1.1 Nature Of Economics Flashcards
Economy
All the goods and services produced in an area
How do economists analyse economic impacts & why
By developing models & making assumptions
Help simplify analysis and reduce wide range of variables
Difficult to conduct experiments (lots of factors impacting economic activity)
What assumption do economists use when building models & why
Assume ‘Ceteris Paribus’ = all other things remain equal (overcomes problem of many factors impacting economic activity)
Positive economic statements
Can be proven true or false (can’t be disputed/contested) Is objective (based on facts)
Normative economic statements
Can’t be proven true/false = can be disputed/contested Is subjective (based on opinions)
Value judgements
= decision made based on values and opinion = normative decisions
What’s based on value judgements
- economic decisions made by individuals
- policy decisions made by governments (why there are multiple gov parties with different policies)
(but use positive economic analysis to help make decisions)
The economic problem (problem of scarcity)
How to use the available scarce (finite) resources to satisfy people’s infinite needs and wants as effectively as possible
3 key questions/decisions to solve the economic problem
What to produce?
How to produce it?
Who to produce it for?
Renewable vs non-renewable resources
Renewable resource = replaced faster than consumed (eg. solar energy)
Non-renewable resource = consumed faster than replaced by natural means (eg. oil, coal) = part of the economic problem (pressure due to rising incomes & population, need to allocate resources well)
Economic agents (who are they)
= groups that participate in the economy
- Consumers (buy goods & services from firms/gov)
- Producers (make goods & services)
- Government (sets rules for other economic agents to follow / produces some goods & services eg. healthcare / roads)
Opportunity cost definition
= value of the next best alternative forgone as a result of the choice made
Importance of opportunity costs to economic agents
Consumers - to decide what to spend incomes on
Producers - to decide what and how to produce goods & services
Governments - to decide what policies to choose
(due to the economic problem, there is always an opportunity cost when decisions are made)
Production possibility frontier (PPF)
= shows the maximum potential output of a combination of two goods or services an economy can achieve when all its resources are fully & efficiently used, given the current level of technology
What is represented by any point on the PPF curve
= maximum productive potential of an economy (point A/D/E)
Opportunity cost on a PPF
Movement along PPF curve creates an opportunity cost (same finite amount of resources allocated) by indicating a change in combination of goods produced
(A to B = opportunity cost of producing 15 more consumer goods is 30 capital goods)
Economic growth / negative economic growth on a PPF
Economic growth = outward shift of PPF (increase in productive potential of the economy = increase in quality/quantity of factors of production)
Negative economic growth = inward shift of PPF (decrease in productive potential of the economy = decrease in quality/quantity of factors of production)
What can cause a decrease in quantity or quality of factors of production
- natural disasters (decrease in land, labour)
- war (decrease in labour, land, capital)
- migration (decrease in labour)
- fall in spending on education (decrease in quality of labour)
- running out of natural resources (decrease in land)
Efficient or inefficient allocation of resources on PPF
On the PPF curve = efficient allocation of recourses (none wasted or underutilised) =A/D/E
Inside PPF curve = inefficient allocation of resources / under-utilised resources = B
Possible or unobtainable production on PPF
Outside PPF curve = unobtainable production (dont have enough resources/technology) = C
Inside & along PPF curve = obtainable but not always efficient
Capital goods vs consumer goods
Capital good = used to produce other consumer goods
Consumer good = used to satisfy needs & wants of consumers, bought by consumers
Effect on economy of more resources being allocated to the production of capital goods
- more capital goods produced = increase amount of consumer goods made (as capital goods used to produce other consumer goods) = overall amount of consumer & capital goods increases = increases maximum productive potential output = PPF curve shifts outwards = increase in economic growth
Specialisation
= when an individual, firm, region or country concentrates on the production of a limited range of goods & services
Division of labour
= specialisation of workers on specific tasks in the production process
What was Adam Smiths views on specialisation & the division of labour
Production could be increased & extra wealth created (increase in productivity due to repetition & automation)
Specialisation on a larger scale (countries) = result in higher incomes & standard of living
What does increased productivity lead to
- higher output & higher quality
- higher living standards (higher incomes)
- more efficient use of resources
Advantages of division of labour
- workers become more skilled through repetition of tasks = potentially higher wages
- workers productivity rises = quality & quantity of output increases (lower unit costs)
- time saved by workers focussing on narrow range of tasks
- cheaper & easier to train workers
Disadvantages of division of labour
- repetition of tasks leads to boredom = less productivity = decrease in quality
- reduce in workers pride if simplified job (likely to quit = possible increase in unemployment)
Advantages of specialising in the production of goods & services to trade
- better quality & higher quantity of products (countries specialise on certain goods/services = greater output = decreased unit costs = increase in consumer surplus & decrease in price)
- higher efficient use of scarce resources
- greater variety within goods between countries (more consumer choice)
- higher trade with other countries
- higher economic growth (increased trade = increased AD) = higher living standards
Disadvantages of specialising in production of goods & services in trade
- structural unemployment (if another countries goods become more competitive = de-industrialisation in domestic country, workers have narrow skill sets = long term unemployment = reduction in productive potential of economy = fall in economic growth)
- over reliance on a few risky industries (if production stops in domestic country = reduces supply in many other countries)
- increased interdependence reduces self-sufficiency (political turmoil = trade wards = stops trade, natural disasters = reduced trade)
- firms may not be able to adapt to changes in taste/fashion if overspecialised
- finite resources may deplete as specialisation of limited goods leads to overconsumption of some resources
The Functions of money
- a medium of exchange (allows people to buy goods & services in exchange for money / barter (other goods))
- a measure of value (price of goods/service reveals its value)
- a store of value (different goods/services hold different values through use of money, exchange rates help determine this)
- a method of deferred payment (allows people to buy things without having enough money & debt to be created eg. mortgage)
Free market economy
= an economy in which resources are allocated solely by the price mechanism
(consumers make decisions based on utility & producers based on profit)
Eg. No country has fully free market economy but some considered as least amount of gov intervention Singapore
Mixed economy
= an economy in which resources are allocated by the state and price mechanism
(most economies as gov needs to intervene to an extent eg. issuing money, protecting property rights, breaking up monopolies)
Command economy
= an economy in which resources are allocated solely by the state (government)
(all factors of production owned or directed by government, no private property, working for a common good, income distribution determined by gov, all workers tend to receive same wage, standardised products, limited prices cause excess demand)
Eg. North Korea
Adam Smith view on type of economy
Believed in free market economy
- resources more efficiently allocated
- businesses aim to maximise profit & consumers aim to maximise utility (invisible hand allows market to operate at an equilibrium, best for society when ppl acted in their best interest)
Friedrich Hayek views on type of economy
Believed in free market economy
- poor better off than those in command economies because at least they had personal freedom
- central planning by governments = small minorities wants forced on whole society
- consumers/producers don’t make supply and demand decisions based on perfect information, but they best know what they need in their own situation
Karl Marx view on type of economy
Believed in command economy & criticised capitalism
- free market economies led to exploitation of workers (firms main aim is to profit maximise = lowest average costs)
- competition in free market economy = firms go out of business = monopolies created = unfavourable consumer market conditions (high prices and low quality).
- inequality increases = private property eventually replaced by common ownership of resources = finally resulting in communism
Advantages of a free market economy
- consumer choice (firms follow profit motive if high demand = more of same good/service available)
- competition between firms (productive efficiency = lower prices & better quality = greater consumer surplus)
- price mechanism adjusts = market operates at equilibrium = no excess demand/supply & maximises consumer/producer surplus (invisible hand)
- high motivation due to competition & higher potential rewards
Disadvantages of a free market economy
- lack of competition in certain markets creates monopolies = higher prices & lower quality = consumer exploitation
- high levels of inequality (rich own more factors of production & grow richer)
- firms will not provide public goods which aren’t profitable = missing markets
- externalities (profit maximisation = produce up to where marginal private cost = marginal private benefit not where marginal social cost = marginal social benefit = over consumption/over production of demerit goods and under consumption/under production of merit goods = welfare loss for society)
Advantages of a command economy
- state maximises social welfare & sets minimum standard of living = less inequality (eg. progressive tax system, low unemployment)
- provision of public goods up to where marginal social cost = marginal social benefit = maximises social welfare (as no profit motive), merit goods increased
- prevention of monopolies (no aim to profit maximise = all markets equal = increase in consumer surplus = no consumer exploitation)
- less resource wastage (no competitive services or advertising)
Disadvantages of command economy
- inefficient allocation of resources (no profit motive = no incentive to operate efficiently = higher costs = higher consumer prices)
- lack of information from state of what consumers demand = slower reactions to changes in market (gov intervention means price mechanism cant function & adjust) = loss of social welfare & wastage
- lack of innovation (no profit motive or competition)
- possible increase in bureaucracy (bribery & corruption)
- less motivation & efficiency as everyone receives same wage
Public vs private sector
Public sector = part of economy controlled / owned by government
Private sector = part of economy not controlled / owned by government
The role of the state in a mixed economy
- creates a framework of rules (consumer protection laws, protect property rights, ensure safety standards, prevent abuse of monopolies)
- supplements & modifies price system (produce public/merit goods eg. transport, parks & limit production of demerit goods, considering externalities and social welfare)
- redistributes income through welfare spending (income tax to take money from rich and give to poor through benefits, provision of services for all eg. education, NHS)
- stabilises the economy, regulates consumers & firms (fiscal & monetary policy prevents extreme low or high demand)
Merit vs demerit goods
Merit goods = goods that the public sector provides free or cheaply because the government wishes to encourage their consumption (education, healthcare, public parks)
Demerit goods = good/service whose consumption is considered unhealthy or socially undesirable due to the perceived negative effects on consumers (alcohol, cigarettes, child pornography)
