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How do societies choose exactly what to produce in order to maximise human happiness?

1) The society must figure out all the possible combinations of goods and services that it can produce given its limited resources and the currently available technology.

2) The society must choose one of these possible output combinations - presumably, the combination that maximises happiness.


Define productive efficiency.

Productive efficiency means producing any given good or service using the fewest possible resources. i.e. what's possible to produce.


Define allocative efficiency.

Allocative efficiency means producing the kinds of goods and services that are going to make people the most happy, and producing them in the correct amounts. i.e. what's best to produce.


Name two major factors that affect both the maximum amounts and the types of output to be produced.

1) Limited resources

2) Diminishing returns


Define Diminishing returns.

Diminishing returns means that the more you make of something, the less return you get on each successive unit. Eventually, the costs exceed the benefits, which limits how much of it you want to produce, even if the product is your favourite thing. Your resources should be devoted to producing units of other things for which the benefits still outweigh the costs. Diminishing returns implies that, in general, we're better off not putting all our eggs in one basket.

Diminishing returns is probably the most important economic factor in determining exactly what to produce out of all the things that can possibly be produced given the limited supply of resources.


How do economists traditionally divide inputs, or factors of production?

Into three classes:

LAND: this means more than just real estate or property. it also refers to all naturally occuring resources that can be used to produce things people want to consume. Land includes the weather, plant and animal life, geothermal energy and the electromagnetic spectrum.

LABOUR: the work that people must do in order to produce things. A tree doesn't become a house without human intervention.

CAPITAL: man-made machines, tools and structures that aren't directly consumed but are used to produce other things that people do directly consume. For example, a car you drive around for pleasure vs an identical car you use to haul around bricks for your construction business is capital. Capital includes factories, roads, sewers, electrical grids, the internet etc.


What is the definition of human capital?

The knowledge and skills that people use to help them produce output.

A worker with high human capital produces more or better amounts than someone with low hum capital, even though they both work the same no. of hours.

Skilled workers therefore are paid more than unskilled workers.

Societies can become richer by improving the skills of their workers through education and training. This way, more is produced and the workers receive a higher level of pay and enjoy a higher standard of living.


With regards to diminishing returns, describe the low-hanging fruit principle.

You are sent to an apple orchard at harvest time to pick apples. In the first hour, you pick a lot of apples because you go for the low-hanging ones which are easiest to pick. In the second hour, you pick less because you have to start reaching awkwardly for fruit that is higher up. And in the third hour you pick even less; you know have to start jumping off the ground to pick an apple.


What is another way of seeing the effect of diminishing returns?

Noting the increase in costs for producing output.

Eventually, the effects of diminishing returns drive prices so high that you stop devoting further labour resources to picking additional apples.


How might a society overcome the diminishing returns factor?

Because the diminishing returns factor assures that a production process eventually becomes too costly, a society normally allocates its limited resources widely, to many different production processes.


What does the Production Possibilities frontier show?

It lets you visualise the effect of diminishing returns and view the trade-offs you make when you reallocate inputs from producing one thing to producing another. I

It also shows how limited resources limit your ability to produce output.


What causes the changing slope of the PPF?

The changing slope of the PPF in the face of diminishing returns is due to the fact that the opportunity costs of production vary depending on your current allocation of resources.

i.e. if you're already producing a lot of apples then the opportunity cost of devoting more labour to apple production is high because you're sacrificing a lot of orange production.

On the other hand, the opportunity costs of devoting that labour to orange production are very low because you only have to give up a few apples.


Any points that lie on the PPF show..

the output combinations you get when you're PRODUCTIVELY EFFICIENT, or wasting none of your resources.


All points below the PPF are...

productively inefficient.

In the real world, you end up at points below the PPF because of inefficient production technology or poor management. For one reason or another, the resources that are available aren't being used to produce as much output as possible.


What factors must be held constant regarding the diminishing returns model?

Regarding diminishing returns, you must bear in mind that we are discussing returns to one changing factor whilst holding others constant.

Another simplification of the diminishing returns model is that, other than the particular input that you are allocating, you are implicitly holding constant all other productive inputs, including tech.

However, tech is constantly increasing, so whilst this is a neat model for getting a handle on the problem, you have to adapt it to use it in the real world.


What happens to the PPF after an increase in technology?

The PPF will shift outwards.

There is now a new combination of outputs thaat, thanks to better tech, can be produced using the same amount of resources as before.

The PPF is still curved because better technologies don't get rid of diminishing returns.


What is a balanced technology shift?

A shift in technology that is balanced will increase your ability to produce more of both goods.

An example is improvements in pesticides and fertilizers that increase crop yields of both apples and oranges.


What are the three main factors that you must bear in mind when considering the fight between leaving the markets alone and government intervention?

1) Modern economies are hugely complicated. Markets handle this complexity easily, but government interventions usually don't - meaning that they often risk substantial reductions in productive and allocative efficiency.

2) Some goods and services, like coal-burning power plants and cocaine, have negative consequences which bring forth substantial pressures for government intervention because these markets, if left alone, produce a lot of these goods and services.

3) Some people end up consuming a very large proportion of the goods and services produced, whereas others end up with very little. This inequality brings about great pressure for gov's to intervene and equalise living standards.


Define Market production.

When one individual offers to make or sell something to another individual at a price agreeable to both.


Define Competitive Markets.

Markets where many sellers compete against each other to attract customers.

Each seller has an incentive to sell at the lowest price possible (subject to their constraints imposed by costs) in order to undercut competitors and steal their customers.

Because every firm has this incentive, prices tend to be driven so low that the businesses can just barely make a profit.


Why do competitive markets tend to guarantee productive efficiency?

Because the best way for sellers to keep prices low is to make sure that they're using all of their resources efficiently and that nothing goes to waste.

Because competition is ongoing, the pressure to be efficient is constant.

Sellers also have a big incentive to improve efficiency in order to undersell their competitors and steal their customers.


What is the beauty of Market Economies?

Markets have the benefit of working out, automatically, the things that people want.

Because production and distribution in modern economies aren't centralised, you don't need to know the big picture i.e. you don't need to gather info on every single consumer (out of 7 billion people).

The real magic of market economies is that they are just a collection of millions and billions of small face-to-face transactions between buyers and sellers.


What is another name for a market economy?

Price systems.

Because prices serve as the signals of that allocate resources. Things in high demand have high prices, things in low demand have low prices.

Because businesses like to make money, they follow the price signals and produce more of what has a high price and less of what has a low price.

In this way, markets tend to take our limited resources and use them to produce what people most want - or, at least, what people are most willing to pay for (in a completely decentralised manner).


What is a command economy?

In a command economy all economic activity is done on the orders of the government.

Example - Communism, long lines, and toilet paper.

Shortages of: sugar, clothing, toilet paper, (more seriously) hypodermic needles and food.

No price system used.

Instead - communism = everyone is equal = everyone gets equal share of goods and services made.

The result = long lines (those who could wait lingest got the most and if there was a line forming you quickly join it).

What caused this? Centralisation.

Central planners in Moskow attempted to determine the correct amounts to produce for 24 million different items = far too complex.


Name two major problems regarding markets?

1) They produce whatever people are willing to pay for, even if these things aren't necessarily good for the people or the environment.

2) Markets are amoral: they don't in any way guarantee fairness or equity.


What are some examples of market robustness?

The fact that illegal drugs are widely and cheaply available despite vigorous government programmes to stop their production and distribution (as long as there are profits to be made you can bet that supply is going to satisfy any demand).

The market for illegal drugs is an excellent example of the fact that markets can deliver things without caring about their social value or negative consequences.

Producers often do things we don't like while giving us things we want i.e. child labour and sweatshops.


What are the three forms of Government intervention in an economy?

1) Penalties or bans on producing or consuming goods and services that are considered dangerous or immoral i.e. ban drugs, impose 'sin taxes' to discourage alcohol or tabacco.

2) Subsidies to encourage the production of goods and services that are considered desirable i.e. education of children and provision of medical care.

3) Taxes on the well-off to provide goods and services to the less fortunate and to reduce inequalities in income and wealth i.e. put towards good park, clean air and art, goods and service for the poor.


What are three reasons against government intervention in the economy?

1) Government programmes are often the result of special interest lobbying that seeks to help some small group rather than to maximizes the happiness of the general population.

2) Government programmes often deliver poor service even when pursing the common good, because they have no competition to create an incentive to produce government goods and services efficiently.

3) Government interventions usually lack the flexability of the price system, which is able to constantly redirect resources to accommodate people's changing willingness to pay for one good rather than another.


What lessons were European lawmakers keen to learn following WW2?

EXAMPLE - The wine Lakes

Falling farm prices = impoverished farmers (majority)

New solution = Common agricultural Policy (CAP)

Guaranteed minimum price for farmers.

Better tech, efficiency and guaranteed min price lead to overproduction.

Thus Consumers paid higher prices and taxes and got lakes of wine and mountains of butter that no one could ever possibly consume.


Define a Market Economy.

One in which almost all economic activity happens in markets with little or no interference by the government.


Define a Traditional Economy

One in which production and distribution are handled along the lines of long standing cultural traditions i.e. in medieval Europe, people were usually unable to be part of the government or attain high military rank unless they were born into the nobility.


Define a mixed economy.

Almost all modern economies are mixed economies. That is, a mixture of command, market and traditional economies (with less importance placed on the traditional aspect).


How do the growth rates of the U.S., U.K. and Japan compare to the likes of India and China?

Catching up quickly - EXAMPLE.

Western Europe, U.S. and Japan have been at the cutting edge of tech for a long time - how do they push their PPF outwards? = invent new tech.

Historically, this means their living standards only grow ~2% per year = would take about 30 years to double.

These countries are rich, not by chance but by a long history of slow and steady progress.

That slowness = other countries can catch up to the living standards very quickly.

I.e. China and India can jump from using old tech to the most advanced very quickly = 6-8% growth rates per year.