Econ 1.1 nature of economics

• Economics


  A social science that develops models to explain how the economy works
• Theory


  An explanation of why something is as it is, expressed in words
• Model


  A simplified representation of reality, expressed in mathematical terms
• Theories and models require assumptions to be made due to the many variables that can change
• Ceteris paribus


  All other things remaining equal
• Economics is a social science, so it is difficult to set up experiments to test hypotheses
• Economists tend to come up with different conclusions for the same set of data
• Positive statement


  An objective statement that can be tested and proven or disproven
• Normative statement


  A subjective statement based on opinion, cannot be proven or disproven
• Economists use positive statements to back up normative statements
• Value judgements can influence economic decision making and policy
• Scarcity


  The basic problem of economics, where finite resources are insufficient to satisfy infinite wants
• Economies try to solve the basic economic problem by determining what to produce, how to produce it, and for whom
• Renewable resource


  A resource that can be replenished or replaced at a level equal to consumption
• Non-renewable resource


  A resource that cannot be readily replaced by natural means at a level equal to consumption
• Opportunity cost


  The cost of one thing in terms of the next best option that has been given up
• Production possibility frontier (PPF)


  The maximum possible combinations of capital and consumer goods that the economy can produce with its current resources and technology
• The PPF is drawn as a curve because the first resources switched from capital to consumer goods are more productive in consumer goods
• The PPF gives no indication of which combination of goods is best
• Any point on the PPF represents the maximum productive potential of the economy
• The opportunity cost can be calculated by moving along the PPF
• Economic growth shifts the PPF outwards, while economic decline shifts it inwards
• Efficient production occurs at all points on the PPF, while inefficient production occurs within the PPF
• Consumer goods


  Goods demanded and bought by households and individuals
• Capital goods


  Goods produced to aid the production of consumer goods in the future
• Specialisation


  The production of a limited range of goods by a company/individual/country, requiring trade to access all needed goods
• Division of labour


  Labour becomes specialised in a particular part of the production process
• Specialisation and division of labour can increase labour productivity and efficiency
• Advantages of specialisation and division of labour

  • Increased labour productivity
  • Higher quality of goods and services
  • More cost-effective to develop specialist tools
  • Time not wasted moving between jobs
  • Workers only need training for one specific task
• Disadvantages of specialisation and division of labour

  • Work can become boring, leading to poor quality and high turnover
  • Reduction in craftsmanship and more standardised products
  • Delays in one process can halt entire production
  • Workforce lacks wide industrial training, risking structural unemployment
• Specialisation


  • Leads to higher quality of goods and services as workers are more skilled at their jobs
  • It is more cost effective to develop specialist tools, improving speed or quality
  • Time is not wasted moving between jobs and getting out tools etc.
  • Workers only need to be trained to do one specific task, rather than many, saving time and money
• The degree to which specialisation or the division of labour is possible will depend on the nature of the task and the size of the firm
• Comparative advantage


  Countries should specialise in producing those goods where they have a lower opportunity cost, and so they are relatively best at producing
• Medium of exchange


  Money can be used to buy and sell goods and services and is acceptable everywhere
• Measure of value


  Money can compare the value of two goods and put a value on labour
• Store of value


  Money is able to keep its value and can be kept for a long time
• Method for deferred payment


  Money can allow for debts to be created and people can pay for things without having money in the present
• Free market economy


  • Individuals are free to make their own choices and own the factors of production without government interference
  • Resources are allocated through the price mechanism
  • The consumer determines what is produced by their willingness to spend their money on a good
  • Consumers make decisions based on satisfaction and producers based on profit
• There are no completely free markets in the world today, because the government has to intervene at least to an extent, for example by issuing money, protecting property rights and breaking up monopolies
• Invisible hand


  Allocates resources to everyone's advantage, allowing the greatest good for the greatest number of people