CIE AS Economics Chapter 1

marginal principle

the idea that economic agents may take decisions by considering the effect of small changes from the existing situation

microeconomics

the study of economic decisions taken by individual economic agents, including households and firms

macroeconomics

the study of the interrelationships between economic variables at an aggregate (economy-wide) level

opportunity cost

in decision making, the value of the next-best alternative forgone

basic questions of resource allocation

what? how? for whom?

model

a simplified representation of reality used to provide insight into economic decisions and events

positive statement

a statement about what is, i.e. about facts

normative statement

a statement involving a value judgement that is about what ought to be

value judgement

a statement based on opinions or personal beliefs, rather than on facts

ceteris paribus

a Latin phrase meaning ‘other things being equal’; it is used in economics when focusing on changes in one variable while holding other influences constant

factors of production definition

inputs into production, including land, labour, capital and enterprise

entrepreneur

someone who organises production and identifies potentially profitable projects to be undertaken

produced resources/fixed capital

inputs into the production process that are the products of a previous manufacturing process

working capital

goods that are used up during the production process

reward to labour

wages or salaries

wage

the reward to labour based on the number of hours worked multiplied by an hourly rate of pay

salary

the reward to labour on an annual basis

reward to capital

interest; the return that the firm gains from using the capital goods in the production process

reward to enterprise

profit

reward to land

rent

what is division of labour and specialisation

a process whereby the production procedure is broken down into a sequence of stages and workers are assigned to specialise in particular stages according to their skills

human capital

the stock of skills and expertise that contribute to a worker’s productivity

labour productivity

the amount of output produced per worker

advantages of specialisation

allows better use of limited resources so that overall the economy can produce more

disadvantages of specialisation

workers likely to get bored with repetitive tasks if they overspecialise and they therefore lose concentration and job satisfaction which may cause them to become inefficient and careless;
if a firm overspecialises in producing narrow range of products, they will suffer if demand for those products falls;
if nations overspecialise, they become dependent on imported goods which could make the country very vulnerable if conflict or war arises

advantages of division of labour

individual workers become skilled at preforming specialised tasks so they become more efficient;
workers do not spend time moving from one activity to another so production process is more efficient

role of the entrepreneur (3)

able to identify potential income earning opportunities for businesses;
willing to assess and bear the risk involved in embarking on new projects and start-ups;
responsible for organising other factors of production in the most efficient and effective way

enterprise culture

an economy in which taking a risk in the production of new products is encouraged in the hope of making a profit

short run

the period over which a firm is free to vary its input of one factor of production (labour) but faces fixed inputs of the other factors of production

long run

the period over which the firm is able to vary the inputs of all its factors of production

very long run

the period of time over which a firm is able to vary the inputs of all of its factors of production and in which technological change may occur and the government policy environment may alter

allocative mechanism

a method of taking decisions about the different uses that can be made of factors of production

market economy

market forces are allowed to guide the allocation of resources within a society

market

a way in which buyers and sellers come together to exchange products

advantages of the market economy

decisions are made by individual consumers, who act in their own self-interest, i.e. seek to maximise their utility or satisfaction when they consume a product;
decisions are made by individual producers, who act in their own self-interest, i.e. seek to maximise their profits;
the use of the price mechanism to allocate resources means that there is no need for any government intervention in the allocation of resources;
competition between firms can lead to greater efficiency

disadvantages of the market economy

merit good will be underprovided and under consumed;
demerit goods will be overprovided and overconsumed;
public good will not be provided or consumed at all because it would be impossible to charge a market price for them;
income and wealth disparities can be very significant

centrally planned economy

decisions on resource allocation are guided by the state

advantages of the planned economy

government intervention in the allocation of resources means it can take decisions in the national interest;
the government can intervene to bring about a more equitable distribution of income and wealth

disadvantages of the planned economy

micromanagement on this scale is costly to implement administratively;
a system with such a large amount of government influence and control will tend to be bureaucratic and, as a result, may be inefficient;
the lack of competition and the lack of the profit motive mean that products are often of poor quality with consumers having little choice

mixed economy

resources are allocated partly through price signals and partly on the basis of direction by government

methods of government intervention in mixed economy

providing market infrastructure, influencing allocation of resourced through imposing taxes and expenditure through regulation

economic problem

a situation where there are not enough resources to satisfy all human needs and wants

how is economics a social science?

Economics is social in the sense that it studies different aspects of human behaviour and, in particular, the choices that humans make. Economics is a science in the sense that it uses an organised system of theories and facts capable of making verifiable predictions. Economics can therefore be regarded as a social science because it uses scientific methods to establish theories that can help explain the behaviour of individuals, groups and organisations in societies.

transition economies

countries that moved from central planning to being a mixed economy

problems of transitional economies

employment, output, inflation, welfare

why is unemployment a problem in transitional economies

in market economy firms aim to maximise profits so they may lay off workers to save on production costs

why is output a problem in transitional economies

in a planned economy, it is possible for the state to support inefficient firms and industries; when state support is ended, such firms and industries may not be able to compete and so output could fall

why is inflation a problem in transitional economies

in a planned economy, the state controls prices so it is easier to keep down the rate of inflation; when prices are determined by the free-market forces of demand and supply, it is more difficult to control prices and so inflation is more likely

why is welfare a problem in transitional economies

a planned economy is able to provide housing and healthcare to everyone; with the introduction of market forces, there may be a fall in welfare provision and this may have a detrimental effect on levels of productivity in the economy

in a transitional economy, firms and consumers need to become accustomed to the idea that…

they have increased freedom to make decisions;
prices need to adjust and take a more active role in providing signals and incentives, that they need to take risk (instead of depending on state to take decisions for them)

production possibility curve (PPC)/production possibility frontier

a curve showing the maximum combinations of goods or services that can be produced in a set period of time given available resources and the state of technology

curve in ppc sometimes called a…

frontier

why is it called a frontier?

because it is the maximum level of output, cannot be beyond the frontier

what does it mean if the level of output is inside the frontier?

there is unemployment of some resources in the economy - inefficient therefore moving towards the frontier reduces unemployment

investment

expenditure undertaken by firms to add to the capital stock; an increase in the capital stock

consumption

household spending on goods and services in the economy

why is the PPC a curve and not a straight line?

not all factors of production are equally suited to the production of both sorts of goods

potential economic growth

an expansion in the productive capacity of the economy

do PPC shifts have to be parallel to original curve?

no because a determinant may affect only one of the goods

private goods/economic goods

goods that are scarce

free goods

goods that are not normally regarded as being scarce

features of a private good

excludability - other people can be excluded from consuming it
consumption is rivalrous - the act of consumption uses up the good
capable of being rejected - a person need not choose to consume it

public good

a good that is non-excludable, non-rivalrous and not capable of being rejected

free-rider problem

when an individual cannot be excluded from consuming a good and thus has no incentive to pay for its provision

merit goods

a good that brings unanticipated benefits to consumers such that society believes it will be underconsumed in a free market (government has better information about merit goods than consumers so government takes decisions on their behalf e.g. minimum school-leaving age)

market failure

a market imperfection which gives rise to an allocation of scarce resources which is not as efficient as it might otherwise have been

market imperfection

a feature of a market which does not perform perfectly because of a failure to make an optimal use of resources, necessitating government intervention

demerit good/merit bads

a good that brings less benefit to consumers than they expect, such that too much will be consumed by individuals in a free market