Central Problem Of Economics

Question 1

What is microeconomics?

Answer 1

(1) Concerned with individual parts of the economy

Such as behaviors and decisions of individuals and firms in particular markets.

(2) Concerned with demand and supply of particular goods and servicecs

Question 2

What is macroeconomics?

Answer 2

(1) Concerned with economy as a whole

(2) Concerned with aggregate demand and aggregate supply

Question 3

Define aggregate demand.

Answer 3

Total amt of spending in the economy, on all goods and services, by economic agents, namely,

(1) domestic and overseas consumers
(2) by the govt, or
(3) by firms when they buy capital equipment or stock up on raw materials

Question 4

Define aggregate supply.

Answer 4

Total national output of goods and services.

Question 5

Define positive statement.

Answer 5

(1) A statement of fact.
(2) Its accuracy can be tested or verified by appealing to facts.

It describes and explains economic phenomena, focusing on facts and cause-and-effect relationships and includes the development and testing of economic theories.

For instance, “Singapore’s economy grew by 7.1 per cent year-on-year in the third quarter of 2021” is an example of a positive statement because you can verify whether it is right or wrong by checking our GDP growth data in 2021.

Question 6

Define normative statement.

Answer 6

(1) A statement of value or opinion. It is a statement about what ought or ought not to be, about whether something is good or bad, desirable or undesirable.
(2) Cannot be proved or disproved by a simple appeal to the facts because it is often subjective and depends on different perspectives, feelings, opinions and value judgments.

Normative economics is thus the branch of economics that expresses value judgements about economic fairness.

For example, “the richest in the world should pay more taxes” is a normative statement. Depending on your individual perspectives and opinions, you may agree or disagree with this statement.

Question 7

What is the central problem of economics? What causes this problem?

Answer 7

Scarcity is the central problem of economics.

Arises from limited resources, and unlimited wants.

Question 8

What are the broad categories of resources or aka, various Factors of Production (FOPs)?

Hint: C-E-L-L

Answer 8

(1) Capital
Economists are only concerend with physical capital.
Man-made resources.
Include machines, factories, transportation and other equipment.

(2) Entrepreneurship
Entrepreneur takes overall responsibility for the decision-making process in a firm so that other FOPs could be combined to provide a good or service.

(3) Land
All natural resources available, can be renewable or non-renewable.

Renewable resources (such as wind and water) renew themselves at a fast enough rate for sustainable economic extraction.

Non- renewable resources (like fossil fuels and mineral ores) do not renew themselves at a fast enough rate to allow for sustainable economic extraction.

(4) Labour aka Human Capital
Refers to people, and their skills and abilities.

Qty of labour available for an economy
= consists of those able and willing to work
= includes employed + unemployed

Question 9

Who are the economics agents?

Answer 9

(1) Consumers
(2) Producers
(3) Government

Question 10

Explain the inevitability of choice by economic agents.

Answer 10

Choices have to be made due to the fundamental economic problem of scarcity.

Scarcity implies that due to limited resources, when making decisions, every individual faces constraints.
Resources devoted to one use cannot be made available for another use.

Hence, there is always an opportunity cost of making a decision.

Question 11

Define opportunity cost.

** Important to know the definition **

Answer 11

The opportunity cost is the (expected) benefits from the next best alternative that is forgone when making a decision.

Question 12

What do opportunity costs include?

Answer 12

Opportunity costs may include both explicit costs and implicit costs of making a decision.

(1) Explicit costs are costs that require a direct money payment
(2) Implicit costs are the value of anything other than the direct payment that is sacrificed (e.g. time) when a decision is made.

Question 13

What is the total opportunity cost in this case?

You spend $400 on a front seat of your favourite K-pop star’s concert. This could have been spent on a pair of AirPods Pro (next best alternative). If you do not attend the concert, you will visit the National Museum.

Hint: Explicit and implict cost.

Answer 13

Explict cost = $400 incurred for the concert which could be spent on AirPods Pro.

Implicit cost = includes time that is spent attending the concert which could be spent on a visit to National Museum.

Thus, opportunity cost is the forgone benefits (satisfaction) from AirPods Pro and a visit to the National Gallery.

Question 14

Explain rational decision making by economic agents.

(1) assumption
(2) explain approach used and when individuals will undertake an activity

Answer 14

(1) In making decisions or choices, economists assume that all economic agents are rational which means that the economic agents aim to maximise their own net benefits.
(2) To do this, these agents use the marginalist approach/principle to make economic decisions, weighing the marginal benefits and marginal costs of an activity. Individuals will only undertake an activity or do more of it when MB >= MC.

Question 15

Explain the Marginalist Principle.

(1) Define MB
(2) Define MC
(3) Explain why rational decision-making dictates that an economic agent should only undertake an activity if MB >= MC.

Answer 15

(1) Marginal benefit (MB) refers to the additional benefit derived from undertaking an additional unit of an activity.
(2) Marginal cost (MC) refers to the additional (opportunity) cost incurred when undertaking an additional unit of an activity.
(3) The marginalist principle states that:

At any given unit of an activity,

If MB>MC, economic agent would gain more benefit than cost through this action. Thus, it is rational for the economic agent to undertake the activity (or do more of it).

If MC>MB, economic agent incur more cost than benefit. Thus, it is rational for the economic agent to not undertake it (or do less of it).

Question 16

Explain rational decision making by consumers.

(1) Aim
(2) Benefits. Hint: LDMU.
(3) Costs & Constraint
(4) Decision-making

Answer 16

AIM
Faced with limited income, rational consumers’ objective is to maximise utility by making rational decisions on the combination of goods and services to consume.

BENEFITS
- marginal utility (MU) is the additional satisfaction gained from consuming one extra unit of the good within a given period of time.

Up to a point, the more of a good consumed, the greater the total utility derived by the consumer.

However, as the quantity of a good consumed increases, the marginal utility falls. This phenomenon is known as the Law of Diminishing Marginal Utility (LDMU).

COST and CONSTRAINT
The marginal cost (MC) of consuming an additional unit of a good is the price paid for the additional unit.

DECISION MAKING
Based on the marginalist principle, a rational consumer will thus consume up to the point where MU (or MB) = Prices (or MC), from the last of the good, thus the consumer’s (total) utility is maximised.

Question 17

Explain rational decision making by producers/firms.

Answer 17

AIM
Faced with limited FOPs, Rational firms’ objective is to maximize profits (total revenue - total cost) and make rational decisions on

(1) what goods and services to produce and
(2) of what quantities to produce
(3) method of productoin (i.e. how to produce these goods and services)

BENEFITS
Marginal revenue (or MB) of producing an additional unit of good is the additional revenue that a producer receives from selling the additional unit of good. 

COST
Marginal cost of production is the marginal cost of producing an additional unit of a good.

The Law of Diminishing Marginal Returns (LDMR) states that when increasing amounts of a variable FOP are used with a given amount of a fixed FOP, there will come a point when each extra unit of the variable factor will produce less extra output than the previous unit.

DECISION MAKING
Based on the marginalist principle, a rational producer will thus produce up to the point where its MR from the last of the good produced is equal to its MC and the firm’s profit is maximised.

Question 18

Explain rational decision making by the Government.

Answer 18

AIM
Faced with government budget constraints (largely determined by its tax revenue), a rational and benevolent government will have to prioritise its spending to maximise the social welfare (so as to maximise the number of votes under a democratic political system) and achieve both its microeconomic and macroeconomic objectives.

• Microeconomic objectives include efficiency and equity.
• Macroeconomic objectives include sustainable and inclusive economic growth, price stability, full employment and a healthy balance of payments.

BENEFIT
Marginal social benefit (MSB) is the marginal benefit of a government’s decision.

COST
Marginal social cost (MSC) is the marginal cost of a government’s decision.

DECISION MAKING
Based on the marginalist principle, a government will make rational decisions to maximise the social welfare by weighing marginal social benefit and cost.

Question 19

How are scarce resources allocated in the economy?

Answer 19

Since resources are scarce, choices have to be made. Any society would need to answer three key economic questions when they make choices:

(1) What and how much to produce?
- Since there are not enough resources to produce all the things that peoples want and desire, choices need to be made on what goods and services get to
be produced and in what quantities.
- Society needs to choose the composition of total output to be produced.

For instance, should the economy devote more of its scarce resources to the production of consumer goods (e.g. food and clothing) or capital goods (e.g. machines and factories)?

(2) How to produce?
Most goods can be produced by a variety of methods with varying combinations of resources. Choices need to be made on the composition of resources used and the technology that is to be adopted.

For example, what resources are going to be used (e.g. more capital or more labour) and in what quantities? What techniques of production are going to be adopted (e.g. AI-directed or human-controlled)?

(3) For whom to produce?
o The total output needs to be distributed among members of the society. How
should this distribution be carried out? Should the good be made available for all regardless of a person’s ability to pay or should its consumption be restricted only to those with the ability to pay?

How a society answers these three questions and decide on the way that scarce resources are allocated will differ depending on the economic system that the society adopts. Broadly, there are three main economic systems.

Question 20

What does the Production Possibility Curve (PPC) / Production Possibility Frontier (PPF)?

Answer 20

A PPC shows all the

(1) maximum attainable combinations of two goods that a country can produce
(2) within a specified time period
(3) with all its resources fully and efficiently employed,
(4) at a given state of technology.