Unit 1 - Basic economic ideas and resource allocation Flashcards
1.1 What’s the economic problem?
The situation of relatively scarce resources in relation to the unlimited wants and needs of people
What are wants and needs?
Wants: Demand for a good that’s less important than the demand for a need.
Needs: Demand for something that’s essential
What’s scarcity?
When there are insufficient resources to satisfy all the needs and wants of people
Who makes decisions on the allocation of scarce resources?
Individuals, firms, and governments
Define opportunity cost
It’s the next best alternative that is forgone as a result of making a choice
3 basic questions of resource allocation
- What goods to produce
- How to produce the goods
- For whom to produce the goods
1.2 Define positive statement
As statement based on factual evidence. It is objective.
Define normative statement
A statement that is based on personal beliefs/opinions and involves making a value judgement. It is subjective.
Define value judgement
A judgement made that’s a reflection on particular beliefs or values
What is ceteris paribus?
Ceteris Paribus means all other things being equal where other factors which could influence a relationship between two variables are assumed to remain constant
Define short run
It’s a period of time in which at least one factor of production remains fixed in supply
Define long run
It’s a period of time where all factors are variable, and output can be increased by using more of all variable factors
Define very long run
A period of time where technical progress is taking place, and it affects the firm’s ability to supply
Define resources
Inputs used to produce goods and services
1.3 What is land FOP?
Land is related to the natural resources of an economy (farmland, rivers, lakes)
What is labor?
Labor is related to the workforce of the economy in terms of physical and mental effort used in production
What is capital?
Capital is the human-made aids of production (machinery, technology)
What is enterprise?
A FOP that takes a risk in organizing the other 3 FOP that promotes efficiency and increases output
What is an entrepreneur?
An individual that takes the risk of organizing the other 3 FOP
What is human capital?
Refers to the human aspect of production (talent, knowledge, abilities)
What is physical capital?
Non-human resources used in the production of goods and services (tools, buildings, machinery)
State the rewards for each FOP
Land = rent
Labor = wages/rent
Capital = interest
Enterprise = profit
Define specialization
Specialization is the concentration on the provision of particular goods or services rather than other products and it encourages firms, individuals and regions to focus on what they are best at producing
Define division of labor
The process where workers specialize in or concentrate on particular tasks
Advantages of division of labor
- Saves time
- Application of technology is made easier
- Increases workers’ skills
- Increased productivity
- Potential to earn higher earnings
Disadvantages of division of labor
- Workers’ dependency on others
- Dependency on technology
- Frustration, boredom, demotivation
- Over-concentration on particular skills
- Unemployment
What are the 2 main roles of an entrepreneur in an economy?
- The organization of other factors like land, labor, capital
- The risk taking that arises with uncertainty that will be associated with the action they take
Define economic system
It’s the way in which a country tries to solve the basic economic problem
Define allocative mechanism
Its where scarce economic resources are allocated between alternative uses
Define consumer sovereignty
It’s the idea that consumers have the spending power to buy and is able to influence production decisions
Characteristics of a market economy
- Decisions are made by sellers and buyers who are expected to act in own self-interest
- producers’ main aim is to maximize profits
- consumers’ main aim is to maximize utility
- efficient allocation of resources is determined by the market forces of demand and supply
- little govt intervention and more control from private sector
Define market economy
Decisions about allocation of resources are held in private sector by buyers and sellers
Define price mechanism
Changes in price (resulting from changes in demand/supply) result in changes of allocation of resources in market economy
Advantages of market economy
- No need for govt intervention as resources are allocated through market forces so govts can focus more on international diplomacy
- Producer’s motive is profit maximization which can be an incentive for sellers to be more innovative and cost-effective
- Cost-effectiveness means lower prices for consumers so they’ll benefit from more choice
- Maximizes producer and consumer surplus
Disadvantages of market economy
- Public goods wouldn’t be provided (police forces)
- Over-consumption and over-production of demerit goods
- Under-consumption and under-production of merit goods
- Can lead to negative externalities like noise or visual pollution
Characteristics of a planned economy
- Decisions are held by govt
- Govt will own most or all of economic resources
- Prices are determined by govt rather than price mechanism
- Key objective is to maximize social welfare than profits
Advantages of planned economies
- Economic decisions can be taken in the interest of the whole society as govt controls most/all economic resources
- Govt decides which goods to be produced and to whom they’re going to be supplied
- Products more likely kept under control and lower rate of unemployment
Disadvantages of planned economies
- Bureaucratic because govt intervenes in so many areas which makes system inflexible and rigid to changes in consumer demand
- Less incentive for firms to be innovative as profit motive isn’t important; variety of goods is less and may be of poor quality
- Majority of firms will be state owned which means lack of competition, high levels of inefficiency and low levels of productivity
What is a mixed economy?
It’s where the decision on allocation of resources is taken in both public and private sector
Characteristics of mixed economies
- Ownership of economy’s resources is divided by public and private sector
- Private sector is influenced by self-interest (producers’ max profits and consumers’ max welfare) while public sector has broader aims relating to public interest
- Competition in private sector and public sector has tax and regulation
- Allocation of resources in private sector is held by price mechanism, for public decisions are taken by govt
What is a transitional economy?
An economy that changes from a planned economy to a mixed economy
Issues of a transitional economy
- Inflation
- Industrial unrest (disagreement between employers and employees)
- International trade
- Employment
- Output
- Reduction in welfare services
- Markets
Define PPC
A curve that shows the different combinations of products that can be produced over period of time given existing resources and level of tech available
What does a PPC show?
- shows the idea of choice
- concept of opportunity cost
- shows max possible output and production that can be achieved
- in order to increase the output of one product, the output of the other needs to be decreased
PPC in microeconomics
- Studies decisions of firms/individuals
- Studies individual markets in economy
- PPC can be used in the concept of opportunity cost or productive efficiency
PPC in macroeconomics
- Studies whole of the economy
- Eg: Rate of inflation, unemployment, economic growth, etc
- PPC can be used to show level of unemployment or economic growth
Define the law of diminishing returns
As EXTRA number of resources are used in production, this leads to smaller increase in output
Define increasing opportunity cost
The extra production of one good involves the increasing sacrifice in another good
Causes of a PPC to shift to the right
- Investment in improved technology
- More supply of labor
- New resources
- Improvement of human capital
- Better management of resources
- Encouraging enterprise culture
Define economic growth
This is the increase of the productive potential in the economy
Define free good
A free good is a good that is NOT scarce, so it doesn’t need a mechanism to allocate it
Define private good
A private good is both rival and excludable. It is relatively scarce, so needs an allocative mechanism
Define rival and excludable
Rivalry - When one person consumes a good, there is less available to others
Excludable - A producer can exclude consumers from using the good by charging a price for the product
Define public good
A public good is a good that is non-rival and non-excludable.
- E.g. streetlamps, police, national defense
Define non-rivalry
When one person consumes a product, it doesn’t reduce the availability of that product to others
Define non-excludability
For a public good, it’s not possible to exclude any person from using that good
What’s the free rider problem?
A type of market failure that occurs when people who benefit from a public good don’t pay/ under-pay for it
What’s non-rejectability?
It’s the idea that certain public goods can’t be rejected such as the police or armed forces
Define quasi goods
Quasi (near/almost) goods have characteristics of both public and private goods
Define merit goods
Merit goods are a product which is under-produced and under-consumed as a result of imperfect information held by consumers.
E.g. Education, healthcare, public libraries
Define imperfect information
It’s a situation where people (both producers and consumers) lack the necessary information to make rational decisions, reducing the extent of efficiency
Define demerit goods
Demerit goods are products that are over-produced and over-consumed as a result of imperfect information held by consumers.
E.g. Alcohol, tobacco
How can governments reduce the consumption of demerit goods?
- taxation on demerit goods making it expensive
- this will reduce the consumer’s demand
- depends on PED of product
- PED is likely to be price inelastic due to addiction so consumers will less likely reduce their consumption of good
Define information failure
This is when people don’t have the full information needed to make informed decisions on their behavior
What is imperfection in the market?
It’s where a market doesn’t behave as it’s expected to which leads to a misallocation of resources
