E - 1) The economic problem and economic methodology

Question 1

What is the purpose of economic activity?

Answer 1

To produce goods and services to meet our needs and wants

Question 2

What is the basic economic problem?

Answer 2

There are infinite wants but finite resources. Resources are scarce in relation to wants

Question 3

What choices need to be made about the allocation of resources?

Answer 3

• What to produce?
• How to produce?
• For whom to produce for?

Question 4

What are the factors of production and their rewards?

Answer 4

• Land: rent
• Labour: wages
• Capital: interest
• Enterprise: profit

Question 5

What is the difference between microeconomics and macroeconomics?

Answer 5

• Microeconomics studies the behaviour of individuals and firms in the market
• Macroeconomics considers the economy as a whole

Question 6

What do rational economic agents aim to maximise?

Answer 6

• Consumers: total utility
• Workers: wages and benefits from work
• Producers: profit
• Government: social welfare

Question 7

What is opportunity cost?

Answer 7

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

Question 8

What are positive statements with an example?

Answer 8

• They describe the world as it is, without making any value judgments. They are based on objective facts and can be proven or disproven
• Example: a rise in minimum wage decreases employment

Question 9

What are normative statements with an example?

Answer 9

• They express an opinion about what ought to be. They are subjective statements that carry value judgments
• Example: the government should increase spending on healthcare

Question 10

What are production possibility frontiers (PPFs)?

Answer 10

Diagrams that shows the maximum possible output combinations of two goods or services an economy can achieve when all resources are fully and efficiently employed

Question 11

What do PPF diagrams look like?

Answer 11

• Capital goods on the y-axis and consumer goods on the x-axis
• Curved due to the law of diminishing returns
• Any point on the curve is productively efficient - all resources are fully employed
• Any point inside the curve is productively inefficient - some resources are unemployed
• Any point outside the curve is unnatianable - cannot be produced with current resources and state of technology

Question 12

What is movement along the PPF curve?

Answer 12

The opportunity cost of producing more of one good which forgoes production of the other (a trade-off). The higher the change in production, the higher the opportunity cost

Question 13

What are shifts in the PPF curve?

Answer 13

• Inward shifts: less resources available to produce with - production possibility decreases
• Outward shifts: more resources available to produce with - production possibility increases

Question 14

What causes inward shifts in the PPF curve with examples?

Answer 14

• Decrease in the quantity of factors of production. Examples: war, conflict, natural disasters
• Decrease in the quality of factors of production. Examples: capital scrapping, labour hysterisis (loss of workers’ skills) in a prolonged recession

Question 15

What causes outward shifts in the PPF curve with examples?

Answer 15

• Increase in the quantity of factors of production. Example: discovery and extraction of new natural resources
• Increase in the quality of factors of production. Example: increase in labour productivity due to better management
• Advancement in technology. Example: a new innovation in resource use

Question 16

What are non-parallel shifts in the PPF curve?

Answer 16

When one of the causes of a shift happens, that only affects one of the goods. The production of one good increases/decreases but the other good stays the same

Question 17

What do straight line PPF curves indicate?

Answer 17

Resources are equally efficient at producing both goods - opportunity cost is constant