Unit 1 Flashcards
In the process of Developing Models, what do economists need to do?
Make Assumptions
What is Ceteris Paribus?
A key assumption that is made is assuming that events occur with ceteris paribus.
This assumption is that other things are being held equal or constant, so nothing else changes.
Why do Economists use Models?
Economists cannot conduct scientific experiments, like in the natural sciences, so models are devised.
Economists then use real-life scenarios to build these models upon, and assumptions are made with the models.
What are Positive Statements?
Statements based on quantitative/reliable data, which isn’t influenced by opinion (objective)
What are Normative Statements?
Subjective judgements based on opinion rather than factual evidence
What is the role of Value Judgements in influencing economic decision + policy?
Normative statements are based on ‘value judgments’
Value judgements can influence economic decision making + policy
Different economists can make different judgements from the same statistic
(e.g. the inflation rate can lead to different conclusions)
What is the Basic Economic Problem?
Our wants and needs is unlimited, but resources are finite (scarce)
What are Non-Renewable Resources?
Non-renewable resources cannot be renewed.
The stock levels decreases over time as it is consumed.
e.g. things produced from fossil fuels; such s coal, oil and natural gas, are non-renewable.
Methods like recycling and finding substitutes (e.g. wind farms) can reduce the decline of the resource.
What are Renewable Resources?
Renewable resources can be replenished; so their stock level can be maintained over a long time period.
e.g. Oxygen, fish + solar power are renewable; assuming the rate of consumption < rate of replenishment
How can Renewable resources be Managed?
They can be managed by limiting/preventing deforestation, imposing fishing quotas, etc.
What is our Current Consumption of renewable goods?
We currently consume more renewable goods at a faster rate than replenishment.
The Worldwide Fund for Nature claims that 2 planets will be needed to meet global demand by 2050.
What does Opportunity Cost mean?
Giving up one thing for the next best alternative.
The loss of other alternatives when one alternative is chosen.
What are the Factors of Production?
Land
Labour
Capital
Enterprise
What are Capital Goods?
Goods used to produce consumer goods (eg machinery)
What are Consumer Goods?
Produced goods that can be sold to consumers.
What does the PPF usually show?
- How much of two goods you can make with the given resources.
- The opportunity cost for if you give up one of more than the other
Why is the PPF diagram usually curved?
There usually isn’t a constant opportunity cost for if you use more of one than the other
What may cause the PPF Curve to Shift to the Right?
Economic Growth
What is the Importance of Opportunity Costs to the economic agents?
Consumers: choosing between 2 products
Producers: (e.g.) choosing between hiring extra staff, or investing in new machinery
Governments: (e.g.) choosing between spending more on NHS, or education
They can’t do both due to finite resources, so a choice has to be made for where the resources are best spent
What is Specialisation?
Workers become skilled in their certain field as they work on that small part so much.
Therefore they work much more efficiently and effectively.
For example, when making a doll, workers can manufacture certain parts of the doll.
What is Division of Labour?
When you divide the process of production into smaller parts, where workers take up each part.
Therefore multiple workers are involved in the process of production.
What is the Relationship between Division of Labour and Specialisation?
When division of labour occurs, work has become specialised in their field of production; and the whole production process happens much more efficiently.
What are the Advantages of Division of Labour?
- What has become specialised, and work more efficiently + quickly
- More choice for what you can work in
- Work is evenly distributed, so everyone works the same amount
What are the Disadvantages of Division of Labour?
- Work becomes boring and monotonous
- Cost money to train workers
- Interdependence: Workers depend on others for the whole production process to work
– If someone is ill and doesn’t go to work, production becomes difficult
– if someone becomes bored/tired and stops working to as high of a standard, production becomes less efficient/becomes a lower standard
Who famously stated/ came up with Specialisation and Division of Labour?
Adam Smith:
The concept was famously stated by Adam Smith, who showed how, through the division of labour, worker productivity can increase, and firms can then take advantage of increased efficiency + decreased costs of production
What are the Advantages of Specialising in certain goods and services within trade (Comparative Advantage)?
- Greater world output, so there is a gain in economic welfare
- Lower ACs, since the market becomes more competitive
- Increased supply of goods to choose from
- Outward shift in the PPF curve
What are the Disadvantages of Specialising in certain goods and services within trade (Comparative Advantage)?
- LEDCs might use up their non-renewable resources too quickly, so they might run out
- Countries could become Over-Dependent on the export of 1 commodity (e.g. wheat) - Commodities have unstable prices, so the economy would suffer.
What are the Functions of Money?
A medium of exchange
A measure of value
A store of value
A method of deferred
How is money a medium of exchange?
Without money, transactions were conducted through bartering; goods + services were traded with other goods + services.
But people didn’t always get exactly what they wanted or needed, and the goods traded weren’t always of the same value. Exchange could only take place if there was a double coincidence of wants
How is money a measure of value?
Money provides a means to measure the relative values of different goods and services. Money also puts a value on labour.
e.g. Jewellery might be considered more valuable than a tablecloth; represented by it costing more money.
How is money a store of value?
Money has to hold its value to be used for payment. It can be kept for a long time without expiring.
However, keep in mind that the quantity of G+S that can be bought with a certain amount can change, due to supply + demand
How is money a method of deferred payment?
Money can allow for debts to be created. This means people can pay for things without having money in the present, but can pay for it later.
This relies on money storing it value.
What are free-market economies also known as?
Laissez-faire economies
What happens in a Free Market Economy (What/How/To Whom)?
What to produce: determined by what the consumer prefers
How to produce it: producers seek profits
For whom to produce it: whoever has the greatest purchasing power in the economy, and is therefore able to buy the good
What are the Advantages of a Free Market Economy?
More Efficient:
Due to wanting higher demand from consumers, firms are likely to lower prices and make more efficient use of scarce resources
The bureaucracy from government intervention is avoided
(Bureaucracy: a system of government in which most of the important decisions are taken by state officials rather than by elected representatives.)
More personal freedom
What are the Disadvantages of a Free Market Economy?
Ignores Equality, as firms only want profit
May lead to the overconsumption of Demerit Goods which have large Negative Externalities
Public Goods are not provided
Merit Goods are Underprovided
There could be Monopolies which could exploit the market
What Happens in a Command Economy?
The Government decides/ determines what goods should be produced, how much should be produced, and the price at which the goods will be offered for sale
What are Some Countries that are in a Command Economy?
China, Cuba + North Korea
What are the Objectives of a Command Economy?
Consumers, workers and the government are all assumed to be working for the ‘common good’.
How much Competition will there be in a Command Economy?
Very Little
What are the Advantages of a Command Economy?
The planner tries to be fair in distributing the output of the economy. Wages are determined by the planners, as are the prices of the goods produced.
Prevents Mass Unemployment
Command economies could produce goods which benefit society..
and ensure everyone has access to basic necessities.
What are the Disadvantages of a Command Economy?
Asymmetric Information: The government are unaware of what is actually happening in Businesses, etc.
Unable to Respond to Consumer Preferences
Power: Command economies create a very Powerful Government, which Threatens Democracy.
Also, the government could end up Controlling Other Aspects of People’s Lives
What is a Mixed Economy (What/How/For Whom)?
What to produce: determined by both consumer and government preferences
How to produce it: determined by producers making profits and the government
For whom to produce it: both who the government prefers, and the purchasing power of private individuals
What is the Role of the State in a Mixed Economy?
The market is controlled by both the government, and the forces of supply and demand
Governments often provide public goods (street lights, roads, police), and merit goods (healthcare, education)
What do Consumers aim to maximise?
Consumers aim to Maximise Utility
What is meant by a Customer’s Utility?
A customer’s utility is the total satisfaction from consuming a good or service
What do Firms aim to maximise?
Firms aim to Maximise Profits
What is the Two-System Model that explains how decisions are made?
Made by Daniel Kahneman; a Nobel Prize winner for his work in behavioural economics
First System: based on common sense estimates, and emotional responses to the choice made. It uses short cuts, and quick decisions are made. This is the dominant system.
But the bias + potential for error in the system could leads to irrational decisions being made
Second System: uses thoughts + reflections, and avoids bias and errors in the first system. This takes longer than the first. -
But the system can be easily manipulated, and so the decisions made could be harmful to the consumers / others
What is the Rational Decision Making Model?
1) Identify the problem: For a firm, this might be falling profits.
2) Find and identify the decision criteria: The firm might have to find information or criteria that will increase their profits. The firm’s criteria might include, for example, keep a certain number of employees or to not change the price of their goods. The criteria might include how the decision will affect stakeholders (the customer and the staff, for instance), and how the quality might be affected.
3) Weigh the criteria: The firm will have to rank the criteria based on their relative importance. They might think keeping all of their employees is the most important, for example.
4) Generate alternatives: The firm might consider some alternative options. For instance, they might think that moving their premises somewhere else will reduce costs and hence increase profits. Perhaps they will consider a loyalty scheme or a promotion for the consumer. Alternatively, the might decide to reduce the size of their workforce.
5) Evaluate alternative options: The firm might now consider which of the alternatives meet their criteria the best, and help them increase their profits the most.
6) Choose the best alternative: Now the firm will choose the alternative they think meets their criteria.
7) Carry out the decision: The firm can now see what the consequences of the decision are.
8) Evaluate the decision: After seeing what effect the decision has on the firm, they can consider whether this was the best option or not.
What are Limitations to the Rational Decision Making Model?
This is not always the best or most realistic way for firms to make decisions.
Although it might be fairer than making an intuitive decision, it takes significantly longer to decide, which is not practical in a firm with strict time constraints.
What is Demand?
The amount of goods and services people choose to buy at any price over a given period of time.
What is meant by Diminishing Marginal Utility?
The falling satisfaction for every additional unit consumed.
The more you have of something, the less satisfied you are with it
This explains why it is a downward slope, as you end up demanding less.
What is the Law of Demand?
There is an inverse relationship between the price of a good or service, and the quantity demanded. (Ceteris Paribus)
What is another reason for the demand curve being downward sloping?
When the price of the good is lower, more can afford it and/or are willing to buy it.
What Factors Affect Demand?
Substitutes
Taxes
Income
Price
Population
Advertising + Fashion
How do changes in prices affect the demand curve?
You go along the demand curve, but it doesn’t shift
What is meant by Responsiveness?
Switching from one good to another
e.g. Lemons to Limes
What is PED?
Price Elasticity of Demand
The demand of a product in relation/response to the price of it.
What is the PED Formula?
%change Quantity Demanded
______________
%change Price
What are the factors of PED?
- Availability of Substitutes
- Degree of Necessity
- Proportion of Consumer Budget it takes up
- Cost of Switching Between Products
- Peak/ Off Peak Demand
- Addictiveness
How do you Work Out the Change?
New Price- Old Price
________________
Old Price
(x 100)
What are the Coefficients of PED?
0 = Perfectly Inelastic
(+/-) 0-1 = Inelastic
(+/-) 1+ = Elastic
(+/-) Infinity = Perfectly Elastic
Which one has a Steeper Demand Curve: Elastic or Inelastic?
Inelastic
A decrease in price leads to a less than proportionate increase in Qd
Why is PED Significant to Firms and the Government?
The burden of an Indirect Tax falls directly on the consumers and the Firms
Inelastic Good:
Firms will put most of the tax burden on the Consumer (because they know the price increase won’t majorly affect demand)
Demand will fall slightly
This is most effective for raising government revenue.
Elastic Good:
Firms will put most of the tax burden on the Producer (because they know the price increase will majorly affect demand)
Demand will fall significantly
This is not as effective for raising government revenue, but is highly effective if the government wants to reduce the demand of a particular good.
What is the Relationship between PED and Total Revenue?
Total Revenue = AR x Quantity
Goods with Elastic Demand:
If firms raise its price, the quantity sold will fall significantly. This reduces total revenue.
Good with Inelastic Demand:
Firms can raise its price, and quantity sold will not fall significantly. This increases total revenue
What is YED?
A measure of Responsiveness of quantity demanded to a Change in Income
What is the YED Formula?
% Change in Income
What are the Coefficients of YED?
(+/-) 1+ = Income Elastic
(+/-) 0-1 = Income Inelastic
Positive = Normal Good (downward sloping curve)
Negative = Inferior Good (upward sloping curve)
Positive Elastic = Luxury Good
Why is YED significant to Firms?
During periods of prosperity (e.g economic growth) when real incomes are rising, firms might switch to producing more Luxury goods and fewer inferior goods.
This is because the demand for luxury goods will be increasing
What is XED?
The Responsiveness of Demand of one good to the changes in price of another good
What are the Coefficients of XED?
(+/-) 0-1 = Cross Inelastic
(+/-) 1+ = Cross Elastic
Positive XED = Substitute Goods
Negative XED = Complimentary Goods
0 XED = Unrelated Goods
Which Way does the XED Curve Go?
Upwards - Substitutes
Downwards - Complimentary
( X axis = Price of A)
( Y axis = Quantity of B)
How do you calculate XED?
|> Quantity of good A / |> Price of Good B
Why are Firms Interested in the XED of their product?
It allows them to see how many competitors they have.
Therefore, they are less likely to be affected by price changes by other firms, if they are selling complimentary goods or substitutes
What Way does the Supply Curve go?
Upwards
As price rises, it encourages firms to produce more so they can make a bigger profit
What is Supply?
The quantity of a good or service that firms are willing to sell at a given price over a given time period.
What Makes a Move Along the Supply Curve?
A change in the Cost of Production