Theme 1 Flashcards
Economics
Economics is the study of how individuals, households, businesses and governments with scarce resources make choices in an attempt to satisfy their needs.
Microeconomics
when we study the behaviour of individuals and businesses up to the level of individual industries
The Basic Economic Problem
the central purpose of economic activity is the production of goods and services to satisfy our changing needs and wants. The Basic Economic problem is that resources as scarce relative to the purposes to of which they could be put. As a result choices have to be made about how to use resources. Thus frequently referred to as ‘scarcity and choice’.
Need
something you must have in order to survive
Want
something that you desire that is not essential for human survival
Opportunity Cost
In decision making, is the value of the next best alternative forgone
Scarcity and Choice
Unlimited wants and scarce resources leads to choices. The issue that irises from scarcity is that is forces people to make choices.
Economic Agents
All economic agents ( producers, consumers and governments) have to make choices and look at opportunity costs i.e.
Consumers have to decide what they buy, where they work
Governments have to decide where to invest funds and raise taxes
Firms have to decide what price to sell at and how to produce
Factors of Production
Economics is concerned about converting inputs into outputs. Inputs are known as Factors of Production.
Capital- man made goods to supply other products such as factories and machinery.
Enterprise-human skill needed to organise the other factors of production and take risks associated with setting up and running a business.
Land-stock of natural resources available for production I.e. land and natural resources
Labour-quantity and quality of human input available for the production process.
Non Renewable resources
Finite in supply- for many there is no mechanism to replenish them
E.g. oil, gas and coal
Renewable Resources
Replaceable if rate of extraction is less than natural rate at which resource renews. If not managed appropriately they may be exhausted. Over extraction may threaten long term supply.
E.g. Solar, wind, Tidal, fish stock and Timber
Model
In order for economists to cope with the complexity of the real world it is essential to simplify reality. Therefore economists work with Models. These are simplified versions of reality allowing economists to focus on key aspects of the world often focussing on just one thing at a time.
How to form a model
Start with an assumption
In order to isolate one factor it is assumed all other factors remain the same.
This is known through the latin phrase ‘Ceteris paribus’ meaning ‘other things being equal’.
It is used in economics when we focus on changes to one variable while holding other influences constant. Models help economists understand complex decisions and predict future behaviour and therefor hold a value but sometimes they may seem remote from reality.
Positive Statement
A positive statement is a statement of fact that can be tested , amended or rejected. Often this might involve cause and effect
Normative Statment
A normative statement is about what “ought” to be- they are subjective and involve value judgement ( a statement based on opinion or beliefs rather than facts)
Productive possibility frontier (PPF)
The nations productive capacity reflects the potential output of an economy. A productive possibility frontier shows the maximum combination of goods that can be produced in a given period with a given set of resources. When considering opportunity cost of this, it is useful to simplify the concept and consider the maximum combination of two types of goods using a diagram.
PPF Graph
PPFs show the maximum production potential of an economy using a combination of two costs or services when resources are fully and efficiently employed. Any point on the frontier shows a point that all resources are being fully utilised so an efficient use of resources.
If point is under the graph it means it isn’t a efficient use of resources( factors of production) for example may have unemployment or not using land properly.
If a point is above the line them it is unattainable with current resources so to reach it you would need more resources- improvement in technology.
If more good x is produced then less of good y produced- opportunity cost.
Scarcity- PPF
The PPF demonstrates the concept of scarcity which refers to the limited availability of resources ( such as labour, capital and land) in relation to the unlimited ( and often growing) wants and needs of society
Trade offs- PPF
The PPF reflects the idea that an economy must make trade-offs when allocating its resources. Producing more of one good necessitates producing less of another. The shape of a PPF highlights, the trade offs required when reallocating resources between two goods.
Opportunity Cost- PPF
The opportunity cost of producing more of one good is the amount of the other good that must be given up. The slope of the PPF represents the opportunity cost of switching from producing one good to producing the other.
Efficiency- PPF
Points along the PPF represent an efficient use of resources where the economy is fully utilising all available resources to produce goods and services. Points inside, the PPF are inefficient, indicating that resources are not fully employed.
Marginal analysis
an approach to decision making based on considering the additional (marginal) benefit and cost of a change in behaviour. Firms will consider the cost of producing an additional unit of output compared to the benefit (marginal return) of selling it.
Shape of PPF- why it curves
The shape of a PPF is commonly drawn as an arc that is concave to the origin. If the law of diminishing returns holds true then the opportunity cost of expanding output of X measured in terms of lost units of Y is increasing. Resources such as land, capital and labour used in producing wheat might not be equally suited to producing beef. If the marginal productivity of resources is declining then the opportunity cost will increase. We are sacrificing more to get a little extra of something.
PPF shift outwards
A PPF shifts outwards when there is an increase in an economy potential to produce goods and services. This outwards shift represents economic growth (macro) which allows the economy to produce more of both goods or to improve its production capabilities. For a business it means they are able to produce more of both goods. For the PPF to shift outwards there needs to be either an increase in the factor inputs available or an increase in the efficiency of supply.
Q2CELL- Quantity, Quality, Capital, enterprise, labour, land.
Inward shift of PPF
It is possible for the productive capacity to shift inwards. e.g. net loss of ppl due to migration, low birth rate, pandemics, natural disaster, war + conflict
PPF- Economic efficiency
The PPF diagram is a useful toll in economics to illustrate different types of economic efficiency. It helps demonstrate the concept of efficiency in resource allocation and provides insight into how an economy can achieve optimal production levels given its available resources. 3 types of economic efficiency are: Productive efficiency, Allocative efficiency and Dynamic efficiency.
Productive efficiency
Occurs when an economy is producing goods and services at the lowest possible cost given its existing technology and resources.
On a PPF diagram, productive efficiency is achieved when the economy is operating on the PPF curve. Points on the PPF represent the max output attainable with given inputs, and any point inside the PPF indicates underutilisation of resources. If the economy operates inside the PPF, it is not reaching productive efficiency because resources are being wasted.
Allocative efficiency
Occurs when an economy is producing a mix of goods and services that best aligns with consumer preferences and social needs. It represents the ideal distribution of resources among different goods to maximise overall satisfaction.
On the PPF diagram allocative efficiency is achieved when the economy is producing at a point on the PPF that matches society’s preferences. If the economy is producing at a point inside the PPF it is not achieving allocative efficiency because it can produce more of one good without sacrificing the production of another good. A point outside the PPF, it is not feasible and achieving such a point would require additional resources or technological advancements.
Dynamic efficiency
Refers to an economy’s ability to grow and expand its production possibilities over time. This involves shifting the PPF outward through technological advancements, investments and innovations.
An outward shift on the PPF indicates that the economy has achieved dynamic efficiency allowing it to produce more goods + services than before with same resources. This might have been achieved through process innovations such as lean manufacturing used in car making or innovation in farming that increases yields of particular crops each year.
Specialisation
Refers to producing what a worker, firm or country is most efficient at.
Adv + DisAdv of Specialising in a narrow product range.
Adv- allows company to specialise effectively
-produce efficiently by building up skills and increasing quality
-charge higher prices
-Increased output
DisAdv- changing demand
-Labour- boring
-finite resources
-over reliance
Division of labour
Refers to production process being broken down into separate specialised tasks/ sequences of stage. By focusing on a particular stage workers can become highly adept and thus more efficient at carrying out that task.
Division of Labour Adv & DisAdv
ADV
-By focusing on one task that they perform well, workers become more productive
-This is likely to lower costs and increase profit margins OR allow the firm to reduce the price. Lower prices are likely to increase standards of living
-Training can be more cost effective as only focusing on a narrow range of skills.
-Working as a team may allow more overall output to be produced.
DISADV
-Monotonous - this may mean workers become bored and de-motivated.
* This may mean they become less productive and take less pride in their work.
* Over-specialisation may lead to a lack of flexibility. Workers may find it difficult to move to other jobs.
Therefore it may be difficult to cover for absent workers or find alternative employment.
* More produced standardised goods may mean less choice for consumers.
Potential gains from specialisation
-Higher labour productivity and rising business profits
>learning by doing increases output per hour worked
>higher productivity lowers costs and supply of goods +services
>increased productivity =higher profits for businesses
-Specialisation creates a surplus output that can be traded for mutual benefits
>Businesses/ countries specialise in areas of relative advantage
>trade increases the range of products we can consume
-Lower Prices cause higher real incomes and GDP growth
>Lower prices gives consumers greater real purchasing power.
>higher productivity allows businesses to pay increased wages
>successful specialisation is a key cause of economic growth
Batered
Before money people bartered, swapped a good for another of similar value, however there had to be a double coincidence of choice for this to happen.
In the economic system nowadays this would be impossible as economy/businesses many workers and households do not make a good/ service in its entirety. So nothing to barter with. Therefore another medium exchange is required. Money is anything that is generally accepted in the settlement of debt. These days for most economies this includes notes, coins and electronic money.
Main functions of money
-Medium of exchange
-Store of value
-Unit of account
-Standard of deferred payment
Main functions of money: Medium of exchange
Money serves as a standard unit of account that facilitates transactions by allowing goods and services to be exchanged for a common and widely accepted medium of exchange.
Main functions of money: Store of value
Money allows individuals to save for future consumption by maintaining its purchasing power over time.
Main functions of money: Unit of account
Money serves as a standard unit of measurement for the value of goods, services, and financial assets, enabling individuals and businesses to compare prices and make informed decisions.
Main functions of money: Standard of deferred payment
Money enables individuals and businesses to make deferred payments, such as loans, mortgages, and insurance contracts, by providing a means of transferable credit.
the 3 economic questions
What goods should be produced?
How? How should the productive resources of the economy be used to produce various goods and services
For whom? Once produced how should they be allocated among the population for consumption
3 types of economies
-Free market
-command
-mixed
Free Market economy
Free market economy allows market forces to guide the allocation of resources through the piece mechanism. In a free market there is a very limited role for the government. Adam Smith argued that in such a system resources would be allocated effectively through the operations of an ’Invisible hand’. For example: Singapore, Switzerland, Luxembourg. Price is dependent on the interaction between demand and supply components of a market. Benefits of a market economy includes increased efficiency, production and innovation. Greater economic freedom from lower government size increases inequality.
Approach to ownership of assets, incentives for employees and entrepreneur’s- Free market economy
The factors of production are all owned by individuals and free for them to allocate the resources how they want without government intervention
Entrepreneurs use profit as an incentive as they’re in control of how they operate to gain a profit. Employees can have higher incomes when the business decides but also if their productivity leads to growth it would likely increase more.
Advantages of free market economy
-An efficient allocation of scarce resources factor resources tend to go where the expected profit is highest.
-Competitive prices for consumers as suppliers look to increase and then protect market share.
-Competition drives innovation & invention bringing higher profits for businesses and better products for consumers.
-The profit motive stimulates investment which encourages economies of scale and lower prices for consumers.
-Competition through trade in goods and services helps to reduce domestic monopoly power and increases choice.
disadvantages of free market economy
-Free markets can fail to achieve an economically and socially efficient and equitable allocation of resources- there are numerous potential causes of market failure that may require government intervention
-Free market activity can lead to a rise in the scale of income and wealth inequality as shown by rise in the Gini coefficient
-Businesses can develop monopoly power which leads to higher prices and damage to consumer welfare
-Under or non-provision of pure public goods (e.g. defence – goods which are non-rival and non-excludable)
-Under-provision of merit goods such as health and education – which many cannot afford – leading to lower social welfare
-Free markets may fail to address negative externalities from production and consumption – unsustainable growth
-Deregulated financial markets often prone to bouts of instability – the fall out from which affects millions not directly involved
Command economics
Where the government undertakes the coordination role, planning and directing the allocation of resources. The government is likely to own most of the countries scarce resources. They will tell businesses what to produce, how much to produce and who to sell to and at what price. The government regulates economy completely. For example Russia, Cuba and North Korea. Command economies were often associated with the political system of Communism. It was Karl Marx, in the Communist manifesto who argued for ‘common ownership of the means of production.’ Prices in the economy must be set by government officials, so they cant arise naturally. Because a command economy is centrally planned, its pros theoretical equality between citizens(lack of inequality),
Approach to ownership of assets, incentives for employees and entrepreneur’s- Command economics
Command economy approach to ownership - requires that the central government own and control the factors of production.
Incentives for employees and entrepreneurs - wades are set centrally for employees and profits are eliminated. This leads to no incentive to increase production or be more efficient. Factors of production being centrally owned leads to a lack of incentive too
Outcomes of an Command economy
Production in command economies is notoriously inefficientas the government feels no pressure from competitors or price-conscious consumers to cut costs or streamline operations. They also may be slower to respond—or are even completely non-responsive—to consumer needs or changing tastes.
Advantages of command economics
-Supporters of command economies argue that it enables the government to overcome market failure, inequality and create a society that maximises social welfare rather than maximises profit
-Command economies can prevent abuse of monopoly power
-Command economies can prevent high unemployment, sometimes a feature of capitalist economies
-Command economies could produce goods which benefit society and ensure everyone has access to basic necessities
-Command economies may be more equitable
Disadvantages of command economics
-Government agencies usually have poor information about what to produce. Centralisation means that decisions are taken by people who may have no access to what is actually happening. This may mean over or underproduction of goods and services and a waste of scarce resources
-Unable to respond to consumer preferences
-Lack of incentives for both workers and businesses ie no incentive to earn more profit/wages set therefore no incentives to work harder
-Inefficient firms are protected and kept going; making it harder for resources to move to dynamic and efficient firms
-Bureaucratic: Command economies tend to be very bureaucratic with decisions help up by planning and committees.
-Price controls invariably lead to shortages and surpluses
Adam Smith
Famous for his book, “The wealth of Nations” (1776).
Seen as an advocate of free market economics and laissez-faire government (leaving markets to regulate themselves wherever possible).
He explained how the “invisible hand” would allocate resources everyone’s advantage. He argued that individuals would act in their own self interest and that this would lead to an economy that maximised benefits.
However, he also recognised that the state also had a part to play.
To be wary about businesses that become too large and have too much power (over prices.).
* The state needed to provide goods and services which the free market would otherwise not provide (roads, bridges, defence etc).
The role of government to regulate financial markets.
There needed to be law enforcement of property law, patents and copyright (to protect
invention).
Despite recognising the need for some government intervention, Smith is regarded as the founder of free market economics.
Friedrich Hayek
Best known as a proponent of the 20th century Austrian School of economics in which there is a strong belief in the role and importance of the individual in the economy rather than any collective group or government. Hayek believed in the liberty and freedom of the individual.
Hayek disagreed with Smith in terms of financial markets, seeing Iess of a role of government. The only role of government was for law and order.
He also argued against command economies citing the problem of economic calculation. He saw that a small group of central planners was responsible for determining how much of every product should be produced and delivered. In his view it would be impossible for them to ever have enough information to properly meet people’s needs.
Hayek believed that markets alone would have the information needed to make these decisions.
What might a rational consumer consider
-Price of product/ service
-Price of other products/ services (opportunity costs)
-Your income- how much can you afford
-Preferences
Utility
In a nutshell you make decision to get maximum satisfaction. Economists refer to satisfaction in this context as Utility. The assumption economists make is that rational customers set out to maximise their utility. The corresponding assumption for firms is that they aim to make as much profit as possible. Maximise profits.
Making a rational decision
- Identify problem
-Outline pros and cons of choices
-Weigh up pros and cons
-Any other alternatives?
-Evaluate all options
-Select the best options
Not always best or most realistic way for firms to make decisions, takes significantly longer to decide which is not practical in a firm with strict time constraints.
Assumptions - rationality
Assumptions are necessary in order to analyse how consumers or firms will act. Economists assume that firms and individuals will behave rationally when making decisions. If we know consumer sets out to maximise satisfaction, then economists can build a model to show under what conditions they would achieve this. It helps economists understand human and business behaviour and to identify situation in which people or firms depart from rationality.
Diminishing marginal utility
Describes a situation where an individual gains less additional utility from consuming a product the more of it is consumed. The margin is one additional unit.
Concept of demand and supply rooted in:
-Individuals maximising their satisfaction- utility
-Firms maximising satisfaction/ reward- profit
Demand
defined as the quantity of a good or service that consumers are willing and able to buy at a given price in a given time period.
