Principles of Economics 1.1 - Introduction to Economics Flashcards
Explain the history about the formation of the definition of Economics
Alfred Marshall’s definition is that it’s ‘the study of mankind in the ordinary business of life’. However, this is vague and not particularly informative
* Alfred Marshall came up with Economics. It traces its origins to the late 19th century. Before then there was only “political economy”
* 3 key questions pertaining to “the economy”
1. What goods should be produced and what services should be provided?
2. How are the goods and services produced?
3. Who should enjoy these goods and services?
Economics is the science that looks to answer these questions
* Underlying those questions is the following issue: resources are limited and we have to make decisions about how to use them. Answering the questions would be easy if resources were so plentiful that society could produce everything its citizens could ever want, but sadly that’s not the case
* We are limited in terms of land, labour and capital – “factors of production”
* A fourth factor, entrepreneurship, is also important
* 2 important concepts: scarcity and choice
The prevailing definition is something akin to the definition provided
by Lionel Robbins: “Economics is the science which studies human
behaviour as a relationship between ends and scarce means
which have alternative uses.”
- Embedded in this are the notions of scarcity and choice
* This Lionel Robbins definition is from his book, where he sought to find a proper definition for Economics
* Economics started out getting taught in Cambridge University and then LSE took the mantel for the king of teaching Economics. There was this whole thing where Lionel Robbins went against another Economist who carried on Alfred Marshall’s work
- Otherwise stated, economics is about how goods and services are
produced, consumed and distributed amongst people in an
economy, given the constraints we face.
This definition
can, however, mask the complexity and extent of the reach of economics. We might characterize households as having unlimited wants, but not everyone in society is materialistic, which the idea of unlimited
wants might imply. Some people are more content with the simple things in life and their choices are based
on what they see as being important. These choices are no less valid but reflect the complexity of the subject. Some people choose to maintain their standard of living through crime. A decision to resort to crime
has reasons and consequences, and these may be of as much interest to an economist as the reasons why
firms choose to advertise their products or why central banks make decisions on monetary policy
Explain the concept of Scarcity
Scarcity is an important concept in economics:
* People don’t have unlimited money to spend.
* Firms (i.e. companies that make stuff) don’t have unlimited resources.
* How do we allocate scarce resources between competing
choices? Well, people have to make trade-offs. This can be in behaviour or resources
* In order to decide, we have to consider the alternatives that are available to us and choose the best available. This means we buy something (or do something) if we like it more than the next best available option.
* Economic agents do a cost-benefit analysis – they look at the costs & benefits of 2 choices and pick the option that has more benefit and less cost
* This leads us to another important concept: opportunity cost.
Explain what a ‘cost-benefit analysis’ is
A technique economic agents use when deciding between 2 choices. They look at the costs & benefits of 2 choices and pick the option that has more benefit and less cost
What are the 3 factors of production? Name one more important economic factor
- Land, labour and capital
- Entrepreneurship
Explain what opportunity cost is
- The opportunity cost of doing something is captured by whatever
you miss out on by doing it. - Of relevance is the next best alternative option.
*For example: - You chose to come to university and study a degree.
- Suppose your second choice would have been to get a job.
- The opportunity cost of going to university is captured by the wages from
full-time work that you have sacrificed in order to be here.* - Opportunity Cost is subjective – the value of what you lose by picking another option can vary depending on who you are as a person. For example, if you don’t care much for travelling around the world, the opportunity cost of exploring the world because ur in uni isn’t that high
What are ‘marginal changes’?
Marginal changes describe incremental changes (for
example to costs and benefits). It’s essentially the gain or loss received from doing 1 unit of an action
What’s ‘marginal benefit’?
The change in benefit
What’s the name for ‘the change in benefit’?
Marginal Benefit
What’s ‘marginal cost’?
The change in cost
What’s the name for ‘the change in cost’?
Marginal Cost
Explain what ‘thinking at the margin’ is
In short, if the marginal benefit of doing something is greater than the
marginal cost, then I would prefer to do that thing
Explain how rationality affects marginal analysis
Marginal analysis is based on the idea that economic agents (i.e.
individuals or firms) seek to maximise or minimise outcomes when
making decisions (and that this is rational).
* Individuals may be assumed to want to maximise their satisfaction.
Firms may be assumed to maximise their profits (or sometimes
minimise their costs).
* If we are talking in terms of how much of something to buy or do,
thinking at the margin means that decision makers will choose a level
such that marginal benefit = marginal cost. Why so?:
- If MB > MC, you would like to buy (or do) more.
- If MB < MC, you would like to buy (or do) less.
- If MB = MC, you are content that you have maximised your choice.
- i.e. If a decision results in greater marginal benefits than marginal costs, it is worth making that decision and
continuing up to the point where the marginal cost of the decision is equal to the marginal benefit
Explain the idea behind rational people responding to incentives
Since rational people make rational decisions by weighing up costs
and benefits, their decisions may change in response to changes in those costs and benefits. This creates opportunities for policymakers to create incentives and
disincentives to alter behaviour. For example, adding a price to plastic bags in supermarkets aims to discourage their
purchase (and use) and encourage people to reuse existing bags
How do economic agents react to the price of a good rising?
- People will generally buy less of it because the cost has gone up.
- Companies will allocate more resources to the production of the
good because the benefit from selling it has risen
Explain the basic idea of trade in Economics
- Trade between people is fundamental in Economics. Imagine it’s 300 years ago and you live in a village, the notion that people in the village go to the bakery to buy bread IS trade. In a barter economy, say you had all the cows so all the milk, you’d exchange milk for bread with the baker.
- In economic activities, there is scope for specialisation. People
can focus on what they are best at, & there can be exchange or redistribution to improve the situation for everyone. - This is linked to opportunity cost (from earlier) and the notion of
“division of labour” (i.e. focusing on certain tasks).
** For example, consider the clothes you are currently wearing: Why didn’t you make them yourself? Why did you buy them? Look at the labels – why weren’t these garments made in the UK?*
What’s an ‘economic system’?
The economic system is the way resources are organised and allocated to address the needs of an economy’s citizens
What’s the name for ‘the way resources are organised and allocated to address the needs of an economy’s citizens’?
The Economic System
What are the features of a capitalist economic system?
Features:
* Private ownership of factors of production.
* Goods & services are exchanged through a price mechanism.
* Firms are predominantly driven by profits
In the context of a capitalist market system, why are markets good?
They are a good way to allocate resources via
decentralised decision-making
What’s a ‘pure market economy’?
A market where there is no government intervention and economic agents are left to their own devices (aligned with Adam Smith’s “invisible hand”)
What’s the name for ‘a market where there is no government intervention and economic agents are left to their own devices’?
A pure market economy
Explain the basis of a ‘pure market economy’ on Adam Smith’s idea
The pure market economy is based off of the ideas introduced by Scottish economist Adam Smith and his ‘invisible hand’. This is it: If each individual person is ‘rational’ and is left totally to their own devices, we will arrive at an outcome where the prices of everything is efficient. There’s nobody guiding their decisions but we still arrive at this equilibrium system where, for example, the price of a pint of milk is what it is and the price of a uni degree is what it is
Explain the main alternative to a pure market economy
A planned economic system,
wherein economic activity is determined by “central planners” like the government which tells everyone their role in society
Give examples of direct interventions in markets on a microeconomic scale (2)
specific taxes, quotas and price ceilings
When do governments most often intervene with a market?
- When there’s a market failure
- If too few companies decide to operate on a certain industry
What’s market failure?
Market failure is where scarce resources are not allocated to their most efficient use by free markets
What’s the name for when ‘scarce resources are not allocated to their
most efficient use by free markets’?
Market Failure
Explain the history of the introduction of ‘Micro’ and ‘Macro’ Economics
In the time of Alfred Marshall, there was no distinction along these lines - only “economics”. In the 1930s Ragnar Frisch invented the terms “microeconomics”
and “macroeconomics” (as well as “econometrics”)
What is Ragnar Friesch famous for as an Economist?
In the 1930s, Ragnar Frisch invented the terms “microeconomics” and “macroeconomics” (as well as “econometrics”). Also, Ragnar Frisch shared the first ever Nobel Prize in Economics during the 60s and was
one of the main driving forces behind the “Keynesian revolution”.
What does ‘Microeconomics’ study?
The behaviour of individuals and firms at a disaggregated level – it looks at specific markets
What’s the name for ‘the study of the behaviour of individuals and firms at a disaggregated level – it looks at specific markets’
Microeconomics
What does ‘Macroeconomics’ study?
The aggregate behaviour of the economy
(e.g. issues like unemployment, inflation, economic growth)
What’s the name for ‘the aggregate behaviour of the economy (e.g. issues like unemployment, inflation, economic growth)’?
Macroeconomics
