Economics is considered a social science. Economists develop models to understand
behaviour. However, it is impossible to perfectly recreate everything. Therefore, models are
based on a set of assumptions. Models and theories are used to explain real world evidence.
These models use real life data and can be used to forecast the future. Nearly all models
rely on assumptions and simplifications
Ceteris Paribus
➔ Due to the large number of variables that can influence any particular economic
interaction in society, economists create models using the principle of ceteris
paribus
◆ 'all other variables remain constant' even when they are highly likely to have
changed
◆ It allows economists to simplify and explain causes and effects
Positive & Normative Statements
➔ Positive economics: objective statements that can be tested by referring to evidence/
data. Made without any obvious value judgements or emotions.
◆ These positive economic statements are based on empirical evidence and
tend to be statements of fact
◆ The key thing here is that these statements can be tested, the results can be
examined and the statement can then be rejected or accepted.
➔ Normative economics are subjective statements which contain a value judgement.
cannot be proven or disproven.
◆ They are what separate political parties and the different economic agendas
they put forward
Role of Value Judgements
➔ Value Judgement: a complete opinion, a judgement as to whether something is right
or wrong
➔ It is a subjective statement of opinion in contrast to an objective factor or theory that
can be tested by looking at available evidence
➔ Value judgements influence individuals choices in the economic decisions they
make (any aspect of their lives)
➔ They influence governments choices with regards to the economic policies they
choose to adopt and spend money on
The Basic Economic Problem: Scarcity
➔ The basic economic problem is that resources are scarce
◆ Scarcity arises because human wants for goods and services are unlimited
but the resources required to produce them are 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
◆ It involves working out how to allocate limited resources as effectively as
possible to satisfy people’s unlimited wants and needs
➔ In a free market, scarcity has a direct influence on prices
◆ The scarcer a resource, ↑ price / The less scarce a resource, ↓ price
v
, ➔ Three parts of the economic problem (economy need to provide answers):
◆ What is to be produced?
◆ How is production to be organised?
◆ Who gets what?
jWhat Economies need to produce goods (called factors of production):
Land is not only land itself but all natural resources below the earth, on the ground, in the
atmosphere and in the sea, such as oil, coal, wheat, water.
➔ Non-renewable resources (coal, oil, gold and copper, gas) cannot be naturally
replenished at a pace that keeps up with consumption. It is finite in supply and so
non-sustainable for future generations. The stock level decreases over time as it is
consumed. Recycling/finding substitutes, such as wind farms, can reduce the rate of
decline of the resource
➔ Renewable resources Renewable resources can be replenished, so the stock level of
the resources can be maintained over a period of time/ infinite supply. (solar, wind
energy, fish stocks, forests (unless exploitation), water). As long as the rate of
consumption is less than or equal to the rate of replenishment, the stock will not fall.
➔ Benefits: Reduction in carbon emissions → can slow down climate change/ increase
life expectancy or quality of life. Employment creation→ reduce poverty/ inequality →
greater investment into renewable energy.
Labour is the collective physical and mental effort of all the workers in an economy. The
value of a worker is their human capital. Education and training will increase the value of
that human capital, + productivity.
Human capital is regarded by economists as complementary to investment in physical
capital, such as new buildings, latest technology…
Capital refers to the man-made resources that are used to produce goods or services in the
future
➔ Working capital: is stocks of raw material, semi-manufactured goods and finished
products waiting to be sold.
➔ Fixed capital is the stock of factories, offices, plants and machinery. It won’t be
transformed into a final product. It is used to transform working capital into finished
products.
Enterprise (initiative) is often shown by entrepreneurs. They organise production and then
take risks in order to try and earn big rewards. (knowing bankruptcy). Economies
encourages enterprise because:
➔ If an economy is successful it will pay tax (government get more money)
➔ Successful businesses create employment
➔ Entrepreneurs create new products that can improve people’s life
These factors of production are inputs, and they produce outputs in the form of goods and
services
,Opportunity Cost
➔ Opportunity cost is the loss of the next best alternative when making a decision
➔ Due to the problem of scarcity, choices have to be made about how to best allocate
limited resources amongst competing wants and needs
➔ Consumers must choose what to buy out of their limited incomes (level of
satisfaction). Producers must choose what to produce with their limited resources
(based on profit). Governments must choose what services to provide out of their
limited tax revenues (maximise social welfare)
➔ Issues: Not all factors have alternatives. Some alternatives are unknown. Agents
may lack information on them. It can be difficult to switch some factors to another use
Economic goods vs free goods:
➔ Economic goods: is a good that derives utility/a good with scarcity and therefore an
opportunity cost/scarcity means people may be willing to pay for it
➔ Free goods: a resource which is so abundant that its availability is not a constraint on
economic activity/in unlimited supply/a good with no opportunity cost/good does not
have a price
Scarcity is not the same as shortage.
➔ A shortage is when the demand for a product is greater than its supply.
Scarcity is when wants for a product are greater than its supply.
Demand means what consumers want and can afford to buy. Therefore if there is enough of
a product to meet the demand of those consumers who want and can afford to pay the price
there is no shortage. However the product will remain scarce because of all those
consumers who want the product but cannot afford to pay the price
Production Possibility Frontiers
➔ The PPF is an economic model that shows the maximum output potential for an
economy when all its resources are fully / efficiently employed
◆ Capital goods are man-made aids to production of consumer goods.
Includes factory, machinery, robotics, and tools.
◆ Consumer goods directly provides utility to consumers, sold to individuals to
satisfy their wants and needs
It gives no indication of which combination of goods is best and so countries have a choice
of what to produce: economics is concerned with explaining why they chose this point. The
curve demonstrates the possible combinations of the maximum output this economy can
produce using all of its resources
Trade-offs: the sacrifice of the production of one good when making a decision to make more
of another good. This is often illustrated by a movement along a production possibility curve.
People face a trade-off when they make a choices
D. More capital goods are being produced at W / capital goods help to
produce more goods in the future.
, The use of PPF to depict opportunity cost using marginal analysis
➔ To produce one more unit of capital goods, this economy must give up
production of some units of consumer goods (limited resources)
➔ If this economy moves from point C (120, 150) to D (225, 100), the
opportunity cost of producing an additional 105 units of consumer goods
is 50 capital goods
➔ A movement in the PPF occurs when there is any change in the
allocation of existing resources within an economy
The use of PPF to depict efficiency, inefficiency, attainable and unattainable production:
◆ Producing at any point on the curve represents productive efficiency
◆ Any point inside the curve represents inefficiency (point E). resources are
not used to their full productive potential. There is the potential to use these
resources more efficiently, which would shift production closer to the curve. In
other words, there is the unemployment of economic resources.
◆ Any point outside the curve is unattainable (point F) aspirational. is not yet
attainable with the current resources.
◆ Not every combination of goods produced will maximise welfare and there
could be only one point which does this.
Efficiency and the production possibility frontier: Every point on the Production
Possibility Frontier (PPF) is productively efficient. Not every point is allocatively efficient.
Efficiency refers to: lack of waste
Shifts in the PPF
Economic growth occurs when there is an increase in the productive
potential of an economy. More consumer goods and more capital goods
can now be produced using all of the available resources
It can be caused by: This can be achieved with the use of supply side
policies.
➔ Improve quality: training and education on labour (more productive workforce) and
better technology
➔ Improve quantity: change in migration policies (allow more foreign workers ↑
production possibilities). An increase in immigration means more labour resources
available for use in production
◆ An increase in demand for goods does not guarantee an increase in
investment / outward shift in the production possibility frontier.
◆ A decrease in unemployment would just move the actual output closer to the
production possibility frontier and not shift it.
