1.1 Nature of economics

Question 1

What is economics?

Answer 1

The study of human behaviour under scarcity

Question 1

What is scarcity?

Answer 1

Describes any situation in which factors of production are finite, whereas wants are infinite

Question 2

What is Ceteris paribus

Answer 2

It is a Latin expression that means ‘other things equal’. Another way of saying this is that all other things are assumed to be constant or unchanging

Question 3

What are consumers?

Answer 3

Those who demand goods and services

Question 4

What are producers?

Answer 4

Those who supply goods and services

Question 5

What is the government?

Answer 5

Those who tax and distribute certain goods and services to both consumers and producers

Question 6

What type of science is economics

Answer 6

A social science

Question 7

What do economists build models?

Answer 7

Due to the complexities in society, economists build models so as to better understand certain interactions

Question 8

What is a model

Answer 8

A simplified version of reality

Question 9

Are all models really simple?

Answer 9

Some models are more complex than others like the circular flow of income model which seeks to demonstrate the interactions of all economic agents

Question 10

What do all models make?

Answer 10

All models make a range of assumptions. These are often generalisations about behaviour, choices and likely outcomes

Question 11

Why are these assumptions necessary?

Answer 11

These assumptions are necessary so as to account for complex human behaviour and constantly changing variables

Question 12

What should always be considered when evaluating different models?

Answer 12

When evaluating different models, the underlying assumptions should always be considered

Question 13

What does thinking like an economist involve?

Answer 13

To think like an economist involves identifying which variables will be studied and which ones will be excluded
It considers the type of relationship between variables (causal or correlation) cause action or correlation

Question 14

Why can two economists studying the same data end up with vastly different interpretations?

Answer 14

This is often due to the different variables that each economist chooses to focus on. This is the complexity found within social sciences

Question 15

Why can economists not make scientific experiments?

Answer 15

This is due to the complexity of human nature and the significant number of social interactions that are taking place in any economy at any given point in time

Question 16

Social scientific method

Answer 16

Define a question to investigate
Develop a hypothesis using ceteris paribus (make a prediction)
Conduct empirical research
Gather data
Analyse the data
Report the conclusions
Empirical research is collected through observations, surveys, opinion polls etc.
The results of the same hypothesis can vary significantly when conducted

Question 17

What is a positive economic statement?

Answer 17

Positive economics is an objective statement
based on empirical evidence
They can be proven to be true or false
Value free

Question 18

What is a normative economic statement

Answer 18

Normative economics focuses on value judgements. These judgements are built around opinions and beliefs as to what the best economic policies or solutions may be

Question 19

What are the roles of value judgments?

Answer 19

Value judgements influence individuals choices in the economic decisions they make
Value judgements influence governments choices with regards to the economic policies they choose to adopt and spend money on

Question 20

What is the basic economic problem

Answer 20

The basic economic problem is that resources are scarce
There are finite resources available in relation to the infinite wants and needs that humans have

Question 21

What does scarcity mean people have to do?

Answer 21

Due to the problem of scarcity, choices have to be made by producers, consumers and governments about the best (most efficient) use of these resources

Question 22

What are renewable resources?

Answer 22

Renewable resources can be used repeatedly and naturally replenished, for example wind generated electricity

Question 23

What are non-renewable resources

Answer 23

Non-renewable resources cannot be naturally replenished at a pace that keeps up with consumption. For example, oil and coal

Question 24

What is opportunity cost

Answer 24

Opportunity cost is the loss of the next best alternative when making a decision

Question 25

What are factors of production?

Answer 25

The different elements that are required to produce goods and services

Question 26

What are the four factors of production?

Answer 26

Capital (working and fixed)
Enterprise
Labour
Land

Question 27

what is specialisation and division of labour?

Answer 27

Specialisation is the production of a limited range of goods by a company/individual/country which means that trade is essential as it is the only way
they are able to access all that they need.
The division of labour is when labour becomes specialised in a particular part of the production process- each person is allocated a specific job

Question 28

Specialisation and division of labour- Adam smith

Answer 28

Adam Smith stated the concept of specialisation and the division of labour and showed how it can increase labour productivity (output per worker), allowing firms to increase efficiency and lower their costs of production.
He visited a factory and observed that the pin making process had been split into 18
different operations. As a result, the company were able to produce 5,000 pins per person employed. If the work had been carried out by workers making the whole pin from start to finish, it would have been less a few dozen.

Question 29

The advantages of specialisation and
the division of labour in organising production

Answer 29

The division of labour enables labour productivity to be increased . Workers will be quicker, better and more efficient as they are concentrating on one thing and so can quickly develop their skills. It also is likely they will have natural abilities or talents in their task.
● This may also lead to a higher quality of goods and services, since workers are
more skilled at their jobs.
● It is more cost effective to develop specialist tools, improving speed or quality.
● Time is not wasted moving between jobs and getting out tools etc.
● Workers only need to be trained to do one specific task , rather than many, saving
time and money.
specialised workers get higher pay
more motivation from job satisfaction
workers focus on what they are better suited to
economies of scale increases (ouput increases, cost decreases)

Question 30

The disadvantages of specialisation and
the division of labour in organising production

Answer 30

If someone is only doing one specific task, it can make work very boring which will
lead to poor quality of work and people leaving the business. Firms can take some
action to reduce this, for example by playing music.
● There is a reduction of craftsmanship and a much more standardised product
because of mechanisation.
● If for some reason production in one process is delayed, every other task has to stop
until that problem is solved.
● The workforce do not have wide industrial training and could therefore suffer from
structural unemployment.
greater cost of training workers
more expensive raw materials and environmental degradation as global output rises
over reliant on every worker

Question 31

specialising in the goods and services to trade advantages

Answer 31

The theory of comparative advantage states countries should specialise in
producing those goods where they have a lower opportunity cost, and so they are
relatively best at producing. This will help them boost their economy. On the whole,
there is greater output globally.

Question 32

specialising in the goods and services to trades disadvanges

Answer 32

Countries may become over-dependent on one particular export and if this fails their
economy may collapse. For example, many developing countries specialise in
farming and if crops fail due to weather they will have no income . Areas such as
Manchester suffered high unemployment as traditional areas of employment, like
shipbuilding, became less important.
● Other countries specialise in non-renewable resources and these could run out, which will result in a huge loss of income for that country. It will also mean the loss of these resources.
● There will be high interdependence and this will cause problems if trade is
prevented, for example because of war

Question 33

what is productivity

Answer 33

output/input

Question 34

what is money

Answer 34

anything that fufills the four functions of money

Question 35

what are the four functions of money?

Answer 35

A medium of exchange: It can be used to buy and sell goods and services and is
acceptable everywhere. The problem with barter was that people could only trade if
there was a double coincidence of wants: where both parties want the good the other party offers. Since money can be used to buy all goods and services, everyone will accept money as they know they can use it to buy what they want.
● A measure of value: It can compare the value of two goods/services/work, such as a table and a skirt. It is also able to put a value on labour.
● A store of value: It is able to keep its value and can be kept for a long time. With
barter, goods such as fruits often went out of date and so could not keep their value.
● A method for deferred payment: Money can allow for debts to be created. People
can therefore pay for things without having money in the present, and can pay for it
later. This relies on money storing its value.

Question 36

what is double coincidence of wants

Answer 36

a situation in which two people each want some good or service that the other person can provide

Question 37

what are the 6 characteristics of money

Answer 37

durability
portability
divisibility
uniformity
limited supply
acceptability

Question 38

what is near money (quasi)

Answer 38

highly liquid and very stable

Question 39

what is non money

Answer 39

not very liquid
value fluctuates

Question 40

what is liquidity

Answer 40

how quickly you can turn it into cash

Question 41

what does a production possibility frontier represent

Answer 41

all combinations of maximum output of two goods/services that can be produced when an economy is being productively efficient- all factors of production are fully employed

Question 42

what are the two types of ppfs

Answer 42

linear and curved

Question 43

what is productive/pareto efficiency

Answer 43

output is produced using the fewest possible resources/ at the lowest possible
where it is not possible to produce more of one good without reducing the production of another

Question 44

what do linear ppfs assume

Answer 44

assumes all factors of production are homogenous

Question 45

why do ppfs tend to be curved

Answer 45

because factors of production are specialised. as such, the opportunity cost of production increases

Question 46

When is an economy able to produce more

Answer 46

if the quantity/ quality of factors of production increases

Question 47

if no particular axis labelled…

Answer 47

label consumer and capital

Question 48

productively efficient

Answer 48

any point on the curve

Question 49

productively inefficient

Answer 49

any point below the curve

Question 50

currently unattainable

Answer 50

any point above above the curve

Question 51

what does a shift in the PPG curve indicate

Answer 51

A shift of the curve indicates a change in the productive potential of the
economy: more consumer and capital goods can be produced or less consumer and capital goods can be produced. There has been a change in the number of resources and/or the technology available to the country and so their potential output has changed.

Question 52

what is a free market economy

Answer 52

where resources are allocated through market forces (supply and demand)
n a free market economy, individuals are free to make their own choices and own the factors of production without government interference. Resources are allocated through the price mechanism. The consumer determines what is produced by their willingness to spend their money on a good. Consumers make decisions based on satisfaction and
producers based on profit. There are no completely free markets in the world today ,because the government has to intervene at least to an extent, for example by issuing
money, protecting property rights and breaking up monopolies. Without this, the market mechanism could not work.

Question 53

Adam Smith on the free market economy

Answer 53

Adam Smith (1723-1790) believed in the free market economy and the laissez-faire
approach by governments. He explained how there was an ‘invisible hand’ in the market which allocated resources to everyone’s advantage, allowing the greatest good for the greatest number of people. He believed competition in the market caused lower prices as firms wanted to be competitive and so this benefits the consumer as they can get goods
cheaply. Smith concluded that each individual’s self-interest managed to produce and purchase the goods and services that society needed. However, he did argue that the state needed to provide goods/services which free markets wouldn’t such as. the laws, property rights and goods such as bridges and roads.

Question 54

Friedrich Hayek

Answer 54

Friedrich Hayek (1899-1992) argued that state control of the economy leads to the loss of freedom. He believed that the poor in free market (or freer market) countries were better off than those in command economies because at least they had personal freedom. Also, he
said that central planning by governments led to what a small minority wanted being forced on the whole of society. Hayek believed that, although individuals don’t make supply and demand decisions based on perfect information, they best know what they need in their own
situation i.e. a consumer knows how much bread they need and a manager knows how many raw materials they need.

Question 55

advantages of a free market economy

Answer 55

The system is automatic due to the invisible hand; resources are moved out of
production of a good when people stop wanting it or costs are too high.
● Consumers have freedom of choice, called consumer sovereignty.
● There is high motivation as people know working hard could lead to high potential
rewards, creating conditions where initiative and enterprise flourish.
● There is political freedom.
● Because firms are in competition, they will produce goods at the lowest cost they
can, ensuring productive efficiency.
● In general, freer market economies tend to have higher growth.

Question 56

disadvantages of a free market economy

Answer 56

There tends to be high levels of inequality, since the rich own more factors of
production and so can grow richer.
● There may be a lack of merit goods (goods considered as intrinsically good) and
little control of demerit goods (intrinsically bad).
● Resources could be wasted on unproductive expenses such as advertising,
switching the factors of production and providing competitive services.
● If competition disappears then there may be monopolies, who charge high prices
and offer low quality of service.
● There is the problem of externalities.

Question 57

Command economy

Answer 57

In a command (planned) economy, all factors of production, except labour, is owned by the state and labour is directed by the state. There is no private property and everyone is assumed to be selfless, working for a common good. Resource allocation is carried out by the government, rather than the price mechanism. The government’s allocation may represent the wishes of the consumer and often focuses on the need to expand certain areas of the economy, such as weapon building. However, planning is so complex that
some decisions are left up to the consumer. Workers receive wages and can spend this on what they want, within limits. Some goods can be purchased whilst others, such as houses, are allocated. Income distribution is determined by the government and all workers, no matter their job, tend to receive the same wage, products are standardised and
prices are limited causing excess demand and queueing.

Question 58

Karl Marx on the command economy

Answer 58

Karl Marx (1818-1883) believed in the command economy and criticised capitalism. Marx
believed that capitalist’s profit came from exploiting labour as they underpaid workers for the
value that they actually created. He wanted remove the difference between the incomes of owners and workers and believed that capitalism would collapse leading to communism. Marx saw businesses growing and workers getting poorer, creating a two class system with a few wealthy capitalists and many underpaid workers. He thought more firms would fail because of competition causing unemployment, lower wages and higher prices and this would lead to discontent amongst the working class. His theory stated that these workers would inevitably rise against property owners and seize control of the means of production. This would lead to a democratic society where everything would be owned by everyone i.e. the fall of capitalism to begin communism.

Question 59

Advantages of the command economy

Answer 59

The state provides a minimum standard of living , ensuring no one is extremely
poor as there is less inequality.
● There is less wastage of resources as there is no need for competitive services nor advertising, which is very expensive.
● Long term planning means that the industry doesn’t have to keep changing and
shifting resources. This is important as some industries may take a number of years to get established and would fail if planning was short term.
● Standardised products means that they are produced cost effectively.
● As the government, who are generally motivated by the wellbeing of the country,
rather than the companies, who are motivated by profit, decide resource allocation, objectives other than profit can be followed: merit goods are encouraged and
increased whilst demerit goods aren’t produced.

Question 60

disadvantages of the command economy

Answer 60

It is impossible for the state to make so many decisions correctly, which could lead to over or under supply and a waste of resources.
● Decision making will be slow as it has to go through various stages and there could
be an increase in bribery and corruption (an increase in bureaucracy).
● As everyone receives the same wage, there is less motivation and efficiency
because people know that working harder will not increase their standard of living.
● Consumers lose their freedom and it is often led by dictators

Question 61

mixed economy

Answer 61

Both types of economies have benefits but also major problems so most economies have tried to move towards some form of compromise economy , called a mixed economy. This is an economy where both the free market mechanism and the government planning process allocate a significant amount of the total resources in the country . Each country will have a different amount of control by the government, but it is usually between
40-60%.

Question 62

the governments role in a mixed economy

Answer 62

Creating a framework of rules: They prevent the abuse of monopolies: a company with more than 25% of market share can be considered as having monopoly power so can take advantage of their customers due to the lack of competition and charge higher prices/provide a poorer service. They can protect customers as they pass a
large amount of consumer protection laws to protect the consumers from poor quality
products or services. They protect property rights, ensuring whatever a person owns
cannot be taken away by someone else. Also, they ensure safety standards,
protecting employers and employees.
● Supplements and modifies the price system: They produce public and merit
goods, such as emergency services and transport, and limit the production of demerit goods like child pornography. Government action ensures the consideration of
externalities.
● Redistributes income: They move income from one group of people to another,
from the rich to the poor. They use tax, such as income tax, to take money away from one group then give the money to the poor. This is in the form of benefits for those who are out of work or on low incomes, and in the provision of services for all, such as education and the NHS, allowing the poor to access these services when they might not have been able to afford to.
● Stabilises the economy: The government will attempt to manage the level of
demand in the economy to prevent extremes of too much or too little demand. They do this through fiscal and monetary policy

Question 63

what are the indicators of what type of economy it is

Answer 63

percentage of government spending
size of public sector work force
political and economic freedom