1.1 The Nature of Economics

Question 1

What are economic decisions based on ?

Answer 1

• normative statements
• moral views
• political judgements
• short term positive consequences

Question 2

What is meant by ceteris paribus ?

Answer 2

• used in economics to rule out the possibility of other factors changing
• it is an indication of the effect of one economic variable in another, keeping all other variables the same

Question 3

What are positive statements ?

Answer 3

• objective statements that can be tested and rejected using available evidence

Question 4

What are normative statements ?

Answer 4

• subjective statements ie. carry value judgements/opinions

Question 5

What is the role of value judgements ?

Answer 5

• most economic decisions are influenced by value judgements ➡️ vary from person to person
• help us to explain why economic policies differ from place to place and from time to time

Question 6

What is the economic problem ?

Answer 6

• resources are scarce but wants are infinite forcing people/ business/govts to make choices

eg.
Land ➡️ natural resources eg. land, climate
Labour ➡️ workforce with necessary skills
Capital ➡️ tools, machinery, factories, infrastructure needed to produce goods
Enterprise ➡️ entrepreneurs organise + take the risk to start

Question 7

How can the economic problem be solved ?

Answer 7

1. What to produce (how to use our capital + resources) eg. hotels or hospitals
2. How to produce (best use of scarce resources) eg. school playing field or use land to build houses ?
3. For whom to produce eg. who will get hospital treatment

Question 8

What is meant by opportunity cost ?

Answer 8

the benefit lost from the next best alternative forgone ➡️ the cost of choice or time

Question 9

Explain opportunity cost ?

Answer 9

• opportunity cost increases as the production of a good increases this is because production always starts with the easiest way (pick the lowest hanging fruit)
• resources becomes more scarce as production increases as more resources (eg. labour) are having to be allocated elsewhere + they become harder to obtain as the ‘lowest hanging fruit’ has been used up

Question 10

What is the difference between non-renewable and renewable resources ?

Answer 10

• non-renewable resources are finite in supply eg. crude oil ➡️ cannot be replenished at a rate that is faster than the rate of consumption
• renewable resources are replaced if the rate of extraction is less than the natural rate at which a resource renews eg. solar energy

Question 11

What is meant by production possibility frontier ?

Answer 11

• illustrates the maximum potential output of an economy when resources are fully employed/utilised

Question 12

What does production possibility frontier (curve) show ?

Answer 12

• 🔔 the max productive potential of an economy when all its resources are full employed/at max efficiency

Shows:
- opportunity cost that comes with producing more than one good
- economic growth or decline (growth when curve shifts outwards)
- possible and unobtainable production (unobtainable outside of curve)
- efficient and non-efficient allocation of resources (inside curve not efficient as not all factors of production are being used)

Question 13

What is meant by pareto efficiency ?

Answer 13

• occurs as it is impossible to make one party better off without making someone worse off ie. resources distributed in the most efficient way

Question 14

Production possibility frontier explained (Possible and unobtainable production) ?

Answer 14

• curve shows the max level of production if everything is at max output
• being inside of the curve is a bad place for the economy to be as not as efficient as could be
• outside of the curve is a impossible position ➡️ cannot be better than max efficiency
• if the curve is moved/pushed outwards it means the economy has grown (by either getting more of something or making more of what your got)
• 🔔 countries want to be as close to the curve as possible as it means they are going more efficient

Question 15

What causes the PPF to shift ?

Answer 15

• a shift of the PPF outwards shows economic growth:
  1. higher productivity/efficiency of factor inputs
  2. increase in capital + labour supply
  3. innovation + invention
  4. discovery/extraction of new natural resources
• an inward shift is caused by a fall in the productive potential of a economy eg. due to natural disasters/war/net migration/long term fall in labour productivity

Question 16

1.1.4 Summary

Answer 16

The max productive potential of the economy:
- illustrates the maximum potential output of an economy when all resources are fully employed/utilised

Opportunity cost:
- the curve shows that is you increase one factor (it’s production) then the other good/factor will decrease eg. increasing the production of bikes decreases the production of cars due to opportunity cost as resources become harder to obtain

Economic growth and decline:
- this can be seen when the curve moves outwards (growth) or when the curve mores inwards (decline)

Efficient and inefficient allocations of resources:
- being on the curve is efficient as resources are being used up to the max and so no/little resources are being used up
- being inside of the curve is less efficient

Question 17

What is a consumer good ?

Answer 17

• goods not used to produce other goods
• consumer goods are consumed by the consumer & do not aid in further production
  eg. a burger, clothes, phones, TVs, a family car, coffee

Question 18

What is a capital good ?

Answer 18

• goods which are used to produce other/consumer goods eg. machinery

eg. car used for taxi, machines, oven in a restaurant, coffee beans in a coffee shop, a school, tools for builders, factories, computers for jobs

Question 19

What is meant by production ?

Answer 19

• converting inputs into outputs

Factors (inputs) ➡️ production ➡️ outputs

eg. Land/Labour/capital goods/enterprise ➡️ making parts + assembling products ➡️ product

Question 20

What is meant by productivity ?

Answer 20

• a way of measuring how efficiently a company or economy is producing output (output per unit of input employed)

Question 21

How is productivity calculated ?

Answer 21

• overall productivity ratio = output/input

🔔 productivity can also be calculated for each individual factor:

• productivity per worker = output /no. of workers
  (would allow a firm with two factories to compare the labour productivity in each factory)
• productivity per worker = output produced of worker A/ 30 days
  (would allow a firm to compare the productivity of individual employees)

Question 22

Why does labour productivity matter ?

Answer 22

• increase output ➡️ increased profits
• more motivated workers
• can set more competitive prices + get ahead of competition (lower unit costs = more competitive)
• higher wages/rising real wages (businesses can afford to pay workers more)
• economic growth ➡️ more £ coming into the country/economy
• international competitiveness (exports)
• decreases chance of inflation (ave. lower costs)

Question 23

How is average cost calculated ?

Answer 23

Total costs/output

Question 24

How can labour productivity be improved ?

Answer 24

• specialisation: when your good at something you want to do it
• skills & qualifications of workforce: become more knowledgeable and skilled at job
• improving worker experience + morale: increasing motivation and skills whilst showing business cares + less likely to have sick days
• technological progress: new technology/machinery are often more efficient ➡️ allows for higher level of output
• substation of labour to capital: machines can work long hours and aren’t affected by other factors eg. sick days HOWEVER can break + expensive

Question 25

What is specialisation ?

Answer 25

• concentrating on a specific product or task

can happen at all levels:
- business (car manufacture)
- region in a country (London Finance)
- a country (Norway leading oil exporter)

Question 26

Advantages of specialisation to businesses ?

Answer 26

✅ greater productivity
✅ greater choice for consumers = more profit
✅ more motivated + quicker workforce
✅ reduced training costs ➡️ only need to be trained in one task
✅ increased competitiveness ➡️ increased output = decreased price per unit
✅ better quality end product/services due to being more knowledgable and skilled + less mistakes likely to be made
✅ workers can focus on their job and build up expertise
✅ time saving ➡️ workers do not need to constantly change tasks/move around

Question 27

Disadvantages of specialisation to businesses ?

Answer 27

❌ job can be repetitive thus staff can lose motivation + become less productive/quit ➡️ will have to recruit more staff
❌ employees may expect higher wages as they are more skilled/ knowledgeable
❌ more specialised = less flexible a business becomes

Question 28

Advantages/disadvantages of specialisation to a country ?

Answer 28

✅ global trade increased as more exports = economic growth
✅ output increases (GDP) ➡️ leads to improved standard of living
❌ country is less self sufficient ➡️ rely on other countries which makes them vulnerable

Question 29

Advantages of specialisation to employees ?

Answer 29

✅ higher wages if business is making more profit for specialised work
✅ sense of achievement to be good at something
✅ improved skills at that jobs

Question 30

Disadvantages of specialisation to employees ?

Answer 30

❌ repetitive doing the same task everyday becomes boring ➡️ lower motivation
❌ quality may suffer
❌ may eventually be replaced by machinery
❌ workers may move to less boring jobs which creates a labour turnover problem
❌ over specialisation = hard to find other jobs (contributes to structural unemployment)

Question 31

What is the division of labour ?

Answer 31

• where production is broken down into many separate tasks/roles (each carried out by a different person ➡️ a type of specialisation)
• increases output per person as people become proficient through constant repetition of tasks and so decreases cost per unit ➡️ leading to decrease in prices for consumers eg. Human rights lawyers
• Adam Smith supporter of this ➡️ wrote about the splitting up the production process of pins into 18 different parts it in his book (productivity stemmed from workers being able to focus on just one task)

Question 32

What are the functions of money ?

Answer 32

1. a medium of exchange: money is a measured instrument that can be used to purchase/trade goods between people (specialisation + division of labour requires a mean of exchanging goods/services)
2. a measure of value: money functions as a unite of account (provides a common measure of value of goods/services being exchanged)
3. a store of value: to be a medium of exchange, money must hold its value over time (other stores of value eg. land + works of art) ➡️ can lose it value over time due to inflation but more liquid than other stores
4. a method of deferred payment: money can be payed later for something we consume now

Question 33

What are the four main approaches to an economy ?

Answer 33

• traditional economy: each new gen. retains the economic position of its parents & grandparents
• command economy: the state/govt controls all resources
• free market: based on consumers buying decisions
• mixed economy: combines the command & free market models

Question 34

Advantages of a command economy ?

Answer 34

*govt decides how resources should be allocated and what should be produced

✅ welfare maximised: govt has more control over economy so they can minimise inequality by redistributing income fairly
✅ low unemployment: govt can try to provide everyone with a job & salary
✅ prevent monopolies: when single firms dominate the economy

Question 35

Disadvantages of a command economy ?

Answer 35

❌ poor decision making: lack of info means govt often make slow/poor decisions of what needs to be produced
❌ restricted choice: consumers have limited choice as firms make what they are told to make
❌ lack of risk taking and efficiency: no incentive as the govt owns all businesses therefore there’s no competition and no one makes a profit except from govt

Question 36

Advantages of a free market economy ?

Answer 36

🔔 goods are allocated based on S&D and the price mechanism ➡️ no/little govt intervention

✅ efficiency: high quality products with best value (price/quality) any product can be sold so must be efficient in production
✅ entrepreneurship: market rewards good ideas encouraging risk taking + innovation as can make a lot of money
✅ lots of choice for consumers (not limited)

Question 37

Disadvantages of a free market economy ?

Answer 37

❌ inequality: leads to huge difference in income (unfair) ➡️ if you can’t work you get no income
❌ non profitable goods are not made: street lighting, drugs for rare treatments, schools, care for elderly would happen as no profit
❌ monopolies: successful firms dominate the market which can be abused (very high prices ect)
❌ illegal things (drugs/guns) can be sold

Question 38

What is a mixed economy ?

Answer 38

• when both the govt and the market play a part in allocating resources (both public and private sector) ➡️ in a pure free market economy there is no public sector visa versa for a pure command economy

Question 39

How do/can govts intervene in a mixed economy ?

Answer 39

1. Changing the law for force/stop firms from doing something
2. Changing tax levels to incentivise or punish behaviour
3. Govt can intervene in the economy by buying/selling/providing goods and services eg. NHS, education, defence ect

Question 40

What did Adam Smith believe ?

Answer 40

🔔 supported the free market + described how the INVISIBLE HAND would allocate resources in societies best interests

• consumers are motivated to maximise profits + the invisible hand leads to lots of consumer choice and lower prices
• invisible hand will lead to the factors of production being allocated exactly where they need to be in the economy + S&D will lead to price levels that work for both the consumer and seller
• govts do not need to be involved in the market except to create the conditions for businesses to thrive/ supporting role
• believed capitalism is highly efficient + everything is determined by competition vs self interest (ultimately is good for the economy)
• also believed in the benefits of specialisation and division of labour

Question 41

What did Karl Marx believe ?

Answer 41

🔔 believed an economy should exist for the benefit of the workforce BUT had little on how the command economy would work
- critiqued the desire for profits, business owners desire for profits will lead to them exploiting the workforce ➡️ low wages + few rights + replace them by machinery
- specialisation = reduce job satisfaction + loss of creativity
- over production + underconsumption will occur (wasting resources by making more than what’s sold)
- workers will eventually revolt and take over production (won’t put up with it forever)
- his ideas led to the rise of communism in the 20th century

Question 42

What did Friedrich Hayek believe ?

Answer 42

🔔 should let free market economy do its thing and govts should have minimal interference except from support (build roads, schools ect)

• govts shouldn’t intervene to allocate resources as they lack info required to allocate them in a way that most benefits society (individual consumerism and producers have best knowledge on what they need) ➡️ the allocation of resources should be left to them and the price mechanism
• price is set by the forces of supply and demand + shows what both consumers and producers want ➡️ S&D therefore will naturally allocate resources more efficiently than govts can