1. Economic Methodology and the Economic Problem

• Economics is the study of how finite resources are allocated to meet infinite wants
• economics is a social science because it studies human behaviour and uses models to explain economic activity
• economics relies upon assumptions and models to make predictions - these are often simplified versions of reality
• economic models need to be tested against real world evidence but experiments are difficult as some variables are uncontrollable
• a positive statement is objective fact based statements that can be proven true or false
• a normative statement is subjective value based statements that cannot be tested or proven
• the economic problem is scarcity
• the economic problem involves limited resources and unlimited wants, leading to opportunity cost
• factors of production:

  • land
  • labour
  • capital
  • enterprise
• land is natural resources eg forests
• labour is human input eg workers
• capital is man made goods used in production eg machinery
• enterprise is entreprenurship, combining the factors and taking risks
• opportunity cost is the cost of the next best alternative foregone when making decisions
• production possibility frontier's (PPF) shows the maximum combination of goods and services that can be produced with given resources
• points ON the PPF curve show efficient use of resources
• points INSIDE the curve show inefficient use of resources
• points OUTSIDE the PPF curve show unattainable positions
• shifts in PPF occur due to changes in the quality or quantity of resources
• specialisation is when individuls, firms or countries focus on producing one type of good or service
• division of labour is breaking down the production into different tasks with workers specialising in one area
• advantages of specialisation & division of labour:

  • increased efficency and output
  • saves time and reduces training costs
• disadvantages of specialisation and division of labour:

  • bordem
  • risk of overdependence
• money needs to function effectively in an economy as:

  • medium of exchange
  • measure of value
  • store of value
  • method of deffered payment
• medium of exchange is used to buy and sell goods and services
• measure of value expresses worth
• store of value keeps value overtime
• method of deferred payments can settle debts
• the free market economy (US): resources are allocated by market forces, limited government intervention
• command economy (North Korea): government decides allocation of resources
• mixed economy: combination of market forces and government intervention
• consumers aim to maximise utility
• firms aim to maximise profits
• government aims to maximise welfare of citizens and focus on macro goals
• positive statements are objective
• normative statements are based on value judgements
• positive statements can be found by “will, and is”
• normative statements can be found from “should, or suggesting one over another”
• the purpose of economic activity is to produce goods and services which satisfy consumer needs and wants
• economists have to make decisions about scarce resources based on:

  • what is to be produced
  • how it should be produced
  • who will benefit from production