1.1 nature of economics

Question 1

what is a social science?

Answer 1

a study of human behaviour and interaction

Question 2

what is an economic model?

Answer 2

• an economic theory or collection of theories which allows us to simulate situations
• they are simplified versions of the world

Question 3

why do economists use models?

Answer 3

to explain how the economy works

Question 4

what does ceteris paribus mean?

Answer 4

• all sciences make assumptions when developing models and theories, and this allows them to simplify the problem
• economists use the term ‘ ceteris paribus’ meaning ‘all other things remaining equal’
• for example, when there is a change in income, demand will shift, ceteris paribus

Question 5

why is it difficult for economists conduct scientific experiments?

Answer 5

humans are unpredictable and varied and exist in complex environments which might affect their behaviour; cannot be reduced to scientific law

Question 6

what is a positive statement?

Answer 6

• a statement which is objective and made without any obvious value judgements or emotions
• they can be tested to be proven or disproven and they are often expressed in the form of a hypothesis that can be analysed and evaluated

Question 7

what is a normative statement?

Answer 7

• one which is subjective and based on opinion, so cannot be proven or disproven
• it often includes words such as ought, maybe, unwise should etc. or says that one action is better than another

Question 8

which 3 questions does the study of economics seek to answer?

Answer 8

what to produce?
how to produce?
for whom to produce?

Question 9

what does ‘scarcity’ mean?

Answer 9

resourses are scarce in relation to the demand placed upon them

Question 10

what is meant by a ‘renewable resource’?

Answer 10

• resource of economic value that can be replenished or replaced on a level equal to consumption
• for example, oxygen, solar power and fish are renewable
• as long as the rate of consumption is less than or equal to the rate of replenishment, the stock will not decrease

Question 11

what is meant by a ‘non-renewable resource’?

Answer 11

• a resource of economic value that cannot be readily replaced by natural means on a level equal to consumption
• this includes fossil fuels such as coal, oil and gas.

Question 12

what is the economic problem?

Answer 12

infinite wants and limited resources; scarcity

Question 13

what are the 4 factors of production?

Answer 13

land
labour
capital
enterprise

Question 14

what is the reward for enterprise?

Answer 14

profit

Question 15

what is the reward for capital?

Answer 15

interest

Question 16

what is the reward for land?

Answer 16

rent

Question 17

what is the reward for labour?

Answer 17

wages

Question 18

why do opportunity costs exist?

Answer 18

scarcity; since we cannot have
everything, we must make decisions

Question 19

what is opportunity cost?

Answer 19

the next best alternative forgone when making a decision in order to receive your first choice

Question 20

give an example of an opportunity cost for a consumer

Answer 20

when buying a new TV, the consumer foregoes spending that money on a smartwatch

Question 21

give an example of an opportunity cost for a firm

Answer 21

by spending £1000 on a marketing campaign, the firm forgoes the benefits of spending that money on capital investment

Question 22

give an example of an opportunity cost for a government

Answer 22

by spending on NHS, the government foregoes the benefits of spending that money on education

Question 23

what is a production possibility frontier/curve?

Answer 23

a diagram showing the maximum possible combinations of two goods or services which can be produced if all resources and technology are used efficiently

Question 24

explain causes of an outward shift in the PPF

Answer 24

finding resources
immigration
investment in capital

Question 25

explain causes of an inward shift in the PPF

Answer 25

resource depletion (eg natural disaster, war)
resource depreciation (skills atrophy after long-term unemployment, lack of investment)

Question 26

what is the difference between consumer goods and capital goods?

Answer 26

consumer goods - goods that are demanded and bought by households and individuals
capital goods - goods that are produced in order to aid the production of consumer goods
consumer goods provide utility directly, capital goods do not

Question 27

what is the difference between actual and potential growth?

Answer 27

actual growth is an increase in output, potential growth is an increase in productive capacity

Question 28

explain why we would not want 100% of our production to be on capital goods

Answer 28

we would have no consumption (and therefore utility) right now

Question 29

explain why we would not want 100% of our production to be on consumer goods

Answer 29

we would forego consumer goods (and their utility) in the future

Question 30

what is specialisation

Answer 30

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

Question 31

what is the division of labour

Answer 31

when labour becomes specialised in a particular part of the production process

Question 32

what did Adam Smith say about specialisation and the division of labour

Answer 32

• he 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 33

advantages of division of labour

Answer 33

• 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

Question 34

disadvantages of division of labour

Answer 34

• 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

Question 35

advantage of specialisation

Answer 35

• 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 36

disadvantages of specialisation

Answer 36

• there will be high interdependence and this will cause problems if trade is prevented, for example 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 necessarily true
• 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.

Question 37

what are the functions of money

Answer 37

a medium of exchange
a measure of value
a store of value
a method for deferred payments

Question 38

explain medium of exchange as a function of money

Answer 38

• 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

Question 39

explain measure of value as a function of money

Answer 39

• 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

Question 40

explain store of value as a function of money

Answer 40

• 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

Question 41

explain method for deferred payment as a function of money

Answer 41

• 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 42

explain what a free market is

Answer 42

• an economy where 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 43

what did Adam Smith believe about free markets

Answer 43

• he 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 44

what did Friedrich Hayek believe about free markets

Answer 44

• he 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
• 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 45

what are the advantages of a free market economy

Answer 45

• 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 46

what are the disadvantages of a free market economy

Answer 46

• 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 47

explain what a command economy is

Answer 47

• an economy where 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 48

what did Karl Marx believe about command economies

Answer 48

• he 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 to 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 49

what are the advantages of a command economy

Answer 49

• 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 50

what are the disadvantages of command economies

Answer 50

• 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 51

explain what a mixed economy is

Answer 51

• 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 52

explain the government’s role in a mixed economy

Answer 52

• 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
• 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