1.1 - Nature of Economics

Question 1

What is economics?

Answer 1

The allocation of scarce resources to provide for unlimited human wants.

Question 2

How is economics a social science?

Answer 2

It is concerned with the study of human behaviour.

Question 3

What does ceteris paribus mean?

Answer 3

All other things being equal. This assumption is needed since economists cannot test model in scientifically controlled experiments.

Question 4

What is a positive statement?

Answer 4

Based on facts which can be tested as true or false and are value free. E.g. the increase in the national living wage from £7.83 to £8.21 per hour in April 2019 has caused unemployment.

Question 5

What is a normative statement?

Answer 5

Based on value judgements which can be proven to be true or false. E.g. it is unfair to cut welfare benefits.

Question 6

What is the role of value judgements?

Answer 6

They have a major influence on economic decision making for consumers and producers. Personal preferences, beliefs and subjective assessment underpin normative economics. Value judgements also have a major role in govt policy making.

Question 7

The economic problem

Answer 7

Based on scarcity - there are finite resources compares to infinite human wants, so choices have to be made about how to use those resources.

Question 8

Define opportunity cost

Answer 8

The value of the next best alternative forgone when a decision is made.

Question 9

What is marginal analysis?

Answer 9

The effects of producing or consuming one extra unit of a good or service - they may both involve both benefits and costs.

Question 10

What are renewable and non-renewable resources?

Answer 10

Renewable: one whose stock level can be replenished naturally.
Non-renewable: one whose stock level decreases over time.

Question 11

Production possibility frontiers

Answer 11

They show the maximum potential output of goods an economy can achieve when all its resources are fully and efficiently employed. An outward shift shows economic growth. Inward growth represents economic decline.

Question 12

Explain the PPFs shape

Answer 12

As more of one good is produced, an increasing amount of the other good is forgone, i.e. opportunity cost rises. This is because not all resources are as efficient as others in the production of both goods.

Question 13

Capital and consumer goods

Answer 13

Consumer: directly provides utility to the consumer.
Capital: used to produce consumer goods so are an investment.

Question 14

What is specialisation?

Answer 14

When an individual, firm, region or country concentrates on the production of a limited range of goods and services.

Question 15

Advantages and disadvantages of specialisation

Answer 15

Advantages: increases productivity, living standards and global output.
Disadvantages: when demand falls there will be structural unemployment

Question 16

What is division of labour?

Answer 16

The specialisation of workers on individual tasks in the production process to increase efficiency. Adam Smith - pin factory in the wealth of nations.

Question 17

Advantages of the division of labour

Answer 17

• increase in productivity: increased repetition leads to high skill
• increase efficiency of resources: reduces cost per unit of output because less time is wasted in switching between tasks or training
• increase in the quality of output: each worker can specialises and produce better quality

Question 18

Disadvantages of the division of labour

Answer 18

• repetition creates monotony and boredom
• breaking down tasks makes it easier to replace more highly skilled workers with machines leading to structural unemployment
• creates interdependence in production: if one group goes on strike then whole production will go into a standstill

Question 19

What is money?

Answer 19

Anything that is generally acceptable in the payment of a good, service or debt.

• medium of exchange
• measure of value
• store of payment
• method of deferred payment

Question 20

What’s a free market economy?

Answer 20

Where all resources are privately owned and allocates through the price mechanism with minimal government intervention. It’s associated with the writing of Adam Smith and Frederick Hayek. Smith said the invisible hand of self-interest guides supply and demand.

Question 21

Advantages of a free market

Answer 21

• economic efficiency and lower prices: firms keep costs down due to competition (productive efficiency) and supply what consumers demand (allocative efficiency)
• quality of products: competition means that firms continually try to improve the quality of their products to gain advantages. There is consumer sovereignty
• greater choice: wide selection of goods and services, workers have a wide range of employment opportunities
• financial incentives: entrepreneurs have an incentive to invest and take risks in order to earn profit and labour works hard to gain more earnings

Question 22

Disadvantages of a free market

Answer 22

• monopolies may form as a result of competition
• distribution of income and wealth is uneven and lack of welfare support may lead to people living in absolute poverty
• external costs and benefits are sometimes ignored
• information gaps persist: people consume excessive amounts of demerit goods such as there is a lack of regulation and taxation to protect consumers
• an insufficient quantity of public goods and merit goods and merit goods is provided
• high inflation in a boom and high unemployment in a slump

Question 23

What is a command economy?

Answer 23

There I’d public ownership of resources which are allocated by the government. Associated with the writings of Karl Marx who believed that production should be directed at human need rather than profit.

Question 24

Advantages of a command economy

Answer 24

• cooperation between firms van lead to high levels of output. Maximisation of output becomes more important than maximisation of profits.
• reduction in inequality as govt controls all wages
• govt is able to limit the external costs from production and consumption
• govt funds provision of public goods like defence and law, also increase production of goods which yield high external benefits
• govt has more control so smaller swings in the business cycle

Question 25

Disadvantages of a command economy

Answer 25

• inefficient allocation of resources, shortages and surpluses as price mechanism has been distorted
• lack of competition leads to inefficiency and so productivity is low
• poor quality products as emphasis is on output
• less choice of g/s to choose and no choice in job
• lack of financial incentives: no incentives to take risks, invest or work hard
• economic growth and living standards tend to improve more slowly

Question 26

What’s a mixed economy?

Answer 26

Where some resources are owned and allocated by the private sector and some by the public sector. They are associated with the writings of John Maynard Keynes. The rationale is to gain advantages of a free economy while avoiding the disadvantages through government intervention to help markets work more efficiently.