What is economics?

Question 1

What is economics?

Answer 1

the study of how people interact with each other and with their natural environment in producing their livelihood

Question 2

Summarise how a simple economy without the government would work.

Answer 2

households and firms are at the heart of the economy
households provide labour force to firms + supply labour for caring responsibilities of vulnerable groups eg elderly
firms purchase labour from households, use this labour to produce goods and then sell these back to households
firms also produce machinery + equipment to sell to other firms
both households and firms use inputs into production eg water (all available in environment)
the economic activities of both firms + households takes its toll on the environment in the form of pollution

Question 3

How would the simple economy work if you included the government?

Answer 3

households would also supply labour hours to the state
the state would contract with firms for goods and services

Question 4

What do external environmental costs arise out of?

Answer 4

Our interactions with our natural environment

Question 5

What does microeconomics study?

Answer 5

the interactions between individual agents (eg firms) and how these interactions essentially evolve over time.

Question 6

How do you study interactions between individual economic agents in microeconomics?

Answer 6

by analysing a particular aspect of individual economic behaviour while ignoring interactions with the rest of the economy (ignore indirect effects)

Question 7

Why do you ignore indirect effects in microeconomics?

Answer 7

to preserve the simplicity of analysis

Question 8

What type of equilibrium is microeconomics an example of?

Answer 8

partial equilibrium rather than general equilibrium

Question 9

What is general equilibrium?

Answer 9

studying the whole economic system together

Question 10

What does macroeconomics study?

Answer 10

all interactions taking place in the economy

Question 11

How does macroeconomics study all interactions taking place in the economy?

Answer 11

by aggregating the behaviour of individuals and analysing the economic system as a whole (taking account of all indirect effects)

Question 12

What does positive economics explain?

Answer 12

how the economy works with out involving personal value judgement

Question 13

What is positive economics (simple) ?

Answer 13

just stating a fact with out imposing value judgment
eg “if we change this, then that will happen” is a common phrase used

Question 14

What does negative economics explain?

Answer 14

how the economy ought to work
statements impose value judgement

Question 15

What assumption is at the heart of standard neo-classical economics?

Answer 15

the rationality assumption

Question 16

What does the rationality assumption dictate?

Answer 16

that every economic agent is always looking to maximise its self interest
firms = profit maximisers
consumers = utility maximisers

Question 17

Why can the rationality assumption be criticised?

Answer 17

because it makes the assertion that everything in economics can be deduced from a single basic assumption (people acting in their own self interest)
this assumption has been violated in many interactions

Question 18

What are examples of the rationality assumption being violated?

Answer 18

Availability heuristic

Framing effect

Anchoring effect

Question 19

How does availability heuristic violate the rationality assumption?

Answer 19

argues that people don’t behave rationally because they give undue importance to info that is easily accessible rather than info that is relevant

Question 20

How does framing effect violate the rationally assumption?

Answer 20

argues that the way information is presented to individuals can influence their decision making –> not behaving rationally
eg saying a gym membership costs £365 a year rather than £1 a day may influence someone who is cash constrained decision to buy membership - sounds more attractive

Question 21

How does the anchoring effect violate/criticise the rationality assumption?

Answer 21

it suggests that individuals over rely on a piece of information as a reference point
eg you’re shown a shoe that costs £1000 then a shoe that costs £100, you view this one as cheap even thought its overpriced because you’ve used the first show as a reference point
argue this is how individuals actually behave –> not rational

Question 22

What are criticisms of economics?

Answer 22

-the rationality assumption has been violated in many interactions
-economic models oversimplify reality
-the issue of distribution hasn’t received enough attention
-limits on information, time or cognitive abilities leads to bounded rationality

Question 23

Why are economic models criticised?

Answer 23

they oversimplify reality to such an extent that their relevance for actual economic policy making is questionable

Question 24

Why can economics be criticised for not giving the issue of distribution enough attention?

Answer 24

critics suggest that economics has predominantly been focused on generating economic growth + not enough attention from economic growth being shared

Question 25

Are these criticisms fair and what steps have economists taken to address them?

Answer 25

whilst there is some merit in the criticisms it is not fair to say economics has not evolved to address them
economists have tried to deal with problems through rise of behavioural economics eg using lab experiments to analyse + predict behaviour that doesn’t conform to rational assumption

Question 26

What do economists use a bench mark for?

Answer 26

to judge how well an economic policy achieves its intended economic outcomes

Question 27

What 4 main components does the bench mark consist of? (what is the rule of 4)

Answer 27

efficiency
equity
growth
stability

Question 28

What is the efficiency component?

Answer 28

is the policy you’re trying to implement achieving that goal?

are the costs equivalent to the marginal utilities of consumers?

Question 29

What is the equity component?

Answer 29

the concept of fairness in the economy

is the economic policy contributing towards fairness?

Question 30

What is the growth component?

Answer 30

the increase in the total output of an economy (GDP)

Question 31

What is the stability component?

Answer 31

does the economic policy contribute towards stability in the economy or not?

Question 32

What are the differences between macro-economics and micro-economics?

Answer 32

Micro-economics deals with interactions of individual economic
agents, whereas, macro-economics aggregates all the interactions of individual agents to determine how the whole economic system functions

but both are useful

Question 33

What are the differences between positive and normative economics?

Answer 33

Positive economics deals with purely causative effects eg “when the price goes up the quantity demanded goes down” whereas, normative economics deals with statements where a value judgement can be imposed eg “raising taxes on the top 5 percentile of income earners is a
better way of reducing inequality than lowering taxes on the top 5 percentile of income earners” - involves a value judgement on income inequality.

Question 34

What are the four main elements of economic policy analysis?

Answer 34

Economic policy is generally directed to achieving four main goals: stabilizing markets, promoting economic prosperity, ensuring business development, and promoting employment

Question 35

Should an economic model try to explain economic reality exactly?

Answer 35

There is always a tension in economic modelling between complexity and simplicity. The closer an economic model gets to approximating reality the more complex it gets and the less analytically clear its predictions become. An ideal economic model therefore strikes the right balance between approximating the complexities of the real world and coming up with clear predictions of human behaviour.