Session 1 Flashcards
Definition of Economics?
Economics is the study of the system that operates to allocate scarce resources between competing ends
What are the key considerations concerning economics in general?
- Productive resources are scarce
- Material needs and desires are effectively unlimited
- People have diverse objectives (or preferences)
- Choices and decisions have to be made
Is production limited or unlimited? Why so?
Production is limited because resources are limited
What are the productive resources according to economics?
Productive resources
- Labour (L)
- Capital (K)
- Technology (A)
- Land (fixed in the background, including natural resources)
What is the production function?
Yt= f (Lt ,Kt) At
What is productive capacity set by?
Productive capacity is set by the availability of L,K and A
What are the economic questions?
- What determines the allocation of existing resources?
- What causes productive capacity to expand?
- What causes under-utilization of resources?
Production Possibility Frontier (Diagram and considerations)
slide 5
- Output is constrained because productive resources are scarce
- Trade-offs are always present
- From A to B, what is the cost of obtaining the extra five units of food? Opportunity Cost
- What happens to opportunity cost as food production rises?
What does a modern economy possess?
A modern economy has a high degree of specialisation in employment and production
Why is specialisation the basis of our prosperity?
Specialisation is the basis of our prosperity, it allows the introduction of more efficient systems of production, with machinery and automation, and encourages technological development.
What does specialisation require?
TRADE
Specialisation means that we have to trade with each other. The baker supplies bread for money and then buys things that others have produced.
What would happen if there was no trade?
In the absence of trade we would have to be self-sufficient, like Robinson Crusoe, and we would be poorer in material terms
Individuals _______ and nations ______
specialise and specialise
What is the definition of absolute advantage?
Individuals should specialise in areas of activity in which they have an absolute advantage over others
The UK could grow bananas, but it is more efficient to buy them from countries in Central America, which have an absolute advantage in production. In exchange the UK sells goods for which it has an absolute advantage in production
Who suggested that individuals and nations should specialise in the areas of activity in which they have an absolute over others?
Adam Smith (An Inquiry into the Nature and Causes of the Wealth of Nations, 1776) suggested that individuals (and nations) should specialise in the areas of activity in which they have an absolute advantage over others.
What is the definition of comparative advantage?
Absolute advantage is an important basis for specialisation but what if an individual (or a nation) has no absolute advantage in area of production
Does it mean that the individual can’t find a suitable job and must live on benefits?
Does it mean that the nation must protect its markets from more efficient foreign producers?
Answers…..no….and……no
David Ricardo (The Principles of Political Economy and Taxation, 1817) argued that everyone can gain from specialisation and trade because it depends on COMPARATIVE rather than absolute advantage
What do specialisation and trade depend on?
Comparative rather than absolute advantage
What is the definition of opportunity cost?
- Consider 2 people. Person 1 is a brilliant surgeon and a very good gardener. Person 2 would be a terrible surgeon and a reasonable gardener
- Person 1 has an absolute advantage in both areas of activity. Should he or she do both?
- NO Person 1 can earn a lot of money as a brain surgeon and the opportunity cost of devoting time to gardening is therefore high
- Is more efficient for person 1 to specialise in brain surgery and employ person 2 to do the garden. Person 1 has a comparative advantage in brain surgery, but person 2 is the low cost producer of gardening services and has a comparative advantage in that area of activity
- Similar reasoning applies in the case of international trade…….countries should specialise according to comparative advantage
What is the requirement for the facilitation of trade?
In the real world goods are bought and sold with money and trade will take place only if money prices reflect opportunity costs.
What is the definition of an economic system?
- Specialisation and trade is efficient, but economic activities have somehow to be organised. Decisions have to be made about what gets produced and who works in which area.
- The economy is the system that operates to organise economic activities
• The system is effectively a set of institutions, rules, laws, customs,
agreements, etc
What are the types of economic systems?
- Planned Economy
- Market Economy
- Mixed Economy
What is a market?
A market is an arrangement through which buyers and sellers are brought together and transactions are made
What are some examples of markets?
product markets, labour markets, financial markets, and so on
What are the two sides to a market?
There are two sides to a market
- Demand…arising from those who want to buy the product or service
- Supply…arising from those who want to sell the product or service
What are the parameters to define the dimensions of a market?
- Location - the market may or may not have a specific geographical
location - Price…the unit price at which the product is bought and sold
- Quantity…the amount of the product which is bought and sold
- Time…the period of time over which the market transactions are made
What is the definition of market demand?
In a product market, demand is the amount that consumers (households) want to buy over a given period of time.
What are the factors influencing demand?
- The product’s own price
- The price of alternative substitute products
- Household incomes
- Consumer preferences
• DX=f (PX , PN, I, Preferences)
What is the demand function?
• DX=f (PX , PN, I, Preferences)
What is the ceteris paribus assumption?
The ceteris paribus assumption. We examine changes in each factor, assuming other factors do not change.
Suppose there is a fall in the prices of apples. Demand goes up, but why?
Substitution effect and income effect
Suppose household incomes rise. How does this affect the demand for apples?
Income effect
Suppose the price of pears goes up. How does this affect the demand for apples?
Substitution effect
Suppose we discover that apples are bad for our health. How does this affect the demand for apples?
Consumer preferences
Draw a market demand curve and describe it
Slide 20
(PRICE v QUANTITY)
- If P falls from P1 to P2, demand rises from Q1 to Q2….a movement from A to B along the demand curve Dx1
- If household incomes rise, the demand curve shifts to the right to Dx2 and at price P1 demand rises to Q3……a move from A to C
- If the price of a substitute product falls, the demand curve shifts to the left to Dx3 and demand falls from Q1 to Q4…….a move from A to D
- What about a shift in preferences away from this product?
What is the definition of market supply?
In a product market, supply is the amount that sellers (firms) want to supply over a given period of time
Market supply is the total amount supplied by all firms operating in the market.
What does market supply depend on?
- The price at which the product is sold
- Production costs and technology
- The number of firms operating in the market
SX = f (PX , Input Costs, Technology, Number of Firms)
What is the Market Supply function?
SX = f (PX , Input Costs, Technology, Number of Firms)
Suppose there is an increase in the price of wheat. What happens to supply?
Supply goes up because wheat production is more profitable
Suppose that wage costs or energy costs fall. What happens to wheat supply?
Supply goes up because wheat production is again more profitable
Suppose technological progress causes an increase in crop yields. What happens to wheat supply?
Supply goes up because farmers can produce more with existing fields
Suppose other farmers move into wheat production. What happens to wheat supply?
Supply goes up because there are more producers
Draw a Market Supply Curve and explain it
PRICE v QUANTITY
Slide 23
- If P rises from P1 to P2, supply rises from Q1 to Q2. ……a move from A to B along the supply curve Sx1
- If new firms enter the market, the supply curve shifts to the right to Sx2 and at price P1 supply rises to Q3…..a move from A to C
- If input costs rise, the supply curve shifts to the left to Sx3 and at price P1 quantity supplied falls from Q1 to Q4…a move from A to D
What is the definition of market equilibrium? Draw a diagram to explain it.
The point where Demand and Supply are in balance.
Slide 24
- The demand curve shows only the quantities that consumers plan to buy at different prices
- The supply curve shows only the quantities that firms plan to sell at different prices
- The market equilibrium is determined at P1, at the point where demand and supply are in balance, at Q1..In equilibrium, the plans of consumers and producers are in balance.
What is the definition of Disequilibrium and Price Adjustment?
Draw a diagram and explain it
Slide 25
At P1 the market is in equilibrium with D = S at Q1 and there is no tendency for price to change
At P2 the market is in a position of excess supply (D < S) and the market price falls towards P1.
At P3 the market is in a position of excess demand (D > S) and price rises towards P1
Draw a diagram and explain adjustment to a change in demand
Slide 26
- Initial equilibrium at P1/Q1
- D shifts from D1 to D2 and excess demand prevails at P1 with demand at Q3 and supply at Q1
- Price begins to rise, stimulating supply and causing demand to contract
- Equilibrium is re-established when price rises to P2 and demand and supply are again in balance at Q2
Draw a diagram and explain adjustment to a change in supply
Slide 27
- Initial equilibrium at P1/Q1
- S shifts from S1 to S2 and excess supply prevails at P1 with demand at Q1 and supply at Q2
- Price begins to fall, reducing supply and stimulating demand
- Equilibrium is re- established when price falls to P2 and demand and supply are again in balance at Q2
