The Economic Problem

Question 1

Production Possibility frontiers

Answer 1

shows the options available when considering production of two types of goods/services

Question 2

PPF efficiency

Answer 2

All points on PPF are productively efficient – produce max output
Not all points allocatively efficient
Point lying outside PPF isn’t achievable – not enough resources
Point lying inside PPF productively inefficient – not maximising resources

Question 3

Causes of shift in PPF

Answer 3

• Improved tech/labour allows more output produced using same resources -> outward shift therefore showing economic growth
• Fewer resources available (e.g. Natural disaster) cause inward shift

Question 4

Trade-off

Answer 4

A trade-off is when you have to choose between conflicting objectives because you can’t achieve all your objectives at same time. Involves compromising and aiming to achieve each of your objectives a bit

Question 5

Opportunity cost

Answer 5

opportunity cost of a decision is the next best alternative that you give up in making that decision

Question 6

Problems with idea of opportunity cost

Answer 6

• Not all alternatives known
• Some factors don’t have alternative uses
• May be a lack of info on alternatives and their costs
• Some factors (e.g. land) can be hard to switch to

Question 7

Uses of opportunity cost

Answer 7

• For consumers, they choose what to spend income on
• For producers, they look at the profit lost by not making an alternative product
• For gov’ts, they look at lost value to society from policies they choose not to implement

Question 8

Free market economy

Answer 8

allocates resources based on supply and demand and the price mechanism. No public sector

Question 9

Free Market Economy Advantages

Answer 9

firms have incentive to be more efficient as consumer will only buy best products in free market

• As best products in demand, encourages entrepeneurship through risk taking and innovation
• Incentives for innovation -> increased choice for consumers

Question 10

Free market economy disadvantages

Answer 10

• Can lead to growing inequality – those with no job receive no income
• Non-profitable goods may not be made e.g. drugs/medicine for rare diseases
• Lead to monopolies -> may be abused

Question 11

Command Economy

Answer 11

gov’t decides how resources allocated. Communist countries have command economies. No private sector

Question 12

Command Economy Advantages

Answer 12

• Maximise welfare – gov’t can prevent inequality, ensure production of goods people need and beneficial to society
• Low unemployment
• Prevent monopolies

Question 13

Command Economy Disadvantages

Answer 13

• Restricted choice – consumers limited in consumption and producers told what to make
• Lack of innovation and efficiency – firms no incentive as they don’t need to make profit
• Poor decision making – lack of info leads to poor gov’t decisions

Question 14

Traditional economic theory: How consumers act rationally

Answer 14

A rational consumer will choose to consumer a good at point where marginal utility equals price
Marginal Utility decreases for extra good, then price willing to pay goes down. Its tis law of diminishing marginal utility that explains why the demand curve slopes downwards

Question 15

Marginal Utility

Answer 15

the benefit from consuming one additional unit of a good

Question 16

Total Utility

Answer 16

the overall benefit gained from consuming a good

Question 17

Law of diminishing marginal returns

Answer 17

states that for each additional unit of a good that’s consumed, the marginal utility gained decreases

Question 18

Economic objective of producers

Answer 18

To max profit – Means firms can survive. Firms can offer better rewards to shareholders and staff. Profit can be invested to make profits later
To max sales/market share – large market share -> monopoly power. Bigger firms more prestigious -> attract best employers

Question 19

Economic objective of consumers

Answer 19

Max utility but not spend more than income – utility varies for people e.g. security for holidays
Max income while having as much free time as they need or want

Question 20

Economic objective of the government

Answer 20

Max ‘public interest’ – 1) Economic Growth 2) Full employment 3) Equilibrium in balance of payments into the country over period of time and payments out 4) Low inflation

Question 21

Choice architecture

Answer 21

Where an individuals choice is influenced by adapting way choice is presented

Question 22

Ways of architecture

Answer 22

Defaults options – people more likely to choose ‘default’ option – can be used to encourage individuals to act in certain way
Framing – context in which info is presented can influence a decision e.g. advertising
Nudges – where some alternatives are made easier to choose than others without removing the freedom of choice
Restricted choice – occurs when people’s choices are restricted
Mandated choices – where people have to make a decision e.g. forcing people to make a choice whether they want to be an organ donor or not

Question 23

Evaluation of choice architecture

Answer 23

– Consumers may react differently to presentation of option as they still have the choice - Consumers may resent gov’t influence and ignore policies - Policies may not be enough and traditional theory may be needed - Depends on quality of info about goods

Question 24

Behavioural Economics

Answer 24

challenges traditional economic theory – not realistic. Tries to improve traditional theory and make it more relevant to real world

Question 25

Behavioural economics - rationality

Answer 25

Behavioural economists believe rationality alone can’t predict consumer behaviour:

• economic agents will likely have imperfect info -> won’t make rational decision -> market failure
• asymmetric info prevents rationality – sellers will know true cost of product but buyers don’t
• limited time to make a rational decision
• computation weakness – people might be very good at calculating costs of alternatives or process and evaluate vasts amount of data
• individuals and firms have sense of fairness and choose to act altruistically
• bounded self-control

Question 26

Bounded rationality

Answer 26

people tend to satisfice rather than spending time trying to make rational decision which maximises utility

Question 27

Biases which affect decision making

Answer 27

• Rules of thumb – useful tools that help an individual make a decision
• Anchoring – placing too much emphasis on one piece of info
• Availability bias – where judgements made about probability of events occurring based on how easy it is to remember such events occurring
• Social norms – behaviour influenced by behaviour of social group
• Habitual behaviour – doing same thing over and over again