1: The foundations of economics

Question 1

What is scarcity?

Answer 1

The situation in which available resources, or factors of production, are finite, whereas wants are infinite.

Question 2

What is economics?

Answer 2

The study of choices leading to the best possible use of scarce resources in order to best satisfy unlimited human wants and needs.`

Question 3

What does scarcity lead to?

Answer 3

Scarcity forces society to make a choice between available alternatives, e.g. “guns or butter” or more realistically a country’s defense or food.

Question 4

What questions does scarcity provoke?

Answer 4

1. What to produce (and how much)
2. How to produce - factors of production
3. For whom to produce - distribution of resources

Question 5

What is resource allocation?

Answer 5

It refers to assigning available resources, or factors of production, to specific uses chosen among many possible alternatives.

Question 6

Are any goods overallocated/underallocated?

Answer 6

We say that weapons are overallocated and there is an underallocation of healthcare and education.

Question 7

Utimately, what does the question “for whom to produce” rely on?

Answer 7

Income distribution since the amount of output people can obtain largely depends on their income.

Question 8

What are the four factors of production? Explain them and give examples for each.

Answer 8

1. Land - natural resources including everything that is under or above the land (minerals, oil reserves, forests, rivers, lakes)
2. Labour - Physical and mental effort provided for the production of resources (plumber, economist, doctor)
3. Capital - a man made factor of production used to produce goods and resources (airports, tools, factories)
4. Entrepreneurship - human skills, the ability to innovate and take risks of failure of a business. It uses the other three factors of production.

Question 9

What are the types of capital?

Answer 9

1. Physical - man-made capital (airports, roads)
2. Human capital - skills and knowledge
3. Natural capital - land and natural resources (air, biodiversity, soil)
4. Financial capital - stocks and bonds or money

Question 10

What is the production possibilities curve/frontier?

Answer 10

A curve that represents all combinations of the maximum amounts of two goods that can be produced by an economy, given its resources an technology, when there is full employment of resources and productive efficiency.

Question 11

What are the points on the PPF referred to as?

Answer 11

Production possibilities.

Question 12

What conditions must be met in order for an economy to be on the PPF?

Answer 12

1. All resources must be fully employed. Any unemployment of some resources would mean the economy would not be producing the maximum it could.
2. All resources must be used efficiently. There must be productive efficiency.

Question 13

What is production efficiency?

Answer 13

Output is produced at the lowest possible cost.

Question 14

What happens if a country is not at production efficiency?Is a country ever on the PPF?

Answer 14

The country will be at a point inside the PPF. No, there is always some productive inefficiency.

Question 15

How does the PPF illustrate the ideas of scarcity, choice, and opportunity cost?

Answer 15

1. No country can move outside the PPF (without trade) showing there is scarcity.
2. Scarcity forces the economy to make a choice about what particular combination of goods it produces, shown as a country must have a point on (or in real life, inside) the PPF.
3. Scarcity means that choice involves opportunity costs, shown by the fact that at any point on the curve, it is impossible to increase the output of one good, without decreasing the output of another. This sacrifice is the opportunity cost. This is shown be a curve in the PPF.

Question 16

Why does the PPF bend outwards to the right?

Answer 16

The opportunity cost changes as you produce more or less of one good. This is because of specialization of factors of production. Different goods require different resources to make them, so as you switch from making microwaves to computers you must give up an increasing amount of microwaves since the factors of production used to produce microwaves are not the same as computers.

Question 17

What does it mean if the PPF is a straight line?

Answer 17

The opportunity cost is constant. This occurs when factors of production for both goods are equal, such as basketballs and volleyballs.

Question 18

Why is economics considered a social science?

Answer 18

It deals with human society and behaviour and particularly those aspects concerned with how people organise their activities and how they behave to satisfy their wants and needs. It is a social science because its approach to studying human society is based on the social scientific method.

Question 19

Outline the social science method:

Answer 19

1. Make observations of the world around us and select an economic question we want to answer.
2. Identify variables we think are important to answer the question.
3. Make a hypothesis about how the variables are related to each other.
4. Make assumptions.
5. Test the hypothesis to see if its predictions fi5 with what actually happened in the real world.
6. Compare the predictions of the hypothesis with real-world outcomes.

Question 20

What is a model?

Answer 20

A simplified representation of something in the real world, used to understand and explain real life situations.

Question 21

What is an economic model?

Answer 21

In economics, models are often illustrated by use of diagrams showing the relationship between important variables. More advanced models may use mathematical equations.

Question 22

What is the difference between a theory and a law?

Answer 22

A theory tries to explain why certain events happen and make predictions whereas a law is a concise statement that is supposed to have universal validity.

Question 23

What is rational economic decision making?

Answer 23

This means that individuals are assumed to act in their best self interest, trying to maximise the satisfaction they expect to receive from their economic decisions.

Question 24

What is a positive statement in economics?

Answer 24

About what things are (facts, true or false)
• They may describe something
• They may be about a cause and effect relationship
•They may be statements in a theory

Question 25

What is a normative statement in economics?

Answer 25

About what things ought to be

Question 26

What are positive and normative economics used for?

Answer 26

Positive for laws and normative for policy making

Question 27

What is the difference between micro and macro economics?

Answer 27

Microeconomics examines the behaviour of individual decision making units in the economy, namely consumers and firms.
Macroeconomics exames the economy as a whole to obtain a broad or overall picture. It looks at totals rather than margins.

Question 28

What is the difference between economic growth and economic development?

Answer 28

Economic growth is when the output produced by an economy increases. Economic development however refers to raising the standard of living and well-being of people.

Question 29

Why is economic growth important?

Answer 29

It is important as a basis for economic development, because it means that more goods and services are being produced, and therefore the standards of living COULD potentially be increased.

Question 30

Does economic development always follow economic growth?

Answer 30

No. It is possible to have growth in the quantity of output produced, but this may not result in a reduction of income inequalities, poverty or unemployment, or in the provision of increased social services such as education, health care and sanitation.

Question 31

Definition of sustainable development?

Answer 31

Development which meets the needs of the present without compromising the ability of future generations to meet their own needs.

Question 32

What are the two ways that the 3 questions can be answered?

Answer 32

The market method and the command method.

Question 33

What is the market method?

Answer 33

Resources are owned by private individuals or groups of individuals and it is mainly consumers and firms or businesses who make economic decisions by responding to prices that are determined in markets.

Question 34

What is the command method?

Answer 34

Resources are owned by the government which makes economic decisions by commands. In practice, commands involve legislation and regulations by the government.

Question 35

Examples of command/market economies?

Answer 35

In reality, no country is ever an entirely command nor an entirely market economy. They may however lean toward one or the other.

Question 36

What does government intervention achieve?

Answer 36

It changes the allocation of resources from what markets working on their own would have achieved.

Question 37

What is economic efficiency?

Answer 37

Making use of resources and avoiding waste. Resources are allocated such that the economy produces the most of the goods society mostly prefers. Maximise satisfaction.

Question 38

What is economic equity? Example of equity?

Answer 38

This refers to the idea of being fair and just. An example of equity, used by many countries, is that people with higher incomes and wealth pay higher taxes.

Question 39

What is the goal of equity?

Answer 39

The goal of equity is not to make distribution of income completely equal, but rather to ensure that people who have little or no income in a market economy, and cannot secure enough of essential goods and services, will be able to survive.

Question 40

Where do economists disagree in terms of equity?

Answer 40

According to many economists there is a trade off between efficiency and equity, in terms of a more equal income distribution. Whilst the government works towards equity, they may give up efficiency, which some economists see as a loss. This was first theorised by Arthur Okun.

Question 41

Why is there a trade off between equity and efficiency?

Answer 41

When the government intervenes and redistributes income, with taxes for example, this results to changes in work effort (people work less hard), savings and investment (people save more and invest less) and attitudes (people have less incentive to acquire new skills,

Question 42

Is there always a trade off between equity and efficiency?

Answer 42

No. Some economists argue the reverse. In countries where income inequalities are so great that very low income people are discourages, or too unhealthy or unskilled to be able to work, income redistribution may work in their favour and make them more productive, thus increasing both income inequality and efficiency.