Economic methodology, scarcity, choice and gains from trade Flashcards
what is scarcity?
society has limited resources and cannot produce all the goods and services people want (unlimited wants)
describe the efficiency vs equity trade-off
Efficiency: Society gets the most that it can from its **scarce resources. **
Equity: The benefits of those resources are distributed fairly among the members of society.
Decisions require
comparing the costs and benefits of alternatives
what is the opportunity cost?
value of the next best alternative foregone
rational decision making consists of
weighing marginal benefits and costs
make decisions where marginal benefits > marginal costs
how do marginal changes create an incentive for people to respond?
Marginal changes create an incentive for people to respond, as people choose an alternative over another on the basis that the marginal benefits outweigh its marginal costs
These incentives can cause people to respond in a predictable way whereby they react to changes in expected MBs and MCs
Why is trade beneficial?
allows specialisation
increases competition, which is passed onto consumers in the form of better services and lower prices
what is a market economy/ free market economy?
economy whereby resources are allocated through the interactions of firms and households in the market
i. e. firms decide who to hire, and what to produce
i. e. households determine what to purchase and who to work for
Individuals own resources and there is private property
describe adam smith’s “invisible hand” metaphor in the 1700
market economy allows efficient allocation of resources via the price mechanism that operates to guide decisions of firms and households
Why may the government intervene in the market?
To address market failure (when markets fail to take into externalities i.e. social costs and benefits from their actions)
what is the ultimate source of improving living standards?
productivity
The production possibilities frontier (PPF) is a graph that
shows the maximum combinations of two goods that are possible, given the economy’s resources and level of technology
what concepts does the production possibility frontier illustrate?
what does the circular flow diagram show?
shows how dollars flow through markets among households and firms in an economy
distinguish between a curved and straight production possibility curve?
an increase in opportunity cost when curved and resources are different
constant opportunity cost and resources are similar
what are 3 factors that may shift the production possibility curve?
- quantity and quality (better education –> better human capital) of resources
- technology (Improve in capital which is a factor of production)
- trade
what is a command economy?
government owns resources and there is no command property
what is comparative advantage?
where a person or country can produce one good more efficiently relative to another good (lower opportunity cost compared to another person or country)
calculate the comparative advantage of both countries
US has a comparative advantage in producing cars
whereas canada has a comparative advantage in producing computers
how does the production possibility frontier show scarcity?
cannot product output beyond the curve, it is impossible
how does the production possibility frontier show opportunity cost?
shown by the specific number of Product A that has to be forgone to produce Product B
how does the production possibility frontier show efficiency?
when the point is inside the curve, as resources are underutilised
if the point is on the PPC curve, efficient as then you are employing all factors of production
is a point outside the production possibility frontier possible?
no
describe how trade can shift the production possibility frontier
when a country trades, they are able to obtain products with lower opportunity cost (as the other country may have a comparative advantage in producing that particular product), than if they were to produce the product themselves. Thus, allowing the country to consume beyond their production possibilities
what are capital goods?
they produce consumer goods (ready for direct consumption)
why is high unemployment a point inside the curve?
as labour is underutilised, thus labour is not used efficiently
find the comparative advantange
when conducting marginal analysis, we look at the
additional benefit and additional cost
what are product markets?
businesses produce goods and services that are sold at product markets
Product markets sell goods and services to individuals
individuals purchase goods and services from the product market
Revenue from product markets to go businesses
who owns resources in free market economy, and what does this include?
individuals and businesses
these include, land, labour, capital and entrepreneurship
describe how government intereacts with the product and factor markets
government purchase goods and services from the product market through government spending
Product market provides goods and services to the government
factor market provides resources to the government
government returns government spending to factor market eg. in form of income
describe marginal analysis
individuals aim to maximise their own self benefit by analysing the marginal benefit and cost of their actions
incentives can be
positive or negative
positive encourages production and consumption e.g. subsidy
negatives discourages production and consumption eg. tax
heart of economics considers
- resources are finite
- wants are unlimited (wants more or better)
- choices must be made
what is absolute advantage?
where a country or person is more efficient or productive at producing a good compared to another person or country
what is a voluntary exchange?
An agreement between two free individuals and/or organizations to buy, sell or trade a good or service. A voluntary exchange contrasts with an exchange that is mandated, for example, by a government. Voluntaryexchanges are the basis of a** free market economy.**
voluntary exchange is
mutually advantageous
no change in total qty of goods available, rather a reallocation of goods
describe gains in trade
person or country should produce what they have a comparative advantage in, and trade what they don’t have comparative advantage in producing (don’t have low opportunity cost)
because the trade **reallocates goods between two individual or the country **in a way that they both prefer, making them both better off
what is positive analysis?
descriptive statements of cause and effect
what happens in the economy and why, without making recommendations about economic policy.
e.g. low wages of workers will lead to an increase in demand for those workers
what is normative analysis?
statements that embody judgements
economic analysis that makes recommendations about economic policy.
e.g. the government should lower wages for the poor
why may the ppf be curved instead of linear?
Due to the law of increasing opportunity costs. The resources used to produce one good, may not be suitable to produce the other good.
Basically, what this means is that as an economy devotes more of its resources to one kind of product, it becomes less efficient.
if the economy is producing close to the maximum amount of butter produced, it’s already employed all of the resources that are better at producing butter than producing guns. In order to produce more butter, then, the economy has to shift some resources that are better at making guns to making butter. This results in a high opportunity cost of butter.
