1. Basic economic ideas and resource allocation Flashcards
Fundamental economic problem of scarcity
1.1.1
Economic problem arises because resources are scarce while people’s wants are unlimited.
The fundamental economic problem means that individuals, firms and governments have to make choices due to the scarcity of resources. Making a choice involves taking decisions on how to allocate scarce resources between many competing uses.
Need to make choices at all levels
(Individuals, firms, governments)
1.1.2
There are certain basic needs that we need satisfy first. Then we want goods that seem less essential but that improve quality of life. These wants are sometimes called luxuries, but what is a luxury for one individual may be considered as an essential for other.
This is because of different scale of preferences(on which you place your more urgent wants at the top and the less urgent at the bottom). Each individual’s scale of preferences is a product of a set of influences, including culture, life experiences. Together which affects our likes and dislikes.
For example: Chainging of wants as we grow older. Single-person household which needs a car with only two doors, changing to family car with 5 doors as his family gets larger.
Another example: People may want to improve their fitness after seeing a TV programme about obesity.
Nature and defenition of opportunity cost, arising from choices
1.1.3
The true cost of any choice made between alternatives is expressed in terms of opportunity cost.
Basic questions of resource allocation:
- How to produce
- For whom to produce
- What to produce
1.1.4
The three questions are related to the allocation of resources.
- What to produce?
Economies can not produce everything, so they need to decide what to produce in what quantities.
- How to produce?
Firms have to consider how resources are used so that they achieve the best outcome.
- For whom to produce?
Governments have to decide whether everyone is going to have a more or less equal share of what is being produced or whether some will have more than others.
Economics as a social science
1.2.1
Simple defenition os economics is the study of how to allocate resources in the most efficient way
Positive and normative statements
(the distinction between facts and value judgements)
1.2.2
Postitive statement refer to what will happen, based on actual evidence or observation.
- A fall in supply of petrol leads to an increase in its price.
- A 10% increase in tourist numbers in Mauritius has created 10% more employment.
Normative statement is when economist expresses an opinion or makes a value judgement within their analysis, the statement can no longer be proven.
- A fall in the supply of petrol should lead to an increase in its price.
- A 10% increase in tourist numbers in Mauritius is likely to create at least 15% more jobs in the tourist industry.
Meaning of the term ceteris paribus
1.2.3
Ceteris paribus allows economists to simplify a situation by assuming that apart from a single change of circumstances, everything else is unchanged. In this way, economists can model the effects of one change at a time.
For example, when analysing the reasons why consumers purchase a product, there may be many reasons. The most important reason is usually price. In analysing the effect of a change in price, it is understood that all other factors that determine consumer demand are ceteris paribus. In other words, they are not subject to change.
Importance of the time period
(short run, long run, very long run)
1.2.4
- Short term - is a time period in which it is possible to change only some inputs. Typically, it is when labour can be increased or decreased to change what is produced.
- Long term - it is possible for all factors of production or resources to change. So, in the long run, a firm may improve the quality and quantity of its capital by building a new factory to increase its output.
- Very long term - is where not only are all factors of production variable but all other key inputs are variable. Key inputs can include technology, government regulations and social concerns.
Nature and definition of factors of production
land, labour, capital and enterprise (mention rewards also)
1.3.1
- Land refers to land itself and all natural resources it has. The reward for land is rent or in case of minerals, like gold, can be a payment for extraction.
- Labour is the human resources available in an economy. The reward is wage.
- Capital a physical resourc made by humans that aids the production of goods. The reward for using capital is financial return.
- Enterprise involves organising production and taking risk. Reward is profit.
Difference between human capital and physical capital
1.3.2
-
Human capital refers to the knowledge, skills, education, training, experience, and other attributes possessed by individuals in a population. It represents the collective abilities and expertise of a workforce.
Characteristics:
Intangible: Human capital is intangible and resides in the minds and capabilities of individuals.
Developed over time: It is often accumulated through education, training, and on-the-job experience. - Physical capital refers to the tangible, physical assets that are used to produce goods and services, like factories, machines, and tools.
- Physical capital is relatively easy to measure and quantify, and it can be bought and sold on the market.
- Physical capital depreciates over time and requires ongoing investment to maintain and replace it.
Division of labour and specialisation
1.3.4
-
Specialisation refers to a situation where individuals and firms, regions and entire economies concentrate on producing some goods and services rather than others.
* It allows individuals to concentrate upon what they are best at doing, meaning more goods and services will be produced.
* The pace of technological change means there is always the possibility that the specialist skills and experience that any individual has acquired may become redundant as the economy develops. Individuals need to be flexible and multi-skilled and to be able to move between occupations.
Divison of labour:
* Large numbers of workers within very large production units has allowed the process of production to be broken down into a series of tasks.
* This division of labour is usually quicker and cheaper than having one person complete each garment on their own. It allows workers to become more specialised and can lead to an increase in output per worker and an improvement in the quality of the finished product.
What are economic systems?
1.4.1
The choices that are made and how they are made is determined by the economic system. It identifies the means by which decisions are made realiting to the three resource allocation questions.
The market economy
1.4.2
- In market economy reources are allocated by the forces of demand and supply through the price mechanism.
- Decisions are regularly taken by individuals and firms.
- The government has little or no direct involvment in resource allocation.
- The role of the government in the market economy is monitor actions on the market and intervene when price mechanism does not provides the best resource allocation.
The planned economy
1.4.3
- The government has a cental role in all decisions that are made.
- The decions-making is based on planning boards and organisations and, in principle, production is controlled by the state.
- The preferences of consumers and manufacturing organisations are controlled centrally.
- In other words, government is responsible for the allocation of all resources in an economy
- Goverment controls the prices of the goods, usually low and fixed prices, which creates problems because of the scarcity emerging from excess demand.
- Government of planned economies tend to set goals to achieve a high rate of growth in order to catch up on the progress made by the advanced market economies.
The mixed economy
1.4.4
The mixed economy is the typical economic system. In a mixed economy, both the private sector and public sector have a part to play in the allocation of resources. Decisions involve an interaction between firms, labour and the government mainly through the market mechanism. There is private ownership of most productive resources although there is some public ownership.
Nature and meaning of a production possibility curve (PPC)
1.5.1
The quality and quantity of factors of production determines an economy’s production possibilities.
Shape of the PPC: constant and increasing opportunity costs
1.5.2
Constant opportunity cost: means when opportunity cost of switching production from one good to another is same proportionate.
Increasing opportunity cost: means that economy is going to lose production of a Good A more than additional unit of producing Good B.
Causes and consequences of shifts in a PPC
1.5.3
A shift in the PPC means that productive capacity has changed.
Two main reasons why shift occur:
- More resources become available in the economy or improvement in the quality of the resources used. This means that there is increase in the factors of production.
- Technological change. Advances in technology makes production processes more effective and efficient which increase productive capacity of an economy.
Significance of a position within a PPC
1.5.4
- At any point exactly on the curve represents a production is maximised.
- Point whithin the curve means that economy allocates its resources ineffitiently since it produces less than it could.
- Point outside the curve is impossible outcome as economy do not have enough resources for that level of production.
Nature and definition of merit goods: under-consumption and imperfect information in the market
1.6.3
A merit good is a good that is thought to be desirable but which is underprovided by the market.
Information failure arises because consumers do not recognise how good or bad a particular product is for them: either they do not have the right information or they simply lack some relevant information.
The ever-increasing information available to consumers should enable them to take rational decisions that maximise consumer welfare. Where this happens, the market works efficiently.
Consumers may recognise the benefits of merit goods but lack the disposable income to be able to afford to buy the goods in the quantity they would like or not at all.
Nature and definition of demerit goods: over-consumption as a result of imperfect information in the market
1.6.4
Consumers may be ignorant of the harmful effects of demerit goods on themselves and on others. Consumers might be indifferent, choosing not to care. This is particularly true of ‘junk food’ which is of low nutritional value, readily available, cheap and quick to consume. In high-income economies especially, adult and child obesity is already a serious problem and expected to get worse.
Governments seek to reduce consumption of demerit good by imposing heavy indirect taxes, advertising restrictions and health warnings and images on cover.
