1.1 Nature Of Economics

Question 1

Economy

Answer 1

All the goods and services produced in an area

Question 2

How do economists analyse economic impacts & why

Answer 2

By developing models & making assumptions
Help simplify analysis and reduce wide range of variables

Difficult to conduct experiments (lots of factors impacting economic activity)

Question 3

What assumption do economists use when building models & why

Answer 3

Assume ‘Ceteris Paribus’ = all other things remain equal (overcomes problem of many factors impacting economic activity)

Question 4

Positive economic statements

Answer 4

Can be proven true or false (can’t be disputed/contested)
Is objective (based on facts)

Question 5

Normative economic statements

Answer 5

Can’t be proven true/false = can be disputed/contested
Is subjective (based on opinions)

Question 6

Value judgements

Answer 6

= decision made based on values and opinion = normative decisions

Question 7

What’s based on value judgements

Answer 7

• economic decisions made by individuals
• policy decisions made by governments (why there are multiple gov parties with different policies)

(but use positive economic analysis to help make decisions)

Question 8

The economic problem (problem of scarcity)

Answer 8

How to use the available scarce (finite) resources to satisfy people’s infinite needs and wants as effectively as possible

Question 9

3 key questions/decisions to solve the economic problem

Answer 9

What to produce?
How to produce it?
Who to produce it for?

Question 10

Renewable vs non-renewable resources

Answer 10

Renewable resource = replaced faster than consumed (eg. solar energy)

Non-renewable resource = consumed faster than replaced by natural means (eg. oil, coal) = part of the economic problem (pressure due to rising incomes & population, need to allocate resources well)

Question 11

Economic agents (who are they)

Answer 11

= groups that participate in the economy

• Consumers (buy goods & services from firms/gov)
• Producers (make goods & services)
• Government (sets rules for other economic agents to follow / produces some goods & services eg. healthcare / roads)

Question 12

Opportunity cost definition

Answer 12

= value of the next best alternative forgone as a result of the choice made

Question 13

Importance of opportunity costs to economic agents

Answer 13

Consumers - to decide what to spend incomes on
Producers - to decide what and how to produce goods & services
Governments - to decide what policies to choose

(due to the economic problem, there is always an opportunity cost when decisions are made)

Question 14

Production possibility frontier (PPF)

Answer 14

= shows the maximum potential output of a combination of two goods or services an economy can achieve when all its resources are fully & efficiently used, given the current level of technology

Question 15

What is represented by any point on the PPF curve

Answer 15

= maximum productive potential of an economy (point A/D/E)

Question 16

Opportunity cost on a PPF

Answer 16

Movement along PPF curve creates an opportunity cost (same finite amount of resources allocated) by indicating a change in combination of goods produced

(A to B = opportunity cost of producing 15 more consumer goods is 30 capital goods)

Question 17

Economic growth / negative economic growth on a PPF

Answer 17

Economic growth = outward shift of PPF (increase in productive potential of the economy = increase in quality/quantity of factors of production)

Negative economic growth = inward shift of PPF (decrease in productive potential of the economy = decrease in quality/quantity of factors of production)

Question 18

What can cause a decrease in quantity or quality of factors of production

Answer 18

• natural disasters (decrease in land, labour)
• war (decrease in labour, land, capital)
• migration (decrease in labour)
• fall in spending on education (decrease in quality of labour)
• running out of natural resources (decrease in land)

Question 19

Efficient or inefficient allocation of resources on PPF

Answer 19

On the PPF curve = efficient allocation of recourses (none wasted or underutilised) =A/D/E
Inside PPF curve = inefficient allocation of resources / under-utilised resources = B

Question 20

Possible or unobtainable production on PPF

Answer 20

Outside PPF curve = unobtainable production (dont have enough resources/technology) = C

Inside & along PPF curve = obtainable but not always efficient

Question 21

Capital goods vs consumer goods

Answer 21

Capital good = used to produce other consumer goods

Consumer good = used to satisfy needs & wants of consumers, bought by consumers

Question 22

Effect on economy of more resources being allocated to the production of capital goods

Answer 22

• more capital goods produced = increase amount of consumer goods made (as capital goods used to produce other consumer goods) = overall amount of consumer & capital goods increases = increases maximum productive potential output = PPF curve shifts outwards = increase in economic growth

Question 23

Specialisation

Answer 23

= when an individual, firm, region or country concentrates on the production of a limited range of goods & services

Question 24

Division of labour

Answer 24

= specialisation of workers on specific tasks in the production process

Question 25

What was Adam Smiths views on specialisation & the division of labour

Answer 25

Production could be increased & extra wealth created (increase in productivity due to repetition & automation) Specialisation on a larger scale (countries) = result in higher incomes & standard of living

Question 26

What does increased productivity lead to

Answer 26

- higher output & higher quality - higher living standards (higher incomes) - more efficient use of resources

Question 27

Advantages of division of labour

Answer 27

- workers become more skilled through repetition of tasks = potentially higher wages - workers productivity rises = quality & quantity of output increases (lower unit costs) - time saved by workers focussing on narrow range of tasks - cheaper & easier to train workers

Question 28

Disadvantages of division of labour

Answer 28

- repetition of tasks leads to boredom = less productivity = decrease in quality - reduce in workers pride if simplified job (likely to quit = possible increase in unemployment)

Question 29

Advantages of specialising in the production of goods & services to trade

Answer 29

- better quality & higher quantity of products (countries specialise on certain goods/services = greater output = decreased unit costs = increase in consumer surplus & decrease in price) - higher efficient use of scarce resources - greater variety within goods between countries (more consumer choice) - higher trade with other countries - higher economic growth (increased trade = increased AD) = higher living standards

Question 30

Disadvantages of specialising in production of goods & services in trade

Answer 30

- structural unemployment (if another countries goods become more competitive = de-industrialisation in domestic country, workers have narrow skill sets = long term unemployment = reduction in productive potential of economy = fall in economic growth) - over reliance on a few risky industries (if production stops in domestic country = reduces supply in many other countries) - increased interdependence reduces self-sufficiency (political turmoil = trade wards = stops trade, natural disasters = reduced trade) - firms may not be able to adapt to changes in taste/fashion if overspecialised - finite resources may deplete as specialisation of limited goods leads to overconsumption of some resources

Question 31

The Functions of money

Answer 31

- a medium of exchange (allows people to buy goods & services in exchange for money / barter (other goods)) - a measure of value (price of goods/service reveals its value) - a store of value (different goods/services hold different values through use of money, exchange rates help determine this) - a method of deferred payment (allows people to buy things without having enough money & debt to be created eg. mortgage)

Question 32

Free market economy

Answer 32

= an economy in which resources are allocated solely by the price mechanism (consumers make decisions based on utility & producers based on profit) Eg. No country has fully free market economy but some considered as least amount of gov intervention Singapore

Question 33

Mixed economy

Answer 33

= an economy in which resources are allocated by the state and price mechanism (most economies as gov needs to intervene to an extent eg. issuing money, protecting property rights, breaking up monopolies)

Question 34

Command economy

Answer 34

= an economy in which resources are allocated solely by the state (government) (all factors of production owned or directed by government, no private property, working for a common good, income distribution determined by gov, all workers tend to receive same wage, standardised products, limited prices cause excess demand) Eg. North Korea

Question 35

Adam Smith view on type of economy

Answer 35

Believed in free market economy - resources more efficiently allocated - businesses aim to maximise profit & consumers aim to maximise utility (invisible hand allows market to operate at an equilibrium, best for society when ppl acted in their best interest)

Question 36

Friedrich Hayek views on type of economy

Answer 36

Believed in free market economy - poor better off than those in command economies because at least they had personal freedom - central planning by governments = small minorities wants forced on whole society - consumers/producers don’t make supply and demand decisions based on perfect information, but they best know what they need in their own situation

Question 37

Karl Marx view on type of economy

Answer 37

Believed in command economy & criticised capitalism - free market economies led to exploitation of workers (firms main aim is to profit maximise = lowest average costs) - competition in free market economy = firms go out of business = monopolies created = unfavourable consumer market conditions (high prices and low quality). - inequality increases = private property eventually replaced by common ownership of resources = finally resulting in communism

Question 38

Advantages of a free market economy

Answer 38

- consumer choice (firms follow profit motive if high demand = more of same good/service available) - competition between firms (productive efficiency = lower prices & better quality = greater consumer surplus) - price mechanism adjusts = market operates at equilibrium = no excess demand/supply & maximises consumer/producer surplus (invisible hand) - high motivation due to competition & higher potential rewards

Question 39

Disadvantages of a free market economy

Answer 39

- lack of competition in certain markets creates monopolies = higher prices & lower quality = consumer exploitation - high levels of inequality (rich own more factors of production & grow richer) - firms will not provide public goods which aren’t profitable = missing markets - externalities (profit maximisation = produce up to where marginal private cost = marginal private benefit not where marginal social cost = marginal social benefit = over consumption/over production of demerit goods and under consumption/under production of merit goods = welfare loss for society)

Question 40

Advantages of a command economy

Answer 40

- state maximises social welfare & sets minimum standard of living = less inequality (eg. progressive tax system, low unemployment) - provision of public goods up to where marginal social cost = marginal social benefit = maximises social welfare (as no profit motive), merit goods increased - prevention of monopolies (no aim to profit maximise = all markets equal = increase in consumer surplus = no consumer exploitation) - less resource wastage (no competitive services or advertising)

Question 41

Disadvantages of command economy

Answer 41

- inefficient allocation of resources (no profit motive = no incentive to operate efficiently = higher costs = higher consumer prices) - lack of information from state of what consumers demand = slower reactions to changes in market (gov intervention means price mechanism cant function & adjust) = loss of social welfare & wastage - lack of innovation (no profit motive or competition) - possible increase in bureaucracy (bribery & corruption) - less motivation & efficiency as everyone receives same wage

Question 42

Public vs private sector

Answer 42

Public sector = part of economy controlled / owned by government Private sector = part of economy not controlled / owned by government

Question 43

The role of the state in a mixed economy

Answer 43

- creates a framework of rules (consumer protection laws, protect property rights, ensure safety standards, prevent abuse of monopolies) - supplements & modifies price system (produce public/merit goods eg. transport, parks & limit production of demerit goods, considering externalities and social welfare) - redistributes income through welfare spending (income tax to take money from rich and give to poor through benefits, provision of services for all eg. education, NHS) - stabilises the economy, regulates consumers & firms (fiscal & monetary policy prevents extreme low or high demand)

Question 44

Merit vs demerit goods

Answer 44

Merit goods = goods that the public sector provides free or cheaply because the government wishes to encourage their consumption (education, healthcare, public parks) Demerit goods = good/service whose consumption is considered unhealthy or socially undesirable due to the perceived negative effects on consumers (alcohol, cigarettes, child pornography)