1.1 Nature of Economics

Question 1

What is a model?

Answer 1

A model is a simplified representation of reality used to provide insight into economic decisions.

Question 2

What is meant by ‘ceteris paribus’?

Answer 2

‘Ceteris paribus’ is Latin for “all other things being equal”. It is assumed with economic models.

Question 3

What is a positive statement?

Answer 3

A positive statement is a fact that can be tested and proved by data.

Question 4

What is a normative statement?

Answer 4

A normative statement includes a value judgement e.g. “should”.

Question 5

How can value judgements influence decision making and policy?

Answer 5

Different people/parties have different views on what is desirable for society.

Question 6

What is the economic problem?

Answer 6

The economic problem is that there are unlimited wants for finite resources (scarcity).

Question 7

What is a renewable resource?

Answer 7

A renewable resource is a commodity that is inexhaustible/replaceable over time, providing that the rate of extraction does not exceed the rate at which the resource renews itself.

Question 8

What is a non-renewable resource?

Answer 8

A non-renewable resource cannot be renewed, as no mechanisms exist in order to replenish them.

Question 9

What is opportunity cost?

Answer 9

Opportunity cost is the value forgone by not selecting the next best option. Economic agents seek the option with the lowest opportunity cost.

Question 10

What are the three economic agents?

Answer 10

1. Consumers.
2. Producers.
3. Government.

Question 11

What does the production possibility frontier (PPF) depict?

Answer 11

The PPF shows the potential output of two goods in an economy by demonstrating the maximum amount of one good that can be made in relation to the other.

Question 12

Where on the PPF is the maximum productive potential of an economy?

Answer 12

Anywhere ON the curve.

Question 13

How can opportunity cost be represented by a PPF?

Answer 13

By moving along the curve and measuring the resources that must be moved from producing one good to the other.

Question 14

How can economic growth be shown by a PPF?

Answer 14

An outward shift of the curve.

Question 15

How can economic decline be shown by a PPF?

Answer 15

An inward shift of the curve.

Question 16

Where on the PPF is there an efficient allocation of resources?

Answer 16

Anywhere ON the curve.

Question 17

Where on the PPF is there an inefficient allocation of resources?

Answer 17

Anywhere BELOW the curve.

Question 18

How can a PPF be used to present currently unattainable production?

Answer 18

Anywhere ABOVE the curve.

Question 19

What will cause a movement along the PPF curve?

Answer 19

A movement along the PPF curve is caused by different allocation of the SAME resources.

Question 20

What will cause the PPF curve to shift?

Answer 20

The PPF will shift as a result of economic growth or decline i.e. changes in the quality/quantity of the factors of production.

Question 21

What are the factors of production?

Answer 21

Capital, Enterprise, Labour and Land.

Question 22

What are capital goods?

Answer 22

Capital goods are durable goods that are used to produce consumer goods.

Question 23

What are consumer goods?

Answer 23

Consumer goods are any tangible commodity produced and subsequently purchased to satisfy the wants and perceived needs of the buyer.

Question 24

What is specialisation and the division of labour?

Answer 24

Specialisation is where a worker completes a specific section of the production process. The division of labour is where the steps in a production task are divided up between workers, leading them to specialise.

Question 25

What part did Adam Smith play in the division of labour?

Answer 25

Adam Smith found that when he divided up the labour in his pin factory, productivity (output/number of workers) increased dramatically.

Question 26

What are the advantages of specialisation and the division of labour? (6)

Answer 26

1. Lower-skilled workers become proficient in a task.
2. Increases the output per worker.
3. Higher output at a lower cost.
4. Competition acts as an incentive to lower costs by innovation.
5. Provides a variety for consumers.
6. Able to focus on improving quality.

Question 27

What are the disadvantages of specialisation and the division of labour? (5)

Answer 27

1. Repetitive, unrewarding work.
2. Lack of motivation can result in decreased quality and efficiency.
3. Goods lack character.
4. If a machine breaks down or a worker is ill, the whole process grinds to a halt.
5. Narrow training reduces job opportunities.

Question 28

What is the advantage of specialising in the production of goods and services to trade?

Answer 28

The opportunity cost of importing a good may be lower than if it was produced in that country.

Question 29

What are the disadvantages of specialising in the production of goods and services to trade? (6)

Answer 29

1. Political factors can lead to sanctions, then potentially shortages.
2. Cost of petrol/pollution.
3. Cheap labour in other countries may lead to worse quality.
4. Loss of jobs in import country.
5. Tariffs (tax on imports).
6. Specialised countries can lose a high proportion of revenue if the value of a good drops.

Question 30

Why is money an efficient medium of exchange?

Answer 30

The value of money is universally agreed upon, therefore it can be used to compare goods and services.

Question 31

What is a free market economy?

Answer 31

In a free market economy, markets are determined purely by the price mechanism, with no government intervention.

Question 32

What is a command economy?

Answer 32

In a command economy, the factors of production are owned and centrally determined by the state.

Question 33

What is a mixed economy?

Answer 33

In mixed economies, markets are determined by the price mechanism, but the state intervenes if the market fails.

Question 34

What were Adam Smith’s main arguments?

Answer 34

Adam Smith believed that the self interest of firms led to optimum resource allocation in order to maximise profits. Competition between firms ensures efficient production. Called the price mechanism the “invisible hand”.

Question 35

What was Friedrich Hayek’s main argument?

Answer 35

Friedrich Hayek believed that governments lack sufficient information to make decisions regarding the economy.

Question 36

What did Karl Marx advocate in terms of the economy?

Answer 36

Karl Marx believed in command economies in order to avoid the exploitation of workers.

Question 37

What are the advantages of a free market economy? (2)

Answer 37

1. Firms allocate resources efficiently to maximise their profits.
2. Competition between firms encourages innovation.

Question 38

What are the disadvantages of a free market economy? (2)

Answer 38

1. Workers may be subjected to exploitation.

2. Prices of essential goods and services may be distorted.

Question 39

What are the advantages of a command economy? (2)

Answer 39

1. The state reduces inequality.

2. Fairer treatment of workers.

Question 40

What are the disadvantages of a command economy? (3)

Answer 40

1. Governments may lack sufficient information.
2. Central planning is expensive.
3. Inefficient allocation of resources can lead to shortages and/or surpluses.