Unit 1.A - the economic problem and its applications Flashcards
- What is economics? - What is the economic problem? - What are wants? - What is an opportunity cost? - Production possibility frontiers (PPF) - Cost benefit analysis (CBA) - What do individuals, businesses, governments want to maximise?
What is the study of economics?
Economics is the study of how we allocate scarce and finite resources to satisfy unlimited and competing wants.
What is the economic problem?
The economic problem is we have only scarce and finite resources yet unlimited and competing wants, so we must sacrifice some goods in order to satisfy others.
What is a want?
A want is anything we can use resources to satisfy.
E.g. a car, a toy, a meal.
What are the key types of want?
- Recurring wants (because they can only be satisfied temporarily e.g. lunch or petrol)
- Wants that change over time (e.g. when you were 7 you wanted a Lego Mansion, when you are 17 you want airpods)
- Complementary wants (wants that create other wants, e.g. you have a want of a car, you satisfy this want by buying a car, but then you have the want for engine oil)
- Needs (necessities e.g. drinking water)
Why do economists assume wants to be infinite?
Wants are assumed to be effectively (if not mathematically) infinite because as we satisfy one want another takes its place e.g. I wanted a car, once I bought one I then wanted a TV, then once I bought a TV I then wanted a new iPhone, etc. Other wants are recurring because they can only satisfied temporarily e.g. lunch and other food items, and some wants change over time e.g. when you were 7 you wanted a lego mansion, when you were 17 you wanted airpods.
How do we apply the concept of opportunity cost to help us maximise our level of satisfaction given our finite level of resources?
If we satisfy wants we value more than the opportunity cost then we are maximising our level of satisfaction given our finite level of resources: opportunity cost helps us to rank wants according to how much utility they bring, so we can weigh up what we lose as a result of satisfying a given want. In this way, we can minimise the effects of the economic problem.
What is a cost benefit anaylsis?
A CBA is a tool used in complex economic decision making scenarios (e.g. the construction of a major infrastructure project) that enables a more sophisticated application of the concept of opportunity cost to determine costs and benefits for best use of resources.
Allows us to weigh up the costs and benefits in common terms to produce a ranking of scenarios by the wants they satisfy considering the resources they would require, so we can determine project with highest net benefit or lowest net cost.
Adresses economic problem by helping us to determine the highest value want and minimise wastage of resources, thus maximising the number and usefulness of wants satisfied given finite resources.
What are the 5 steps of developing a cost-benefit analysis?
1) Develop a well-defined plan/idea
2) Consultation of a wide range of stakeholder groups
3) Consider how each stand to benefit or be disadvantaged (now and in the future) including financial, social, and economic impacts.
4) Attempt to put all costs and benefits into a common measurement (usually $$$)
5) Determine which plan/project has the highest net benefit or lowest net cost.
What are the 3 major ways to determine $ val of non-monetary costs/benefits?
- Replacement costs (e.g. the value of one swift parrot lost in a development is the cost of protecting another elsewhere).
- Willingness to pay (e.g. asking people in a survey how much they would be prepared to pay to protect a line of scenery, a quiet neighbourhood, etc)
- Revealed preferences (e.g. examining how much people value health by how much they spend on gym memberships, vitamins, how much parents value education by how much they’re willing to spend on school fees)
What is a production possibility frontier?
A PPF is a graphical representation of opportunity cost, in which the cost of producing one good is shown in terms of the cost of producing another (e.g. guns and butter): in this way, it models different ways of using a fixed set of resources. (Models the different combination of wants satisfied by the scarce and finite resources available).
What is a production possibilities schedule?
A production possibilities schedule is the data set that informs a production possibility frontier curve.
What are the underlying assumptions of the PPF?
- Only two goods or services can be produced
- Resources are fixed
- No change in the state of technology
- All resources are fully employed.
How do economists assume individuals rank wants?
Economists assume that individuals are rational utility maximisers: we preferentially satisfy wants that bring us the greatest utility. This means we will satisfy wants that we value more than the opportunity cost.
What is utility?
Utility is a vague term referring to general satisfaction and avoidance of pain (not necessarily what will bring us happiness) e.g. paying a parking fee is a source of utility although it’s not a source of pleasure. Getting vaccinated is a high source of utility although we don’t enjoy it at the time. Utility may also describe the returns of having a house, having a car, paying taxes.
How do economists assume firms rank wants?
Economists assume that businesses are rational profit maximisers: in the long term businesses will choose to satisfy wants that maximise profit.
E.g. if a business can produce product A which has a high cost of production or product B with a very low cost of production, it will produce B as this maximises profit.
E.g. if BP were trying to maximise short-term profit as much as possible they wouldn’t be trying to go carbon neutral, but by doing so they will maximise long-term profit.
