1.1 The Nature Of Economics

Question 1

Economics as a social science

Answer 1

Economics is primarily considered as a social science, involving the study of people and societies.

Economics is about dealing with scarcity, making choices and, the consequences of those choices.

Question 2

Microeconomics

Answer 2

Microeconomics studies the behaviour of individuals and firms in making decisions regarding resource allocation.

Question 3

Positive economic statements

Answer 3

Objective statements based on evidence or facts that can, therefore, be proved or disproved.

Question 4

Normative economic statements

Answer 4

Subjective statements based on value judgements and cannot be proved or disproved.

Question 5

Distinguishes Between Positive and Normative Statements

Answer 5

An objective economic analysis should predominantly use positive statements. However, normative statements is often necessary when making policy recommendations.

Question 6

Scarcity

Answer 6

There are limited resources available to meet unlimited wants and needs.

Question 7

Factors or Production

Answer 7

Capital, enterprise, labour and land

Question 8

Capital

Answer 8

The assets and machinery needed in the production process to transform resources into goods.

Question 9

Entrepreneurship

Answer 9

The strategic initiative and risk taking involved in starting a business.

Question 10

Labour

Answer 10

The physical human work put in to transform resources into goods.

Question 11

Land

Answer 11

All natural resources, raw materials, the fertility of the soil and resources found in the sea.

Question 12

Opportunity cost

Answer 12

The next best alternative that is forgone when a choice is made.

change in y/change in x

Question 13

Ceteris Paribus

Answer 13

“Other things being equal”

Question 14

The use of ceteris paribus assumption in building models

Answer 14

The ceteris paribus assumption is valuable for simplifying complex economics relationship, making them easier to analyse and understand. (Cause-and-effects relationships)

Question 15

The inability in economics to make scientific experiments

Answer 15

• Economics is a social science involving people.
• Consequently, economic policies that may have been effective at one time in one country may not have the same impact at another time or in another country.

Question 16

The role of value judgement in influencing economic decision making and policy

Answer 16

• Economists tend to use positive statements to back up normative statements.
• Value judgements can influence economic decision making and policy. Different economists may make different judgements from the same statistic.

Question 17

Renewable resources

Answer 17

A natural resource that can be replaced naturally after use.
eg. Solar energy, wind power, wood and fish.

Question 18

Non-renewable resources

Answer 18

Natural resources where continued consumption will eventually result in their exhaustion.
eg. Oil, copper, platinum.

Question 19

Economics goods

Answer 19

Created from resources that are limited in supply and so are scarce. Consequently, they command a price.

Question 20

Free goods

Answer 20

Unlimited in supply, such as sunlight, or sand on a beach. Consumption by one person does not limit consumption by others. Therefore, the opportunity cost of consuming a free good is zero.

Question 21

Production possibility frontiers

Answer 21

Shows the maximum potential output of two goods that can be produced in an economy when all resources available is fully utilised.

It helps illustrate scarcity, opportunity costs and trade-offs.

Question 22

Capital goods

Answer 22

Used by businesses to produce other goods or services.

Question 23

Consumer goods

Answer 23

Products bought by customers for personal use.

Question 24

The economic problem

Answer 24

• The central purpose of economic activity is the production of goods and services to satisfy needs and wants.
• Resources are scarce but wants and needs are infinite so economic agents have to make choices:
  What to make
  Who to make it for
  How to make it

Question 25

Marginal analysis

Answer 25

Looks at the additional costs and benefits when you produce more of ‘Good A’ or ‘Good B’.

Question 26

Economic growth

Answer 26

An increase in the productive capacity of the economy indicating an increase in real output.

Question 27

Economic decline

Answer 27

A decrease in the productive capacity of the economy indicating a decrease in real output.

Question 28

Factors causing an outward shift in the PPF

Answer 28

• increase in natural resources
• development of new methods of production that increase productivity
• advance in technology
• improvements in education and training that increase productivity of the workforce
• factors that lead to an increasing in the size of workforce eg. immigration, an increase in retirement age, better childcare enabling more women to join the workforce.

Question 29

Factors causing an inward shift in the PPF

Answer 29

• Natural disasters that cause a destruction of productive capacity
• depletion of natural resources
• factors causing a reduction in size of the workforce, eg. emigration, an increase in number of years spent in compulsory education
• a deep recession that results in a loss of productive capacity with factories closing down permanently.

Question 30

Division of labour

Answer 30

Occurs when the work is split up into, small specialised tasks.

Question 31

Adam Smith and the division of labour

Answer 31

In the Wealth of Nations Adam Smith set out the view that economic growth could be achieved by increasing the division of labour.

Question 32

Advantages of the division of labour

Answer 32

• Specialisation: concentration on specific, repetitive tasks improves efficiency.
• Increased Productivity: due to higher output per person
• May lead to a higher quality of goods and services, since workers are more skilled at their jobs.
• 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 33

Disadvantages of division of labour

Answer 33

• Monotony and boredom for workers: this could results in a decrease in productivity.
• If for some reason production in one process is delayed, every other task has to stop until that problem is solved.
• Absenteeism: staff using invalid reasons to not show up to work due to low job satisfaction.
  High turnover: staff move on to other, less boring firms.
• There is a lack of variety because all goods produced on a production line are identical.

Question 34

Specialisation

Answer 34

Refers to a firm/individual/region producing a good where they have a comparative advantage.

Question 35

Advantages of Specialisation

Answer 35

• Higher labour productivity and rising business profits
• Specialisation create a surplus output that can be traded for mutual benefit, increasing the range of products we can consume.
• Lower prices cause GDP growth and give consumers greater real purchasing power. It allows businesses to pay increased wages.
  Successful specialisation is a key cause of economic growth.

Question 36

Disadvantages of Specialisation

Answer 36

• A country becoming over-dependant on imported goods/services.
• Increased in unemployment due to uncompetitive goods with low export rates.
• Imports persistently exceeding exports leading to net loss.

Question 37

Money

Answer 37

Anything that is used as a means of exchange for goods and services.

Question 38

Functions of money

Answer 38

• A Medium of Exchange: enabling people to specialise, exchanging the money earned from doing a specialist job for the goods and services they wish to buy.
• A store of value: Can be saved or stored for future use without losing its purchasing power over time.
• A measure of value: Enabling people to assess the value of different goods and services by comparing prices.
• A method for deferred payment: Money is accepted in each market. 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.

Question 39

Free market economy

Answer 39

An economic system in which prices are determined by supply and demand with no government intervention.

• Adam Smith advocated for the “invisible hand” of the market to allocate resources efficiently without the need of government intervention. Consequently, the free market economy would result in an ordered market with producers responding to changes in consumer wants in such a way that there was little waste.
• Friedrich Hayek argued in his book The road of Serfdom that attempts by governments to determine the answers to the questions of what to produce, how to produce and for whom are doomed to failure.
  State planning would involve restrictions on freedom and the use of force.

Question 40

Command Economy

Answer 40

An economic system where the government or a central authority makes all decisions about the production and distribution of goods and services.

• Karl Marx thought that capitalism was inherently unstable because workers are exploited by the bourgeoisie.
  Ultimately, there would be a proletariat revolution in which communism would result.

Question 41

Mixed economy

Answer 41

A combination of a free market economy and a command economy. Both the private sector and government play significant roles in economic decision making.

Question 42

Advantages of Free Market economies

Answer 42

• 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.
• Consumer sovereignty: this implies that consumer spending decisions determines what is produced.
• Increased choice: consumers have a wide choice of goods and services compared with a command economy.
• There is a high motivation as people know working hard could lead to high potential rewards creating conditions where initiative and enterprise flourish.
• Because firms are in competition, they will produce goods at the lowest cost they can, ensuring productive efficiency.

Question 43

Disadvantages of Free Market economies

Answer 43

• Inequality: those who own resources are likely to become richer than those who do not own resources.
• Externalities: these are costs and benefits to third parties that are not taken into account when goods are produced and consumed.
• Monopolies: there is a danger that a firm may become a sole supplier of a product and then exploit consumers by charging prices higher than the free market equilibrium.

Question 44

Advantages of Command economies

Answer 44

• Greater equality: the state can ensure that everyone can enjoy a minimum standard of living and that no one is extremely rich.
• No exploitation: privately owned monopolies are unable to exploit workers and consumers.
• 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.
• Resources may be allocated by the state to maximise social welfare.

Question 45

Disadvantages of Command economies

Answer 45

• No consumer sovereignty: decisions by state rather than consumers determine what is produced.
• Inflexibility: the state may be slow to react to changes in consumer needs.
• Shortages and surpluses: if the state miscalculates supply and demand then there may be excess demand and/or excess supply of goods and services.
• 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.
• Decision-making will be slow as it has to go through various stages and there could be an increase in bribery and corruption.

Question 46

The role of state in a mixed economy

Answer 46

Regulation: The government establishes laws and regulations to ensure fair competition, prevent monopolies, and protect consumers.

Provision of Public goods and services: governments provide essential services and goods that the private sector may not supply efficiently, such as infrastructure, public education and healthcare.

Welfare and Redistribution: social safety and income redistribution policies to address poverty and inequality.

Stabilisation and Economic Planning: fiscal and monetary policies to manage economic cycles and prevent economic crisis .