Economics so far

What is the basic economic problem?

Scarcity of resources + unlimited wants → the need to make choices which incur an opportunity cost.

What is labour?

Mental and physical effort in a workforce for a wage.

What three basic questions does an economic agent try to answer?

1.  What to produce? (how to allocate resources / understanding the market)

2.  How to produce? (capital vs labour)

3.  For whom to produce? (who is the target audience)

What does the production possibility curve represent?

A diagrammatic illustration of the basic economic problem

What do points on the ppc show?

Full use of resources → productively and allocatively efficient.

What does any point inside the curve show?

Inefficient use of resources (wasted potential / spare capacity).

What does any point outside the PPC curve show?

Impossible – not enough resources.

What does any movement along the curve involve?

Opportunity cost, re allocating resources

What does a concave (bowed-out) PPC show?

Increasing opportunity cost due to non-homogeneous (diversified / not all the same) resources. Land used first is best for wheat; subsequent land is less suited, so opportunity cost rises.

What does a straight-line PPC show?

Constant opportunity cost due to homogeneous (identical / all the same) resources.

Example of non-homogeneous resources leading to increasing opportunity cost?

As more rice is produced, fields that are better for rice than wheat are used → opportunity cost of rice rises.

What causes the PPC to shift?

Changes in the quantity (Q) or quality (Q) of the factors of production (FOPs).

What causes an outward shift of the PPC?

Increase in quantity or quality of FOPs (economic growth). Examples:

•  Technological advancements

•  Investment in capital/infrastructure

•  Net immigration

•  Policies to increase birth rate

•  Better healthcare / education & training

•  Annexation of land

•  Cuts in corporation tax / reduction of red tape

•  Reclaiming land (e.g. flood defences)

What causes an inward shift of the PPC?

Decrease in quantity or quality of FOPs. Examples:

•  Natural disasters

•  War

•  Pandemics/epidemics

•  Civil unrest (strikes, protests destroying capital)

•  Failure to maintain infrastructure

•  Lack of investment in education/training (human capital deteriorates)

What is an economy?

A geographical area that tries to solve the basic economic problem.

Define gdp

The total value of the final output produced within an economy in a given time period

Define GNP

GDP + Net Factor Income from abroad (e.g. KFC in Uruguay contributes to USA GNP).

What is net factor income?

Funds entering the economy from local FOPs working abroad minus money sent out by foreign FOPs working within the economy.

•  Inflows > Outflows → more £ enters the UK

•  Outflows > Inflows → the UK loses £

E.g. KFC contributes to USA NFI

In a closed economy with no government or trade, what is the relationship?

GDP = Total Output = Total Expenditure = Total Income

What are injections?

Any funds that enter the circular flow of income (Government spending G, Exports X, Investment I).

What are leakages / withdrawals?

Any funds that leave the circular flow of income (Taxes T, Imports M, Savings S).

State the Bath-tub Theorem.

•  Injections > Leakages → GDP ↑, economy grows

•  Injections < Leakages → GDP ↓, economy contracts

•  Injections = Leakages → GDP constant, economy stable

What is Aggregate Demand?

The level of planned expenditure in an economy in a given time period.

Formula: AD = C + I + G + (X – M)

What does the AD curve show?

Inverse relationship between general price level and real GDP (downward sloping).

When is the economy in equilibrium?

When Aggregate Supply = Aggregate Demand.

What causes a movement along the AD curve?

A change in the general price level (inflation/deflation).

•  GPL ↑ → AD contracts (movement left along curve)

•  GPL ↓ → AD expands (movement right along curve)

What causes a shift of the AD curve?

Any factor other than the price level that changes the components of AD (C, I, G or X–M).

What is the largest component of AD in the UK?

Consumption (C)

Write the Keynesian Consumption Function.

C = C₀ + cY

•  C₀ = autonomous consumption (minimum amount needed to survive even when Y = 0)

•  cY = induced consumption (MPC × income)

•  MPC = ΔC / ΔY (gradient of the consumption function)

As income increases so does induced consumption they spend more because they can

What does the Keynesian Consumption Function show?

Total consumption rises as income rises because consumption is made up of autonomous + induced consumption. Induced consumption depends on MPC × Y earned.

Why is MPC usually higher for low-income households?

They tend to spend a larger proportion of any extra income; higher-income households tend to have a lower MPC.

What is real disposable income? RDY

Income after taxes + benefits

How does real disposable income affect consumption?

When RDY rises (income after tax & inflation), households spend more as they can afford more goods/services → C ↑.

How do interest rates affect consumption?

Higher interest rates raise the opportunity cost of spending → households save more → C ↓ (and vice versa).

What is the wealth effect?

When the value of physical + financial assets rises, households feel more confident about the economy → ↑ consumer confidence → ↑ spending on durables + non-durables → C ↑.

How does household composition affect consumption

Larger households tend to have less disposable income per head but more needs/wants → higher total consumption.

How does consumer confidence affect consumption?

High confidence (optimistic about jobs, promotions, earnings) → spend more → C ↑

Low confidence → save more (nervous about the future) → C ↓.

Q: How do expectations of future prices affect consumption?

A: Expectation of falling prices → hold back spending.

Expectation of rising prices → bring purchases forward (especially big-ticket items) → C ↑ now.