The Basic Economic Problem Flashcards
What is the basic economic problem?
Scarce/ finite resources and infinite wants
What does a society have to
decide as a result of the basic
economic problem?
What goods to produce, how to
make them and who should
receive them.
What are the four factors of
production and the four types of income that goes with each?
Land (rent) labour (wages) capital (interest) entrepreneurship (profit)
What does land entitle?
All natural resources such as
land, minerals, rivers, oil and
the sea.
What does labour entitle?
The quantity and quality of
people available for work.
What does capital entitle?
Anything made for the purpose
of further production such as
tools, machines and factories.
What does entrepreneurship
entitle?
It is entrepreneurs who take
risks in the pursuit of profit.
What is the definition of
opportunity cost?
The cost of the next best
forgone alternative.
What does the PPC show?
It shows all the maximum
combinations of two goods that
an economy can produce with
a given set of resources.
Why is a point outside the PPC
completely unattainable unless
what occurs?
A point outside the PPC is
unattainable due to scarcity
unless the PPC were to shift
outwards.
Why is a point inside the
frontier wasteful?
Not all the resources are being
used which is inefficient.
What is the opportunity cost of moving onto
the frontier?
The opportunity cost of producing more of either good is zero as nothing has to be forgone in order to produce more.
Why does technology allow for the PPC to shift outwards?
It allows us to make more goods with the same set of resources
What happens to the PPC if there is a
technological advance in one industry alone?
The PPC pivots outwards rather than moving parallel to the old PPC.
What is another factor (other than technology) that
can push the PPC outward?
The discovery of new resources.
What can PPC’s be used to show the concept of?
Opportunity cost (as well as scarcity and choice).
What is referred to as constant returns?
Giving up constant amounts of resources in one
industry and getting constant amounts of resources used in another industry in return.
Why is a curved PPC more realistic?
Resources can’t be switched between industries with perfect ease in real life.
What are yields diminishing returns?
The returns we get from switching resources get lower and lower.
What are some examples of natural advantages that a country might have that allows them to specialise in the production of something?
Climate, raw materials, cheap labour, skills or
technology.
What are the advantages of specialisation?
Total output of goods and services is raised,
quality can be improved, more wants and needs
may be satisfied (due to a higher output at a lower
cost), consumers have improved access to to a
greater variety of higher quality products, it
increases the size of the market and increases
competition.
Why is competition good?
It helps to keep prices down and it maintains low
inflation.
What are the disadvantages of specialisation?
It may eventually reduce efficiency and increase
unit costs as unrewarding and repetitive work
lowers worker motivation and productivity,
workers begin to take less pride in their work and
quality suffers, some workers receive narrow
training and may not be able to find an alternative
job (structural unemployment), mass-produced
standardised goods tend to lack variety and if one
machine breaks down then the entire factory
stops.
What is an economic system?
A particular set of social institutions which deals
with the production, distribution and consumption
of goods and services in a particular society.
What is a market economy?
No state intervention in markets; resources are allocated purely by the markets. Associated with ‘laissez-faire’ idea.
What is a planned economy?
The state owns the factors of production and all
the decisions of what, how and for whom are
made by the government.
What is a mixed economy?
An economy which adopts a mixture of the two
systems.
What has trade and technology enabled us to do?
Make and consume more goods.
What is the price system?
When prices are determined by the interaction of
supply and demand
What happens when demand exceeds the available supply?
Prices are driven upward.
What functions do prices serve?
Rationalising, providing incentives and signalling.
What are the advantages of a market
economy?
- Market forces are free to determine the prices of goods, and how much they produce. Firms decide what to produce based on consumer ‘demand’ which leads to more efficient allocation of resources
- Consumers also have a far greater choice of goods on offer, and there is more of an incentive for firms to produce efficiently, since their profits depend on it
When are the disadvantages of the market economy?
When the market fails and this happens due to issues of inequality, asymmetric information and
externalities. BUT this inequality can be corrected by government interventions to some degree via progressive taxes
What are incomes determined by?
Ownership of the four factors of production.
What are normative statements?
Subjective statements/opinions about what ought
to be or what should be happening, they are said
to carry value judgements.
What are positive statements?
Statements that can be back up by evidence
What is division of labour?
The assignment of different parts of a
manufacturing process or task to different people
who have skills for that certain task (they are specialised) in order to improve efficiency.
How can the PPC shift outwards?
By increasing the quantity of factors of production
(land, labour, capital and entrepreneurship) or by
increasing the quality of factors of production
(education and technology).
Give examples of different types of technology
that have allowed for the agricultural industry to
produce more food with a fraction of the
resources we once used.
Increased mechanisation, improved skills and
biotechnology.
Other than technology, what has led to an
increase in our living standards?
Trade
What is the advantage of dividing up labour and
specialising?
The welfare of the group is higher than if
everyone attempts to be self-sufficient as long as
everyone swaps their gains.
What is the central feature of a free market
system?
Its reliance on the price system.
What are the advantages of mixed economies?
Benefit consumers
More regulation, may help to reduce prices or increase prices depending on the good, demerit/merit
What are the disadvantages of mixed economies?
- Lack of government support. If the economy is given too much freedom, disadvantaged groups will not receive sufficient support from the government.
- A mixed economy may lead to too much government intervention
What indicates whether a supplier should make
more or less of a product?
The signals coming from the market.
What causes suppliers to respond to market
signals?
Their desire to maximise their profits.
Why are consumers in an economic democracy in
a market system?
They vote with their money for the products that
they want.
Why does consumer sovereignty prevail in the
market system?
Any producer that fails to respond to consumer
demand will go out of business.
What is the effect of firms trying to maximise their
profits and what does this lead to?
They want to reduce their costs of production as
much as possible and this leads to an efficient use
of resources.
What is the distribution of income?
This shows how evenly incomes are distributed
within the population.
Why is inequality a significant failure of the market
system?
It leads to the provision of luxuries for the rich
before others have the basic necessities of life.
What is the purpose of normative statements?
They are trying to persuade you of the particular
merits or demerits of a particular policy decision
or issues.
What is Specialisation?
Occurs when economic units such as individuals, firms, regions or countries concentrate on producing specific goods or services
What is the specialised use of workers called in an organisation?
Division of labour
Impact of specialisation?
Increases output as economic units become more effective and efficient in what they produce
Barter
Occurs when goods and services are exchanged for other goods and services between two parties
Maximisation
Occurs when an economic agent tries to obtain the most that they can from the economic activity that they undertake
What is ceteris paribus?
all other things being equal
How do economic agents behave?
Rationally
What do households set out to maximise?
satisfaction/ utility
Of central importance is the idea that economic agents are seen to respond to what?
Incentives
For example - suppose a household realises that the price of a particular good has fallen, then it is an incentive to consume more of it
Knowledge about the effect of incentives can also be crucial for government. For example…
…a government may wish to influence the consumption of certain products such as tobacco. Knowing the incentives that people face, a government may be able to influence their behavior
What are incentives and what are they typically?
A thing that motivates or encourages one to do something in a free market - economic growth, profit
What are the incentives for a mixed economy?
- Important to have economic freedom but some government control over the economy so that less profitable, yet necessary, industries aren’t ignored
- Seeking to promote stable growth and investment, which a mixed system allows to happen by having a combination of decisions made by firms and decisions made by the government
In a market economy people are motivated by what?
Self-interest (essentially making money)
Consumer demand determines what?
What is produced
The main incentive in a market economy is quite effective. Explain it?
If goods are overpriced people will buy less of them, so prices naturally fall
Within planned economies incentives are what?
Less obvious
Workers receive the same income, in a planned economy,no matter how hard they work meaning there is a tendency for people to shirk (avoid/neglect) so production tends to be what?
Low
Within a planned economy the total economic output is… and consumer choice is…
- Low
- Limited
What is productive efficiency?
Occurs when an optimal level of output is produced using all resources that are available in the economy. The more efficient production is, the fewer inputs are needed and, therefore, the cheaper it is
What is allocative efficiency?
About distributing and assigning the resources a firm has available to it in the most effective way to satisfy the demand of the consumer
