Economic Methodology and the Economic Problem

Question 1

Ceteris Paribus

Answer 1

A key assumption that is made is assuming that events occur with ceteris paribus. This assumption is that other things are being held equal or constant, so nothing else changes.

Question 2

Economists cannot conduct scientific experiments

Answer 2

Economists cannot conduct scientific experiments, like in the natural sciences, so models are devised. Economists then use real-life scenarios to build these models upon, and assumptions are made with the models.

Question 3

Positive statements

Answer 3

Positive statements are objective. They can be tested with factual evidence, and can consequently be rejected or accepted.
Look for words such as ‘will’, ‘is’.

For example, “Raising the tax on alcohol will lead to a fall in the demand of alcohol and a fall in the profits of pub landlords” is a positive statement. “Higher temperatures will lead to an increase in the demand for sun cream” is also a positive statement.

Question 4

Positive statements key

Answer 4

The key thing here is that these statements can be tested, the results can be examined and the statement can then be rejected or accepted.

Question 5

Normative statements

Answer 5

Normative statements are based on value judgements. These are subjective and based on opinion rather than factual evidence.
Look for words such as ‘should’, and if the statement is suggesting one action is more credible than another.

Question 6

Value judgement

Answer 6

Value judgements can influence economic decision making and policy. Different economists may make different judgements from the same statistic. For example, the rate of inflation can give rise to different conclusions.

Question 7

People’s views

Answer 7

People’s views concerning the best option are influenced by the positive consequences of different decisions and by moral and political judgements.

Question 8

The purpose of economic activity

Answer 8

The purpose of economic activity is to produce goods and services which satisfy consumer needs and wants.

Question 9

Economic resources are the factors of production

Answer 9

These are land, labour, capital and enterprise.

Question 10

Economic resources are the factors of production. The factors of production (CELL):

Answer 10

Capital, Entrepreneurship, Land, and Labour

Question 11

Capital

Answer 11

Physical: goods which can be used in the production process Fixed: Machines; buildings Working: finished or semi-finished consumer goods

Interest from the investment

Question 12

Entrepreneurship

Answer 12

Managerial ability. The entrepreneur is someone who takes risks, innovates, and uses the factors of production. Resources are drawn together into the production process.

Profit- an incentive to take risks

Question 13

Land

Answer 13

Natural resources such as oil, coal, wheat, water. It can also be the physical space for fixed capital.

Rent

Question 14

Labour

Answer 14

Human capital, which is the workforce of the economy.

Wages

Question 15

The environment

Answer 15

The environment is a scarce resource. There are only a limited amount of resources on the planet. These are made up of renewable and non-renewable resources.

Question 16

Renewable resources

Answer 16

Renewable resources can be replenished, so the stock level of the resources can be maintained over a period of time. For example, commodities such as oxygen, fish, or solar power are renewable assuming the rate of consumption of the resource is less than the rate of replenishment. If the resource is consumed faster than it is renewed, the stock of the resource will decline over time.

Question 17

Non-renewable resources

Answer 17

Non-renewable resources cannot be renewed. For example, things produced from fossil fuels such as coal, oil and natural gas are non-renewable. The stock level decreases over time as it is consumed. Methods such as recycling and finding substitutes, such as wind farms, can reduce the rate of decline of the resource.

Question 18

The basic economic problem

Answer 18

The basic economic problem is scarcity. Wants are unlimited and resources are finite, so choices have to be made. Resources have to be used and distributed optimally.

Question 19

Opportunity cost

Answer 19

The opportunity cost of a choice is the value of the next best alternative forgone. In the above example, the opportunity cost of choosing the crisps is the chocolate bar.

Question 20

Production possibility frontiers (PPFs)

Answer 20

Production possibility frontiers (PPFs) depict the maximum productive potential of an economy, using a combination of two goods or services, when resources are fully and efficiently employed.

Question 21

The law of diminishing returns

Answer 21

The law of diminishing returns states that the opportunity cost of producing more yoghurt increases, in terms of the lost units of cheese that could have been produced.

Question 22

Capital goods

Answer 22

Capital goods are goods which can be used to produce other goods, such as machinery.

Question 23

Consumer goods

Answer 23

Consumer goods are goods which cannot be used to produce other goods, such as clothing.

Question 24

Productively efficient

Answer 24

All points on the boundary are productively efficient. This is because resources are being used to their productive potential so it is efficient.
However, not all points are allocatively efficient. This is because more of one good cannot be produced without reducing the amount of the other product available.

Question 25

Allocative efficiency

Answer 25

Allocative efficiency is when no one can be made better off without making someone else worse off. Another name for this is Pareto efficiency.
If more of both goods could be produced, there would be a gain in allocative efficiency. This is because there is an improvement in welfare.
The PPF only shows potential output, and allocative efficiency is concerned with how goods are distributed in society.