Economic Methodology and the Economic Problem

Question 1

What is the “economic problem”

Answer 1

Attempting to satisfy the unlimited desires of humans using scarce resources.

Question 2

What is a positive statement?

Answer 2

This is an objective statement, which can be tested to see if its true or false using factual evidence
Eg: Higher taxes will increase tax revenues - this can be tested to see if its true

Question 3

What is a normative statement?

Answer 3

Normative statements are based on value judgements. These are subjective and opinions, rather than factual statements

Eg: The best way to correct market failure is through tax
- there is no clear way to test this and it is simply an opinion
- it is therefore a normative statement

Question 4

What is the purpose of economics? What are the 3 key economic decisions?

Answer 4

Economics is the science of making decisions about using scarce resources in order satisfy the unlimited wants/desires of humans

3 Key Economic Decisions:
- What gets produced - An economy can choose the mix of goods produced. Eg: What proportion should be spent on defence compared to the environment?
- How is it produced - Economists can decide who should produce it and how. They can also change the materials used. All of this changes the costs and logistics.
- To whom it benefits accrue - An economic system needs to decide how much of the output goes to workers, pensioners and all those involved.

Question 5

What is the difference between positive and normative economics?

Answer 5

• Positive Economics is the scientific and objective study of economics, of the allocation of resources and workings of markets
• Normative Economics is concerned with judgements and scrutiny of the economic world. They are ultimately opinion statements about how the markets and world of economics should work. For example “The government should increase tax”

Question 6

What is Ceteris Paribus and how do we use it?

Answer 6

Economists often use “Ceteris Paribus’ ‘ to help simplify reality so that their models explain their points better.
This means “all other things equal, or remaining the same ‘’, which allows economists to isolate the factor or point the theory demonstrates.

Question 7

What is scarcity?

Answer 7

This is the idea that there are limited resources available yet humans (are assumed) to have unlimited needs
This means that the demand for a good or service is greater than the availability of the good or service, therefore economics must decide the allocation of such resources

Question 8

What is opportunity cost in words?

Answer 8

In microeconomic theory, the opportunity cost of a choice is the value of the best alternative forgone where, given limited resources (scarcity), a choice needs to be made between several mutually exclusive alternatives

Question 9

What is the difference between scarce resources and non scarce resources?

Answer 9

• Scarce resources (eg: the environment): economic goods have a much greater desire than supply (at a price of zero), and therefore are limited in supply
• Non scarce resources (eg: air) which are freely available: free goods. These goods have enough supply to completely satify the desired for them from humans

Question 10

What are the 4 factors of production in economics? What are their definitions? Who provides these resources and why?

Answer 10

Households provide factors of production to firms

Owners of factors of production receive payments when they let other economic agents use them for a period of time. Eg: Owners of land may receive let or rent payments, owners of machinery and capital can profit off these things by renting them or using them to produce goods

The 4 factors of production:
- Land (natural resources)
- Labour (the workforce of an economy)
- Capital (Stock and assets which are used to aid future production)
- Enterprise (The creativity, organisational intelligence and willingness to take risks and to organise production in firms in order to seek out profitable opportunities)

Question 11

What is the difference between working and fixed capital?

Answer 11

Fixed Capital is capital which is not used up in the production process such as machines. Working Capital is capital which is used up in the production process such as raw materials)

Question 12

How is the environment a economic good? What does it mean that the environment is a scarce good?

Answer 12

Environmental resources can command a price when sold (eg Copper) and the environment is therefore an economic good

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 13

What is entrerprise as a factor of production?

Answer 13

The creativity, organisational intelligence and willingness to take risks and to organise production in firms in order to seek out profitable opportunities

Question 14

What are the rewards/incentive of providing each of the factors of production?

Answer 14

Capital: - Firms borrow money from households (through banks) to purchase capital and fund projects. People benefit from the interest by lending out money, or if they directly rent out capital they will receive rent money
Entrepreneurship Managerial ability: - Profit- an incentive to take risks
Land: - Rent
Labour: - Wages

Question 15

What are free goods?

Answer 15

Goods which are unlimited in their supply and therefore don’t have an opportunity cost

Question 16

What is an economic good?

Answer 16

A product or service which can command a price when sold

Question 17

What is a production possibilities frontier? How does it demonstrate the ideas of opportunity cost and scarcity?

Answer 17

The Production Possibility Frontier (PPF), is a model that shows the possible combinations of two products or services that could potentially be produced by a society.

Scarcity: The boundary shows the maximum potential output if all resources are utilised as efficiently and fully as possible. The existence of the boundary shows how the resources are limited and unlimited production is not possible.

Opportunity Cost: To produce more of one good, another must be given up as it will be given a larger allocation of resources at the cost of producing the other thing, (known as the opportunity cost.)

Question 18

What is the difference between consumer and capital goods?

Answer 18

• Capital goods are goods which can be used to produce other goods, such as
  machinery.
• Consumer goods are goods which cannot be used to produce other goods, such as clothing.

Question 19

What does the outer boundary of a PPF curve show? What is the efficiency at these points?

Answer 19

All points on the PPF Boundary show the maximum potential output for that combination of products/services when all factors of production are fully and most efficiently deployed

However, this may not be the most efficient combination/selection of goods/services for an economy, or have the best allocative efficiency. (when social welfare is maximised)

Question 20

What does it mean if an economy is producing within the curve?

Question 21

How can economic growth or decline be shown on a PPF Curve? What causes growth or decline?

Answer 21

Growth: Boundary moves further out
Decline: Boundary moves further in

Growth is caused by either an increase in the quantity or productivity of factors of production

Question 22

Which points on the following diagram are productively efficient? What do the points D and C represent?

Answer 22

Prod Efficiency: B, A

ALL POINTS on the boundary of a PPF are productively efficient. This is because resources are being used to their productive potential so it is efficient.

C represents productive inefficiency

Question 23

How is economics as a subject classified? Why is this debatable?

Answer 23

Economics is often classified as a social science. It’s the study of how groups of individuals make decisions about the allocation of resources

In economics it is often much more difficult to conduct such experiments. Factors are much harder to control, and therefore it is harder to determine or isolate which factor is causing the data. This leads to many theories listing different interpretations and reasons for some data or a trend.
As factors rarely can be fully isolated in experiments to prove the certain validity of theories, economics often use words such as “it is likely that’’, to express this uncertainty.
For this reason some groups think economics cannot be considered as a science.

Question 24

What are some assumptions of a PPF Curve?

Answer 24

o A fixed amount of resources are used (eg: the ppf for a factory does not suddenly employ more capital)
o There is a constant state of technology

Question 25

What is allocative efficiency? What is productive efficiency?

Answer 25

Allocative Efficiency: When economic resources are allocated such to produce the combination of goods and services that maximise economic welfare

Productive Efficiency:
Productive efficiency is when a firm produces the lowest Average Total Cost. Therefore productive inefficiency occurs when a firm produces at costs above the lowest possible costs
This is where MC intersects ATC
Productive efficiency can only occur if a firm achieves technical efficiency, which is when for a given quantity of inputs, the maximum quantity of outputs are achieved
If an economy is producing on the boundary of the PPF, then all firms within the economy will be considered productively efficient

Question 26

Explain the difference between renewable and non renewable resources

Answer 26

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.

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 27

What is the factor of production enterprise?

Answer 27

The creativity, organisational intelligence and willingness to take risks and to organise production in firms in order to seek out profitable opportunities