Economic methodology and the economic problem
- Created by: ekenny5
- Created on: 27-10-20 12:14
economic methodology
- economics as a social science - study the choices people make uder conditions of scarcity and uncertainty, not a natural sciemce as they are not exact results, never sure how people act under different circumstances, consumers not always rational
- traditional economic theory is that consumers maximise own satisfaction and businesses maximise profits
- behavioural economics studies the social aspects of decisions
- positive statement - objective statements that can be tested, ammended or rejected referring to evidence
- normative statement - carry value judgement about what ought to be (which objective is most important/bigger impact
- politicians and governments make decisions using normative statements (what they think based on the positive statements)
- microeconomics is the study of how individual firms, industries and consumers/households behave together
- what consumers decide to buy, how businesses determine what is produced and how it's supplied
- analysing the effect of government regulations, subsidies, taxes ect on consumer habits and supply/demand
The nature and purpose of economic activity
- the production of goods and services to satisfy needs and wants
- needs are things that are neccessary for an organism to live a healthy life, eg water
- wants are to feel a desire for something, to wish for
- aiming for economic welfare - evaluating well being, usually measure in income/GDP - ^income, ^welfare (though this isnt always the case as there is a large inequality of wealth, and a large income gap
- key economic decisions are:
- what to produce
- how to produce
- who is to benefit from the goods and services produced
Economic systems
An economic system is a network of organisations used to resolve the probelm of what, how much and for whom to produce
the types of ecocomy are:
- free market
- mixed
- command
Free Market Economy
- markets allocate resources
- driven by profit motive
- limited role for state
- private sector dominates
- the invisible hand - businesses compete for consumers using better quality and/or lower prices. any unwanted products won't be purchased and will drop out of the market
- lassaiz faire approach from the governments
- Hong Kong ranks as 90.2% economically free, the highest in the world, with extremely low tax rates and minimal business regulations
- Singapore is second at 89.4% economically free
- New Zealand, Switzerland and Australia make up the rest of the top 5 most economically free markets
- Adam Smith in the 1700s wrote the wealth of nations, where he displayed his belief in free markets, saying people act in their own self interest (businesses maximise profit and consumers maximise own satisfaction), so the invisible hand would sort out the supply/demand within an economy
Mixed Economy
- mix of state and private ownership
- government intervention in markets
- the mix will vary between countires, governments make limits and regulations for private producers eg sugar tax
- governments involved with improving welfare, eg healthcare, benefits, education, minimum wage. for example in the UK, USA and Canada
- Fredrich Hayek believed that free market economies allow for more efficient resource allocation, but that government intervention is necessary
Command Economy
- most resources are state owned
- planning allocates resources
- little role for market prices
- restricted freedom for citizens
- businesses/governments have no competition so could have higher prices
- Karl Marx believed in command economies, saying that free market economies led to the exploitation of workers, as profit is the main aim of businesses. This economy fits in with Marx' theory of commmunism
- the least free (most command-like) economies are Zimbabwe, Equatorial Guinea, Bolivia, Timor-Leste and Algeria
- famously used by formally USSR and Cuba
Free Market Competition
- efficeint allocation of scare resources - go where the market return is the highest
- competitive prices for consumers
- more innovation as businesses need competitive advantage
- profit motive stimulates capital investment
- competition with international trade helps reduce domestic monopoly power and increases choice
The Role of the State
- in mixed economies
- state owned industries wholly or part-state owned indsutries eg RBS, Network Rail
- welfare state - welfare benefits, universal, eg state pension, means tested eg housing benefits
- government spending on public services - education and health, capital spending on infrastructure
Economic Resources
economic resources = factors of production
- the inputs available to supply goods and services in an economy
- Land - natural resources available for production, this could include the sea for oil
- Labour - the human input into the process of production
- Capital - goods used in the supply of other goods eg machinery and tech
- Enterprise - entrepreneurs organising factors of production and taking risks, to generate profit
Factor Rewards - how incomes flow in and out of each of the main factors of production
- Land - rental income to land owners
- Labour - wages and salaries from employers
- Capital - interest from savings and dividends from shares, ^productivity with machinery
- Enterprise - profit
The Economic Problem
ulimited wants with limited supply
the rationing of scarce resources is done by
- market price - increased price decreases demand eg house prices ^ as only limited supply, so less people can now afford house prices
- consumer income - free prescriptions if unemployed
- assessment of need
- household postcode
- education level
- age
- gender
- nationality
Types of Goods
capial goods are goods that are used to make consumer goods and services eg machinery, hardware, buildings
consumer goods and services are goods/services that satisfy needs and wants directly
consumer durables provide a steady flow of satisfaction utility over time eg washing machine
consumer non-durables are used up in the act of consumption eg a cup of coffee
consumer services eg hair cut
non-renewable resources - finite supply, for some there are no mechanisms for replenishing them, the rate of extraction depends on current market price (^price as lower supply). though as a switch to renewable resources price decreases of finite resources
renewable resources - replaceable over time providing that the rate of extraction of the resource is less than the natural rate at which the resource renews itself
free goods - do not use any factor inputs when supplied. zero opportunity cost eg air
Opportunity Cost
measures the cost of a choice in terms of the next best alternative forgone or sacrificed -- a good way to evaluate a decision - look at what could have been
eg work vs leisure choices
government spending proiroties
investment today vs consumption tomorrow
use of scarce farming land, what to grow/produce
Production Possibility Diagrams
- PPF show alternative combinations of two goods or services attainable when all resources are fully and efficiently employed
- normally draw a PPF as concave to the origin, when we move along the PPF, as resources are allocated towards good Y, the extra output gets smaller
- law of diminishing marginal returns, occurs because not all factor inputs are equally suited to producing items leading to lower productivity
- if the equlibrium point lies on the curve, it is operating at full current potential, productivley effiecient
- if below the curve, not all tghe factor inputs are being used efficiently eg unemployment
- if above the curve, this productive potential is not yet attainable
Economic Growth
economic growth causes the PPF to shift outwards, this could be due to improvement in the factor inpus, eg more advanced technology
economic shrink causes the PPF to shift inwards, eg natural disasters or the brain drain, meaning the overall production potential has decreased - this is permanent, unlike strikes or unemployment which are the inputs not being used efficiently
- when operating inside the curve, get closer to the curve by increasing outputs of goods and services
- trade between countries allows nations to consume beyond their own productive potentials
- producing more of both goods with the same resources represents an improvement of welfare and gain allocative efficiency
PPF Opportunity Cost
to produce 100 more cotton, we must produce 40 less wheat (opportuinty cost of wheat)
Diminishing return
if 100 more cotton loses 40 wheat, but then to make another 80 cotton, we lose another 80 wheat, there is a higher opportunity cost further down the curve. this is diminishing return
it is still productivley efficient as it's operating on the curve, but the opportuity cost is still greater
Linear PPF
A straight line PPF is an indication of perfect factor substitutability of resources
The marginal opportunity cost of switching resources between consumer and capital goods is constant
The exact same resources/labour are needed for both outputs. They are substitutable
Outward shift in a linear PPF is increasing a countries potential output due to changes in production technology or more factor inputs. More can be made at each level
Causes of Outward Shifts
- higher productivity/efficiency of factor inputs > increases output per unit of input used in production
- better management of factor inputs eg decrease waste or increase quality
- increased stock supply of capital and laboour supply eg inward migration/ capital investment
- innovation and invention of new products and resources > improved production process helps increase efficiency
- discovery/ extration of natural resources (land) > comercially viable laand inputs drives extraction - eg Dubai oil being discovered in the 1980s and was extracted, GDP went from around $40bn USD in 1980 to around $340bn in 2015
Causes of Inward Shifts
- natural disasters/ destruction of resources > no longer as many resources so production potential decreases
- civil or international wars > liked to destruction of factor inputs eg land and labour
- outward labour migration > shrinking labour force (brain drain)
- persistant depression > decline of productivity, net investment negative
Resource Depreciation and Depletion
Depreciation is the loss in value of assets over time (not including natural resources)
- machinery
- skill atrophy (waste)
- buildings
- basic infrastructure
Depletion is the loss in value of natural resources over time
- human capital flight
- capital scrapping
- natural disasters
- deforestation
Economic Recovery and Growth
Recovery means getting closer to the curve. During recovery aggregate demand will be rising. this leads to an increase in real national output, and a decrease in amount of spare capacity. Factor inputs are more efficient, eg increased employment
Growth means increased supply of both goods (increased productive capacity). Supply side policies (labour policies and apprenticeships) can shift out the PPF
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