Section 1: The Economic Problem Flashcards
Why is Economics considered a social science
Looks at the behaviour of humans, either as individuals or as a part of an organisation
Explain 5 aspects of the methodology used by Economists
Develop theories and create economic models to explain phenomena
Use simplifying assumptions to limit the number of variables in an investigation
Test theories and models against relevant known facts, making use of observation, deduction, graphs, statistics and other tools
Use empirical data to improve and revise their economic model
Use economic models to make predictions
What does ceteris paribus mean and why is it used
‘all other things remaining equal’
When economists are looking at the relationship between two factors they assume that only these two factors change and all other factors that would have an effect remain the same
Explain the two kinds of economic statements
Positive statement: objective statements that can be tested by referring to the available evidence
Normative statements: subjective statements which contain a value judgement
What is the basic economic problem
‘How can the available scarce resources be used to satisfy people’s infinite needs and wants as effectively as possible?’
What are the four factors of production
Land, Labour, Capital, Enterprise
What are free goods
A good that has no opportunity cost and can be consumed as much as possible without affecting availability to others
What are economic goods
A good that is scarce and which can be therefore traded
Explain Land
Includes all natural resources in and on it
Also includes the animals that live on it
Explain Capital
Equipment used in producing goods and services
Capital is different from Land because it has to be made first
Explain Enterprise
The willingness to take a risk to make a profit
What does scarcity require
The careful allocation of resources
What are goods
Physical products you can touch
What are services
Intangible things
What is the purpose of economic activity
To increase people’s economic welfare by creating outputs that satisfy their various needs and wants
What are the three fundamental questions when it comes to the allocation of resources
What to produce?
How to produce it?
Who to produce it for?
What are the three economic agents
Producers - firms or people that make goods or provide services
Consumers - people or firms who buy the goods and services
Governments - a government sets the rules that other participants in the economy have to follow, but also produces and consumes goods and services
In a market economy what is the assumption made about the economic agents
They are assumed to be rational
What is a market
A system in which the production of goods and services is determined by demand and supply
What is the purpose of a market
It is a way to allocate resources to different economic activities
What is a free market
This market allocates resources based on supply and demand and the price mechanism
What are mixed economies
A combination of free markets and government intervention
List 3 pros of a free market economy
Efficiency - Any product can be bought and sold, only those of the best value will be in demand - so firms have an incentive to try to make goods in the most efficient way possible
Entrepreneurship - In a market economy, the rewards for good ideas can make entrepreneurs a lot of money - this encourages risk-taking and innovation
Choice - The incentives for innovation can lead to an increase in choice for consumers
List 3 cons of a free market economy
Inequality - lead to huge differences in income and in a completely free market, anyone who is unable to work would receive no income
Non-profitable goods may not be made - drugs to treat rare conditions may never sell
Monopolies - Successful businesses can become the only supplier of a product - this market dominance can be abused
What is a command economy
An economy where it is the government that decides how resources should be allocated
List 3 pros of a command economy
Maximise welfare - Governments can redistribute income fairly - can ensure the production of goods that people need and that are beneficial to society
Low unemployment - The government can try to provide everyone with a job and a salary
Prevent monopolies - Monopolies can be prevented by the government
List 3 cons of a command economy
Poor decision-making - A lack of information means the governments may make poor decisions about production
Restricted choice - Consumers have a limited choice and firms are told what to make
Lack of risk taking and efficiency - Government-owned firms have no incentive to increase efficiency, take risks or innovate - no profit incentive
What is market failure
When free markets result in undesirable outcomes
What does the government often do when market failure happens
Might change laws, offer tax breaks or create some other kind of incentive to try to influence people’s behaviour
Governments can also intervene in the economy by buying or providing goods or services
What two things do mixed economies have
A public and private sector
Explain the public and private sector
The government is known as the public sector
Privately owned businesses make up the private sector
Explain 6 aspects of the ideology of Adam Smith
His ideas has shaped traditional economic theory
Big believer in the free market and he described how its ‘invisible hand’ would allocate resources in society’s best interest
This is because consumers are motivated maximise their self benefit and producers are motivated to maximise profit
In the free market, consumers’ demand and producers’’ supply will lead to price levels being set at a point which benefits them both
In order for the free market to work there can’t be any monopolies and there would have to be low barriers to entry so competition can be maximised
He also wrote about specialisation and the division of labour
Explain 4 aspects of the ideology of Karl Marx
Critical of the free market
Believed it created a situation where the small ruling class (bourgeoisie) dominated and exploited the larger working class of wage earners (the proletariat)
He argued that the profit-maximising bourgeoisie would exploit workers until the proletariat eventually rose up in a revolution and took over
This will lead to the workers controlling production and everyone having a share in the ownership of resources
Explain 4 aspects of the ideology of Friedrich Hayek
Supporter of the free market and critic of command economies
He believed that governments shouldn’t allocate resources - lack information to properly allocate
He believed consumers and producers have the best knowledge of what they want or need, allocation should be left to them and the price mechanism
He saw the price mechanism as a way for consumers and producers to communicate - the price level set would show what consumers and producers want
What is a margin
The change in a variable caused by an increase of one unit of another variable
How do you calculate the marginal cost
Total Cost at the new output level - Total Cost at one unit less than that = Marginal Cost
If the total cost of making 100 ice creams is £100 and the total cost of producing 101 ice creams is £102, what is the marginal cost of making the 101st ice cream
102 - 100 = 2
£2
What does traditional economic theory assume about the economic agents involved
That they seek to maximise utility
What is marginal utility
The benefit gained from consuming one additional unit of a good
What is total utility
The overall benefit gained from consuming a good
What is the law of diminishing marginal utility
The idea that when each additional unit of a good is consumed the marginal utility decreases
At what point will a rational consumer choose to consume a good
When marginal utility = price
What is the shape of the demand curve and explain why that is
It is a downward sloping curve because as each additional unit is consumed the satisfaction decreases
How do you work out the profit for a firm
total revenue - total costs
What are firms assumed to want to maximise
Give 3 reasons
Profit
Profit means the firm can survive
Greater profit allow firms to offer better rewards for their shareholders and staff
Profit can be reinvested in the business in the hope of making more profits later
Give three things firms want to maximise besides profit
A larger market share could lead to monopoly power - can charge higher prices
Bigger firms are often considered more stable and prestigious so they attract the best employees
Some firms may have ethical objectives
How does the government balance the resources of a country with the needs and wants of the population
Economic growth : usually measured by growth in a country’s GDP
Full employment : everybody of a working age who is capable of working, having a job
Equilibrium in the balance of payments : a balance between the payments into the country over a period of time and the payments out
Low inflation : keeping prices under control, as high inflation can cause serious problems
What do consumers want to maximise
Utility while not spending more than their income
What assumption is made when it comes to consumers
We assume it is spent rationally
How do behavioural economists challenge traditional economic theory
They look at the impact of social, psychological and emotional factors on the decision making to try to make realistic predictions about the future
What are the two assumptions made by traditional economists
Agents are utility maximisers
Agents are rational
What do governments seek to do
To balance the resources of a country with the needs and wants of the population (public interest)
What is the term used to refer to a rational individual
Homo economicus
Give 3 reasons why consumers may not act rationally
The time available may not be sufficient in order to make a rational decision
Insufficient or incorrect information
People might not be able to process the vast amounts of data and compare the costs and benefits of the alternatives
Explain the theory of bounded self control
Rational individual is assumed to have total self control
Behavioural economists argue that consumers don’t have total self control
Explain the 5 biases behavioural economists believe that consumers have
Rules of thumb - time saving patterns to make decisions
Anchoring - placing too much emphasis on one piece of information
Availability bias - judgements are made about the probability of events occurring based on how easy it is to remember those events
Social norms - behaviour can be influenced by the persons social group of culture
Habitual behaviour
Which economic theory do governments use when making decisions and why
Behavioural economic theory
Traditional makes too many unrealistic assumptions
Give 4 examples of choice architecture
Default options - people are more likely to choose the default option
Framing - the context in which information is presented can influence a decision
Nudges - where alternative are made easier without removing the freedom of choice
Restricted choice - choices are limited
Mandated choice
What are the 2 different types of information that explains why a consumer may act irrationally
Imperfect - won’t have all the information to make a rational decision
Asymmetric - when one party has more information than the other in a transaction
What is choice architecture
Where an individual’s choice is influenced by adapting the way the choice is presented
What does PPF stand for
Production Possibility Frontiers
What does a PPF do
Shows you the options available when you consider the production of just two types of goods or services
What is opportunity cost
The opportunity cost is the value of the next best alternative foregone
Give 4 problems with using opportunity cost to make an economic decision
Not all alternatives are known
May be a lack of information about the alternatives
Some factors have alternative uses
Some factors may be hard to switch to an alternative use
Give 3 things that can cause a PPF to shift outwards
Increased workers
Increased resources
Improved tech
What does a shift outwards to a PPF show
Economic growth
What is the price sold for a product decided by
The demand and supply in the market
