Theme 1 - Markets and Market Failure [INCOMPLETE - NO GOV INTERVENTION] Flashcards
Why do economists develop models
- explain how economy works
- developed by putting forward model, gathering evidence, accepting/challenging/disregarding model
- too many variables which can change so assumptions are made
Why do economists make assumptions when developing models
- too many variables which can change
- allows them to simplify problem
- ceteris paribus = all other things remaining equal
What is a positive statement
- objective and made without any obvious value judgements
- can be tested to be proven/disproven
- expressed in the form of a hypothesis that can be analysed and evaluated
What is a normative statement
- subjective and based on opinion
- cannot be proven/disproven
What are value judgments
- influence economic decision making and policy
What is the economic problem
- stems from the basic problem of scarcity
- how to use the available scarce resources to satisfy people’s infinite needs and wants as effectively as possible
What are the questions that economics sets out to investigate
- what to produce
- how to produce it
- who to produce it for
What are economic agents and who are they
- groups that participate in the economy
- producers, consumers and the government
What do the economic agents do
- producers create goods and services
- consumers buy goods and services made by firms
- the government sets out the rules that other economic agents must follows, also produces some goods and services like infrastructure and healthcare
What is a renewable resource
- resource of economic value that can be replenished or replaced on a level equal to consumption
- as long as rate of consumption is less than or equal to rate of replenishment, stock will not decrease
What is a non-renewable resource
- resource of economic value which cannot be readily replaced by natural means on a level equal to consumption
What is opportunity cost
- the value of the next best alternative foregone
- same resource cannot be used to produce different goods at the same time so decisions have to be made on where to use them
How do the economic agents make decisions for opportunity cost
- consumers choose how to use their limited income based on what gives them the greatest level of satisfaction
- producers choose what to do with their limited resources and decisions are based on profit
- the government decides where to spend their limited tax revenue based on what maximises social welfare
What are the factors of production
- capital
- enterprise
- land
- labour
What is capital
- goods used to make other goods and services (machinery)
What is enterprise
- willingness of people in business to take risks to make a profit
What is land
- natural resources which can be used to make goods and services
What is labour
- all the work done by humans in production
What is a possibility production frontier (PPF)
- shows maximum possible combinations of capital and consumer goods that economy can produce with its current resources and technology
- no indication which combination is best
When is an economy efficient
- economic efficiency is achieved when resources are used for their best use
- at all points on PPF curve, resources are allocated efficiently
What does a movement on the PPF curve show
- a change in the combination of goods produces
What does a shift on the PPF curve show
- change in productive potential of the economy
What are consumer goods
- goods that are demanded and bought by households and individuals to increase satisfaction
What are capital goods
- goods that are produced in order aid the production of consumer goods
What is specialisation
- production of a limited range of goods by a company/individual/country
What is division of labour
- when labour becomes specialised in a particular part of the production process
What is productivity
- output produced over inputs used
Who is Adam Smith and what did he believe in
- economist who focused on specialisation and division of labour
- stated how they can increase labour productivity, allowing firms to increase efficiency and lower production costs
What does increased productivity lead to
- higher output and quality
- higher living standards
- more efficient use of resources
What are the advantages of specialisation and division of labour in production
- DoL allows labour productivity to be increased so workers are quicker, better and more efficient
- lead to higher quality of goods and services
- more cost effective
- time is not wasted
- workers only need to be trained to do one specific task, which saves time and money
What are the disadvantages of specialisation and division of labour in production
- work can become repetitive and boring which leads to poor quality
- reduction in craftsmanship, leading to more of a standardised production
- if one area of production is delayed, all other following areas need to be stopped
- workforce do not have wide industrial training and could suffer from structural unemployment
What are the advantages of specialisation and division of labour in trade
- theory of comparative advantage states countries should specialise in producing goods where they have lowest opportunity cost, so they are relatively best at producing. Helps boost economy
What are the disadvantages of specialisation and division of labour in trade
- countries may become over-dependent on one particular export, if this fails their economy may collapse => primary product dependency
- other countries specialise in non-renewable resources and these could run out, leading to a huge loss of income
- high interdependence
- more competition to cut costs so wages may fall (not necessarily true)
What are the functions of money
- medium of exchange
- measure of value
- store of value
- method of deferred payment
How is medium of exchange a function of money
- allows money to be used to buy and sell goods and services and is acceptable everywhere
How is measure of value a function of money
- can compare value of two goods
- puts value on labour
How is store of value a function of money
- able to keep its value and can be kept for a long time
How is method for deferred payment a function of money
- money can allow for debts to be created
- people can therefore pay for things without having money in the present and pay for it later
- relies on money storing its value
What can lower costs from specialisation and DoL lead to
- increased investment
- higher wages
- lower prices
- greater chance for new and improved products emerging
What are the different types of economies
- free market economy
- mixed economy
- command economy
What is the free market economy
- individuals are free to make their own choices and own the factors of production without government interference
- resources are allocated through price mechanism
- consumers make decisions based on satisfaction
- producers makes decisions based on profit
- no economy is completely free as government has to intervene to an extent
What did Adam Smith think about the free market economy
- believed in this economy and the laissez-faire approach by governments
- explained how there was an invisible hand in the market which allocated resources to everyone’s advantage
- believed competition in the market caused lower prices and benefits consumer
- did also argue state needs to provide some goods/services (laws, property rights, infrastructure)
What did Freidrich Hayek think about the free market economy
- argued state control of economy leads to loss of freedom
- believed poor in free market countries were better than those in command economies as they had freedom
- central planning by governments led to what a small minority wanted being forced on the whole society
- consumers know what they need in their own situation
What are the advantages of a free market economy
- system is automatic due to invisible hand
- consumers have freedom of choice (consumer sovereignty)
- high motivation as people know working hard could lead to high potential rewards
- political freedom
- as firms are in competition, they will produce at lowest cost, ensuring productive efficiency
- free market economies have higher growth
What are the disadvantages of a free market economy
- higher levels of inequality
- lack of merit goods and little control of demerit goods
- resources could be wasted on unproductive expenses such as advertising
- if competition disappears then there may be monopolies
- problem of externalities
What is a command economy
- all factors of production (but labour) is owned by the state and labour is directed by the state
- everyone is working for a common good
- resource allocation carried out by government
- all workers receive save wage and products are standardised
What did Karl Marx think about the command economy
- believed in command economy and criticised capitalism
- believed capitalist’s profit came from exploiting labour
- wanted to remove difference between incomes of owners and workers
- two class system in capitalism (businesses growing by workers getting poorer)
What are the advantages of a command economy
- state provides minimum standard of living, less inequality
- less wastage of resources as there is no need for competitive services
- long term planning means industry doesn’t have to keep changing and shifting resources
- standardised products mean they are produced cost effectively
- government (who are motivated by wellbeing of country), decide resource allocation
What are the disadvantages of a command economy
- impossible for state to make so many decisions correctly, could lead to over or under supply and a waste of resources
- decision making is slow as there’s many stages and there could be increased bribery and corruption
- less motivation and efficiency as everyone receives same wage so people will know working harder does not increase standard of living
- consumers lose freedom
What is a mixed economy
- compromise economy between free market and command
- both free market mechanism and government planning process allocate a significant amount of total resources in a country
What is the governments role in a mixed economy
- creating a framework of rules
- supplements and modifies the price system
- redistribute income
- stabilises the economy
How does the government create a framework of rules in a mixed economy
- prevent the abuse of monopolies
- protect consumers as they pass a large amount of consumer protection laws
- protect property rights
- ensure safety standards protecting employers and employees
How does the government supplement and modify the price system in a mixed economy
- produce public and merit foods and limit production of demerit foods
- government action ensures the consideration of externalities
How does the government redistribute income in a mixed economy
- move income from one group of people to another
- use taxes to take money from one group and give the money to the poor
- form of benefits for those out of work or on low incomes
How does the government stabilise the economy in a mixed economy
- attempts to manage level of demand in the economy to prevent extremes of too much or too little demand
- do this through fiscal and monetary policies
How do consumers make rational decisions
- aim to maximise utility
- utility is the satisfaction gained from consuming a product
- rational consumer is called Homo Economicus, who makes decisions by calculating the utility gained from each decisions and chooses the one which gives most satisfaction
How do producers make rational decisions
- aim to maximise profit
- economic theory assumes firms are run for their owners and shareholders and so aim to maximise profit in order to keep shareholders happy
How do governments make rational decisions
- aim to maximise social welfare
- voted in by public and work for public so aim to maximise their satisfaction by taking decisions which increase social welfare
Why may consumers not behave rationally
- habitual behaviour / consumer inertia
- influence of other people’s behaviour
- consumer weakness at computation
What is demand
- the quantity of a good or service purchased at a given price over a given time period
How do movements on a demand curve look like
What is the difference between a shift and movement on the demand curve
- movement is caused by a change in the price of the good
- shift is caused by a change in any other factor which affects demand
What is a contraction in demand
- quantity demanded falls because of an increase in price
What is an extension in demand
- quantity demanded rises due to a decrease in price
How do shifts on a demand curve look like
What are the conditions of demand
- population
- income
- related goods
- advertising
- taste/fashion
- expectations
- seasons
- legislation
How does population affect demand
- if population rises, demand increases so curve shifts to the right
- there are more people in the country who would want a good
How does income affect demand
- for most goods, if income increases, demand increases and shifts to right as people can afford to buy more of the product
- fall in come then demand decreases and shifts to left
- however, for some goods, increase in income and lead to fall in demand (income elasticity of demand