Economics Unit 1 Exam

What is economics?

The science of choice

Main branches of economics

Macroeconomics and microeconomics

Microeconomics

is the study of the economic behaviour of individual consumers and businesses. Microeconomic analysis will include the study of specific markets , why certain goods are preferred, or how the government taxes might influence consumption and production

Positive Economics

fact based economic statements that can be verified or tested to be either true or false. Objective and testable theories

Normative Economics

based on opinion or value judgements. Given their subjective nature, they cannot be tested or verified as either true or false

Economic Activity

all transactions that we undertake, or indeed all economic activity that naturally takes place in the economy

The concept of Economic Activity

can be described as the process if production, income, and expenditure that takes place in every economy

Production

can be thought of as the process if making a good or service

Income

is the money given to those involved in the production of goods and services

Expenditure

is the spending of income on goods and services

Relative Scarcity

the unlimited needs and want of societies are largen than the resources available to satisfy those needs and wants

Needs

the basic goods and services that are necessary for survival

Wants

considered to be something we desire to have to improve our satisfaction or quality of life, but that aren’t necessary for survival

Goods

are tangible, physical and storable items (e.g. cars, food, books) that can be owned and transferred

Services

intangible actions, skills, or efforts provided by others (e.g. healthcare, banking, haircuts) that cannot be stored or owned

Resources

are those things that are used to produce goods and services; also referred to as factors of production

Land or Natural Resources

refers to all those resources that occur in nature. These can be used in the production process to generate more elaborate products or consumed in their raw from.

Labour

refers to the mental and physical effort by humans in the production process. It primarily includes all the workers employed by businesses or the government in return for income, in the form of a wage or salary.

Capital

refers to those resources that have been made by combining labour and natural resources to create a more sophisticated input in the production process. Capital goods are made with the intention of making more goods and services in the future and generally these will increase the efficiency with which resources can be converted into products for final consumption.

Opportunity Cost

is the highest valued alternative foregone - the cost of the action you choose. It is measured by the value that would have been created by using the resources in their next best alternative use

Productive Efficiency

also referred to as technical efficiency entails maximizing outputs of goods and services from all available resources. Its anywhere along the PPC curve and maximizes output with no wastage.

Allocative Efficiency

occurs when resources are used to produce goods and service in a way that best satisfies society. Its somewhere on the PPC curve and is the combination that best meets the preferences of society

The Economic Questions

What, How, Who

What

which goods and services will be produced and in what quantity. How we allocate our scarce resources

How

how will the various goods and services be produced. How we allocate our scarce resources and what combination of factors of production will be used to produce the goods and services

Who

who will consume the goods and services, for whom to produce? How the goods and services will be distributed and allocated

The Economic Systems

• Market Capitalism

• Market Socialism

• Planned Capitalism

• Planned Socialism

Market Capitalism

is where the allocation of resources is decided by the market and productive resources are owned by private individuals and firms

Market Socialism

is where the government owns most of the resources but the market decides what goods and services are produced

Planned Capitalism

is an unusual economic system where the government directs the private owners of productive assets on how to produce certain goods and services

Planned Socialism

is where the government is primarily responsible for resource allocation and they own most of the resources

Circular Flow 1 Household - Business

Resources/factors of production provided to the business sector - labour, land, capital

Circular Flow 2 Business - Household

Income returns to the household sector for providing resources/factors of production - wages, salaries, rent, interest, profits

Circular Flow 3 Government/Household - Business

Expenditure on goods and services

Circular Flow 4 Business - Household

Production of goods and services (real GDP)

Cost-Benefit Analysis

is a comparison of the expected costs and benefits of something. They are used to determine if something is worth it

Material Living Standards

any increase real GDP or economic activity will help to raise material living standards. The higher levels of production lead to more income and/or employment enabling households to purchase more goods and services, thereby increasing their material prosperity

Non-material living standards

are a wide range of factors that influence our well-being beyond our ability to purchase goods and services. These ‘non-material’ or ‘quality of life’ factors that impact on our overall living standards

Living Standards

Ultimately, economic activity takes places because it improves our individual and collective standards of living, both in material and non-material terms

Tradeoff

If we wish to gain something of value with our money or time, we must forego the opportunity to do a range of other things with said money or time. These tradeoffs are necessary because we have a limited amount of money to spend and an infinite amount of things to spend it on, thus the problem of relative scarcity.

Dynamic efficiency

is the speed at which resources are reallocated from one area of production to another.

intertemporal efficiency

efficiency is achieved when resources are appropriately allocated between current consumption and future consumption.

Representative consumer

The traditional view of consumer behavior is the theory of the representative consumer or the 'rational man'

The Law of Diminishing Marginal Utility

The law of diminishing marginal utility states that each additional/marginal unit of a good or service that is consumed generates less utility/satisfaction than the previous one.

Positive incentive

A benefit or reward that encourage economic agents to make specific decisions or act in a particular way.

Negative Incentives

A cost that discourages economic agents to make a specific decision or act in a particular way.

Positive Externality

A positive externality in consumption occurs when consuming a good or service provides benefits to third parties not directly involved in the transaction.

Negative Externality

A negative externality in consumption occurs when consuming a good or service imposes a cost on third parties not involved in the transaction.

Nudge

A more subtle approach from the government to influence consumers behavior towards making more sensible decisions. It aims to bring about change in peoples behavior without resorting to financial incentives.

GDP

Gross domestic product is the standard measure of the value added creates through the production of goods and services through a given period of time.

Moral Hazards

occurs when people who cannot be easily monitored can be tempted to act in an irresponsible way if someone else is going to cover the cost of their behavior.

Traditional view for business

Businesses act purely for their own benefit with the aim to maximize their profit.

Consumer sovereignty

Consumers determine what and how much to produce through their expenditure. Businesses are motivated by profit and respond accordingly to produce the goods and services that consumers want.

Increase production

Governments use incentives to affect a businesses costs of production, profits and production decisions.

Decrease production

Governments can withdraw subsidies which increase the cost of production

Tariffs

Tariffs are taxes on imports, the removal of tariffs is a financial incentive that lowers the price of imported goods, exposing Australian businesses to import competing businesses.

Traditional view of government

The traditional role of the government is to maximize both dimensions of living standards, non-material and material.

Macroeconomic goals

- Sustainable economic growth

- Full employment

- Low and stable inflation

Sustainable economic growth

Involves achieving the highest rate of growth without jeopardizing inflation and intertemporal efficiency

Full employment

entails achieving the maximum growth in employment and the lowest level of unemployment possible without jeopardizing low and stable inflation.

Low and stable inflation

Involves keeping increases in the general price level between 2 and 3 percent.

Redistribution of income

Government will aim to promote a more equitable distribution of income, governments seek to distribute income in a fair but not equal manner, to ensure all members of society can enjoy a dignified standard of living.

Economic stabilisation

is when the level of economic activity is neither too strong nor too weak.

aggregate demand

is the total demand for all final goods and services in an economy at different price levels over a given period of time.

aggregate supply

is the total quantity of goods and services that all producers in an economy are willing and able to supply at different price levels over a given period of time.

Behavioural Economics

Combines economics and psychology to explain why consumers often make irrational decisions influenced by biases, emotions and social factors.

Traditional Economics

Assumes consumers are rational, fully informed and always act to maximise utility and self-interest. You cannot predict human behavior just using math’s, which is what is involved with traditional economics.

Bounded Rationality

Consumers cannot always make fully rational decisions because of limited information, time, cognitive ability and complexity.

Bounded Willpower

The notion that consumers do not possess absolute self-control when confronted and make decisions that are not in their long-term interests.

Bounded Self-Interest

Consumers are social beings and as such care about fairness, and are not always driven by narrow self interest to maximise their personal benefit.

Availability Heuristic

A tendency for consumers to rely on, and use information, that is easiest to remember or access when making decisions.

Herd Behaviour

Consumers follow the actions or choices of others instead of making independent decisions.

Overconfidence Bias

Where consumers often overestimate their ability to make good decisions.

Vividness

Consumers place too much importance on memorable or dramatic information or observations when making decisions.

Status Quo Bias

The tendency for consumers to stick with a existing choices or habits even though the decision to do so may no longer be in their best self-interest

Anchoring Effect

Consumer decisions are heavily influenced by an initial piece of information or “anchor”.

Framing Bias

The way information is presented affects consumer choices.

Loss Aversion

A cognitive bias whereby consumer feel losses more acutely than equivalent gains. They prefer certainty over risk.

Utility

The satisfaction or benefit gained from consuming a good or service.

Homo Economicus

The traditional economic assumption that consumers are perfectly rational and always maximise utility.

Present Bias

Consumers prioritise immediate rewards over long-term benefits.

Expected Value

The probability-weighted average outcome of a decision

Nudge

A subtle and low-cost strategy used to influence behaviour without removing freedom of choice.

Choice Architecture

The way choices are organised or presented to influence decision making.

Soft Paternalism

Government intervention that guides behaviour while still allowing freedom of choice.

Hard Paternalism

Government intervention that restricts or forces behaviour for consumers’ own benefit.

Incentive

A factor that encourages a particular behaviour.

Positive Incentive

A reward or benefit used to encourage behaviour.

Negative Incentive

A penalty or cost used to discourage behaviour.

Sugar Tax

A tax imposed by the government on sugary drinks designed to reduce consumption and address obesity-related negative externalities.

Market Failure

When resources are allocated inefficiently by the market.

Consumer Behaviour

The way consumers make decisions about spending and consumption.

Economic Reasoning

Using economic concepts and logic to explain decisions and outcomes.

Procrastination bias - Businesses

Businesses can use procrastination bias by making subscriptions or memberships sufficiently difficult or time-consuming to cancel.

Present bias - Businesses

Businesses use present bias by encouraging consumers to focus on the immediate benefits of a purchase while ignoring the future costs or financial consequences.

Availability Heuristic - Businesses

Businesses use availability heuristic by making their products or advertisements highly memorable, so consumers are more likely to recall and choose their brand when making decisions.

Status quo bias - businesses

Businesses may exploit this by making existing plans or subscriptions the default option, reducing the likelihood that consumers will switch or cancel.

Bounded Willpower - Businesses

Bounded Willpower - Businesses

Market

Any space that allows buyers and sellers to interact and exchange goods and services. (May or may not be a physical place)

Assumptions of a competitive market (3 points)

• A large number of buyers and sellers

• Homogenous product, meaning has substitutes

• Ease of entry and exit in the market