Nature of economics
Economics as a social science
● Economics is a social science - it studies society and behaviour
● Ceteris paribus - all other things being equal
○ It is used to rule out the possibility of other factors changing
● Economic models simplify real world problems to explainable relationships
Positive and normative statements
● Positive statement - a statement that is testable
● Normative statement - a statement that contains a value judgement and
cannot be tested
○ Often used in economic policy to persuade others of the writer’s view
The economic problem
● Wants are infinite but resources are scarce so decisions have to be made
about their allocation as not all wants / needs can be fully satisfied
● There are 4 factors of production
○ Land - natural resource
○ Labour - quantity and quality of the people available for work
○ Capital - man made goods used in the production of other goods
○ Enterprise - individuals who organise factors of production & take risks
● Economies with high quality factors of production have good factor
endowments
● Sustainable resources can be exploited without being diminished
● Renewable resources can be replaced
● Non-renewable resources cannot be replaced
● Economic goods are finite at one point in time so have a value
● Free goods are infinite e.g. air
● Opportunity cost - the benefit forgone from the next best alternative when an
economic decision is made
PPFs
● A PPF curve shows the combinations of goods that can
be produced when all resources are being used fully and
efficiently
● On the PPF curve - maximum productive potential and
an efficient allocation of resources
, ● Economic growth - outwards shift from one curve to another
● Economic decline - inwards shift (conflict / natural disaster)
○ Shows a reduction in the number of factors of production available
● Inefficient allocation of resources - lying within the PPF curve
● Productive efficiency - producing the maximum number of goods with current
resources and production takes place at the lowest cost
○ Occurs at any point on the curve
● Allocative efficiency - producing goods and services that are demanded by
consumers
○ Occurs at one point on the curve
Capital vs consumer goods
● Capital goods are used in the production of other goods
● Consumer goods are used by consumers to satisfy their wants / needs
● There is a trade off between capital and consumer goods
○ More capital goods now = less consumer goods but more in the future
○ More consumer goods now = less capital goods now and less
consumer goods in the future
The law of diminishing marginal returns / opportunity cost
● As production increases, marginal output decreases as one factor of
production is assumed to be fixed in the short run
● Marginal cost = opportunity cost in PPFs
● Inverted PPF - opportunity cost decreases at higher levels of output
● Linear PPF - opportunity cost remains the same
● Convex PPF - opportunity cost increases at higher levels of output
Specialisation and the division of labour
● Productivity - unit of output per unit of input
● Labour productivity - unit of output per worker
The division of labour
● Smith said that one worker can produce 10 pins a day but if 10 workers
specialise they can produce 48,000. This happens because:
○ Workers improve their skills
○ They do not waste time moving between tasks
○ They find better ways of doing their job / use machinery
○ It is more cost effective to provide them with capital
● Advantages of the division of labour
○ More efficient and higher output
● Disadvantages of the division of labour
, ○ Monotonous / boredom - may reduce productivity
○ Workers cannot be redeployed if needed - inflexible
Specialisation
● Specialisation - the production of a limited range of goods in cooperation with
others so a whole range of goods is produced
● Advantages
○ More efficient and higher world output
○ Benefits from trade - larger markets, economies of scale
○ More choice and quality
● Disadvantages
○ Can lead to mass disruption
○ Over reliance on a single region
○ Risk of structural unemployment
The functions of money
● Store of value
○ Ruined by inflation
● Unit of account
○ Allows prices to be compared
○ Reflects the value that society places on a good
● Medium of exchange
○ Both parties have to know about the currency
○ Useful when there is a double coincidence of wants
○ Allowed for the expansion of specialisation and trade
● Standard of deferred payment
○ Ruined by inflation
● NOT a method of barter
Free market economies, mixed economy and command economy
Economic system - a complex network of individuals, organisations and institutions
and their social and legal interrelationships which allocate resources
Free market economy
● The basic problem of scarcity is resolved mainly through the market
● Profit determines what is produced and competition ensures efficiency
● Friedrich Hayek - The Road to Serfdom
○ Government intervention leads to the imposition of the will of the
minority on society
○ Governments should only intervene in the provision of public goods
Economics as a social science
● Economics is a social science - it studies society and behaviour
● Ceteris paribus - all other things being equal
○ It is used to rule out the possibility of other factors changing
● Economic models simplify real world problems to explainable relationships
Positive and normative statements
● Positive statement - a statement that is testable
● Normative statement - a statement that contains a value judgement and
cannot be tested
○ Often used in economic policy to persuade others of the writer’s view
The economic problem
● Wants are infinite but resources are scarce so decisions have to be made
about their allocation as not all wants / needs can be fully satisfied
● There are 4 factors of production
○ Land - natural resource
○ Labour - quantity and quality of the people available for work
○ Capital - man made goods used in the production of other goods
○ Enterprise - individuals who organise factors of production & take risks
● Economies with high quality factors of production have good factor
endowments
● Sustainable resources can be exploited without being diminished
● Renewable resources can be replaced
● Non-renewable resources cannot be replaced
● Economic goods are finite at one point in time so have a value
● Free goods are infinite e.g. air
● Opportunity cost - the benefit forgone from the next best alternative when an
economic decision is made
PPFs
● A PPF curve shows the combinations of goods that can
be produced when all resources are being used fully and
efficiently
● On the PPF curve - maximum productive potential and
an efficient allocation of resources
, ● Economic growth - outwards shift from one curve to another
● Economic decline - inwards shift (conflict / natural disaster)
○ Shows a reduction in the number of factors of production available
● Inefficient allocation of resources - lying within the PPF curve
● Productive efficiency - producing the maximum number of goods with current
resources and production takes place at the lowest cost
○ Occurs at any point on the curve
● Allocative efficiency - producing goods and services that are demanded by
consumers
○ Occurs at one point on the curve
Capital vs consumer goods
● Capital goods are used in the production of other goods
● Consumer goods are used by consumers to satisfy their wants / needs
● There is a trade off between capital and consumer goods
○ More capital goods now = less consumer goods but more in the future
○ More consumer goods now = less capital goods now and less
consumer goods in the future
The law of diminishing marginal returns / opportunity cost
● As production increases, marginal output decreases as one factor of
production is assumed to be fixed in the short run
● Marginal cost = opportunity cost in PPFs
● Inverted PPF - opportunity cost decreases at higher levels of output
● Linear PPF - opportunity cost remains the same
● Convex PPF - opportunity cost increases at higher levels of output
Specialisation and the division of labour
● Productivity - unit of output per unit of input
● Labour productivity - unit of output per worker
The division of labour
● Smith said that one worker can produce 10 pins a day but if 10 workers
specialise they can produce 48,000. This happens because:
○ Workers improve their skills
○ They do not waste time moving between tasks
○ They find better ways of doing their job / use machinery
○ It is more cost effective to provide them with capital
● Advantages of the division of labour
○ More efficient and higher output
● Disadvantages of the division of labour
, ○ Monotonous / boredom - may reduce productivity
○ Workers cannot be redeployed if needed - inflexible
Specialisation
● Specialisation - the production of a limited range of goods in cooperation with
others so a whole range of goods is produced
● Advantages
○ More efficient and higher world output
○ Benefits from trade - larger markets, economies of scale
○ More choice and quality
● Disadvantages
○ Can lead to mass disruption
○ Over reliance on a single region
○ Risk of structural unemployment
The functions of money
● Store of value
○ Ruined by inflation
● Unit of account
○ Allows prices to be compared
○ Reflects the value that society places on a good
● Medium of exchange
○ Both parties have to know about the currency
○ Useful when there is a double coincidence of wants
○ Allowed for the expansion of specialisation and trade
● Standard of deferred payment
○ Ruined by inflation
● NOT a method of barter
Free market economies, mixed economy and command economy
Economic system - a complex network of individuals, organisations and institutions
and their social and legal interrelationships which allocate resources
Free market economy
● The basic problem of scarcity is resolved mainly through the market
● Profit determines what is produced and competition ensures efficiency
● Friedrich Hayek - The Road to Serfdom
○ Government intervention leads to the imposition of the will of the
minority on society
○ Governments should only intervene in the provision of public goods
