1 - Economic Methodology and the Economic Problem Flashcards
What is economics?
- A social science
- Studies the economic behaviour of both individuals and groups of people, and the economic relationships between individuals and groups
- E.g. demand theory or how seeing how consumers interact with firms or producers
What key assumption do economists make on economics as a whole?
- Economists need to make assumptions
- A key assumption is assuming that events occur with ceteris paribus. This assumption is that other things are being held equal or constant, so nothing else changes.
How is science portrayed differently in economics compared to natural sciences?
- Economists cannot conduct scientific experiments so models are devised
- Economists then use real-life scenarios to build these models upon, and assumptions are made with the models.
What is a positive statement?
- A statement of fact that can be scientifically tested to see if it is correct or incorrect
- They’re objective
How can positive statements be tested?
With factual evidence, and can consequently be rejected or accepted
What is an example of a positive statement relating to demand of alcohol?
Raising the tax on alcohol will lead to a fall in the demand of alcohol and a fall in the profits of pub landlords
What’re the advantages of positive statements?
These statements can be tested, the results can be examined and the statement can then be rejected or accepted
What is a normative statement?
A statement based on value judgements and cannot be refuted just by looking at the evidence
How do you find a positive statement?
Look for words such as ‘will’, ‘is’
How do you find a normative statement?
Look for words such as ‘should’, and if the statement is suggesting one action is more credible than another
What is an example of a normative statement relating to allocative resources?
- ‘The free market is the best way to allocate resources’
- Based on opinion and suggests one method of resource allocation is better than another.
What do value judgements influence?
- Economic decision making and policy
- Different economists may make different judgements from the same statistic. E.g. the rate of inflation can give rise to different conclusions.
What is the impact of moral and political judgements?
People’s views concerning the best option are influenced by the positive consequences of different decisions and by moral and political judgements
What is a need?
Something that is necessary for human survival e.g. food, clothing, warmth or shelter
What is a want?
Something that is desirable, e.g. phone, but isn’t necessary for survival
What is the purpose of economic activity?
To produce goods and services which satisfy consumer needs and wants
What is required to produce goods and services which satisfy consumer needs and wants
Using resources (inputs in the form of the factors of production) to produce outputs (the goods and services)
What are the three questions economists ask to make the decision about how to use scarce resources?
- What is to be produced?
- How should it be produced?
- Who will benefit from the goods and services produced?
Why is ‘what is to be produced?’ a question economists have to ask when deciding about how to use scarce resources?
- The government and private sector is faced with this decision. They also have to consider how much of each good is to be produced.
- Due to the problem of opportunity cost, they have to be careful about the decisions made.
Why is ‘How should it be produced?’ a question economists have to ask when deciding about how to use scarce resources?
- It considers how the goods and services produced will be distributed
- The rewards from each factor of production are considered.
- Firms aim to minimise costs and maximise profits, so production needs to be efficient
- They will consider how much each factor of production costs and how productive it is
- This will help them decide between labour intensive production and capital intensive production
Why is ‘who will benefit from the goods and services produced?’ a question economists have to ask when deciding about how to use scarce resources?
- Consumers who have purchasing power can benefit from the goods and services produced
- Those who are willing and able to pay the price charged for a good or service will get the good or service
What is an economic system?
The set of institutions within a community decides what, how and for whom to produce
What is a market economy?
An economy in which goods and services are purchased through the price mechanism in a system of markets
What is a command economy?
An economy in which government officials or planners allocate economic resources to firms and other productive enterprises
What is a mixed economy?
An economy that contains both a large market sector and a large non-market sector in which the planning mechanism operates
What is production?
Converts inputs or factor services into outputs of goods and services
What is a capital good (producer good)?
A good which is used in the production of other goods or services
What is a consumer good?
A good which is consumed by individuals or households to satisfy their needs or wants
What are economic resources?
- The factors of production.
- These are land, labour, capital and enterprise.
What are factors of production?
- Inputs into the production process
- E.g. land, labour, capital, and enterprise
What is capital and its reward/ incentive?
- Physical: goods which can be used in the production process Fixed: Machines; buildings Working: finished or semi-finished consumer goods
- Reward = Interest from the investment
What is entrepreneurship and its reward/ incentive?
- Managerial ability.
- The entrepreneur is someone who takes risks, innovates, and uses the factors of production. - Resources are drawn together into the production process
- Reward = Profit- an incentive to take risks
What is land and its reward/ incentive?
- Natural resources such as oil, coal, wheat, water
- It can also be the physical space for fixed capital
- Reward = Rent
What is labour and its reward/ incentive?
- Human capital, which is the workforce of the economy
- Reward = Wages
What type of resource is the environment?
- A scarce resource
- There are only a limited amount of resources on the planet
- These are made up of renewable and non-renewable resources
What is a renewable resource?
- A resource (e.g. timber) that with careful management can be renewed as it is used
- This is important in environmental economics, and can be managed by preventing or limiting deforestation, or imposing fishing quotas. Renewable resources are sustainable.
What are examples of renewable resources?
- Commodities such as oxygen, fish, or solar power are renewable assuming the rate of consumption of the resource is less than the rate of replenishment.
- If the resource is consumed faster than it is renewed, the stock of the resource will decline over time
What is the problem currently with renewable resources?
Resources are being consumed faster than the planet can replace them. The Worldwide Fund for Nature claims that two planets will be required to meet global demand by 2050 if this continues
What is an non-renewable resource?
- A resource (e.g. oil) that is scarce and runs out as it is used
- Can’t be renewed
What are examples of non renewable resources and how they run out over time?
- Things produced from fossil fuels such as coal, oil and natural gas are non-renewable
- The stock level decreases over time as it is consumed
- Methods such as recycling and finding substitutes, such as wind farms, can reduce the rate of decline of the resource
What is the fundamental economic problem and why?
- Scarcity
- Wants are unlimited and resources are finite, so choices have to be made. Resources have to be used and distributed optimally
What is an example of scarcity?
- If you only have £1 and you go to a shop, you can buy either the chocolate bar or the packet of crisps.
- The scarcity of the resource (the money) means a choice has to be made between the chocolate and the crisps
What is the link between scarcity and opportunity cost?
Scarcity gives rise to opportunity cost.
- The opportunity cost of a choice is the value of the next best alternative forgone.
- E.g. when deciding which snack the opportunity cost of choosing the crisps is the chocolate bar
As an example, how does opportunity cost link when buying a car
- If a car was bought for £15,000 and after 5 years the value depreciates by £5,000, the opportunity cost of keeping the car is £5,000 (which could have been gained by selling the car), regardless of the starting price
Who are economic agents?
An individual, a household or a firm
Where does a choice arise from when relating to an economic agent?
An economic agent has to choose between two or more alternatives which are mutually exclusive, in the sense that it is impossible or impractical to achieve both at the same time
How is opportunity cost important to economic agents based on examples?
- Producers might have to choose between hiring extra staff and investing in a new machine.
- The government might have to choose between spending more on the NHS and spending more on education
- They cannot do both because of finite resources, so a choice has to be made for where resources are best spent.
Draw a production possibility diagram?
(image)
What is a key feature of a production possibility diagram?
Production possibility frontier (PPF)
What does the PPF illustrate in a production possibility diagram?
The different combinations of two goods, or two sets of goods, that can be produced with a fixed quantity of resource, providing we assume that all available resources are being utilised to the full
What does the PPF show in this diagram (diagram)?
Shows what the economy can produce, assuming that all the labour, capital and land at the country’s disposal are employed to the full, and assuming a given state of technical progress
What features of the fundamental economic problem does the production possibility diagram illustrate?
- Resource allocation
- Opportunity cost and trade-offs
- Unemployment of economic resources
- Economic growth
What are the two macroeconomic ways in which PPF diagrams can be used?
- To show economic growth
- To show full employment and unemployment
What is resource allocation?
The process through which available factors of production are assigned to produce different goods and services
What is productive efficiency?
- For the economy as a whole occurs when it is impossible to produce more of one good without producing less of another
- For a firm it occurs when the average total cost of production is minimised
When does productive efficiency occur?
Occur when output is maximised from available inputs
How does productive inefficiency occur?
Occur when producing more of one good involves reducing production go other goods
With what PPF shows, what does that mean for productive efficiency and inefficiency?
- All points on the economy’s production possibility frontier are productively efficient
- By contrast, all points inside the PPF are productively inefficient
What are capital goods?
Goods which can be used to produce other goods, such as machinery.
What are consumer goods?
Goods which cannot be used to produce other goods, such as clothing
How is economic growth shown in PPF and how can it be achieved?
- Economic growth can be shown by an outward shift in the PPF, from the curve with point A on it, to the curve with point B on it.
- A decline in the economy would be depicted by an inward shift
- Can be achieved with the use of supply side policies
What does the original curve drawn of PPF assume?
- A fixed amount of resources are used
- There is a constant state of technology
Explain this PPF curve.
Moving from Point A to B will lead to an increase in services (21-27). But, the opportunity cost is that output of goods falls from 22 to 18.
At point D, the economy is inefficient. At point D, we can increase both goods and services without any opportunity cost.
Productive efficiency is any point on the PPF curve. On the PPF curve, it is impossible to increase one choice, without causing less production of the other.
What is opportunity cost?
The cost of giving up the next best alternative.
What is economic growth?
The increase in the potential level of real output the economy can produce over a period of time.
