1.1 Nature of economics Flashcards
Define Ceteris Paribus
1.1.1
Ceteris paribus means “everything else remains constant” in Latin, therefore the assumption of “ceteris paribus” is when economists focus on changing one variable against another, whilst assuming all other variables to be unchanged.
Define the difference between a positive statement vs. a normative statement
1.1.2
Positive: objective, able to back with facts and evidence, value free.
Normative: subjective, based off value judgements, unable to be supported by evidence.
Value judgements: based on one’s opinion/beliefs rather than facts.
Define the economic problem
1.1.3
The economic problem of scarcity.
Situation in which people’s unlimited infinite wants exceed the limited resource available to fulfil those wants.
Define economic goods
1.1.3
Goods that are scarce or created from scarce resources. Limited in supply
Define free goods
1.1.3
Goods unlimited in supply -have no opportunity cost.
Define opportunity cost
The value of the next-best alternative foregone i.e. most desirable alternative given up as the result of a decision.
Related to marginal analysis
Define trade-off
Where one object is sacrificed in order to obtain another object.
Define the economic agents
1.1.3
3 key groups of decision makers:
1. Consumers - individuals & households.
Make choices on their expenditure, they demand goods & services. Need income to purchase. Make decisions on the supply of their labour.
2. Producers - people/firms
Producing goods/supplying services. Make choices on what they produce, techniques of production & prices they sell at.
3. Gov
Decide amount of involvement in prod & consumption process. Undertakes expenditure. Influences economy through taxation & regulation of markets.
Opportunity cost crucial - each face constraints on their choices.
Difference between renewable & non-renewable resources
Renewable: rate of extraction is lower than the natural usage rate, so can be replenished. Can be depleted too rapidly.
Non-renewable: Reserves are finite & unable to be replenished. Extraction and supply based on current prices i.e. prices guide resource allocation.
Define the 3 key economic questions
- WHAT goods/services to produce i.e. how should resources be allocated?
- HOW productive resources of the economy should be used to produce these goods/services?
- WHOM to produce for?
Define the factors of production
Resources used in the production process - human & physical.
1. LAND - the land & anything that comes from it e.g. oil, natural gas, fish from the sea. Paid by: rent
2. LABOUR - work/effort put into the prod. of the goods/services. Paid by: wages & salaries
3. CAPITAL - machinery/tools/buildings used to prod. goods/services e.g. delivery cans, pencils, desks, computers, conveyor belts.
Paid by: interest
4. ENTERPRISE - (entrepreneurship) combines all FoP. Paid/motivated by: profit.
Define an entrepreneur
A risk-taker, organises production and identifies projects to be undertaken. Combines land, labour and capital into goods/services to earn a profit.
Define capital goods
Goods useful not in themselves but for goods/services they can help produce in the future.
e.g. tills, software, machinery
Define consumer goods
Produced for present consumption & to satisfy human needs & wants directly.
Split into consumer durables, consumer non-durables and consumer services.
Difference between consumer durables, consumer non-durables and consumer services.
Consumer durables - provide a steady flow of utility/satisfaction.
e.g. washing machine, computers.
Consumer non-durables - used up during their consumption.
e.g. food, drink, energy
Consumer services e.g. car service, insurance, take away, haircuts.
Define the PPF
Production Possibility Frontier is a graphical representation of that maximum combination of goods/services an economy can produce in a given period when all available FoP are being fully used.
Two types of PPF
Concave to origin - due to law of diminishing marginal returns and increasing opportunity cost.
Linear - constant opportunity cost.
Define the Law of Diminishing Marginal Returns
Employing an additional factor of production will eventually cause a relatively smaller increase in output.
Define the Law of Increasing Opportunity Cost
The more resources put to producing good X, the extra output gets smaller.
Define the Marginal Cost of a good
The opportunity cost of producing one more unit of the good
Define productively efficient
FoP being used to their max. No wastage/unemployment of resources
Define Allocative Efficiency
Is what is being produced satisfying consumer demand. Not shown on the PPF
Define Pareto Efficiency
Nobody can be made better off without making someone worse off. Anywhere on the PPF is Pareto Efficient.
What does it mean if the PPF shifts outwards?
Represents potential economic growth:
Increase in production of either goods/services w/o opp cost of giving up production of the other is possible.
Caused by increase in quality/quantity of FoP e.g. better education/training/hi-tech capital. Micro level: increase in workers.
An economy investing in capital goods is more likely to see a greater shift outwards in the long run.
What causes the PPF shifts inwards?
Caused by civil wars/natural disasters e.g. earthquakes.
Quantity/quality of labour decreases.
Define division of labour
A process whereby the production procedure is broken into a sequence of stages & workers are assigned to a particular stage.
Advantages of division of labour
Workers are trained to specialise in their role, hence they develop greater skill and are able to do their job more efficiently.
There is:
- less wastage of materials
- less time spent on their task & reduced movement time
- inc efficiency
- inc productivity & output
Training can be more cost-effective when focused on specific tasks.
Reduction of average long-run costs - economies of scale.
Disadvantages of division of labour
- Repetitive; tedious & workers become bored/careless
- High absenteeism & turnover
- Over-specialisation; team of workers become inflexible (difficulty to cover parts of prod. processes if one is ill/ delays if one section fails/breaks down & holds up whole prod. line)
- Structural unemployment due to narrow training
- Can only produce standardised products (no special aspect, loss of craftsmanship)
Example of specialisation between firms
Car firms - specialise manufacturing tyres, windscreens, assembling final product etc.
Why is there specialisation between nations/countries?
Some countries are better equipped to produce some products than others e.g. suitable climatic conditions
Advantages of specialisation between nations/countries
Under comparative advantage theory, countries specialise in goods they can produce at lowest opportunity cost.
- Allows country to make full use of its resources
- Prod. can increase, reducing costs & prices
- Can then trade w/ other countries
- Export surplus & create an injection into the circular flow of income & raise economic growth
Disadvantages of specialisation between nations/countries
Overdependence in one product e.g. oil
- Makes economy vulnerable to external shocks & changing trade patterns e.g. extreme weather, exchange rate fluctuations, loss of competitiveness & structural unemployment
- Overextraction of resources (natural resources unable to replenish)
- Interdependence created through mutual trade can lead to declining trade e.g. COVID-19 China prod. stopped.
Define markets
A set of arrangements that allows transactions to take place and brings together potential buyers & sellers.
- can be online, local, international, physical & non-physical
- Important in helping allocate resources & prices act as signals.
e. g. firm cannot sell its output at the price it has chosen - signal about the way buyers perceive the product.
Define the functions of money
- Medium of exchange - can understand the measure of value. Provides unit of account
- Store of value - must be possible to use for future transactions
- Standard of deferred payment (method) - firms may agree on an order they will meet in the future & when the payment will be made.
Characteristics of money
- Acceptable to all
- Portable & durable
- Divisible
- Scarcity
- Difficult to forge
Scarcity & difficult to forge -> excessive supply would devalue the currency
Development of modern money
- Barter (economy) required a double coincidence of wants
- Commodity money e.g. shells/sharks teeth
- Representative money - gold & silver & handed out receipts (bank notes)
- Token money; no intrinsic value
Define the coordination problem
How to ensure firms produce the commodities that consumers wish to consume?
Answering the 3 key q’s - What, How, Whom?
Define Free Market Economy
An economic system based on price mechanism, which is guided via supply and demand, for allocation of resources with little or no government intervention.
Promoted by Adam Smith who believed in laissez-faire approach by govs.
“Invisible hand”
Fredrich Hayek - state control of economy leads to loss of freedom.
What to produce: determined by what consumer prefers
How to produce it: producer seeks profits
For whom to produce it: whoever has the greatest purchasing power in the economy & is, therefore, able to buy the good
Advantages of Free Market Economy
- System is automatic
- Consumer sovereignty as consumers have freedom of choice
- High motivation due to high potential rewards; encourages innovation & flourishing enterprise
- Political freedom & tend to have higher growth
- Firms in competition so produce goods at the lowest cost they can (ensure productive efficiency)
Disadvantages of Free Market Economy
- High levels of inequality (rich own more FoP so can grow quicker)
- Resources wasted on unproductive expenses e.g. advertising, providing competitive services.
- Problem of externalities
- If competition disappears, monopolies may arise; charge high prices & offer low-quality goods/services
Define a Command Economy
All FoP, except labour, is owned by the state. Labour is directed by the state.
Gov. plans & directs allocation of resources rather than the reliance on price mechanism.
What to produce: determined by what gov prefers
How to produce it: gov & their employees
For whom to produce it: who gov prefers
Advantages of Command Economy
- State provides a min standard of living; less inequality
- Less wastage of resources; no need for advertising/competitive services (expensive)
- Long term planning means industry doesn’t have to keep shifting & changing resources. Import as some industries take several years to get established and would fail if planning was short term.
- Standardised products means they are produced cost effectively
- Gov decide allocation of resources & are generally motivated by wellbeing of country as opposed to companies motivated by profit; objectives other than profit are followed; merit goods encouraged & increase, demerit goods aren’t produced.
Disadvantages of Command Economy
- Impossible for state to make so many decisions correctly
- Decision making slow as it must go through various stages & there could be an increase in bribery & corruption
- Increase in bureaucracy
- Everyone receives same wage, less motivation & efficiency as people know working harder will not increase their standard of living
- Consumers lose freedom & often led by dictators
Define a mixed economy
Where both free market mechanism & gov. planning process allocate resources in the country.
Each country usually has between 40%-60% of control by gov.
What to produce: determined by both consumer & gov preferences
How to produce it: determined by producers making profits & the gov
For whom to produce it: both who gov prefers & purchasing power of private individuals
Role of gov. in mixed economy
Gov. intervene by:
Creating a framework of rules
Prevent abuse of monopolies (company with more than 25% of market share)
Protect customers with consumer protection laws.
Protect property rights & ensure safety standards, protecting employers & employees.
Raising revenue through taxes & redistributing income in the form of benefits.
Stabilise economy.
Produce public & merit goods e.g. emergency services or public transport
Limit production of demerit goods
Considers and acts against externalities
Advantages of mixed economy
Governments are able to intervene and ensure a minimum standard of living and to correct other market failures.
Example of free market economy
Index of Economic Freedom - Hong Kong; most economically free market in the world.
Low tax rates, relaxed regulations on businesses & highly capitalist economic system.
Example of command economy
North Korea, Cuba, Venezuela, Congo & Eretria.
Benefit from low levels of inequality as gov controls wages & employment but suffer food shortages, high inflation, corruption.
North Korea - 20% children affected by malnutrition due to the lack of healthy food.
Example of mixed economy
UK economy
1948 free National Health Service
1980s Margaret Thatcher reduced role of state significantly & shifted economy to become more market orientated.
Denationalised British Petroleum, British Gas, British Steel, National Express, British Airways, British Telecome. Sold off dozens of state-owned enterprises. to the private sector.
Economic decision-makers are primarily concerned with…
maximising welfare.
The objective of economic activity is…
to satisfy consumer wants.
An economic good is …
that has an opportunity cost.
Economics is…
study of how society allocates scarce resources in order to maximise welfare.
The basic economic problem is…
that resources have to be allocated between competing uses.
