1
AS ECONOMICS: MARKETS AND MARKET FAILURE
3.1.1 – Economic Methodology and the economic problem
3.1.1.1 Economic methodology
Statement types
Positive statements Statements that can be tested against real-world data
Normative statements Opinions that require value judgements to be made
Value judgements Statements or opinions that are not testable/verifiable
- Depend on views of individual
Economic models
Economic models Models used to show the essential characteristics of complicated
economic conditions in order to analyse them and predict the
result of changes of variables
3.1.1.2 The nature and purpose of economic activity
Nature and purpose of economic activity
Central purpose of - To produce goods and services to meet needs and wants
economic activity - Increased economic welfare for citizens
Goods Tangible products
Services Intangible products which provide intangible benefits
Economic welfare Benefit or satisfaction an individual or society gets from
allocation of resources judged by:
- How well off people feel
- How much people have
- Standard of living
- Physical wellbeing
Key economic decisions - What to produce
- How to produce
- Who is to benefit from the goods and services produced
Economic objectives of various members
Consumers Rational choices designed to maximise own welfare
Workers Maximise gain from working
- Higher wages
- Better working conditions
Firms Maximise profits (when total firm revenue > total costs)
Governments - Increase welfare of people
- Increase own popularity
3.1.1.3 Economic resources
1|T. Chaudhary
,2
Economic resources
Need Something that is essential for human survival e.g. food
Want Something desirable e.g. branded products but not necessary for human survival
FACTOR OF PRODUCTION - Inputs into the production process FACTOR INCOME
Capital Stock of goods used to make other goods Interest
Man-made aids of production
Enterprise Risk takers who bring factors of production together Profit
Land Minerals, land itself, resources taken from world Rent
Labour Potential workforce Wages
(Physical people, skills, abilities, intelligence)
Factor market Market for factors of production
Renewable resources Resources that are able to be replenished over time
EG: forests, fish stocks
Non-renewable resources Resources that are not able to be replenished over time
EG: oil, coal
3.1.1.4 Scarcity, choice and the allocation of resources
Economic problem
Economic problem How to allocate scarce resources when there are infinite wants
Scarcity means choices have to be made→ opportunity cost
Opportunity cost Next best alternative forgone when economic decision is made
Economic goods Scarce goods with an opportunity cost
Free goods Goods that aren’t scarce with no opportunity cost
3.1.1.5 Production possibility diagrams
Production possibility frontier (PPF)
Production Curve depicting the various combinations of two products that can
possibility be produced
frontier Indicates maximum possible output that can be achieved:
- In a particular time period
- Given a fixed set of resources
- Given fixed technology
Point within PPF → not all resources being used to full capacity
Not possible to go beyond PPF in the short term
Law of diminishing returns – as more resources are allocated
to product A, the extra output gets smaller so more of product B
has to be given up → occurs because not all factor inputs are
equally suited to producing items
Productive - Firm: Operating at minimum total cost producing maximum total output from inputs
efficiency - Economy: Cannot produce more of one good without producing less of another
- Any point on the PPF is productively efficient
Allocative - Output level where the price equals the Marginal Cost (MC) of production
efficiency
2|T. Chaudhary
, 3
- Reached where it is not possible to make anyone better off without making
someone worse off → Pareto efficiency
- Therefore, this is when there is optimal distribution of goods and services
PPF and opportunity cost
Shift Product A Product B Opportunity cost
U→V W→Y X→Z Reduction in product A (W – Y)
V→U Y→W Z→X Reduction in product B (Z – X)
Factors which would cause the PPF to shift outward
Finding new resources New factors of production:
- Increase in population
- Discovering mineral deposits or oilfield
Improving technology - Fewer resources required to produce unit of output
- Resources freed up to be used in other areas
Increasing productivity - Workers produce more output with same inputs
- Capital investment → increased production potential
Improving quality - Invest in human capital
of resources - Increases productivity and thus output
Methods of doing this:
- Division of labour
- Specialisation
Productivity Measure of efficiency: ratio of inputs to outputs
Labour productivity Output per worker per period of time
Human capital Skills, abilities, motivation and knowledge of labour
Division of labour Breaking production process down into sequence of tasks
- Each worker assigned to particular task
Specialisation - Production of limited range of goods
- By factor of production, firm or country
- In cooperation with others so full range produced
- Medium of exchange needed to benefit from specialising
Part-shifts of the PPF
1. Efficiency and productivity increases in production of one good
2. Increase in productive potential for good B
3. No increase in maximum output of A
4. PPB1 shifts to PPB2
Factors which would cause the PPF to shift inward
3|T. Chaudhary
AS ECONOMICS: MARKETS AND MARKET FAILURE
3.1.1 – Economic Methodology and the economic problem
3.1.1.1 Economic methodology
Statement types
Positive statements Statements that can be tested against real-world data
Normative statements Opinions that require value judgements to be made
Value judgements Statements or opinions that are not testable/verifiable
- Depend on views of individual
Economic models
Economic models Models used to show the essential characteristics of complicated
economic conditions in order to analyse them and predict the
result of changes of variables
3.1.1.2 The nature and purpose of economic activity
Nature and purpose of economic activity
Central purpose of - To produce goods and services to meet needs and wants
economic activity - Increased economic welfare for citizens
Goods Tangible products
Services Intangible products which provide intangible benefits
Economic welfare Benefit or satisfaction an individual or society gets from
allocation of resources judged by:
- How well off people feel
- How much people have
- Standard of living
- Physical wellbeing
Key economic decisions - What to produce
- How to produce
- Who is to benefit from the goods and services produced
Economic objectives of various members
Consumers Rational choices designed to maximise own welfare
Workers Maximise gain from working
- Higher wages
- Better working conditions
Firms Maximise profits (when total firm revenue > total costs)
Governments - Increase welfare of people
- Increase own popularity
3.1.1.3 Economic resources
1|T. Chaudhary
,2
Economic resources
Need Something that is essential for human survival e.g. food
Want Something desirable e.g. branded products but not necessary for human survival
FACTOR OF PRODUCTION - Inputs into the production process FACTOR INCOME
Capital Stock of goods used to make other goods Interest
Man-made aids of production
Enterprise Risk takers who bring factors of production together Profit
Land Minerals, land itself, resources taken from world Rent
Labour Potential workforce Wages
(Physical people, skills, abilities, intelligence)
Factor market Market for factors of production
Renewable resources Resources that are able to be replenished over time
EG: forests, fish stocks
Non-renewable resources Resources that are not able to be replenished over time
EG: oil, coal
3.1.1.4 Scarcity, choice and the allocation of resources
Economic problem
Economic problem How to allocate scarce resources when there are infinite wants
Scarcity means choices have to be made→ opportunity cost
Opportunity cost Next best alternative forgone when economic decision is made
Economic goods Scarce goods with an opportunity cost
Free goods Goods that aren’t scarce with no opportunity cost
3.1.1.5 Production possibility diagrams
Production possibility frontier (PPF)
Production Curve depicting the various combinations of two products that can
possibility be produced
frontier Indicates maximum possible output that can be achieved:
- In a particular time period
- Given a fixed set of resources
- Given fixed technology
Point within PPF → not all resources being used to full capacity
Not possible to go beyond PPF in the short term
Law of diminishing returns – as more resources are allocated
to product A, the extra output gets smaller so more of product B
has to be given up → occurs because not all factor inputs are
equally suited to producing items
Productive - Firm: Operating at minimum total cost producing maximum total output from inputs
efficiency - Economy: Cannot produce more of one good without producing less of another
- Any point on the PPF is productively efficient
Allocative - Output level where the price equals the Marginal Cost (MC) of production
efficiency
2|T. Chaudhary
, 3
- Reached where it is not possible to make anyone better off without making
someone worse off → Pareto efficiency
- Therefore, this is when there is optimal distribution of goods and services
PPF and opportunity cost
Shift Product A Product B Opportunity cost
U→V W→Y X→Z Reduction in product A (W – Y)
V→U Y→W Z→X Reduction in product B (Z – X)
Factors which would cause the PPF to shift outward
Finding new resources New factors of production:
- Increase in population
- Discovering mineral deposits or oilfield
Improving technology - Fewer resources required to produce unit of output
- Resources freed up to be used in other areas
Increasing productivity - Workers produce more output with same inputs
- Capital investment → increased production potential
Improving quality - Invest in human capital
of resources - Increases productivity and thus output
Methods of doing this:
- Division of labour
- Specialisation
Productivity Measure of efficiency: ratio of inputs to outputs
Labour productivity Output per worker per period of time
Human capital Skills, abilities, motivation and knowledge of labour
Division of labour Breaking production process down into sequence of tasks
- Each worker assigned to particular task
Specialisation - Production of limited range of goods
- By factor of production, firm or country
- In cooperation with others so full range produced
- Medium of exchange needed to benefit from specialising
Part-shifts of the PPF
1. Efficiency and productivity increases in production of one good
2. Increase in productive potential for good B
3. No increase in maximum output of A
4. PPB1 shifts to PPB2
Factors which would cause the PPF to shift inward
3|T. Chaudhary
