Nature of Economics

1.1.1 - Economics as a Social Science

  • Economists develop models using assumptions to understand micro and macroeconomic impacts.
  • Ceteris Paribus: Assumption that all factors except one remain constant.
    • Simplifies analysis of policy effects, such as a decrease in interest rates affecting Aggregate Demand.
  • Economic models (e.g., Phillips Curve) explain relationships through research on economic statistics.

1.1.2 – Positive and Normative Statements

  • Positive Statements: Fact-based and objective, e.g. "Inflation increased by 1%."
  • Normative Statements: Opinion-based and subjective, e.g. "Monetary policy is ineffective."
  • Value judgements affect government policy decisions, showcasing the contrast between political perspectives.

1.1.3 – The Economic Problem

  • Scarcity: Limited resources vs. unlimited wants.
    • Forces decisions on production: what, how, and for whom to produce.
  • Opportunity Costs: The cost of the next best alternative when making choices.
  • Resource Types:
    • Renewable: Replenished naturally, e.g. solar energy.
    • Non-renewable: Depleted faster than regenerated, e.g. oil.

1.1.4 – Production Possibility Frontiers (PPF)

  • PPF: Curve showing maximum production capacity of two goods.
    • Pareto Efficiency: No resource reallocation can increase one good's output without reducing another.
  • Moving along the PPF illustrates trade-offs and opportunity costs.
    • Points within PPF indicate inefficiency; outside the curve indicates unattainability, requiring new resources.

1.1.5 – Specialisation and the Division of Labour

  • Adam Smith: Advocated for specialisation to enhance productivity and wealth.
    • Advantages: Increased output, less wastage, lower unit costs.
    • Disadvantages: Worker boredom and over-reliance on specific industries can lead to unemployment if conditions change.

1.1.6 – Free Market Economies, Mixed Economies, and Command Economies

  • Free Market (Adam Smith): Resources allocated efficiently through self-interest.
  • Command Economy (Karl Marx): Resource allocation by the state, critiqued capitalism for exploiting workers.
  • Mixed Economy: Combines elements of both; allows for limited government intervention.

How Markets Work

1.2.1 – Rational Decision Making

  • Producers aim to maximise profits and consumers to maximise utility.
    • Decisions made where marginal cost equals marginal revenue (for producers) and where marginal cost equals marginal utility (for consumers).

1.2.2 – Demand

  • Demand: How much consumers are willing to buy at various prices.
    • Shifts in Demand Curve: Caused by factors like income changes, tastes, advertising, and prices of related goods.

1.2.3 – Price, Income, and Cross Elasticities of Demand

  • Price Elasticity of Demand (PED): Sensitivity of demand to price changes.
  • Income Elasticity of Demand (YED): Responsiveness of quantity demanded to income changes.
  • Cross Elasticity of Demand (XED): Responsiveness of demand for one good to the price change of another good.

1.2.4 – Supply

  • Supply: Quantity firms are willing to offer at various prices, usually positively correlated with price.
  • Shifts in Supply Curve: Influenced by production costs, technology, taxes, subsidies, and number of firms.

1.2.5 – Elasticity of Supply (PES)

  • Measures responsiveness of quantity supplied to price changes, with interpretations similar to PED.

1.2.6 – Price Determination

  • Equilibrium Price: Where supply equals demand; market clears.

1.2.7 – Price Mechanism

  • Functions:
    • Rationing: Allocates resources during excess supply/demand.
    • Signalling: Price changes communicate information to consumers and producers.
    • Incentives: Higher prices encourage increased production.

1.2.8 – Consumer and Producer Surplus

  • Consumer Surplus: Difference between what consumers are willing to pay vs. actual price.
  • Producer Surplus: Difference between the price received and minimum acceptable price.

1.2.9 – Indirect Taxes and Subsidies

  • Indirect Tax: Tax added to a product's price, influencing cost and demand.
  • Subsidy: Financial support to increase production or lower consumer prices.

1.2.10 – Alternative Views of Consumer Behaviour

  • Rational consumers don't always exist; factors like habits, emotions, and weaknesses affect decisions.

Market Failure

1.3.1 – Types of Market Failure

  • Externalities: Costs/benefits to third parties not reflected in market prices.
  • Public Goods: Non-rival and non-excludable, prone to under-provision.
  • Information Gaps: Asymmetric information leads to poor economic decisions.

1.3.2 – Externalities

  • Negative Externalities: Overproduction leads to costs borne by third parties.
  • Positive Externalities: Underproduction leads to unrecognized societal benefits.

1.3.3 – Public Goods

  • Characteristics: Non-rival and non-excludable, often provided by the government to avoid free rider problems.

1.3.4 – Information Gaps

  • Asymmetric vs. symmetric information affects market efficiency and decision making.

Government Intervention

1.4.1 – Government Intervention in Markets

  • Indirect Tax and Subsidies: Used to influence consumption patterns.
  • Government Regulation: Aims to limit negative externalities but can lead to inefficiencies.
  • Trade Pollution Permits: Limits emissions while allowing some flexibility.

1.4.2 – Government Failure

  • Occurs when government intervention leads to inefficiencies that worsen the initial market failure.