Economic Methodology/The Economic Problem Flashcards
Profit =
Total revenue - total costs
Common economics assumption
‘Ceteris’ paribus’: meaning ‘all else being equal’(e.g. the assumption rational businesses are seeking to make a profit), which helps us examine the likely impact of one particular change to an economic variable
Economics definition
Economics studies the choices people take under the conditions of scarcity and uncertainty
Three types of economy
- Free Market Economy
- Command Economy
- Mixed Economy
Free market economy examples
UK, America, EU, Japan, in 2024, Argentina(the world’s most radical free-market experiment) grew again.
Free market economy
Individual consumers/businesses/markets are free to make their own individual decisions with their money and property, without consulting anyone(what to produce, how to produce what they’re producing and for who ).
Driven by the profit motive, the private sector dominates.
Here, the price mechanism performs the central economic task of allocating scarce resources among competing uses through the markets which make up the economy.
Command economy examples
China, Russia, Cuba, North Korea
Command economy
Where the government/authorities make all the decisions(what to produce, how to produce it and for whom).
Factors of production
Capital - wealth in the form of money/other assets owned by a person/organisation(for equipment)
Land
Labour
Enterprise - the person with the ideas and money to start a successful business
Microeconomics
The study of economics at the level of the individual firm, industry or consumer/household e.g. how individual businesses respond to changing economic factors, or how consumers decide what to buy
Economic problem
What to produce!
How to produce?
On what basis is the output distributed/allocated?
scarcity of resources
Interventionists
Economists believing the government/authority should play a crucial role in the decision making and allocating resources within society(the government should take care for you in a country freely).
Either directly or through imposing regulations on market(which interventionists do) to enable them to allocate resources more ‘fairly’ or in a way which does not damage society.
Example of free marketers
Conservatives(leave decisions to the market)
Examples of interventionists
The Labour government
Opportunity cost
The cost of a choice made in terms of the next best alternative foregone or sacrificed
Capital goods
Goods we use to make consumer goods and services(e.g. van, computer - equipment we use in factories/businesses)
Consumer goods
Goods we buy to satisfy our needs and wants
Rationing-
A market mechanism of allocating scarce goods and services when market demand out-weighs the available supply
Different ways of rationing scarce resources
By Market Price
By Consumer Income
By Assessment of Need
By Household Postcode(people are disadvantaged at where they live as a result of their postcode)
By Education Level
By Age
By Gender
By Nationality
Opportunity cost(investing today for consumption today)
The opportunity cost of an economy investing resources in new capital goods is the production of consumer goods given up for today.
Pension
Putting a little amount of money from your working wages into your pension scheme, to ensure money to live on when you retire
Consumer durables
Products providing a steady flow of satisfaction/utility over their working life
Consumer non-durables
Products used up in the act of consumption e.g. grocery foods
Consumer goods(sub divisions)
1) Consumer durables
2) Consumer non-durables
3) Consumer services
What is a straight line production possibility frontier?
An indication of perfect factor substitutability of resources
What happens if the production possibility frontier is a straight line?
The marginal opportunity cost of switching resources between consumer and capital goods is constant
How do businesses respond to consumers’ changing desires?
Businesses realise consumers prefer capital goods to consumer goods, so reallocate resources to produce more capital goods
Outward shift in the Production Possibility Frontier
Increases in production technology, more factor resources/inputs(e.g. more workers) can cause the PPF to shift outwards, trade between countries(for nations to consume beyond their own PPF- for gains in economic welfare) and producing more goods with the same resources(improvement in welfare and allocative efficiency) leading to an increase in a country’s potential output, so more capital goods can be produced for each level of output of consumer goods
Main function of a PPF
A PPF shows alternative combinations of two goods or services attainable when all resources are fully and efficiently employed
What happens as we normally move down along the PPF?
As more resources are allocated towards Good Y, the extra output gets smaller. This is explained by the law of diminishing marginal returns, which occurs as not all factor inputs are equally suited to producing items, leading to lower productivity,
Advantages of entrepreneurial businesses
Know how to get people to invest money, to maximise their own profit
What happens with diminishing returns/marginal utility?
The marginal(extra) output of good Y diminishes as more factor resources are allocated to it, so each extra unit of consumption gives less satisfaction and utility.
Specialisation
The concentration of production on a narrow range of goods or services
Specialisation advantages
- Higher output/maximisation of output
- Wider range of goods
- Greater Allocative Efficiency
- Higher Productivity
- Quality improvements
How specialisation brings higher output
More mutually beneficial trade(export revenue can rise)
More economic growth(resources focused on efficient production)
More choice for consumers
More job opportunities
How does specialisation bring a wider range of goods/services
Less scarcity of resources
More efficient use of limited factors of production
How does specialisation bring higher productivity?
Through better use of workers e.g. in school, specialist teachers are found, lowers firms’ cost of production, passed to consumers by lower prices
Disadvantages of specialisation
- Finite resources
- Changes in fashion/taste
- Deindustrialisation
- National interdependence
How can specialisation cause finite resources?
Some companies require a special input of a specific product, but struggle if the product goes out of favour e.g. Saudi Arabia highly depend on the commodity of oil, Bangladesh highly depend on the use of fossil fuels like oil(its economic development is reliant on industrialisation), Russia also rely on the commodity of oil and natural gas
How are changes in fashion/taste caused by specialisation a disadvantage?
If a product goes out of favour compared to another, businesses overspecialised on selling that product(e.g. DVDs) are doomed
How is Deindustrialisation caused by specialisation?
If another foreign firm is more efficient than a specialised company at producing a particular product, the company/factory may close down e.g. Britain don’t manufacture cars any more, because other countries do it faster and cheaper.
Britain steel making: In the 1960s, it was the 5th largest producer of steel, now it’s 26th
During the twentieth century, the UK went from over 3000 coal mines to just 30(decline in coal mining).
Division of Labour
Breaking down the production process into separate tasks upon specialisation
How scientific methodology may be used in economics
- Observing consumer behaviour in the marketplace.
- Forming a hypothesis to explain how consumers spend their money.
- Developing predictions from the hypothesis
- Using evidence to test the predictions
- Concluding evidence supports hypothesis- demand theory develops: further tests
- Evidence doesn’t support predictions: new or revised hypothesis
What happens if a hypothesis fails to survive the test to which it’s exposed?
- Outright rejection
- Hypothesis is changed, usually by diluting it, to make it less deterministic
What happens if evidence supports the hypothesis?
The hypothesis has survived the test/tests to which it has been exposed
Ha Joon Chang economic theory
No economic argument can be free from politics and ethics
Value judgement
About whether something is desirable or not e.g. economics necessarily requires government ministers make value-based judgements when deciding on economic policies
Impact of moral and political judgements
Whatever decision is eventually made in the course of framing government economic policy, there will always be winners who gain and losers who suffer as a result of the decision. Governments claim they have a moral right to make such decisions, arguing their political manifesto published before the previous general election gives them the mandate, supported by the voters, to carry out their policies
Improving economic welfare
Satisfying people’s needs and wants
Economic system
The set of institutions within which a community decides what, how and for whom to produce
Barriers that separate or break up information
Transport costs
Lack of information
Breakdown of command economies
Not pure planned ecomomies, with production but not consumption planned, and shortages resulted, which, together with the generally inferior quality of consumer goods, contributed to the breakdown of command economies
Example of communist countries moving away from being pure command economies
China is now more capitalist than the USA and the mixed economies of Western Europe - ‘state capitalism’ describes China’s economy
When did the UK economy develop into a mixed economy?
After WW2 ended in 1945, with a number of important industries such as coal, rail and steel nationalised and taken into public ownership
Benefits of UK as a mixed economy
1940s-1970s: majority of UK people believed certain types of economic activity(production and distribution of consumer goods) were best suited to private enterprise and the market economy, however they also accepted important services(education, healthcare and roads) should be in part be provided by the government, outside the market, and financed through the tax system
Critics of UK as a mixed economy
From 1980 onwards, many economists and politicians began to blame the mixed economy for the UK’s deteriorating economic performance: the public and non-sectors of the economy inefficient and wealth consuming - critics of the mixed economy wanted increased private ownership and market production
Policies to change nature of UK economy
Economic liberalisation:
1. Privatisation
2. Marketisation
3. Deregulation
The UK economy is now much closer to being a pure market and private enterprise economy than it was 45 years ago.
Privatisation
The sale of state-owned assets(e.g. nationalised industries) to private owners
Marketisation
Prices charged for goods and services that the state previously provided free of charge
Deregulation
Attempts to remove barriers to entry and government red tape and bureaucracy from the operation of markets
Production
Converts inputs or factor services into outputs of goods and services
Entrepreneurs
People who address the issues introduced earlier, deciding what to produce, how to produce it and for wjom to produce it.
Environmental resources
All the natural resources as part of the economic system
Examples of environmental resources
Physical resources(soil, water, forests)
Gases(hydrogen and oxygen)
Abstract resources(solar energy, wind energy and water)
Examples of scarce environmental resources
In most countries and regions where large numbers of people live, clean air and drinkable water are scarce commodities
What does scarcity result from?
The fact people have unlimited wants, but resources to meet these wants are limited
Inter-temporal choice
The study of how people make choices about what and how much to do at various points in time, when choices at one time influence the possibilities available at other points in time
Economic growth
The increase in the potential level of real output the economy can produce over a period of time
Short-run economic growth
Makes use of spare capacity and takes up the slack in the economy
Long-run economic growth
Increases total productive capacity
Resource allocation
The process through which the available factors of production are assigned to produce different goods and services
When does productive efficiency occur?
When producing more of one good involves reducing production of other goods
How is National interdependence caused by specialisation?
Examples:
In the 19th and 20th century, countries in Western Europe and North America completed the process of industrialisation: labour became specialised. Labour specialisation is also called the division of labour: no longer were people building entire cars at the Ford factory: labourers started doing a single task on every single car
Evidence of dependence on specialisation
The Apple iPad comes from China.
Bread comes from Ukraine - we ran out of bread during the pandemic, because we use wheat to make bread which comes from Ukraine.
BP is a British multinational oil and gas company headquartered in London.
Samsung comes from South Korea, with a Samsung TV.
Advantages for Division of Labour
1) Workers highly productive(wages increase, savings, costs of production and prices decline)
2)Specialist capital for workers
3)Lower prices, higher quantity/choice and quality for consumers
Disadvantages of division for labour
1) Workers demotivated
2) High worker turnover
3) Risk of long term unemployment
4) Highly standardised goods/services
5) Workers’ skills may suffer(over-specialisation)
