ECONOMICS THEME 1.1

• Economic as a social science


  Economists develop models to explain how the economy works, for example theories of supply and demand or the circular flow of income. These are developed by putting forward a model, gathering evidence and then accepting, changing or disregarding the model.
• Theory and model


  The words "theory" and "model" can be used interchangeably and there is no exact distinction between the two. However, theories can often be expressed in words whilst models, because they require greater precision, are expressed in mathematical terms. The purpose of theories and modelling is to explain why something is as it is. They are simplified to make them more useful.
• There are too many variables which can change within an economic model and so assumptions must be made.
• Ceteris paribus


  All sciences make assumptions when developing models and theories, and this allows them to simplify the problem. Economists use the term ' ceteris paribus' meaning 'all other things remaining equal'. For example, when there is a change in income, demand will shift, ceteris paribus.
• Scientific experiments

  • There are many different types of science covering a wide field of knowledge, all linked by the method of building a model or theory. Theories or models which gain universal acceptance are called laws.
  • However, economics is a social science and so, unlike with natural sciences like physics and chemistry, it is difficult to set up experiments to test hypothesis. As the economist has to gather data in the ordinary, everyday world, other variables are always changing so it difficult to decide whether or not evidence supports or disagrees with a hypothesis. Therefore, economists tend to come up with very different conclusions for a particular set of data.
  • Some people argue economics is not a science because it studies human behaviour and human behaviour cannot be reduced to scientific law. However, groups of individuals are much more predictable than individuals themselves, and much of economics deals with groups rather than individuals. The laws can not be definite because we cannot know exactly what each individual will do.
• Positive statement

  A positive statement is a statement which is objective and made without any obvious value judgements or emotions. They can be tested to be proven or disproven and they are often expressed in the form of a hypothesis that can be analysed and evaluated. Statements about the future can be positive if they can be proven or disproven in the future.
• Positive statements

  • Raising taxes will lead to an increase in tax revenue
  • Warm weather will lead to an increase in ice cream sales
• Normative statement


  A normative statement is one which is subjective and based on opinion, so cannot be proven or disproven. It often includes words such as ought, maybe, unwise, should etc. or says that one action is better than another.
• Normative statements


  • The free market is the best way to allocate resources
  • The government should increase taxes
• Economists use positive statements


  To back up normative statements
• Value judgements can influence economic decision making and policy. Different economists may make different judgements from the same statistic, for example rising inflation could mean different things.
• The economic problem

  The basic problem of economics is that of scarcity. People have finite needs, but infinite wants, as no one would choose to live at the level of basic human living standards if they can enjoy more. Although wants are infinite, resources are finite and limited.
• Scarcity is a relative concept as resources are not necessarily scarce in themselves but they are scarce in relation to the demands placed upon them.
• Examples of scarcity

  • Water in India and China
  • Food shortages around the world
• Economies try to solve the basic economy problem by working out what to produce, how to produce it and for whom production should take place.
• Renewable resource

  A resource of economic value that can be replenished or replaced on a level equal to consumption. For example, oxygen, solar power and fish are renewable. As long as the rate of consumption is less than or equal to the rate of replenishment, the stock will not decrease.
• Non-renewable resource

  A resource of economic value that cannot be readily replaced by natural means on a level equal to consumption. This includes fossil fuels such as coal, oil and gas.
• Opportunity cost

  The cost of one thing in terms of the next best option which has been given up.
• Opportunity cost example

  • If you go into a shop with £1, you can only buy a chocolate bar or a bag of crisps. If you chose the chocolate bar, the opportunity cost is the bag of crisps that you could not buy due to your limited resources.
• Consumers will make choices on how to use their limited income based on what gives them the greatest level of satisfaction. Producers must choose what to do with their limited resources and their decisions will be based on profit. The government must make decisions on where they should spend their limited tax revenues based on what will maximise social welfare. There is no opportunity cost for free resources.
• Production possibility frontier (PPF)

  The PPF shows the maximum possible combinations of capital and consumer goods that the economy can produce with its current resources and technology.