The nature of economics

Question 1

What are positive economic statements?

Answer 1

Positive economic statements are based on facts that can be proved and disproved. They can be verified as true by reference to the date or by a scientific approach.

Question 2

What are normative economic statements? (3)

Answer 2

Normative economic statements are statements based on value judgements meaning they are impossible to prove or disprove.
They are usually associated with economic policy discussions and relate to what:
1) Might be good or bad.
2) Might be fair or unfair.
3) Should be or ought to be.

Question 3

What is the basic economic problem?

Answer 3

The basic economic problem is that people’s wants are infinite while resources are limited. This is the reason for the economic problem of scarcity.

Question 4

What choices must be made about resources? (3)

Answer 4

1) What to produce and how much to produce?
2) How should the goods and services be produced?
3) How should the goods published be allocated?

Question 5

What are the resources of a country referred to as?

Name all four.

Answer 5

The resources of a country are referred to as the factors of production. Four factors of production may be identified:

1) Land - includes all natural resources, ra w materials, the fertility of the soil and resources found in the sea.
2) Labour - this refers to the physical and mental effort that goes into the production of goods and services.
3) Capital - any man-made aid to production including factory buildings, machinery, offices and It equipment which are used to make other goods and services.
4) Enterprise - The entrepreneur performs two essential functions:
a) Bringing together the factors of production so that goods and services can be produced.
b) Taking the risks involved in production.

Question 6

What are renewable resources?

Answer 6

Renewable resources are resources that can be replaced naturally after use, they are sustainable unless they are consumed quicker than they can be replaced.

Question 7

What are non-renewable resources?

Answer 7

Non-renewable resources are resources that will eventually be completely depleted.

Question 8

Define opportunity cost.

Answer 8

Opportunity cost is the benefit that would have arise if resources had been used to produce the next best alternative when a choice is made.

Question 9

What are economic goods?

Answer 9

Economic goods are goods that are made from resources that are scarce in supply, so that the goods themselves are scarce and therefore command a price.

Question 10

What are free goods?

Answer 10

Free goods are goods which are unlimited in supply, consumption by one person does not limit consumption by another. The opportunity cost of consuming these goods is zero.

Question 11

What does a PPF show?

What can be said about points inside and outside of the PPF curve.

Answer 11

A PPF shows the maximum potential output of an economy when all resources are fully and efficiently employed.
Any points inside the PPF curve represent levels of output which are obtainable.
Any points outside the PPF curve represent levels of output which are currently unobtainable.

Question 12

What are capital goods?

What are consumer goods?

Answer 12

Capital goods are goods required to produce other goods, both capital and consumer.
Consumer goods are goods that give satisfaction or utility to consumers.

Question 13

What is marginal analysis concerned with?

Answer 13

Marginal analysis is concerned with the impact of additions and subtractions from the current situation, the rational decision maker will only decide on an option if the marginal benefit outweighs the marginal cost.

Question 14

In the instance of PPFs what is economic growth.

Answer 14

In terms of PPF analysis, economic growth is referred to as an increase in the productive potential of the economy or output of the economy, indicating an increase in real output.

Question 15

What is economic decline?

Answer 15

Economic decline refers to decrease in the productive potential or output of the economy, indicating a decrease in real output. This is shown by an inward shift of the PPF.

Question 16

What will be the impacts of reducing production of consumer goods in order to produce more capital goods?

Answer 16

A reduction in the production of consumer goods will lead to a fall in current living standards. However, in the long run, the increased production of capital goods will cause an increase in the productive potential of the economy resulting in an eventual rightward shift of the PPF. In the long run there could be an increase in the production of capital and consumer goods leading to a rise in future living standards.

Question 17

What factors may cause an outward shift of the PPF curve? (5)

Answer 17

1) Discovery of new natural resources, e.g. oil.
2) Development of new methods of production which increase productivity.
3) Advances in technology.
4) Improvement in education and training which increase the productivity of the workforce.
5) Factors which lead to an increase in the size of the workforce, e.g. immigration, or an increase in the retirement age.

Question 18

What factors may cause an inward shift of the PPF? (4)

Answer 18

1) Natural disasters.
2) Depletion of natural resources.
3) Factors causing a reduction in the size of the workforce, e.g. emigration.
4) Deep recession, resulting a loss of productive capacity, such as factories closing down.

Question 19

What is the meaning of the division of labour?

Answer 19

The division of labour is when workers specialise in very specific tasks, the work is divided into smaller parts so that each worker is responsible for a very small part of the product or service being provided.

Question 20

What are the advantages of the division of labour? (5)

Answer 20

1) Each worker specialises in tasks for which he/she is best suited.
2) Therefore, each worker only has to be trained to complete one task.
3) Less time is wasted because a worker no longer has to move from one task to another.
4) In manufacturing this allows a production line to be set up and allows for increased use of machinery.
5) In turn, this helps to increase the productivity and to reduce the average costs of production.

Question 21

What are the disadvantages of the division of labour? (4)

Answer 21

1) Monotony and boredom for workers which could result in a fall in productivity.
2) Loss of skills: workers trained in one particular task have only limited skills, this could be a problem if they are made redundant.
3) A strike by one group of workers could bring the whole production process to a standstill.
4) There is lack of variety because all produced on a production line are the same.

Question 22

What are the advantage and disadvantages to the specialisation of trade?

Answer 22

Advantages:
If a country specialises in the production of certain goods and services and then trades these in exchange for goods and services that it does not produce, then it can benefit from increased output, greater choice and lower prices.
Disadvantages:
This could mean that a country becomes overly dependent on imported goods and services. If its goods and services are not competitive then there could be unemployment and the country’s value of imports may persistently exceed the value of exports.

Question 23

Give three reasons why the division of labour may be limited.

Answer 23

1) The size of the market - if there is only a small market then it will be difficult to specialise.
2) The type of the product - for example designer fashion products are likely to be unique and not suitable for the division of labour.
3) Transport costs - if these are high then large-scale production and the division of labour may not be possible.

Question 24

What are the functions of money?

Answer 24

1) As a medium of exchange - enabling people to specialise, exchanging money earned from doing a specialist job for the goods and services they wish to buy.
2) A store of value - enabling people to save in order to buy goods in the future.
3) A measure of value - enabling people to assess the value of different goods and services.
4) A means of deferred payment - enabling people to buy goods and pay for them on credit.

Question 25

What is a free market economy?

What are the characteristics of a free market economy? (5)

Answer 25

The free market economy is one in which the questions about how to produce and allocate resources are determined by market forces.
The main characteristics are:
1) Private ownership of resources.
2) Market forces, i.e. supply and demand determine prices.
3) Producers aim to maximise profit.
4) Consumers aim to maximise satisfaction.
5) resources are allocated by the price mechanism.

Question 26

What is a command economy?

What are the main characteristics of a command economy? (5)

Answer 26

The command or centrally planned economy is one in which the questions about scarcity are determined by the state.
The main characteristics are:
1) State ownership of resources.
2) Price determination by the state.
3) Producers meet production targets set out by the state.
4) Resources are allocated by the state.
5) There is greater equality of wealth and income than in a free market economy.

Question 27

What is a mixed economy?

Answer 27

The mixed economy is a mixture of the command economy and the free market economy. In these economies some resources are allocated by the price mechanism and some are allocated by the state. What differs between countries is the degree of the mix.

Question 28

What are the advantages of free market economies? (6)

Answer 28

1) Consumer sovereignty - spending decisions by consumers determine what is produced.
2) Flexibility - the free market system can respond quickly to changes in consumer wants.
3) No officials are ned to allocate resources.
4) Competition and profit motive help to promote an efficient allocation of resources.
5) Increased choice for consumers compared with a command economy.
6) Economic and political freedom for consumers and producers to their own resources.

Question 29

What are the disadvantages of free market economies? (5)

Answer 29

1) Inequality - those who own resources are likely to become richer than those who don’t.
2) Trade cycles - free market economies may suffer from instability in the form of slumps and booms.
3) Imperfect information - consumers may be unable to make rational decisions if they have inadequate information or if there is asymmetric information.
4) Monopolies - There is a danger that a firm may become the sole supplier of a product and then exploit consumers by charging prices higher than the free market equilibrium.
5) Externalities - these are costs and benefits which are not taken into account when goods are produced and consumed.

Question 30

What are the advantages of a command economy? (5)

Answer 30

1) Greater equality - the state is able to ensure that everyone enjoys a minimum standard of living and that no one is rich.
2) Macroeconomic stability - the state can ensure that booms and slumps are smoothed out.
3) External costs and benefits may be taken into account when planning production.
4) No exploitation - there is no exploitation of workers and consumers by privately owned monopolies.
5) The state can ensure that all workers are employed.

Question 31

What are the disadvantages of the command economy? (4)

Answer 31

1) The absence of the profit motive and competition may make the allocation of resources inefficient.
2) The absence of the profit motive may reduce incentives for investment.
3) Restrictions on freedom of choice, people would be directed into the jobs deemed to be needed by the state.
4) Shortages and surpluses - if the state miscalculates supply and demand then there may be excess supply/demand of goods and services.

Question 32

What is the role of the state in mixed economies?

Answer 32

1) Defence and internal security.
2) Provision of public goods.
3) Provision of essential public services - e.g. education and health.
4) Redistribution of income from the rich to the poor.