4.1.1 - THE ECONOMIC PROBLEM
1. Everyone has basic needs in life - food, water and clothing etc.
2. Everyone also has infinite wants - phones, clothing, cars etc
3. There is a limited amount of resources in the world to satisfy these needs and wants
how can the available scarce resources be used to satisfy people’s infinite needs and wants as effectively as possible?
THE 4 FACTORS OF PRODUCTION
These are Capital, Enterprise, Land and Labour (CELL)
Land
The majority of these resources are scarce
- Non renewable resources (natural gas, oil, coal)
- Renewable resources ( power, wind, wood)
- Material extracted by mining (diamonds, gold)
- Water
- Animals found in the area
Labour
- This is the work done by the people that contribute to the production process
- The population available to do so is called the labour force
- Unemployed: people who are capable and willing to work but who don’t have a job
- Human capital: the value of of a person in the labour force
- E.g this increases with education and specialisation (making you a more scarce resource)
Capital
- Capital is the equipment that is used to aid in the production process
- E.g machines, factories
- Different from land because capital has to be made from natural resources
- Much of it is paid by the government - e.g the country’s road network is a form of capital
Enterprise
- this refers to the people who take risks to create things from the three other factors of production (entrepreneurs)
- Set up and run businesses
- If the business fails, they lose a lot of money (vice versa)
GOODS AND SERVICES
Good : ‘physical’ products you can touch such as washing machines and apples
Services: ‘intangible’ things such a s medical check ups or train journeys
Producers → firms or people that make goods or services
- decide what to make and set a price
Consumers → people or firms who buy the goods and services
- decide what they buy and how much they’re willing to pay for it
Governments → sets the rules that other participants in the economy have to follow, but also produce goods and services
- intervene in the way producers and consumers act (e.g setting a maximum price)
PPF CURVES
Production Possibility Frontiers
These show how to maximise the possible output. This one shows how to maximise the number
of houses and vehicles, using the existing level of resources.
1. Points A,B,C,D are all achievable without using any extra resources. However the
resources must be used as efficiently as possible
2. A movement along the curve corresponds to allocating more resources to the
production of another [A to B means more houses -> less vehicles]
3. In other words this causes a trade-off between building more houses or more vehicles
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, 4. All points on the PPF curve are productively efficient, because they all maximise output. However they are not all
allocatively efficient because not all points will reflect the wants and needs (more houses are needed than cars)
5. Point E lies outside the PPF curve, so it isn’t achievable using the current level of resources.
6. Point F is inside the curve - this means that making this mix of goods is productively inefficient. Therefore you could
build more houses without making fewer vehicles
SHIFTS IN PPF CURVES
A PPF shows what's possible using a particular level of resources
(e.g. a particular number of people, a particular amount of capital and raw materials, and so
on)
If this level of resources is fixed, then movements along the PPF just show a reallocation of
those resources
However, if the total amount of resources changes, then the PPF itself moves.
For example, increased resources (e.g. an increase in the total number of workers) would
mean that the total possible output of that economy would also increase so the PPF shifts
outward.
For the economy shown by this PPF, the extra output could be either more houses or more
vehicles or a combination of both.
OUTWARDS SHIFTS
● increased total number of workers
● improvements in labour (working conditions)
● improved technology
INWARDS SHIFTS
● natural disasters
● poor health or working conditions
PPF CURVES CAN GROW ON ONE SIDE ONLY
PPF curves can grow just on one side.
This is normally due to improved technology.
In this case, this particular technology only helps with the house-building industry.
This means that the PPF has been stretched only in one direction.
OPPORTUNITY COST
The opportunity cost of a decision is the next best alternative that you give up in making that decision
This is what you give up in order to do something else
- i.e the cost of the choice that is made
- In this case, moving from A to B means you have the opportunity to build 21,500 extra houses at the cost of giving up
40,000 vehicles.
Problems:
1. Often not all alternatives are known
2. Some factors don’t have alternatives
3. There may be a lack of information about the alternatives and their costs
4. Some factors can be hard to switch (e.g land)
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,MARKETS AND ECONOMIES
1. A market is used to allocate resources.
2. Each buyer and seller in a market chooses to exchange something they have for something they don’t have - this isn’t
necessarily a good.
○ E.g exchanging labour for a salary
3. In a free market it is assumed that
○ The worker would prefer to have a wage, and less free time
○ Employer would prefer to have less money, and someone do their work
4. Exchanging things results in a particular allocation of resources
A free market allocates resources based on supply and demand and the price mechanism
In a command economy the government decides how the resources should be allocated. E.g Soviet Union
1. Market failure occurs when free market results in undesirable outcomes - e.g traffic congestion
2. Governments intervene when market failure occurs
○ Might change the law
○ Offer tax breaks
○ Might also buy goods and services
3. When government and the market allocates resources, this is called a mixed economy
○ Most countries have mixed economies (UK, Spain etc)
MIXED ECONOMY
1. Include a private and a public sector
○ Businesses are owned privately making the private sector
2. The private sector survives purely from profit
MARIGNS
1. The margin is the change in variable per extra unit added of another variable
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, 4.1.2 - BEHAVIOURAL ECONOMICS
THE UTILITY THEORY
Utility is the amount of satisfaction or benefit that a consumer gains from consuming a good or service. Consumers aim to
maximise utility per pound spent and so will compare their perceived satisfaction with the price of the good or service.
UTILITY MAXIMISATION THEORY: individuals and firms seek to get the highest satisfaction from their economic decisions. rational consumers will consume a good
or service only if the perceived satisfaction is greater than, or equal to, the price
TOTAL UTILITY MARGINAL UTILITY
The overall benefit gained from consuming a good or The benefit gained from consuming one extra unit of
service a good or service
RATIONAL CONSUMERS
● It is assumed that a rational individual will always try to maximise their utility
○ They do this by comparing costs vs benefits
● Rational consumers are assumed to have self total control
○ Limited control is known as ‘bounded self control’
● A rational consumer will always consume where marginal utility = price
WHY DON’T CONSUMER ACT RATIONALLY?
Limits on decision making are known as ‘bounded rationality’
● Imperfect information
○ Won’t have all the information they need to make a rational decision leading to market failure
● Asymmetric information
○ One party has more information than the other
○ E.g sellers often have more information than buyers and take advantage of consumers
● Social, psychological and emotional factors
● Time limited to make a decision
○ Doesn’t allow them to take all factors into account
● People might not be able to process and evaluate vast amounts of information
BIASES IN DECISION MAKING
● Rules of thumb: these are known as “thinking shortcuts”. Individuals make decisions based on previous experiences or
bounded rationality. Ie: you order the same drink every morning in your local coffee shop because it is the one you have
previously enjoyed and know for sure that you will like. It’s your automatic choice.
● Anchoring: the tendency of individuals to rely on particular pieces of information, especially on situations where they lack
knowledge or experience. For example, a consumer choosing between car insurance premiums online may focus on price as
the key point of comparison rather than the features, excesses and exclusions of individual policies.
● Availability: when people make judgements about the probability of events by recalling recent instances.
○ Ie: stockpiling snow shovels and path-clearing salt after Philomena in Madrid
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, ● Social norms: what society dictates has a big influence on individual decision-making.
○ Examples include drinking or smoking due to social pressure, telethons for charitable events such as comic relief,
pressuring ads to avoid driving fast and under the influence of alcohol.
● Altruism and fairness: people are motivated to do the right thing. Therefore, decisions include giving to charity, doing
voluntary work etc. are seen as irrational in traditional economics but individual consumers can gain a big sense of
satisfaction and extra utility.
BEHAVIOURAL ECONOMIC POLICIES
CHOICE ARCHITECTURE
● Choice architecture refers to the way choices are presented to consumers
● Well-designed choice architectures can help consumers avoid making irrational decisions and poor choices. This could
improve consumer welfare.
● For example, a consumer might be offered fewer choices, to avoid the time cost and consideration it takes to evaluate an
extra choice.
● An example of choice architecture is placing healthy snacks at eye level whilst placing unhealthy snacks in difficult places to
reach
○ This is because consumers are more likely to see those at eye level first and buy them
FRAMING
● Framing is the way by which consumers are influenced by the context of how a choice is presented.
○ The context includes word choices and it affects the choice consumers make.
● For example, if consumers are told the monthly payment for a good or service, rather than the aggregate yearly payment,
they are more likely to purchase the good or service, since it seems more affordable.
NUDGES
● Nudges aim to change the behaviour of consumers without taking away their freedom of choice.
○ It comes under the category of choice architecture.
● For example, rather than banning something like junk food, replacing it with healthier food is a nudge.
● This still allows consumers to make a free choice, but it alters their behaviour to choose the healthier option.
● It is sometimes argued that nudges are manipulative and consumers do not get a free choice with them. However, due to
imperfect information that exists between consumers and firms, nudges can help prevent consumers making irrational or
poor choices, so their welfare is maximised.
DEFAULT CHOICE
● A default choice is when a consumer is automatically enrolled into a system, such as a pension scheme.
● Consumers are more likely to participate when they are automatically enrolled.
● It is the choice the consumer takes if they take no action.
RESTRICTED CHOICE
● The choice of the consumer is restricted, but it is still there.
MANDATED CHOICE
● A mandated choice is when consumers are required to state whether they wish to participate in an action.
● For example, in the UK everyone who applies or renews their driving licence is asked if they wish to sign up for organ
donation
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, 4.1.3 - PRICE DETERMINATION IN A COMPETITIVE MARKET
● A market is where buyers and sellers exchange goods and services
● Price and quantity are determined by supply and demand in the market
COMPETITIVE MARKETS
● Where there are a large number of consumers and producers
● When no single consumer or producer can influence the allocation of resources by the market or the price that goods and
services can be bought at
ASSUMPTIONS
● Consumers act rationally
● Consumers aim to maximise their welfare by buying goods and services to maintain or improve their quality of life
● Producers compete to provide consumers what they want at the lowest price possible
○ So they can maximise profit by selling to the most customers
DEMAND
Demand curve shows the relationship between price and quantity demanded
DEMAND IS THE QUANTITY OF A GOOD/SERVICE THAT CONSUMERS ARE WILLING AND ABLE TO BUY AT A GIVEN PRICE OVER A PERIOD OF TIME
SHIFTS IN DEMAND
SHIFTS ARE NOT THE SAME AS MOVEMENTS ALONG THE CURVE
- Shifts occur when PASIFIC happens
- movements occur when price changes.
PASIFIC:
1. Population
○ More population means more buyers, therefore more demand
2. Advertisement
○ If a company effectively advertises loads the amount of goods sold increases, increasing demand
3. Substitutes
○ If a good has little substitutes the demand will increase as they don’t have any alternatives
4. Income (disposable)
○ If you society has a more disposable income it is likely that demand will increase
5. Fashion & Taste
○ If something is in fashion then demand will increase, shifting demand to the right
6. Income Tax
○ If income tax is very then you will have less disposable income, shifting demand to the left
7. Compliments
○ Goods that result of buying another good
■ Petrol + cars
○ If demand for cars increase then demand for petrol increase
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