micro 1.1 - nature of economics

Question 1

economic models?

Answer 1

why do economists develop models?
- Economists develop models/theories to explain how the economy works e.g. demand and supply diagrams or the circular flow of income

how are models developed in economics?
- They are developed by putting forward a model, gathering evidence and then accepting, changing or disregarding the model

why are assumptions made when creating economic models?
- There are too many variables which can change within an economic model and so assumptions must be made like ceteris paribus

• it is difficult to set up experiments to test hypothesis —> economists have to gather data in the ordinary everyday world —> variables are constantly changing —> difficult to come to a conclusion

Question 2

positive, normative statements and value judgments

Answer 2

• positive statement - a positive statement is objective - can be tested to be proven or disproven e.g. “raising tax will lead to an increase in tax revenue”
• normative statement - a normative statement is subjective - cannot be proven or disproven e.g. “the government should increase taxes”
• value judgement- an evaluative statement of how good or bad you think an idea or action is

Question 3

ceteris paribus, basic economic problem, opportunity cost, renewable resources, non renewable resources, 4 FOP

Answer 3

• ceteris paribus - all other things remaining the same
• basic economic problem - infinite wants and scarce resources
• opportunity cost - the value of the next best alternative foregone
• renewable resources - cannot be depleted over time e.g. wood, solar and wind
• non renewable resources - deplete overtime e.g. coal oil and gas

4 FOP:
- capital - things that man has made to allow for greater production of goods and services e.g. machinery
- enterprise - the ability to bring all the factors of production together and take a risk in return for profit
- land - natural resources but it can also be a physical space for machinery
- labour - workers that can produce goods and services

Question 4

productive possibility frontier (PPF)

Answer 4

• PPF - shows the maximum combination of goods that can be produced in a given period with a given set of resources
• points along PPF curve - efficient use of resources
• points inside PPF curve - inefficient use of resources
• points outside PPF curve - producing it is unattainable with current resources
• a shift of the PPF curve indicates economic growth or decline
• movement - a movement along the curve indicates a change in the combination of goods produced
• point on x or y axis - economy uses all its resources to produce good A or good B
• opportunity cost PPF - the opportunity cost of producing more of 1 good is the amount of the other good that must be given up
• macro PPF labelling - consumer goods + capital goods// goods + services
• micro PPF labelling - 2 specific goods e.g. laptops and tablets
• consumer goods - products used by consumers
• capital goods - used by a business to produce consumer goods

Question 5

specialisation and the division of labour

Answer 5

• specialisation - concentration of production on a narrow range of goods and services
• if workers specialised in one task, adam smith estimated that just 10 workers could produce 48,000 pins per day
• division of labour - production process being broken down into separate specialised tasks

advantages:
- focusing on a particular stage - workers become highly skilled and more efficient - more productive - lowers unit costs for firms - lower costs can be passed onto consumers in the form of lower prices - demand increases - profit increases
- workers only need to be trained to do 1 specific task - saves time and money
- time is not wasted moving between jobs and getting tools out etc

disadvantages:
- task repetition leads to boredom - lower motivation - poor quality work (evaluation - firms can take some action to reduce this e.g. by playing music)
- if there’s a problem in the production process - every other task has to stop until that problem is solved

advantages of specialisation in trade:
- high labour productivity lowers unit costs for firms - exports are more internationally competitive

disadvantages of specialisation in trade:
- countries may become over-dependent on 1 particular export that they specialise in - if this fails, their economy may collapse
- specialisation creates over dependency on other countries’ resources
- specialisation increases the rate of resource depletion - if these resources run out then this results in a huge loss of income for that country

Question 6

functions of money

Answer 6

function of money:

• prior to money, bartering existed - exchanging goods or services for other goods or services without the use of money

a medium of exchange:
- money can be used to buy goods and services and is acceptable everywhere as people know that they can use it to buy what they want
- the problem with bartering was that people could only trade if there was a double coincidence of wants where both parties want the good the other party offers

a measure of value:
- money allows us to compare the value of two goods/services

a store of value:
- it able to keep its value and can be kept for a long time (evaluation - inflation means that this is not always true) - with bartering, goods such as fruits often went out of date and so could not keep their value

a method for deferred payment:
- money can allow for debts to be created —> people can buy things without having money in the present

Question 7

governments role in a mixed economy

Answer 7

• they move income from one group of people to another - income is redistributed
• government spend money on merit goods e.g. schools and public goods such as flood defences

Question 8

free market, command and mixed economy

Answer 8

• free market economy (adam smith) - where resources are allocated through the price mechanism

features:
- private ownership of resources
- invisible hand - prices are determined by the forces of demand and supply
- profit motive
- competition

advantages:
- competition - lower prices and better quality goods/services
- profit motive - firms are incentivised to be more efficient

disadvantages:
- wealth is concentrated in the hands of a few - increases inequality
- public goods are under provided

• command economy (karl marx) - an economy where the government allocates resources

features:
- state ownership of resources - government decides what, how, and for who to produce

advantages:
- social equality
- less unemployment
- the government owns monopoly businesses so consumer exploitation through high prices can be avoided

disadvantages:
- inefficiency - lack of profit motive
- lack of competition - poor quality goods/services

• mixed economy (friedrich hayek) - a combination of free market and command economies