Nature of Economics

• Ceteris paribus


  All other things held constant
• Positive Statement

  Can be tested with factual evidence and can be rejected/accepted
• Normative Statement


  Subjective and asked on opinion rather than factual evidence

  Value judgement
• The Economic Problem

  Unlimited wants but finite resources which creates an opportunity cost (next best alternative foregone)
• Factors of Production

  Capital

  Entrepreneurship

  Land

  Labour
• Production Possibility Frontier

  Maximum productive potential of an economy, using a combination of two goods and services, when resources are fully and efficiently employed
• Law of diminishing returns

  The opportunity cost of producing good A increases in terms of the lost units of good B that could’ve been produced
• Shift of PPF

  Economic growth or decline
• Movement along PPF


  Change in number of capital/consumer goods
• Capital goods

  Goods that can be used to make other goods
• Consumer goods


  Goods that can’t be used to create other goods
• Specialisation


  When each worker completes a specific task in a production process

  Increases productivity and decreases the cost of production through the division of labour
• Advantages of Specialisation 


  Increased output and quality as production is focused on what people are best at

  Increased variety of goods

  Increased competition- incentive for firms to lower costs
• Disadvantages of Specialisation

  Repetition leads to decreased motivation which affects quality and productivity; workers become dissatisfied

  May only learn a few skills which aren’t transferrable- structural employment

  Producing a lot of one type of a good through specialisation could lead to variety decreasing for consumers

  Could be a higher worker turnover for firms- employees become dissatisfied with their jobs and leave regularly
• Functions of Money

  Medium of exchange

  Measure of value

  Store of value

  Method of deferred payment
• Free Market Economies


  Forces of supply and demand allocate resources with no government intervention

  Adam Smith-invisible hand

  Friedrich Hayek- free markets allowed for creativity, innovation, and entrepreneurship
• Disadvantages of Free Market Economies


  Adam Smith recognised monopoly power that could arise from the free market, ignores inequality and tends to benefit the wealthiest, overconsumption of demerit goods could have large negative externalities, public goods aren’t provided and merit goods are underprovided
• Advantages of Free Market Economies 


  Likely to be efficient as they only produce goods and services demanded

  Likely to lower the average costs and make better use of scarce resources- overall output of the economy increases

  Bureaucracy avoided

  Freedom gained from having a free economy leads to more personal freedom
• Command Economies


  Government allocates all resources

  Marx- saw free market as unstable, saw profits coming from exploitation of labour in the free market and by not paying workers to cover the value of their work; argued for common ownership of means of production
• Advantages of Command Economy

  Easier to coordinate resources in times of crises

  Can compensate for market failure by reallocating resources so everyone can access basic necessities

  Reduced inequality and society can maximise welfare rather than profit

  Prevents monopoly power abuse
• Disadvantages of Command Economy

  Don’t have full information to know what to produce and may not meet consumer preferences

  Limits democracy and personal freedom
• Mixed Economy 


  Features of free and command economies in which the market is controlled by both the government and forces of supply and demand

  Government provides public and merit goods

  Produces for who the government prefers and the purchasing power of private individuals