if Country A is better at making both cars and computers than Country B, but Country A is especially better at making cars, it should focus on cars and trade for computers from Country B, which should focus on computers. This way, both countries benefit

• country A has the comparative advantage in cars because, even though it’s better at making both cars and computers, its advantage in making cars is greater. It gives up less to make cars compared to computers

• Country B has the comparative advantage in computers because, while it’s not as good as Country A at making either product, it’s relatively better at making computers (it has a lower opportunity cost when making computers)

• so, Country A should specialise in cars, and Country B should specialise in computers, and then they can trade to benefit both

1.1.5 SPECIALISING IN THE PRODUCTION OF GOODS AND SERVICES TO TRADE- DISADVANTAGES

• countries may become over dependent on one particular export and if this fails their economy may collapse- e.g. many developing countries specialise in farming and if crops fail due to weather they will have no income

• countries specialise in non-renewable resources and these could run out, which will result in a huge loss of income for that country- will also mean the loss of these resources

• high interdependence- will cause problems if trade is prevented, e.g. bc of war

• Some say that increased specialisation means there will be more competition to cut costs and therefore wages will fall- not necessarily true

1.1.5 OUTPUT

• refers to the total amount of goods or services produced by a business, industry, or economy over a certain period of time- the final result of combining inputs (land, labour, capital, and entrepreneurship) in the production process

• An economy’s output might be measured by its GDP, which reflects the value of all goods and services produced in the country

1.1.5 FUNCTIONS OF MONEY

• the introduction of specialisation in production means that a form of exchange is necessary to allow everyone to access what they need

• The earliest method of exchange was barter but this had many problems- these problems led to the development of money which has four key functions- a medium of exchange, a measure of value, a store of value and a method for deferred payment

1.1.5 A MEDIUM OF EXCHANGE

• can be used to buy and sell goods and services and is acceptable everywhere

• problem with barter was that people could only trade if there was a double coincidence of wants: where both parties want the good the other party offers

• since money can be used to buy all goods and services, everyone will accept money as they know they can use it to buy what they want

1.1.5 A MEASURE OF VALUE

• can compare the value of two goods, such as a table and a skirt.

• also able to put a value on labour

1.1.5 A STORE OF VALUE

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

• with barter, goods such as fruits often went out of date and so could not keep their value

1.1.5 A METHOD FOR DEFERRED PAYMENT

• Money can allow for debts to be created

• people can therefore pay for things without having money in the present, and can pay for it later (e.g. credit)

• this relies on money storing its value

1.1.5 CHARACTERISTICS OF MONEY

• valuable

• durable

• portable

• divisible

• accepted

• difficult to counterfeit

• uniform

1.1.6 FREE MARKET ECONOMY

• economy that has no government intervention in the allocation of resources or the distribution of goods/services

• individuals own the factors of production without government interference

• resources are allocated through the price mechanism

• consumers make decisions based on satisfaction and producers based on profit

• there are no completely free markets in the world today , because the government has to intervene at least to an extent, for example by issuing money, protecting property rights and breaking up monopolies- w/out this, the market mechanism could not work

1.1.6 ADAM SMITH

• believed in the free market economy and the laissez-faire approach by governments

• explained how there was an ‘invisible hand’ in the market which allocated resources to everyone’s advantage

• believed competition in the market caused lower prices as firms wanted to be competitive and so this benefits the consumer as they can get goods cheaply

• did argue that the state needed to provide goods and services which free markets wouldn’t such as. the laws, property rights and goods such as bridges and roads

1.1.6 FRIEDRICH HAYEK

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

• believed that the poor in free market (or freer market) countries were better off than those in command economies because at least they had personal freedom

• said that central planning by governments led to what a small minority wanted being forced on the whole of society

• believed that, although individuals don’t make supply and demand decisions based on perfect information, they best know what they need in their own situation

1.1.6 FREE MARKET- ADVANTAGES

• the system is automatic due to the invisible hand; resources are moved out of production of a good when people stop wanting it or costs are too high

• high motivation as people know working hard could lead to high potential rewards, creating conditions where initiative and enterprise flourish

• political freedom

• bc firms are in competition, they will produce goods at the lowest cost they can, ensuring productive efficiency

• efficient allocation of scarce resources- resources go towards where the expected profit is highest

1.1.6 FREE MARKET- DISADVANTAGES

• high levels of inequality, since the rich own more factors of production and so can grow richer

• a lack of merit goods (goods considered as intrinsically good) such as health and education- leads to a lower level of social welfare

• Resources could be wasted on unproductive expenses such as advertising, switching the factors of production and providing competitive services

• If competition disappears then there may be monopolies, who charge high prices and offer low quality of service

• problem of externalities leading to an unsustainable economic growth

1.1.6 COMMAND ECONOMY

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

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

• Resource allocation is carried out by gov- represents best wishes of consumers

• planning is so complex that some decisions are left up to the consumers- workers receive wages and can spend this on what they want, within limits

• some goods can be purchased whilst others, such as houses, are allocated

• Income distribution is determined by the government and all workers tend to receive the same wage, products are standardised and prices are limited causing excess demand

1.1.6 KARL MARX

• believed in the command economy and criticised capitalism

• believed that capitalist’s profit came from exploiting labour as they underpaid workers

• saw businesses growing and workers getting poorer, creating a two class system

• thought more firms would fail because of competition causing unemployment, lower wages and higher prices and this would lead to discontent amongst the working class

• stated that these workers would inevitably rise against property owners

• would lead to a democratic society where everything would be owned by everyone-the fall of capitalism to begin communism

1.1.6 COMMAND ECONOMY- ADVANTAGES

• state provides a minimum standard of living , ensuring no one is extremely poor as there is less inequality

• less wastage of resources as there is no need for competitive services nor advertising, which is very expensive

• Long term planning means that the industry doesn’t have to keep changing and shifting resources- important as some industries may take a number of years to get established and would fail if planning was short term

• Standardised products means that they are produced cost effectively

• generally motivated by the wellbeing of the country, rather than the companies, who are motivated by profit, decide resource allocation, objectives other than profit can be followed: merit goods are encouraged and increased whilst demerit goods aren’t produced

1.1.6 COMMAND ECONOMY- DISADVANTAGES

• impossible for the state to make so many decisions correctly, which could lead to over or under supply and a waste of resources

• decision making will be slow as it has to go through various stages and there could be an increase in bribery and corruption

• as everyone receives the same wage, there is less motivation and efficiency because people know that working harder will not increase their standard of living

• consumers lose their freedom and it is often led by dictators

1.1.6 MIXED ECONOMY

• both types of economies have benefits but also major problems so most economies have tried to move towards some form of compromise economy

• both the free market mechanism and the government planning process allocate a significant amount of the total resources in the country

• each country will have a different amount of control by the government, but it is usually between 40-60%

1.1.6 GOV’S ROLE IN A MIXED ECON (R)

CREATING A FRAMEWORK OF RULES

• prevent the abuse of monopolies: a company with more than 25% of market share

• They can protect customers as they pass a large amount of consumer protection laws to protect the consumers from poor quality products or services

• protect property rights

• ensure safety standards

1.1.6 GOV’S ROLE IN A MIXED ECON (PS)

SUPPLEMENTS AND MODIEIFES THE PRICE SYSTEM

• produce public and merit goods, such as emergency services and transport, and limit the production of demerit goods

1.1.6 GOV’S ROLE IN A MIXED ECON (RI)

REDISTRIBUTES INCOME

• move income from one group of people to another, from the rich to the poor

• use tax, such as income tax, to take money away from one group then give the money to the poor- in the form of benefits for those who are out of work or on low incomes, and in the provision of services for all, such as education and the NHS

1.1.6 GOV’S ROLE IN A MIXED ECON (S)

STABILISES THE ECONOMY

• government will attempt to manage the level of demand in the economy to prevent extremes of too much or too little demand