1.1 Nature of Economics Flashcards
Theme 1
What is Microeconomics?
Study of the behaviour of individual markets within the economy. E.g. interaction between consumers and producers.
What is Macroeconomics?
Study of the behaviour of the whole economy at a national level. Involves economic issues such as inflation, unemployment, etc.
Why is Economics a Social Science?
It studies human behaviour in relation to the economy. Based on empirical (past) evidence.
What is the Ceteris Paribus Assumption?
Other things remaining constant. This applies when considering how one economic variable affects another.
What are some examples of the Ceteris Paribus Assumption?
- Law of Demand
- Supply and Price
- Marginal Utility
When do we drop the Ceteris Paribus Assumption?
When considering multiple variables and behavioural economics.
What are Positive Statements?
Objective, can be evaluated based on empirical evidence.
Often involve cause and effect theories.
Uses certain words such as ‘will’ and ‘have’.
What are Normative Statements?
Subjective, value judgments / opinions based on moral beliefs, personal considerations or policy preferences.
Not testable through empirical analysis alone.
Uses possible words such as ‘should’, ‘would’ and what ‘ought’ to be.
When are Positive and Normative Statements used?
Economic analysis.
What is the Basic Economic Problem?
How to allocate finite/scarce resources to meet the unlimited wants.
What does scarcity mean?
A finite amount.
What does infinity mean?
A never-ending amount.
What is an opportunity cost?
The benefits forgone/sacrificed for the next best conclusion.
What are economic choices?
Alternative uses of scarce resources.
What are free goods, with an example?
Infinite goods. E.g. Air.
What are economic goods?
Scarce goods.
What is a renewable resource, with an example?
A natural resource that can be replenished as it is being used. E.g. Wind.
What is a non-renewable resource, with an example?
A finite resource that is not being replenished as fast as it’s being used. E.g. Oil.
What is poverty?
When a person lacks basic necessities or has a low relative income compared to others.
What is marginal analysis?
An approach to economic decision-making based on considering the additional benefit and cost of change in behaviour.
What are the three economic agents and what do they make choices about?
Consumers - Expenditure.
Producers - Price and what to produce.
Government - Influence the economy through choices of taxation and regulation.
What does the PPF graph represent?
Maximum output of two goods/services that can be produced when all available resources are fully and efficiently employed.
What does scarcity mean (PPF)? Give an example.
Limited availability of resources. E.g. labour, capital, etc.
What is a trade-off?
To produce more of one good you have to produce less of the other.
What does efficiency mean and where can it be found on the PPF graph?
The full utilisation of resources. Found along the curve.
What does inefficiency mean and where can it be found on the PPF graph?
Inefficient use of resources. Found inside the curve.
What are constraints and growths?
When PPF shifts inwards or outwards due to availability of resources, technical advancements or improvements in productivity.
What is the equation for opportunity cost?
Lost output / Gained output
What does an outward shift in PPF indicate?
Economic growth.
What reasons cause an outward shift of PPF?
Increase in efficiency, increase in productivity and increase in productive capacity.
These are caused by technological advancements, investments and innovations.
What are the three types of efficiency?
Productive efficiency, allocative efficiency and dynamic efficiency.
What is productive efficiency?
When goods/services are produced at the lowest possible cost.
What is allocative efficiency?
Ideal distribution of goods/services that best align with consumer preferences and social needs, to maximise overall satisfaction.
What is dynamic efficiency?
The economy’s ability to grow and expand in production possibilities over time. Found on the curve of a shifted outward PPF.
What are capital goods? Give an example.
Goods used as part of the production process that are invested. E.g. machinery.
What are consumer goods?
Goods produced for consumption.
What is specialisation?
Process of focussing on a specific task or area of production which has a comparative advantage.
What is a comparative advantage?
When a firm produces a particular good/service at a lower opportunity cost compared to its trading partners.
What is the division of labour?
When the production process is broken down into separate tasks.
What economist came up with the idea of Division of Labour?
Adam Smith, 1776.
What are the advantages of Division of Labour?
Higher output per person - improves productivity.
Involves specialising in a specific task - makes an individual more skilled and proficient in the task, increasing efficiency.
Economies of scale - higher profitability for firms and more affordable products for consumers.
Learning by doing - productivity and effectiveness can be improved through repetitive tasks.
What are economies of scale?
When more units of a good/service can be produced with lower average input costs.
What is learning by doing?
The process of acquiring knowledge, skills and expertise through direct hands - on experience.
Refines methods and allows workers to gain insights through practical experience.
What are the disadvantages of Division of Labour?
Due to repetitive tasks:
- Risk of repetitive strain injury.
- Reduced job satisfaction damages labour productivity - Increases workplace absenteeism.
- Unrewarding, can cause alienation.
- Workers take less pride, so quality suffers.
- High worker turnover - workers move to less boring jobs which increases hiring/training costs.
- Struggle to find alternative jobs, as lack variety of skill.
- Mass-produced standardised goods lack variety for consumers.
What are potential gains from specialisation?
- Higher labour productivity.
- Rising business profits.
- Creates surplus output, increasing trade for mutual benefit.
- Lower prices cause higher income and GDP growth.
What are functions of money?
- Medium of exchange.
- Store of value / measure of value.
- Unit of account.
What is a command/planned economy, and what characteristics does it have?
The government decides how resources are allocated.
-Centralised
-Ownership of resources - State/public sector
-The government decides all economic activities
- State/public sector answers basic economic questions
- The government sets the price; no market equilibrium
- Resources allocated equally and fairly to meet what is socially desirable
What is a mixed economy and what characteristics does it have?
Some decisions are made by the government, some decisions are made by the market.
-Limited freedom of choice, subject to government intervention
-Ownership of resources in both the public and private sector
-Government creates laws and regulates business activities; upholds property rights
-Both the public and private sector answer basic economic questions
-Behavioural incentives: Self-interest; maximise utility and profits; risk-taking linked to reward earned, subject to government intervention
-Price determined by price mechanism, subject to government intervention
-Resource allocation is driven by utility and efficiency subject to government intervention
What is a free market economy and what characteristics does it have?
The allocation of resources is decided by the market.
-Decentralised
-Private sector owns resources
-Little or no role of government
The private sector answers basic economic questions
-Behavioural incentives: Self-interest; maximise utility and profits; risk-taking linked to reward earned
-price determined by the price mechanism
-Resource allocation is driven by competition; utility and efficiency
What is a market?
A set of arrangments that allows transactions to take place.
What did Adam Smith believe in regard to the free market economy?
Resources are allocated efficiently through ‘An Invisible Hand’.
What did Adam Smith mean by ‘An Invisible Hand’?
Free markets can incentivise individuals, to act in their own self-interest to produce what is societally necessary.
What did Karl Marx believe in regard to the free market economy?
He argued that in a capitalist society with private ownership, the owners of capital would exploit their position at the expense of labour, eventually resulting in revolution.
What did Friedrich Hayek believe in regard to the free market economy?
Believed markets are more effective as they rely on people responding to signals and incentives whereas governments are faced with imperfect information.
Didn’t believe in government intervention as he thought it would be damaging.
What are the advantages of a free market economy?
-Competition incentivises firms to produce efficiently and innovate.
-Consumers have a wide range of choices.
-Can lead to rapid economic growth and higher living standards.
What are the disadvantages of a free market economy?
-Inequalities in income and wealth can be significant.
-lack of public goods as without government intervention essential services may not be provided.
-Prone to economic cycles of booms and busts.
What are the advantages of a command economy?
-Aim to reduce income inequality through central planning.
-Central control can provide stability during a crisis.
-Resources can be directed toward public services and social welfare.
What are the disadvantages of a command economy?
-Central planning may discourage innovation and individual initiative creating a lack of incentive.
-Resources may be misallocated which can lead to shortages or surpluses due to the allocation inefficiency.
-Often involve complex bureaucracies.
What is the role of the state in a mixed economy?
-Regulation. E.g. consumer protection, environmental standards and financial markets.
-Provide public goods/services.
-Welfare and redistribution. I.e. Social safety nets and income redistribution policies to address poverty and inequality.
-Stabilisation and economic planning; use fiscal and monetary policies to manage economic cycles and prevent economic crises.
What is marginal utility?
The additional satisfaction a consumer gains from consuming one more unit of a good/service.
What is the law of diminishing marginal utility?
As a consumer consumes an additional unit, the marginal utility decreases.
What is the rational choice theory?
Choices are made using a prudent and logical approach that will give the greatest satisfaction and in the highest self-interest. However, the assumption is not always true.
What is behavioural economics?
Analysis of how decisions are made that seem to contradict rational decision-making.
What is profit?
Total revenue - total cost of production.
What are the assumptions of rational decision-making?
Consumers set out to maximise utility.
Firms aim to maximise profit.
What is an extension and contraction?
Movements along a demand curve.
Extension - Increase in quantity demanded due to a fall in price.
Contraction - Decrease in quantity demanded due to a rise in price.
What does the Law of Demand state?
As price decreases, quantity demanded increases and vice versa.
What are shifts in demand?
Outward (right) - Increase in demand.
Inward (left) - Decrease in demand.
What factors cause a shift in demand?
Change in …
- Taste/preferences
- Incomes
- Price of related goods
- Expectations
- Size/structure of the population
- Interest rates
- Law
How does the law of diminishing marginal utility affect the shape of the demand curve?
At higher quantities, consumers are less willing to pay a higher price.
What is Price elasticity of Demand?
The responsiveness of quantity demanded of a good to a change in price.
