Theme 1

• Positive statements

  Facts that can be approved or disapproved
• Normative statements

  Opinions that can't be approved or disapproved
• Ceteris paribus

  When one variable changes the others remain constant
• The economic problem

  How to allocate scarce resources effectively given unlimited want
• Questions to ask when allocating scarce resources

  1. What to produce - what's in most demand

  2. How to produce - most cost effective way to save scarce resources

  3. Who to produce for - people who are willing to pay
• Factors of Production


  • Capital - man made aid of production
  • Enterprise - people who risk to make goods and services
  • Land
  • Labour - people who actually make the goods and services
• Opportunity cost

  The next best alternative
• Production Possibility Frontier (PPF)

  • Shows maximum possible production of 2 goods or services with the given Factors of Production
  • Shows various combinations of 2 goods or services that can be produced given the Factors of Production
  • If a point is on the line it is productively efficient - used up FoP to maximum level
  • If a point is inside the PPF curve its productively inefficient - haven't used up FoP to maximum level
  • If a point is outside the PPF curve its productively unattainable - overused FoP
• Allocative efficiency

  What's being produced is satisfying consumers demands
• Pareto efficiency

  Nothing can be made better of without making something else worse of
• Assumptions of Rational Decision Making

  • Consumers act rationally by aiming to maximise utility (level of satisfaction gained from consuming a product)
  • Producers act rationally by aiming to maximise profits
• Law of Demand

  Inverse relationship between price and quantity
• Factors that cause a shift in the demand curve

  • Population
  • Advertising
  • Substitutes price
  • Interest rate
  • Fashion/taste
  • Income
  • Complementary price
• Income effect

  When Price level increases, our income can't always stretch as far causing us to save more reducing quantity demanded
• Substitutes price effect

  If a firm increases the price of a good, consumers will go to rival companies and buy same goods for a cheaper price
• Price Elasticity of Demand (PED)

  % change in Quantity demanded / % change in price
• Cross Price Elasticity of Demand (XED)

  % change in Quantity demanded of good A / % change in price in good B
• Income Elasticity of Demand (YED)

  % change in Quantity demanded / % change in income
• Law of Supply

  Direct relationship between Quantity demanded and price
• Factors that cause a shift in the supply curve

  • Productivity
  • Indirect tax
  • Number of firms
  • Technology
  • Subsidy
  • Weather
  • Cost of Production
• Price Elasticity of Supply (PES)

  % change in Quantity supplied / % change in price
• Specialisation

  When a firm/individual/country focuses on producing a certain goods/services
• Division of labour

  Work split into smaller specialised tasks
• Adam Smith says division of labour increases economic growth. Uses the example of pin making. One person can make one pin a day but if we split the job into 18 different operators, 12 pounds of pins can be made in a day. This suggests that more production is possible in the same amount of time.
• Pros in organising production

  • Workers specialise in a role that their best at
  • Less training needed
  • Less time wasted
  • Increase productivity
• Cons in organising production

  • Lack of skills
  • Decrease productivity
  • Strike in one part of the task can cause a shutdown in the whole production
• Pros of specialising in production of Goods & services to trade

  • We can trade with other countries on goods that we don't specialise in and give them in returns goods we specialise in. Increases output
• Cons of specialising in production of Goods & services to trade

  • Overdependent on imported goods
• Limits of Division of Labour

  • Size of market - small then harder to specialise
  • Type of product
  • Transport cost - high costs = div of labour not possible
• Excess supply

  Quantity supplied is greater than quantity demanded at existing price
• Excess supply

  • Contraction in the supply curve (Q1 - Qe)
  • Extension in demand curve (Q2 - Qe)
• Excess demand

  Quantity demanded is greater than quantity supplied at existing price
• Excess demand

  • Extension in supply curve (Q3 - Qe)
  • Contraction in demand curve (Q4 - Qe)
• Key functions of the price mechanism in a free market economy

  • As a rationing device - market forces ensure quantity demanded = quantity supplied
  • As a signalling device - produce increases or decreases amount supplied
  • As an incentive - firms making a profit is an incentive for selling goods/services
  • Determine change in want - change in demand will reflect in change in price
• Consumer surplus

  The difference between how much a person is willing to spend on a good and how much they actually pay
• Producer surplus

  The difference between price producer received and cost of supply
• Indirect Tax

  Tax on expenditure
• Types of indirect tax

  • Ad Valorem tax - tax imposed on a product based on its assessed value
  • Specific Tax - fixed amount of tax on a product
• Specific tax when demand is indirect

  • Inward shift in supply
  • When its inelastic, consumer bare the higher tax burden than producer
• Specific tax when demand is direct

  • Inward shift in supply
  • Steeper lines
  • When its elastic, producers bare the higher tax burden compared to consumers