Chapter 2: Economic Models

Question 1

KEY TERM:
Model

Answer 1

a simplified representation of a real situation that is used to better understand real-life situations.

Question 2

KEY TERM:
Production Possibility Frontier

Answer 2

a model that illustrates the trade-offs facing an economy that produces only two goods. It shows the maximum quantity of one good that can be produced for any given quantity produced of the other.

Question 3

KEY TERM:
Inadaptability of Resources

Answer 3

well-suited inputs are used up and less adaptable inputs must be used instead.

Question 4

KEY TERM:
Factors of Production

Answer 4

the resources used to produce goods and services.

Question 5

KEY TERM:
Land, Labour, Physical Capital, Human Capital

Answer 5

• a resource supplied by nature.
• the economy’s pool of workers.
• created resources such
  as machines and buildings.
• the educational achievements and skills of the labor force.

Question 6

KEY TERM:
Technology

Answer 6

the technical means for producing goods and services.

Question 7

KEY TERM:
Comparative Advantage

Answer 7

the advantage a country (or individual) has in producing a good or service if its opportunity cost of producing the good or service is lower than other countries’ (or other peoples’) cost.

Question 8

KEY TERM:
Barter

Answer 8

trade in the form of the direct exchange of goods or services for other goods or services.

Question 9

KEY TERM:
Absolute Advantage

Answer 9

the advantage a country (or individual) has in producing a good or service if the country can produce more output per worker than other countries (or people).

Question 10

KEY TERM:
Circular-flow Diagram

Answer 10

a diagram that represents the transactions in an economy by two kinds of flows around a circle: flows of physical things such as goods or labor in one direction and flows of money to pay for these physical things in the opposite direction.

Question 11

KEY TERM:
Household

Answer 11

a group of people that share their income.

Question 12

KEY TERM:
Firm

Answer 12

an organisation that produces goods and services for sale and employs members of households.

Question 13

KEY TERM:
Market for Goods and Services

Answer 13

markets in which firms sell goods and services that they produce to households.

Question 14

KEY TERM:
Factor Markets

Answer 14

markets in which firms buy the resources they need to produce goods and services (includes labor market and capital market). Determines an economy’s income distribution.

Question 15

KEY TERM:
Income Distribution

Answer 15

the way in which total income is divided among the owners of the various factors of production in an economy.

Question 16

KEY TERM:
Positive Economics

Answer 16

the branch of economic analysis that describes the way the economy works.

Question 17

KEY TERM:
Normative Economics

Answer 17

the branch of economic analysis that makes prescriptions about the way the economy should work. Prescriptions are for citizens (requires value judgement) not economists.

Question 18

3 types of economic models?

Answer 18

• create or find a real but simplified economy, then extrapolate the results.
• simulate the workings of an economy on a computer.
• most effective form of economic modelling is the construction of “thought experiments” (simplified, hypothetical versions of real-life situations) – later supported with mathematics.

Question 19

PPF - efficiency, opportunity cost, economic growth

Answer 19

• no missed opportunities in production, no producing of more of one good without producing less of the other. Command economies are notorious for inefficiency in allocation.
• increasing opportunity cost represented in a bowed-out curve, inadaptability of resources.
• expansion of PPF. Increase in factors of production. Increase in technology (innovation).

Question 20

Why do economists disagree?

Answer 20

• media exaggerates polarising debates while underreporting issues that are agreed upon.
• economics is tied up with politics.
• values (trump over untested economic policies).
• differing simplifications and assumptions in the models that economists’ use.

Question 21

Assumptions of comparative advantage model?

Answer 21

includes 2 countries, PPF linear, no mobility of input (for example, labor cannot move abroad), feasible (total production = total consumption), attractive (trade is worth it), balanced (import expenditure = export revenue).

Question 22

Lessons of comparative advantage model?

Answer 22

• illustration of gains through trade and specialisation by the means of increased consumption.
• everyone has a comparative advantage and disadvantage in producing something.

Question 23

Simplifications of circular-flow diagram?

Answer 23

ignoring firm-to-firm sales and external influences – injections and leakages.