Nature of Economics Flashcards
Economic Model
Theoretical construct - building a hypothesis about behaviour that can be tested, supported, amended or rejected
Assumption
Assumed behaviour of consumers and businesses
Ceteris Paribus Assumption
All other factors held constant - helps to isolate the impact of one factor e.g. a change in either price or income on demand
Social vs Natural science
Social: studies of human behaviour, dynamic inter-relationships
Natural: studies of the natural world
Positive and Normative statements
Positive: Objective statements that can be tested, amended or rejected by referring to the available evidence e.g. “Rates of lung cancer will decrease if smoking is banned”
Normative: Value judgements that cannot be tested and are subjective rather than based on a fact i.e. should, ought, fair (NOT OPINION) e.g. “Smoking is the most dangerous threat to our health in modern times”
Value Judgement
A value judgment contains a normative statement concerning what ought/should happen in a given situation.
Economic problem
Arises from the scarcity of resources - e.g. unlimited wants and finite resources (limited inputs available to satisfy unlimited needs and wants)
Renewable and Non-renewable resources
Renewable: Can be replenished e.g. solar power, fish stocks, forestry (wood)
Non-renewable: Finite resources, cannot be replenished e.g. crude oil, gas, coal
Opportunity Cost
Cost of choosing to consume/produce a good/service in terms of the next best alternative forgone
- does not only refer to financial choices e.g. time
Economic Agents
Consumers, Producers, Government - anyone engaged in some form of economic activity
Production Possibility Frontiers/Curves - PPF PPC
Shows all the possible combinations of two or more goods that can be produced when all resources are used efficiently
- opportunity cost (directly related to the shape of the curve) and how efficient a firm or country is being
PPF straight line
If the shape of the PPF curve is a straight-line:
- the marginal opportunity cost remains constant as the production of different goods is changing (amount of one good given up to produce the other does not change) (product increases/decreases by regular intervals)
Diminishing Marginal Returns
The more of a good that is produced the harder it is to produce it efficiently
- because producers use the best factors of production first and will need to use less efficient factors of production as they make more
Diminishing Marginal Returns example
Increasing milk production from 20 to 24 units will require more resources than the 16 to 20 increase
- because a business will be using inferior factors of production (due to scarcity) than the previous units produced
- so the business will have to sacrifice more of the alternative product (cotton) than before, meaning the opportunity cost is higher
Maximum productive potential for an economy on PPF l Pareto efficiency
Anywhere on the PPF, which is the curve/frontier itself
*Pareto efficiency: implies resources are allocated in the most economically efficient manner, but does not imply equality or fairness
Efficient allocation of resources - Pareto efficiency
Combination of scarce inputs and outputs such that any change in the economy can make someone better off only by making someone worse off (inequality)
Production potential
Shows the maximum limits to output
Capacity: the maximum output that a business can produce in a given period with the available resources
Marginal analysis examples
- A baker does not decide to produce 5,000 loaves of bread in a year, but decides what to produce each day or week
- A typical consumer does not decide to drink 4 cans of cola at the beginning of each day, rather they make 4 individual decisions, one at a time
Economic growth or decline on PPF
Growth: an outward shift signifies an expansion of a country’s productive potential i.e. long-term economic growth
Decline: an inward shift signifies decline of a country’s productive potential
Economic growth
A long-run increase in a country’s productive capacity and capabilities shown by growing real national output
Economic decline
A contraction in the value of national output shown by a negative rate of real GDP growth in a recession
Outward shift in PPF
Shifts outwards through:
-increased quantity or quality of factors of production
Anything that creates more resources OR allows them to be used more efficiently
e.g. Discovering oil (more land)
e.g. Better education system (better quality labour)
Inward shift in PPF
Shifts inwards through:
- War
- Natural disasters (destroy resources)
- Migrant workers returning home
Anything that means there are less resources OR resources used less efficiently
Efficient or inefficient allocation of resources on PPF
Efficient: on the curve/frontier
- combination of goods fall on the PPF, the society is achieving productive efficiency
- efficient allocation on resources
Inefficient: inside the curve
- combination of goods produced fall inside the PPF, the society is productively inefficient
- resources are available but used inefficiently e.g. unemployment
Possible and unobtainable production
Possible:
- choices inside the PPF are inefficient
- choice on the PPF are efficient
Unobtainable:
- choices outside/beyond the PPF are unattainable because they cannot be produced using currently available resources (lack of resources)
Movements along PPF
The opportunity cost of producing each in terms of the other
- represents the economy’s choice about the relative amounts of each product to produce
Movement along PPF curve
Opportunity cost (trade off)
Movement from inside PPF onto PPF
There being less unused resources
Capital and consumer goods
Capital: any good deployed to help increase future production e.g. PP&E, tangible assets (buildings, machinery, equipment, vehicles, tools) that are then used to produce other goods and services
Consumer: any good used by consumers and have no future productive use
- bought and consumed by households to satisfy current wants or needs
*PP&E
Property, plant, and equipment: long-term, tangible assets that a company owns (most often fixed) e.g. trucks, machinery, factories, and land, allows a company to conduct and grow its business
- PP&E is depreciated over time and can be sold for its salvage value.
*Salvage value
the estimated value of an asset at the end of its useful life. It represents the amount that a company could sell the asset for after it has been fully depreciated. On the other hand, book value is the value of an asset as it appears on a company’s balance sheet
Infrastructure
Includes physical capital such as transport networks, energy, power and water supply and telecommunications networks
Specialisation/Division of Labour
A system whereby each worker concentrates on performing a few specific tasks in the production process (remember car activity)
Specialisation benefits
- Reduces the problem of scarcity i.e. greater output
- Wider range of goods and services available
- Develop expertise in specialism over time
- Higher quality of goods and services
- Trade increased (economy grows)
Specialisation drawbacks
- Demand falling
- Change in tastes
- Competitors
- Wages and raw materials
- Hard meeting demand
- Lack of raw materials
Adam Smith - reasons specialisation works
1) Specialisation in a particular small job allows workers to focus on the parts of production they’re most skilled at
2) Workers who specialise in certain tasks often learn to produce more quickly and with higher quality
3) Specialisation allows businesses to take advantage of economies of scale, meaning for many goods, as the level of production increases, the average cost of producing each individual unit declines (similar to bulk buying)
- economies of scale implies that production is becoming more efficient as the scale of production rises
Division of labour industries
- Vehicle assembly
- Construction industry
- Smartphone assembly
Economies of scale example
If a factory produces only 100 cars per year each car will be quite expensive to make, on average. However, if a factory produces 50,000 cars each year, then it can set up an assembly line with huge machines and workers performing specialised tasks, and the average cost of production per car will drop
Advantages of specialisation in organising production
To the business:
- Specialist workers become quicker at producing goods therefore: - Production becomes cheaper per good
- Production levels are increased
- Each worker can concentrate on what they are good at and build their expertise
To the worker:
- Higher pay for specialised work
- Improved skills at that job
Disadvantages of specialisation in organising production
To the business:
- Greater cost of training workers
- Absence of 1 worker may stop whole production line
- Quality may suffer if workers become bored by the lack of variety in their jobs
- Higher staff turnover, greater cost in finding new employees
To the worker:
- Boredom of doing same job
- Their quality and skills may suffer
- May eventually be replaced by machinery
Advantages of specialising in the production of good/services TO TRADE
- Allows a country to make full use of their economic resources
- Increases the scale of production (leads to lower costs and prices)
- Surplus can be exported, an injection into the circular flow of income
Disadvantages of specialising in the production of goods/services TO TRADE
- World prices for a product might fall leading to declining revenues
- Risk of over-specialising and structural unemployment
- Might lead to over-extraction of a country’s natural resources
Staff turnover (turnover in HR)
Replacing an employee with a new employee
Production and Productivity
Production: the process of producing goods/services also referring to quantity
Productivity: measures the efficiency/rate of production of goods/services
Labour productivity
Output per worker/unit employed
Bigger markets
Specialisation and global trade increase the size of the market offering opportunities for economies of scale
Globalisation
The growing integration and interdependence of the world economy
Competition and lower prices creating low inflation
Increased competition acts as an incentive to minimise costs, keep prices down and therefore maintains low inflation
Functions of money
1) Medium of exchange
2) Store of value
3) Unit of account
4) Standard of derferref payment
Medium of exchange
Money: allows goods and services to be traded without the need for barter system (trade/cashless)
Store of value
Refers to any asset whose “value” can be used now or used in the future (value can be retrieved later)
- people can save now to fund spending at a later date
Unit of account
Refers to anything that allows the value of items to be compared (easy to understand)
Standard of deferred payment
Refers to expressing the value of debt i.e. if people borrow today, they pay back their loan in the future in a way acceptable to the person loaning
Key characteristics of money
Durability, Portable, Divisible, Hard to counterfeit, Generally accepted by population, Valuable
Economic systems
1) Free market (capitalist)
2) Command/Centrally planned economy (socialist/communists)
3) Mixed economy (combination of centrally planned and free market)
Free market
An economic system that supports the free flow of capital and exchange of goods between individuals and nations without governments intervening to control that flow (system of buying/selling goods/services that is not under the control of the government)
Command/Centrally planned economy
All resources are owned by the government or central authority, who decide what to produce, how to produce it and who for
Mixed economy
Some factor resources are owned by the public sector (i.e. the government/state) and some are owned by the private sector
Adam Smith Markets and Economies
- described self-interest and competition in a market economy as the “invisible hand” that guides the economy
*Friedrich Hayek Markets and Economies
Emphasised importance of individual freedom and limitations of government intervention in the economy
- argued the market is a more efficient mechanism for allocating resources than centralised planning that attempts to control the economy through regulation leading to unintended consequences and a loss of freedom
*Karl Marx Markets and economies
Condemned capitalism as a system that alienates the masses, reasoning:
- although workers produce things for the market, market forces, not workers, control things
- required to work for capitalists who have full control over the means of production and maintain power in the workplace
Free market advantages
- Efficient allocation of scarce resources (tend to go where the expected profit is highest)
- Competition drives innovation & invention bringing higher profits for businesses and better products for consumers
- The profit motive stimulates investment which encourages economies of scale and lower prices for consumers
Free market disadvantages - Numerous potential causes of market failure that may require government intervention
- Can lead to rise in scale of income & wealth inequality shown by rise in Gini coefficient
- Under-provision of merit goods (health & education) which many can’t afford, leading to lower social welfare
- May fail to address negative externalities from production & consumption i.e. unsustainable growth
Role of state in Mixed economy
Intervenes in markets to correct one or more market failures
