1.1 Nature of Economics Flashcards
Theme 1
1
Q
What is Microeconomics?
A
Study of the behaviour of individual markets within the economy. E.g. interaction between consumers and producers.
2
Q
What is Macroeconomics?
A
Study of the behaviour of the whole economy at a national level. Involves economic issues such as inflation, unemployment, etc.
3
Q
Why is Economics a Social Science?
A
It studies human behaviour in relation to the economy. Based on empirical (past) evidence.
4
Q
What is the Ceteris Paribus Assumption?
A
Other things remaining constant. This applies when considering how one economic variable affects another.
5
Q
What are some examples of the Ceteris Paribus Assumption?
A
- Law of Demand
- Supply and Price
- Marginal Utility
6
Q
When do we drop the Ceteris Paribus Assumption?
A
When considering multiple variables and behavioural economics.
7
Q
What are Positive Statements?
A
Objective, can be evaluated based on empirical evidence.
Often involve cause and effect theories.
Uses certain words such as ‘will’ and ‘have’.
8
Q
What are Normative Statements?
A
Subjective, value judgments / opinions based on moral beliefs, personal considerations or policy preferences.
Not testable through empirical analysis alone.
Uses possible words such as ‘should’, ‘would’ and what ‘ought’ to be.
9
Q
When are Positive and Normative Statements used?
A
Economic analysis.
10
Q
What is the Basic Economic Problem?
A
How to allocate finite/scarce resources to meet the unlimited wants.
11
Q
What does scarcity mean?
A
A finite amount.
12
Q
What does infinity mean?
A
A never-ending amount.
13
Q
What is an opportunity cost?
A
The benefits forgone/sacrificed for the next best conclusion.
14
Q
What are economic choices?
A
Alternative uses of scarce resources.
15
Q
What are free goods, with an example?
A
Infinite goods. E.g. Air.
16
Q
What are economic goods?
A
Scarce goods.
17
Q
What is a renewable resource, with an example?
A
A natural resource that can be replenished as it is being used. E.g. Wind.
18
Q
What is a non-renewable resource, with an example?
A
A finite resource that is not being replenished as fast as it’s being used. E.g. Oil.
19
Q
What is poverty?
A
When a person lacks basic necessities or has a low relative income compared to others.
20
Q
What is marginal analysis?
A
An approach to economic decision-making based on considering the additional benefit and cost of change in behaviour.
21
Q
What are the three economic agents and what do they make choices about?
A
Consumers - Expenditure.
Producers - Price and what to produce.
Government - Influence the economy through choices of taxation and regulation.
22
Q
What does the PPF graph represent?
A
Maximum output of two goods/services that can be produced when all available resources are fully and efficiently employed.
23
Q
What does scarcity mean (PPF)? Give an example.
A
Limited availability of resources. E.g. labour, capital, etc.
24
Q
What is a trade-off?
A
To produce more of one good you have to produce less of the other.
25
What does efficiency mean and where can it be found on the PPF graph?
The full utilisation of resources. Found along the curve.
26
What does inefficiency mean and where can it be found on the PPF graph?
Inefficient use of resources. Found inside the curve.
27
What are constraints and growths?
When PPF shifts inwards or outwards due to availability of resources, technical advancements or improvements in productivity.
28
What is the equation for opportunity cost?
Lost output / Gained output
29
What does an outward shift in PPF indicate?
Economic growth.
30
What reasons cause an outward shift of PPF?
Increase in efficiency, increase in productivity and increase in productive capacity.
These are caused by technological advancements, investments and innovations.
31
What are the three types of efficiency?
Productive efficiency, allocative efficiency and dynamic efficiency.
32
What is productive efficiency?
When goods/services are produced at the lowest possible cost.
33
What is allocative efficiency?
Ideal distribution of goods/services that best align with consumer preferences and social needs, to maximise overall satisfaction.
34
What is dynamic efficiency?
The economy's ability to grow and expand in production possibilities over time. Found on the curve of a shifted outward PPF.
35
What are capital goods? Give an example.
Goods used as part of the production process that are invested. E.g. machinery.
36
What are consumer goods?
Goods produced for consumption.
37
What is specialisation?
Process of focussing on a specific task or area of production which has a comparative advantage.
38
What is a comparative advantage?
When a firm produces a particular good/service at a lower opportunity cost compared to its trading partners.
39
What is the division of labour?
When the production process is broken down into separate tasks.
40
What economist came up with the idea of Division of Labour?
Adam Smith, 1776.
41
What are the advantages of Division of Labour?
Higher output per person - improves productivity.
Involves specialising in a specific task - makes an individual more skilled and proficient in the task, increasing efficiency.
Economies of scale - higher profitability for firms and more affordable products for consumers.
Learning by doing - productivity and effectiveness can be improved through repetitive tasks.
42
What are economies of scale?
When more units of a good/service can be produced with lower average input costs.
43
What is learning by doing?
The process of acquiring knowledge, skills and expertise through direct hands - on experience.
Refines methods and allows workers to gain insights through practical experience.
44
What are the disadvantages of Division of Labour?
Due to repetitive tasks:
- Risk of repetitive strain injury.
- Reduced job satisfaction damages labour productivity - Increases workplace absenteeism.
- Unrewarding, can cause alienation.
- Workers take less pride, so quality suffers.
- High worker turnover - workers move to less boring jobs which increases hiring/training costs.
- Struggle to find alternative jobs, as lack variety of skill.
- Mass-produced standardised goods lack variety for consumers.
45
What are potential gains from specialisation?
- Higher labour productivity.
- Rising business profits.
- Creates surplus output, increasing trade for mutual benefit.
- Lower prices cause higher income and GDP growth.
46
What are functions of money?
- Medium of exchange.
- Store of value / measure of value.
- Unit of account.
47
What is a command/planned economy, and what characteristics does it have?
The government decides how resources are allocated.
-Centralised
-Ownership of resources - State/public sector
-The government decides all economic activities
- State/public sector answers basic economic questions
- The government sets the price; no market equilibrium
- Resources allocated equally and fairly to meet what is socially desirable
48
What is a mixed economy and what characteristics does it have?
Some decisions are made by the government, some decisions are made by the market.
-Limited freedom of choice, subject to government intervention
-Ownership of resources in both the public and private sector
-Government creates laws and regulates business activities; upholds property rights
-Both the public and private sector answer basic economic questions
-Behavioural incentives: Self-interest; maximise utility and profits; risk-taking linked to reward earned, subject to government intervention
-Price determined by price mechanism, subject to government intervention
-Resource allocation is driven by utility and efficiency subject to government intervention
49
What is a free market economy and what characteristics does it have?
The allocation of resources is decided by the market.
-Decentralised
-Private sector owns resources
-Little or no role of government
The private sector answers basic economic questions
-Behavioural incentives: Self-interest; maximise utility and profits; risk-taking linked to reward earned
-price determined by the price mechanism
-Resource allocation is driven by competition; utility and efficiency
50
What is a market?
A set of arrangments that allows transactions to take place.
51
What did Adam Smith believe in regard to the free market economy?
Resources are allocated efficiently through 'An Invisible Hand'.
52
What did Adam Smith mean by 'An Invisible Hand'?
Free markets can incentivise individuals, to act in their own self-interest to produce what is societally necessary.
53
What did Karl Marx believe in regard to the free market economy?
He argued that in a capitalist society with private ownership, the owners of capital would exploit their position at the expense of labour, eventually resulting in revolution.
54
What did Friedrich Hayek believe in regard to the free market economy?
Believed markets are more effective as they rely on people responding to signals and incentives whereas governments are faced with imperfect information.
Didn't believe in government intervention as he thought it would be damaging.
55
What are the advantages of a free market economy?
-Competition incentivises firms to produce efficiently and innovate.
-Consumers have a wide range of choices.
-Can lead to rapid economic growth and higher living standards.
56
What are the disadvantages of a free market economy?
-Inequalities in income and wealth can be significant.
-lack of public goods as without government intervention essential services may not be provided.
-Prone to economic cycles of booms and busts.
57
What are the advantages of a command economy?
-Aim to reduce income inequality through central planning.
-Central control can provide stability during a crisis.
-Resources can be directed toward public services and social welfare.
58
What are the disadvantages of a command economy?
-Central planning may discourage innovation and individual initiative creating a lack of incentive.
-Resources may be misallocated which can lead to shortages or surpluses due to the allocation inefficiency.
-Often involve complex bureaucracies.
59
What is the role of the state in a mixed economy?
-Regulation. E.g. consumer protection, environmental standards and financial markets.
-Provide public goods/services.
-Welfare and redistribution. I.e. Social safety nets and income redistribution policies to address poverty and inequality.
-Stabilisation and economic planning; use fiscal and monetary policies to manage economic cycles and prevent economic crises.
60
What is marginal utility?
The additional satisfaction a consumer gains from consuming one more unit of a good/service.
61
What is the law of diminishing marginal utility?
As a consumer consumes an additional unit, the marginal utility decreases.
62
What is the rational choice theory?
Choices are made using a prudent and logical approach that will give the greatest satisfaction and in the highest self-interest. However, the assumption is not always true.
63
What is behavioural economics?
Analysis of how decisions are made that seem to contradict rational decision-making.
64
What is profit?
Total revenue - total cost of production.
65
What are the assumptions of rational decision-making?
Consumers set out to maximise utility.
Firms aim to maximise profit.
66
What is an extension and contraction?
Movements along a demand curve.
Extension - Increase in quantity demanded due to a fall in price.
Contraction - Decrease in quantity demanded due to a rise in price.
67
What does the Law of Demand state?
As price decreases, quantity demanded increases and vice versa.
68
What are shifts in demand?
Outward (right) - Increase in demand.
Inward (left) - Decrease in demand.
69
What factors cause a shift in demand?
Change in ...
- Taste/preferences
- Incomes
- Price of related goods
- Expectations
- Size/structure of the population
- Interest rates
- Law
70
How does the law of diminishing marginal utility affect the shape of the demand curve?
At higher quantities, consumers are less willing to pay a higher price.
71
What is Price elasticity of Demand?
The responsiveness of quantity demanded of a good to a change in price.
72
What is the equation for PED?
% Change in quantity demanded / % Change in Price
73
What are the values of PED?
Inelastic - PED between 0 and -1.
Elastic - PED is less than -1.
Perfectly elastic - PED is equal to - infinity.
Perfectly inelastic - PED = 0.
74
What factors influence PED?
- Availability of close substitutes.
- Cost of switching suppliers.
- Degree of necessity.
- Brand loyalty.
75
Why are some uses of PED?
- Determining pricing policy and how it impacts revenue.
- Indicates competition faced.
- Government decision on which good to indirectly tax.
76
How does PED impact total revenue?
PED elastic - Price increases, TR decreases.
PED inelastic - Price increases, TR increases.
PED = Unitary, no change to TR.
77
What is Income elasticity of demand?
The responsiveness of demand for a good to change in income.
78
What is the equation for YED?
% Change in demand / % Change in income
79
What are the values of YED?
Necessity - YED is between 0 and 1
Luxury - YED is greater than 1
Inferior - YED is negative
80
What are the uses of YED?
- Effect of recession/growth on demand.
- Business planning for product range
- Help firms anticipate future demand
81
What are normal goods?
As consumer income increases, demand for goods increases.
82
What are inferior goods?
As consumer income increases, demand for goods decreases.
83
What is Cross elasticity of demand?
Responsiveness of demand for a good to change in the price of a related good.
84
What are the values of XED?
Weak substitute - XED is between 0 and 1
Strong substitute - XED is more than 1
Weak compliments - XED is between 0 and -1
Strong compliments - XED is less than -1
85
What are the uses of XED?
- Marketing strategies
- How demand will be affected by competitors change in price.
86
What are substitutes?
Goods that can be used in place of each other to satisfy a similar need or desire.
87
What are compliments?
Goods are typically consumed or used together as they enhance each others value.
88
What does the Law of Supply state?
As price falls, quantity supplied decreases, and vice versa.
89
What are the shifts of a supply curve?
Decrease - Shift to the left.
Increase - Shift to the right.
90
What factors cause a shift in supply?
- Change in costs of production.
- Change in production technology.
- Change in weather/climate.
- Strikes, pandemics.
- Changes in indirect taxes.
- Change in producer subsidies.
- Change in price of subsidies in production.
- Change in number of firms supplying the market.
91
What is price elasticity of supply?
The responsiveness of quantity supplied of a good to change in price.
92
What is the equation for PES?
PES = % Change in quantity supplied / % change in price.
93
What are the values of PES?
Inelastic - PES is between o and 1.
Elastic - PES is more than 1.
Perfectly elastic - PES = Infinity.
Perfectly inelastic - PES = 0.
94
What factors influence PES?
- Time period.
- Bottlenecks in supply.
- Breakdowns in supply chains.
- Ease of entry into the market.
- Spare capacity.
- Stock levels.
- Availability of producer substitutes.
95
What is short run?
Period in which at least one factor of production is fixed in supply.
96
What is long run?
Period in which all factors of production are flexible in supply.
97
What is equilibrium?
When consumers and producers agree so Quantity demanded = Quantity supplied, and the market clears.
Also Known As market clearing price.
98
How can a firm fix excess supply?
Lower prices to incentivise consumers to increase demand.
99
How can a firm fix excess demand?
Increase prices to ration demand.
100
What are functions of prices?
Help to allocate scarce resources via signalling, incentivising and rationing functions.
101
What is rationing?
If supply is limited, price rises to ration the good to those most willing and able to pay.
102
What is incentivising?
Higher prices incentivise producers to extend supply as they anticipate more profit.
Lower prices incentivise consumers to extend their demand as they pay less for a good yielding the same utility.
103
What is signalling?
Prices provide information.
If prices change due to a shift in demand, it signals producers to adjust their output levels.
If prices change due to a shift in supply, it signals consumers to rethink how much they purchase.
104
How does the price mechanism impact local markets?
Price is determined by supply and demand.
Influenced by local factors such as the weather.
105
How does the price mechanism impact national markets?
Covers the entire country and considers supply and demand at a broader scale.
Influenced by national policies and regulations, such as trade policies.
106
How does the price mechanism impact global markets?
International trade is influenced by factors such as the exchange rate.
Prices are interconnected and can impact local and national markets.
107
What is the consumer surplus?
Difference between total amount consumer are willing/able to pay for a good/service, and the total they pay.
Measure of consumer welfare.
108
What is the producer surplus?
Difference between what producers are willing and able to supply a good for, and the price they actually receive.
Measure of producer welfare.
109
What is an indirect tax?
Tax imposed on producers by the government.
To pass on some of the indirect tax to consumers, producers raise prices.
Form of government intervention to address market failure.
110
How does indirect tax affect producers, consumers and the government?
Producers - Increases supply costs.
Consumers - Higher prices.
Government - Raise tax revenues.
111
What is a tax incidence?
How the final burden of tax is shared between producers and consumers.
112
How is the burden separated based on how price elastic or inelastic demand is?
Elastic - burden more on the producer.
Inelastic - burden more on the consumer.
113
What are producer subsidies?
Payments to producers by the government to reduce costs of production.
114
What are consumer subsidies?
Payments to consumers to allow them to purchase more of a good/service.
115
How is the benefit separated for subsidies based on how price elastic or inelastic demand is?
Elastic - benefit mostly to producer.
Inelastic - benefit mostly to consumer.
116
How do governments impact subsidies?
Provide subsidies.
Create dependency on government support, discourages private investment and innovation.
Cause misalignment between prices and production costs.
117
What is rational consumer behaviour?
Decision making process based on making choices that maximise utility.
118
What is irrational consumer behaviour?
When people make systematic and persistent deviations from rational choice.
119
What are some examples of irrational consumer behaviour?
- Influenced by others
Peer pressure, social networks, trends, herd behaviour.
- Habitual behaviour and default bias.
Stick to what they know, do what is easiest.
- Human limitations
Weakness at computation - inability to calculate profitability due to limited brain power, time, mislead.
- Risk aversion
More likely to prefer less rewards for less risk.
- Time preference
Typically prefer a reward earlier.
120
What causes market failure?
Price mechanism fails to allocate scarce resources efficiently OR operation of market forces lead to a net social welfare loss.
121
What is complete market failure?
When the market does not supply products at all, resulting in 'missing markets'.
122
What is partial market failure?
When the market functions but produces either the wrong quantity or wrong price.
123
What are the main types of market failure?
Externalities
Under - provision of public goods.
Information gaps
124
What are private costs?
Any cost a consumer or producer pays in order to buy or produce goods.
125
What are external costs?
Occurs when producing or consuming a good imposes a cost (negative effect) upon a third party.
126
What are social costs?
Costs incurred by society as a whole.
127
What are private benefits?
Benefits received by producers or consumers directly involved in a transaction.
128
What are external benefits?
A benefit that occurs to a third party as a result of actions of another party.
129
What are social benefits?
Benefit to society from producing or consuming a good.
130
What is a negative externality of production.
Spillover external cost arising from production of a good.
MSC > MPC
Overproduction of demerit goods.
Negative spillover = pollution, environmental damage.
131
What is a negative externality of consumption?
Spillover external cost arising from the consumption of a good.
MSB < MPB
Overconsumption of demerit goods.
Negative spillover = Obesity, gambling.
132
What does S, C and B represent in externalities?
S = Corrected market equilibrium.
C = Supply
B = Demand
133
What is a positive externality of consumption?
Spillover external benefit arising from consumption of a good.
MSB > MPB
Underconsumption of merit goods.
Spillover = Healthcare, education.
134
What is a positive externality of production?
Spillover external benefit arising from the production of a good.
MSC < MPC
Underproduction of merit goods.
135
What is MPC?
Marginal private cost.
All costs of producing one more unit of the good to the producer.
136
What is MSC?
Marginal social cost.
All the costs of producing one more unit of the good to society.
137
What is MSB?
Marginal social benefit.
All the benefits of consuming one more unit to society.
138
What is MPB?
Marginal private benefit.
All the benefits of consuming one more unit of good by the consumer.
139
What are some policies to address negative externalities?
- Banning / restricting output.
- Legislation / regulation = rules to restrict.
- 'Nudge' policies = behavioural methods to reduce consumption.
- Indirect tax.
- Pollution permit trading scheme = create incentives for firms to reduce pollution.
140
What are some policies to address positive externalities?
- Legislation / regulation = rules to enforce.
- Subsidy.
- 'Nudge' policies = Behavioural method to encourage more consumption.
- Government provision = provide free services.
141
What are some evaluation points for externality policies?
- Size of externality.
- Unintended consequences.
- Government failure.
- Opportunity cost.
142
What are the features of public goods?
Non - excludable = Once the good is provided, it is impossible to prevent people from benefitting from it.
Non - rivalrous = Consumption of a good by one does not prevent or reduce benefit of another persons consumption.
143
What are the features of a private good?
Sold through market by the private sector firms.
Excludable = if consumers are not willing or able to buy.
Rivalrous = One persons consumption reduces amount left.
144
What are Quasi - public goods?
Excludable yet non-rivalrous.
Under provision can lead to market failure.
145
What is the free rider problem?
Someone who consumes a good without paying for it.
Hard to charge consumer for benefitting from a public good once it has been provided.
146
Why does the private sector not supply public goods?
As consumers do not reveal preferences if they believe they can get a free ride, there is no demand curve in the market.
No incentive to provide as it is not profitable.
Market failure.
147
What are some solutions to the market failure of public goods?
- Government provision through tax.
- Government funding through taxation and charging.
- Voluntary / charitable donations.
- Communities can pay collectively.
148
What are advantages and disadvantages to intervention to solve market failure of public goods?
Advantages:
- Equity.
- Efficiency.
- Overcomes free rider problem.
- Public sector investment is higher.
Disadvantages:
- Information failure.
- Possible diseconomies of scale.
- Costly and wasteful.
- Corruption issues.
149
What is asymmetric information?
When consumers and producers have different amounts of information.
150
What is symmetric information?
When both parties in a transaction have access to the same information.
151
What is information failure?
When people have inaccurate information, so they potentially make 'wrong' decisions.
152
What are information gaps?
Exist when either producers or consumers do not have access to information they need to make fully informed decisions, leading to misallocation of scarce resources = market failure.
153
What is adverse selection?
Those who take out insurance are more likely to be at highest risk; more payouts.
154
What are moral hazards?
Being insured means you are more careless and make riskier decisions.
155
What causes undervaluations?
Information gap = unaware of benefits, causing underconsumption.
156
What causes overvaluation?
Information gap = extra societal cost, causing overcompensation.
157
What is a solution to information gaps?
Improve information.
158
What is the effect of government intervention of indirect taxes?
Increase production costs, Decrease supply
Increase market price, Decrease demand
Discourages production and consumption of demerit goods and reduces negative externalities.
159
What is the effect of government intervention of subsidies?
Decreases cost of production, Increases production
Decreases market price, Increases demand
Encourages production and consumption of merit goods.
160
What is maximum price?
Price ceiling below price equilibrium, creating a shortage.
Consumption is encouraged, increasing QD.
However, QS decreases.
161
What is the effect of maximum price?
Prevents monopolies exploiting consumers.
Controls market price.
Welfare gain for consumers by keeping prices low.
Firms may lose incentives if not profitable, so supply decreases, risking missing markets.
162
What is minimum price?
Price floor implemented on demerit goods to discourage consumption.
QD decreases, QS increases, creating a surplus.
163
What are the effects of minimum price?
Improved standard of living.
Provide an incentive to work.
164
What are trade pollution permits?
Firms are allowed to pollute up to a certain amount, any surplus on permit can be traded.
165
What are advantages of trade pollution permits?
Long run incentivises green production methods.
Government raise revenues from permits.
Raises revenue for greener firms.
166
What are disadvantages of trade pollution permits?
Firms relocate where they can pollute without limits.
Firms pass higher costs of production onto consumers.
Expensive for governments to monitor emissions.
Potential firms are disincentivised.
167
What are the effects of state provision of public goods?
Merit goods are more accessible.
Yield positive externalities.
Expensive, opportunity cost.
168
What are the effects of the provision of information?
Ensure no information failure.
Expensive to police.
169
What are the effects of regulation?
Positive externalities.
Black market.
Heavy fines, disincentive to break rules.
Raise cost of firms, which they pass onto consumers.
170
What is government failure?
Due to ineffective intervention in the market, there is a net welfare loss created.
171
What are the causes of government failure?
Distortion of price signals - ineffective allocation of resources as the price mechanism cannot act freely.
Unintended consequences - consumers react in unexpected ways; behavioural economics.
Excessive administrative costs - social benefit is not worth the cost.
Information gaps - time consuming and expensive to achieve perfect information, and it is impractical, so assumptions are made.
172
What are the four factors of production?
Land
Labour
Capital
Enterprise
173
What is tragedy of the commons?
Individuals acting out of their own self interest exploit a public resource. Natural resources are overused, and risks leading to environmental degradation and depletion.
174
What is a carbon tax?
Indirect tax on producers.
175
What are advantages of carbon taxes?
Makes the polluter pay.
Incentivises firms to lower their emissions.
Revenue generated can be spent on their environmental initiatives.
176
What are disadvantages of carbon taxes?
Hard to assess true cost.
Price inelastic goods are impacted weakly.
Rise in tax evasion.
177
What is carbon emission trading/cap-and-trade?
Government set a limit on total emissions that can be produced.
Incentivises firms to emit less as they can increase revenue by selling permits.
178
