1.1 Nature Of Economics Flashcards
Developing models (why economist make them)
They develop models to explain how the economy works, e.g. theories of supply and demand or the circular flow of income. These are developed by putting forwards a model, gathering evidence and then accepting, changing or disregarding the model.
What are theories
They can often be expressed in words
What are models
Expressed in mathematical terms
Why are assumptions made
When there are too many variables which can change within an economic model
What is ceteris Paribus
All other thing remain equal
How is econ a social science
It is difficult to set up experiments to test hypothesis. As economists has to gather data in the every day world other variables are always changing. However, it is still a science as it is all linked by the method of building a model or theory
Argument for why econ isn’t a science
It studies human behaviour which cannot be reduced to scientific law. However, groups of people are much more predictable than individuals themselves
What is a positive statement
A statement which is objective and made without any obvious value judgments or emotions. Can be proven or disproven and are expressed in the form of a hypothesis
What is a normative statement
One which is subjective and based on opinion so cannot be proven or disproven. It often includes words like “ought, maybe, unwise, should etc. or says one is better than the other.
Value judgments
These can influence economic decision making and policy. Different economists may make different judgments from the same statistic
The Economic problem:
-problem of scarcity
-renewable and non-renewable resources
-opportunity costs
Problem of scarcity
People have finite needs but infinite wants as no one would choose to live at the level of basic human living standards. Although wants are infinite, recourses are finite. It is a relative concept as recourses are not necessarily scarce themselves but are scarce in relation to the demand placed upon them.
Renewable recourses
They are recourses of economic value that can be replenished or replaced on a level equal to consumption. E.g. oxygen, solar power and fish.
As long a the rare of consumption is less than or equal to the rate of replenishment, the stock will not decrease.
Non-renewable resource
A resource of economic values that cannot be readily replaced by natural means on a level equal to consumption.
What are opportunity costs
When the same recourse cannot be used to produce different goods at the same time so decisions have to be made on how to use them.
It is the cost of one thing in terms of the next best option which has been given up.
Difference between consumers choice and producers and the government choice on the opportunity costs
Consumers make choices on what gives them greatest level of satisfaction
Produces make a choice based on profit
Government must make decisions on where they should spend limited tax tenues based on what will maximise social welfare.
Four factors of production:
Land - natural resources used in production
Labour - all productive human effort (value of worker is human capital)
Capital - all man made recourses that are used to produce goods and services in the future. Owners of capital receive interest on their land.
Entrepreneurship - willingness and ability to take the risk of combining other three factors
What do production possibility frontiers show
Shows the maximum possible combinations of capital and consumer goods that can be produced with its current resources and tech
What are PPF diagrams usually drawn as a curve
Because the first recourses that are switched from capital to consumer good production are resources that are it adding much to capital goods but will be much more productive in the production of consumer goods and vice verse
Maximum potential of an economy (PPF)
It is any point on the curve that represents the maximum productive potential of the economy, the most that the country can produce
PPF graph representing growth of economy
The PPF maximum potential line will shift outwards as the economy can produce more of both goods. This can be achieved by increasing the quantity and quality of resource.
Reasons for decline in economy’s maximum potential
It can produce less of capital and consumer goods due to a number of factors: natural disasters, natural recourses running out or a decrease in quality/quantity due to war, migration or fall in spending on education
How is economic efficiency achieved
When recourses are used for their best fit - at all points on the PPF recourses are allocated efficiently.
Where is production shown as inefficient on a PPF diagram
Below the PPF curve where production of the goods are not maximising output.
When would a point be out of the curve on a PPF diagram
When it is unobtainable production (not enough resources/tech to produce)
What does a movement along the curve indicate
A change in the combination of goods produced: more capital goods are produced and less consumers goods are produced or vice versa
What does a shift of the curve indicate
A change in the productive potential of the economy: more consumer and capital goods can be produced or less can be produced. There has been a change in the number of resources and tech available to the country and so their potential output has changed.
What is specialisation
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 what is needed
Division of labour
When labour becomes specialised in a particular part of the production process.
How can a country maximise the amount of goods and services it can produce
They need to ensure that all factors of production, including workers, undertake the tasks they are best at.
What is the concept Adam Smith stated
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.
Adam Smith’s example of specialisation and division of labour
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 pin per person employed. If there wasn’t division of labour workers would of made less than a few dozen
Advantages of divisions of labour
-enables labour productivity to be increased (workers will be quicker, better and more efficient as they can develop skills quicker)
-may lead to higher quality of goods and services
-more cost effective to develop specialist tools, improving speed or quality.
-time is. Jot wasted between moves and getting tools out
-workers may be trained to only do one specific task which saves money and time
Disadvantages of division of labour
-one specific task is boring which will lead to poor quality of work and people quitting (firms take actions like playing music to reduce this)
-there is a reduction of craftsmanship and much more standardised product because of mechanisation.
-if production in one process is delayed every other task is stopped
-the workforce do not have wide industrial training and could therefore suffer form structural unemployment
What will the degree to which specialisation or division of Labour being possible depend on
Nature of the task and the size of the firm.
What is it essential to do when countries specialise
It is essential they they trade in order to obtain all the goods and services that consumers demand. Trade has some advantages and disadvantages
Advantages of specialisation of production for countries
The theory of a comparative advantage stares countries should specialise in producing goods consumers demand when they have a lower opportunity cost, and so they were relatively best at producing.
This will help them boost their economy (greater output globally)
disadvantages of specialisation of production for countries
Countries may become over-dependent on one particular exports
Other counties specialise in non-renewable recourses and these could run out
There will be high interdependence and this will cause problems if trade is prevented (e.g. because of war).
Some say that increased specialisation means there will be more competition to cut costs and therefore wages will fall, but this is not necessary true.
Functions of money:
Medium of exchange
A measure of value
A store of value
A method for deferred payment
What is a medium of exchange
It can be used to buy and sell goods and services and is acceptable everywhere. Prevents the problem with barter
A measure of value
It can compare the value of two goods such as a table and a skirt. It is also able to put a value on labour
A store of value
It is above to keep its value and can be kept for a long time. With barter, goods such as fruits often went out of date and could not keep their value
A method of deferred payment
Money can be allowed for debts to be created. People can therefore pay for things without having money in the present, and can pay for it later. It relays on moment storing its value.
What is a free market economy
Where individuals are free to make their own choices and own the factors of production without government interference.
How are recourses allocated in a free market
Recourses are allocated through the price mechanism. The consumer determines what is produced by their money. Consumer decisions are based on satisfaction and producers based on profit.
Examples of how governments are required to intervene to an extant preventing a market form being completely free
Issuing Monet, protecting property rights and breaking up monopolies
Adam smith believe of free market …
He believed in free market economy and the laissez-faire approach by governments. He explained how there was an invisible hand
Adam smith’s invisible hand explained
There is an invisible hand in the market which allocated resources to everyone’s advantage, allowing the greater good for the greater number of people. Adam smith believed competing in the market causes lower prices as firms warned to be competitive and so this benefits the consumer as they can get foods cheaply.
What did Adam Smith argue about free market economy
The state needed to provide goods/services which free markers wouldn’t such as the laws, property rights and goods such as bridges and roads
Friedrich Hayek
He argued that state control of the economy leads to the loss of freedom. He believes that the poor in free market countries were better off than those in command economies as at least they had personal freedom.
He said the central plan Ning by governments led to what a small minority wanted being forced into a whole society.
He believes although individuals don’t make supply and demand decisions based on perfect information, they know beer what they need in their own situation.
Free market economy advantages:
- system is automatic due to the invisible hand; recourses are moved out of production of a good when people stop wanting it or costs are too high.
-consumers have freedom of choice (consumer sovereignty)
-There is high motivation as hard work can leas or high potential rewards - there is political freedom
- in general, freer market economies tend to have higher growth
Free market economy disadvantages:
-there there to be high levels of inequality since the rich own more factors of production and so can grow richer
- there must be a lack of merit goods and little control of demerit goods
-recourses could be wasted on unproductive expenses like advertising
-if competition disappears then there may be monopolies who charge high prices and offer low quality of service
-there is the problem of externalities
Command economy
In a command 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 working for a common food. Some goods are allocated such as housing. All workers no matter their job tend to receive the same wage, products are standardised and prices are limited causing excess demand and queuing
Karl Marx
He believed in command economy and critiqued capitalism and capitalism would collapse leading to communism. He believes capitalist’s profit came from exploiting labour as they underpaid workers for the value that they created. His theory stated that these workers would inevitably rise against property owner and seize control of the means of production leading to a democratic society
Advantages of command economy:
- 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 Kate 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 costs effectively
-the government is generally motivated by the well-being of the country rather than companies who are motivated by profit
Disadvantages of Command economy.
-it is impossible for the state to make so many decisions correctly, which could lead to over or under supply and a waste of recourses
-decision making will be slow as it has to go through various stages and there could be an increase in bribery and corruption
-as everyone receives the same wage, there is less motivation and efficiency
-consumers lose their freedoms
Mixed economy
Both types of economies compromise to form this economy. It is both the free market mechanism and the government planning process allocate a significant amount of the total recourses in the country.
Governments role is a mixed economy:
Creating a framework of rules - prevent abuse of monopolies
Supplements and modifies the price system - producing public and merit goods and limit production of demerit goods ensuring the consideration of externalities
Redistributes income - use tax to rise money away form one group the give money to the poor.
Stabilises the economy - attempt to manage the level of demand in the economy to prevent extremes of too much or too little demand through fiscal and monetary policy.
