Nature of economics 1.1

Question 2

What is an economic model? Why are they used?

Answer 2

A model is a simplified representation of reality, designed to provide insight into economic decisions and events. They allow economists to make assumptions that help them better understand the complexity of the real world.

Question 3

What is Ceteris paribus?

Answer 3

Latin for ‘all else being equal’ - changing one variable at a time while holding the others constant

Question 4

Why can’t economists conduct scientific experiments?

Answer 4

As economics is a social science, it deals with real world problems. It would be impossible for all variables to be controlled at a large enough scale to give meningful results and to control how people act

Question 5

What is a positive statement
Give an example

Answer 5

A statement that is fact based, objective and can easily be tested.
For instance, the tax rate is 40%

Question 6

What are normative statements and value judgements? Give an example

Answer 6

Normative statements are statements which use value judgements (personal beliefs about the worth of something) usually to state what ought to be. They are subjective, less easily tested and based off the speakers opinion. For example “the tax rate should be lowered - it’s too high”

Question 7

What is the economic problem?

Answer 7

That, at an individual and societal level, we have unlimited wants and finite resources, and this creates scarcity. Thus, decisions have to be made on how best to allocate resources.

Question 8

What is the difference between a renewable and a non renewable resource?

Answer 8

A renewable resource is a resource that will replenish it’s stocks naturally to replace that lost through consumption within a human time frame
A non renewable resource is a resource that can’t replenish its stocks at the same rate at which it is consumed, so will eventually run out - they are finite

Question 9

What is an opportunity cost?

Answer 9

In decision making, the next best alternative forgone.

Question 10

What is the relevance of opportunity cost to consumers?

Answer 10

Consumers have to make choices on how to use their limited income to give them the greatest level of utility

Question 11

What is the relevance of opportunity cost to producers?

Answer 11

Producers have to decide how best to allocate their scarce factors of production to make the most profit

Question 12

What is the relevance of opportunity cost to producers?

Answer 12

Producers have to decide how best to allocate their scarce factors of production to make the most profit

Question 13

What is the relevance of opportunity cost to the government?

Answer 13

How best to spend their limited tax revenue to maximise societal welfare

Question 14

What are factors of production

Answer 14

Resources used in the production process to create output
Capital
Enterpise
Land
Labour

Question 15

What is a ppf?

Answer 15

a graphical representation showing the maximum combinations of output for two goods or services that can be produced in a given time with available resources

Question 16

How do you show economic growth or decline on a PPF?

Answer 16

A shift in or out

Question 17

How do you show an inefficient, efficient and unobtainable (in the short run) use of resources on a PPF?

Answer 17

Any point within the PPF curve is ineffecient, as factors of production are not being used to their full extent to create maximum output.
Any point along the PPF is effecient, as FoPs are being used to their full extent.
Any point beyond the PPF curve is unobtinable production as the society/buisness does not have the resources necessary to produce at that level

Question 18

Why are most PPFs curved?

Answer 18

to illustrate the law of diminishing returns, which states that each additional factor of production has less marginal output than the previous one, as not all factors of production are suited to a particular good or service

Question 19

What do movements and shifts represent on a ppf?

Answer 19

A movement along the curve represents a change in the combination of the goods or services produced
A shift in or out represents a change in the productive capacity of an economy

Question 20

What is specialisation?

Answer 20

When an economic agent focusses their resources on producing a particular good or service.

Question 21

What is the division of labour?

Answer 21

A process whereby the production procedure it broken down into a sequence of stages and workers are assigned to a particular stage. Smith said that 10 workers could produce 48,000 pins a day if each of 18 tasks is assigned to a particular worker

Question 22

What are the benefits of the division of labours

Answer 22

Productivity will increase as workers become specialised in a skill, increasing unit output per worker and therefore reducing average cost.
Quality increases as workers become specialised in a skill, therefore increasing ups
More efficient use of time, as workers don’t waste time moving from task to task

Question 23

What are the drawbacks of division of Labour?

Answer 23

Work becomes repetitive, making work boring, possibly decreasing worker motivation and therefore increasing absenteeism
Workforce becomes inflexible, so hard to find cover

Question 24

What are the four functions of money?

Answer 24

Medium of exchange
Measure of value
Store of value
Method of deferred payment

Question 25

What is the main problem of a barter economy

Answer 25

It requires a double coincidence of want - to complete an economic transaction, you have to find someone who wants what you have, and you have to want what they have - if thi was to be faced by a whole economy, transactions would be extremely inefficiient

Question 26

What is a free market economy?

Answer 26

A free market economy is where the laws of supply and demand are the sole basis of the economic system, free from government intervention. Adam Smith argued that in this system, the 'invisible hand' of market forces would fairly allocate resources.

Question 27

What is a mixed economy?

Answer 27

Where market forces are complemented by some government intervention.

Question 28

What is a command economy?

Answer 28

A command economy is where resources are allocated entirely through the government.

Question 29

What are the benefits of a free market?

Answer 29

* Allocative efficiency - market in the long run will always operate at P* Q* (D=S), here resources are allocated exactly to meet consumer demand and societal surplus is maximised. Here, any shortages/surpluses in the system will not exist in the long run due to the price mechanism * increased consumer sovreignty * Encourages competition - in a highly competitve market, firms will have to compete with each other, meaning prices should stay low and consumers have greater sovreignty * Dynamic efficency - firms have an incentive to invest in R&D, so technological advancements may happen at a greater rate. This may bring long run average costs down, increasing economic welfare.

Question 30

What are the pros of a command economy?

Answer 30

* greater control over externalities - as the government is motivated by societal wellbeing, they are likely to produce at the society optimum level of production, internalising externalities and ensuring adequte levels of merit goods * In a command economy, the government controls wages, employment, and prices. Therefore, extremes in wealth and income will not exist.

Question 31

What are the negatives of a free market?

Answer 31

* Markets can fail - in acheiving the benefits of a free market, a lot of assumptions have beeen made. it is very rare for a market to be perfectly allocatively efficient. If a firm has monopoly power, it will produce at MC=MR, as firms are profit maximising, so artificially raise prices to acheive supernormal profit. * No control over merit and demerit goods - leadinging to greater externalities in society, creating deadweight welfare loss * Higer inequity and inequality - the market price may exclude consumers in a lower socio-economic group from accessing a good or service, if this is a necesity it can lead to low wekfare.

Question 32

What are the drawbacks of a command economy?

Answer 32

* lack of innovation - as the government is the sole supplier for industry, there is no incentive to become more productively efficient or invest in R&D as there is no competition. This means prices may be higher and society will not advance in the same way * Bureaucratic ineffeciencies - a central planning government will allways have imperfect information, they will not be able to allign supply and demand to match perfectly with the demands of consumers. thus, the market will never be allocatively efficient. * consumers will have less choice and freedom, as there is only one supplier in the market. *

Question 33

What is a firm?

Answer 33

an organisation that brings together factors of production to create output