Economic methodology, scarcity, choice and gains from trade

Question 1

what is scarcity?

Answer 1

society has limited resources and cannot produce all the goods and services people want (unlimited wants)

Question 2

describe the efficiency vs equity trade-off

Answer 2

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.

Question 3

Decisions require

Answer 3

comparing the costs and benefits of alternatives

Question 4

what is the opportunity cost?

Answer 4

value of the next best alternative foregone

Question 5

rational decision making consists of

Answer 5

weighing marginal benefits and costs

make decisions where marginal benefits > marginal costs

Question 6

how do marginal changes create an incentive for people to respond?

Answer 6

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

Question 7

Why is trade beneficial?

Answer 7

allows specialisation

increases competition, which is passed onto consumers in the form of better services and lower prices

Question 8

what is a market economy/ free market economy?

Answer 8

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

Question 9

describe adam smith’s “invisible hand” metaphor in the 1700

Answer 9

market economy allows efficient allocation of resources via the price mechanism that operates to guide decisions of firms and households

Question 10

Why may the government intervene in the market?

Answer 10

To address market failure (when markets fail to take into externalities i.e. social costs and benefits from their actions)

Question 11

what is the ultimate source of improving living standards?

Answer 11

productivity

Question 12

The production possibilities frontier (PPF) is a graph that

Answer 12

shows the maximum combinations of two goods that are possible, given the economy’s resources and level of technology

Question 13

what concepts does the production possibility frontier illustrate?

Answer 13

Question 14

what does the circular flow diagram show?

Answer 14

shows how dollars flow through markets among households and firms in an economy

Question 15

distinguish between a curved and straight production possibility curve?

Answer 15

an increase in opportunity cost when curved and resources are different

constant opportunity cost and resources are similar

Question 16

what are 3 factors that may shift the production possibility curve?

Answer 16

1. quantity and quality (better education –> better human capital) of resources
2. technology (Improve in capital which is a factor of production)
3. trade

Question 17

what is a command economy?

Answer 17

government owns resources and there is no command property

Question 18

what is comparative advantage?

Answer 18

where a person or country can produce one good more efficiently relative to another good (lower opportunity cost compared to another person or country)

Question 19

calculate the comparative advantage of both countries

Answer 19

US has a comparative advantage in producing cars

whereas canada has a comparative advantage in producing computers

Question 20

how does the production possibility frontier show scarcity?

Answer 20

cannot product output beyond the curve, it is impossible

Question 21

how does the production possibility frontier show opportunity cost?

Answer 21

shown by the specific number of Product A that has to be forgone to produce Product B

Question 22

how does the production possibility frontier show efficiency?

Answer 22

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

Question 23

is a point outside the production possibility frontier possible?

Answer 23

no

Question 24

describe how trade can shift the production possibility frontier

Answer 24

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

Question 25

what are capital goods?

Answer 25

they produce consumer goods (ready for direct consumption)

Question 26

why is high unemployment a point inside the curve?

Answer 26

as labour is underutilised, thus labour is not used efficiently

Question 27

find the comparative advantange

Answer 27

Question 28

when conducting marginal analysis, we look at the

Answer 28

additional benefit and additional cost

Question 29

what are product markets?

Answer 29

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

Question 30

who owns resources in free market economy, and what does this include?

Answer 30

individuals and businesses

these include, land, labour, capital and entrepreneurship

Question 31

describe how government intereacts with the product and factor markets

Answer 31

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

Question 32

describe marginal analysis

Answer 32

individuals aim to maximise their own self benefit by analysing the marginal benefit and cost of their actions

Question 33

incentives can be

Answer 33

positive or negative

positive encourages production and consumption e.g. subsidy

negatives discourages production and consumption eg. tax

Question 34

heart of economics considers

Answer 34

1. resources are finite
2. wants are unlimited (wants more or better)
3. choices must be made

Question 35

what is absolute advantage?

Answer 35

where a country or person is more efficient or productive at producing a good compared to another person or country

Question 36

what is a voluntary exchange?

Answer 36

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.

Question 37

voluntary exchange is

Answer 37

mutually advantageous

no change in total qty of goods available, rather a reallocation of goods

Question 38

describe gains in trade

Answer 38

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

Question 39

what is positive analysis?

Answer 39

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

Question 40

what is normative analysis?

Answer 40

statements that embody judgements

economic analysis that makes recommendations about economic policy.

e.g. the government should lower wages for the poor

Question 41

why may the ppf be curved instead of linear?

Answer 41

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.