Theme 1 Flashcards
What is an economic model?
A simplified version of reality designed to help understand the causes and effects of economic events.
What is a positive statement?
A statement which can be supported or refuted by evidence.
What is the economic problem?
There are scarce (finite) resources and unlimited wants.
What are renewable and non-renewable resources?
Renewable resources can be exploited over and over again (e.g. a forest); non-renewable resources can only be exploited once (e.g. coal).
What is a PPF?
A production possibility frontier shows the maximum possible output of two goods assuming that all resources are used efficiently.
What does ceteris paribus mean?
The assumption that whilst the effects of a change in one variable are being investigated, all other variables are kept constant.
What is a normative statement?
A statement that cannot be supported or refuted because it is a value judgement.
What are the factors of production?
Resources that are inputs into the production process. They are:
* Labour - the workforce of an economy
* Capital - manufactured aids to production (e.g. factories, tools)
* Land - the land itself but also natural resources
* Enterprise - individuals who organise the other 3 factors of production.
What is meant by opportunity cost?
The benefits forgone of the next best alternative.
How can a PPF show the maximum productive potential of an economy?
The maximum productive potential of an economy is any point on the PPF (e.g. X or Y).
How can a PPF show opportunity cost?
With a movement along the PPF
For example, moving from point X to Y indicates that the opportunity cost of producing 3 more consumer goods is one capital good.
What points on a PPF indicate inefficiency, efficiency, and unattainability?
Inefficient - inside the PPF, e.g. W
Efficient - on the PPF, e.g. X or Y
Unattainable - beyond the PPF, e.g. Z
Producing at an inefficient point indicates that some resources are unemployed. For instance, at point W, there may be unemployed workers and unused factories.
What is meant by specialisation?
When individuals, firms, or nations focus production on a narrow range of goods or services.
What is division of labour?
Specialisation by workers who perform different tasks at different stages of the production process.
How can a PPF show economic growth?
By shifting outwards
This can occur due to improvements in the quality or quantity of factors of production, such as education, training, technological advancements, immigration, and investment.
What causes a PPF to shift left?
A decline in resources, such as those destroyed in a war or natural disaster.
How does the allocation of resources affect economic growth?
Using more resources to produce capital goods will increase future factors of production, shifting the PPC outwards.
What are the advantages of the division of labour?
- Workers become very skilled and productive at one task
- Increases output
- Reduces unit costs
Less time spent on making each good contributes to these advantages.
What is a disadvantage of the division of labour?
Boring for workers
Additional disadvantage includes higher unemployment due to machines replacing workers.
What are the functions of money?
- Medium of exchange
- A measure of value
- A store of value
- A method of deferred payment
Examples include purchasing goods, measuring value through prices, saving for future purchases, and taking out loans.
What does ‘allocation of resources’ mean?
Use of factors of production
It refers to what the economy will use its resources for, such as making tanks, vaccines, or smartphones.
What is the link between specialisation and markets?
Specialisation leads to production for sale in markets
Individuals who specialise in one product wish to sell it to buy other products they want.
What is a market?
An arrangement where buyers and sellers exchange goods and services.
What are the different economic systems?
- Free market economy
- Command economy (planned economy)
- Mixed economy
Free market relies on markets without government intervention, command economy is government-controlled, and mixed economy combines both.
What are the advantages of a free market economy?
- More choice for consumers
- Higher quality products
- Greater efficiency
Competition among businesses leads to these advantages.
What are the disadvantages of a free market economy?
- Greater inequality
- Possibility of market failure
Wealth tends to accumulate with entrepreneurs and capital owners.
What are the advantages of a planned economy?
Reduced inequality
The government allocates resources to ensure that income and wealth are more evenly distributed.
What are the disadvantages of a planned economy?
Less choice and quality of products
Less efficiency
The government is not motivated by profits, leading to lower incentives to satisfy consumers and reduce costs.
What is meant by rational decision making?
When an economic agent makes choices that result in the optimal level of benefit
It is assumed that all agents will act rationally, maximizing utility for consumers and profits for firms.
Why does the demand curve slope downwards?
Due to the law of diminishing marginal utility
Marginal utility declines as the number of goods consumed increases, leading consumers to pay less for additional units.
What did Adam Smith think about economic systems?
Favoured a free market approach
He believed economies function best when individuals act in their own self-interest and emphasized the importance of specialization and division of labor.
What did Karl Marx think about capitalism?
Inherently unstable due to inequality
Marx criticized free markets for creating inequality.
What was Friedrich Hayek’s view on resource allocation?
Governments are incapable of allocating resources efficiently
He favored free markets as a solution.
What is meant by demand?
The quantity of a good or service consumers are willing to buy at a given price
A demand curve illustrates the law of demand: higher price leads to lower quantity demanded, and vice versa.
How does an increase in price affect demand?
Leads to a contraction in demand
This is shown by a movement up the demand curve.
How does a decrease in price affect demand?
Leads to an extension in demand
This is shown by a movement down the demand curve.
What is the law of diminishing marginal utility?
The additional satisfaction declines as the number of goods consumed increases
For example, satisfaction from the first chocolate bar is higher than from the second or third.
What is the relationship between price changes and demand?
Only a change in price leads to contractions or extensions
Demand contracts or extends as a movement along the curve, not a shift of the curve.
What factors cause demand to increase or decrease?
The demand curve shifts due to:
* Changes in real income
* Changes in the price of other goods (substitutes and complements)
* Tastes/fashion/trends
* Advertising
* Population size
These factors influence consumer behavior and preferences.
What is the relationship between the price of other goods and demand?
Substitute goods are alternatives for consumers. An increase in the price of a substitute leads to an increase in demand for the original good. E.g., if Sprite’s price increases, demand for Coke increases.
Complementary goods are consumed together, and an increase in the price of a complement decreases demand for the original good.
What are normal goods?
Normal goods are goods for which an increase in income leads to an increase in demand and vice versa. E.g., a laptop.
This reflects a direct relationship between income and demand.
What are inferior goods?
Inferior goods are goods for which an increase in income leads to a decrease in demand and vice versa. E.g., bus transport.
This reflects an inverse relationship between income and demand.
What is meant by supply?
Supply is the quantity of goods that producers are willing and able to sell at a given price in a given time period.
The law of supply states that higher prices generally lead to greater quantities supplied.
What is the shape of a supply curve and why?
The supply curve is upward sloping because of the law of supply: higher prices lead to greater quantity supplied, while lower prices lead to lower quantity supplied.
Producers are motivated by profit; higher prices allow for more profit.
How does a change in price affect supply?
An increase in price leads to an extension in supply, while a decrease leads to a contraction in supply.
This is shown by movements along the supply curve, not shifts of the curve.
What causes supply to decrease?
Factors causing supply to shift to the left include:
* Increase in production costs
* Increase in indirect taxes
* Lower subsidies
* Reduction in the number of firms
* Adverse weather conditions
Leftward shifts indicate a decrease in supply.
What happens if the price is above the equilibrium price?
Quantity supplied would be greater than quantity demanded, resulting in excess supply (surplus).
Firms will reduce price until demand equals supply, reaching equilibrium.
What factors cause supply to increase?
Factors causing the supply curve to shift to the right include:
* Lower production costs
* New technology
* Reduction in indirect taxes
* Increase in subsidies
* Increase in the number of firms
Rightward shifts indicate an increase in supply.
What is market equilibrium?
The equilibrium price and quantity in a market is where demand equals supply.
What happens if the price is below the equilibrium price?
Quantity demanded would be greater than quantity supplied, resulting in excess demand (shortage).
Firms will increase price until demand equals supply, reaching equilibrium.
Fill in the blank: A decrease in price leads to a ______ in supply.
contraction
True or False: Only a change in price leads to contractions/extensions in supply.
True
Fill in the blank: An increase in production costs leads to ______ in supply.
decrease
What is the result of excess supply in the market?
Firms respond by reducing price, causing demand to extend and supply to contract until equilibrium is reached.
What is indicated by a leftward shift of the supply curve?
A decrease in supply.
What is indicated by a rightward shift of the supply curve?
An increase in supply.
