Microeconomics Topic 1: The Economic Problem

Microeconomics Topic 1: The Economic Problem 1.1 Unit content Six topics: 1.1.1 Economics as a social science 1.1.2 Positive and normative economic statements 1.1.3 The economic problem 1.1.4 Production possibility frontiers 1.1.5 Specialisation and the division of labour 1.1.6 Free market economies, mixed economy and command economy

1.1.1 Economics as a social science - syllabus Microeconomics Topic 1: The Economic Problem 1.1.1 Economics as a social science - syllabus Students should be able to: Explain the process of thinking like an economist: the process of developing models in economics, including the need to make assumptions Define ‘ceteris paribus’ and explain its use in building models Explain why economists are unable to carry out scientific experiments

1.1.1 Introduction What is economics? Economics is usually divided into two parts: microeconomics and macroeconomics. What is the difference?

1.1.1 Models and assumptions Microeconomics Topic 1: The Economic Problem 1.1.1 Models and assumptions Economics is a social science: Economists develop models. What is a model? But models require assumptions.

1.1.1 What are the assumptions? Microeconomics Topic 1: The Economic Problem 1.1.1 What are the assumptions? “Free school meals for children at infant school will reduce the cost in the future for the NHS” Assumptions:

Microeconomics Topic 1: The Economic Problem 1.1.1 Ceteris paribus Ceteris paribus is a _______ phrase meaning “other things being equal”. It is used in economics when we focus on changes in one variable while holding other influences constant

1.1.1 Why can’t economists use scientific experiments? Microeconomics Topic 1: The Economic Problem 1.1.1 Why can’t economists use scientific experiments?

1.1.2 Positive and normative economic statements - syllabus Microeconomics Topic 1: The Economic Problem 1.1.2 Positive and normative economic statements - syllabus Students should be able to: Distinguish between positive and normative economic statements Assess the role of value judgements in influencing economic decision making and policy

1.1.2 Value judgements Value judgements are statements or opinions that are not testable (cannot be verified) and depend on the views of the individual and the values they hold. E.g.

Microeconomics Topic 1: The Economic Problem 1.1.2 Normative statements Normative statements are based on value judgements which cannot be proven or tested as true or false. E.g. So normative statements depend on ___________________________ Value judgements influence economic decision making and policy.

1.1.2 Positive statements Positive statements are statements that can be tested against real data. Positive statements are more objective and scientific. E.g. Note: positive statements can be tested and possibly found to be _________

1.1.2 Positive and normative statements Microeconomics Topic 1: The Economic Problem 1.1.2 Positive and normative statements _______ statements are assertions of a fact They can be tested and proved or disproved. They are value free and are scientific or objective. ________ statements are value judgements They cannot be tested as true or false. They often contain words such as fair or unfair. Remember to read the news – look for examples!

1.1.3 The economic problem - syllabus Microeconomics Topic 1: The Economic Problem 1.1.3 The economic problem - syllabus Students should be able to: Explain the problem of scarcity – where there are unlimited wants and finite resources Distinguish between renewable and non-renewable resources Evaluate the importance of opportunity costs to economic agents (consumers, producers and government)

What do you need? What do you want? 1.1.3 Needs and wants What do you need? What do you want?

1.1.3 The Economic Problem and opportunity cost Microeconomics Topic 1: The Economic Problem 1.1.3 The Economic Problem and opportunity cost The basic economic problem is that there are __________ wants and ____________ resources. Who does this problem affect? ___________________________________ Resources are scarce (finite or limited). If resources (e.g. money) are used for one thing (e.g. buying a ___________) then they cannot be used for something else (e.g. buying a ___________). This is called opportunity cost.

1.1.3 Definition and example of opportunity cost Microeconomics Topic 1: The Economic Problem 1.1.3 Definition and example of opportunity cost So opportunity cost is the next best alternative foregone (given up) when an economic decision is made. Note: it is only the next best alternative not a range of alternatives. E.g. if the government builds a new toll road for £Xmillion pounds the opportunity cost could be ____________________________ Drivers will have to pay £10 to use the road and their opportunity cost could be _______ ______________________________

1.1.3 Opportunity cost questions 2013-14 costs Microeconomics Topic 1: The Economic Problem 1.1.3 Opportunity cost questions 2013-14 costs Bone marrow transplant Cochlear transplant Gastric (stomach) by-pass Hip replacement Liver transplant Natural birth in NHS hospital One round of IVF treatment Planned caesarean in NHS hospital £70,000 £70,000 £17,000 £8,900 £6,000 £5,000 £2,400 £1,800

Microeconomics Topic 1: The Economic Problem 1.1.3 Economics agents In economics we tend to talk about three groups of economic agents. Which are the three key groups of economic agents? If is often a good idea to evaluate how these three will be affected.

Microeconomics Topic 1b: The Economic Problem - economic resources, objectives and choice 1.1.3 Factors of production Factors of production are the economic resources used for producing goods and services. What do you need to produce goods?

1.1.3 Examples of factors of production Land includes Labour includes Capital: Enterprise: NOTE capital has different meanings but in Economics capital can be used to generate income. So cash or a bank loan would not count as capital (in economic terms); it is what the money is used for which is the factor of production.

Microeconomics Topic 1: The Economic Problem 1.1.3 Resources A resource is a factor of production used to produce goods and services. There is a wide range of resources ranging from renewable resources (things which can be replenished e.g. ______________) to non-renewable resources (e.g. _______ ___________). This is an exam definition from June 2014, what is it defining? “resources that can be replenished or sustained for future generations”

1.1.3 Renewable versus non-renewable resources Microeconomics Topic 1: The Economic Problem 1.1.3 Renewable versus non-renewable resources Renewable resources are also called sustainable resources. What is a sustainable resource? E.g.? Non-renewable resources are also known as finite resources (or finite economic resources). E.g.

1.1.3 Free goods versus economic goods Microeconomics Topic 1: The Economic Problem 1.1.3 Free goods versus economic goods Free goods are those which are not scarce and they have no opportunity cost. E.g. Economic good are goods which are scarce and have an ______________ cost

1.1.4 Production possibility frontiers - syllabus Microeconomics Topic 1: The Economic Problem 1.1.4 Production possibility frontiers - syllabus Students should be able to: Use PPFs to depict: the maximum productive potential of an economy; opportunity cost (through marginal analysis), economic growth or decline; the efficient (or inefficient) allocation of resources; possible and unobtainable production Distinguish between movements along and shifts in PPFs and assess possible causes of such changes Distinguish between capital and consumer goods

1.1.4 The production possibility frontier A production possibility frontier shows the different combination of economic goods which an economy is able to produce if all resources are used. For example consider an island which can only produce wine or grain. In a given period of time islanders can choose to produce only wine, only grain or a combination of the two according to the table on the next slide:

1.1.4 Example of PPF: plot this data Wine (thousands of bottles) Grain (thousands of bushels) 15 5 14 9 12

Microeconomics Topic 1: The Economic Problem 1.1.4 PPF questions The PPF shows the different combinations of output for this island if all resources are used to their full potential. What would happen at point a? What would happen at point b?

1.1.4 PPF and productive efficiency Points on the PPF occur when the country is using its resources efficiently. This is called productive efficiency. It is producing as much as physically and technologically possible given the technology at the time. Points on the PPF do not necessarily maximise economic welfare but they do show that resources are not being _______

Microeconomics Topic 1: The Economic Problem What does a PPF show? 1.1.4 PPF summary What does a PPF show?

1.1.4 PPF and opportunity cost Microeconomics Topic 1: The Economic Problem 1.1.4 PPF and opportunity cost The PPF also illustrates the idea of choice and opportunity cost. What does a movement along the PPF show? The PPF is curved and so moving along does not show a constant opportunity cost – opportunity cost is ____________

1.1.4 PPF and opportunity cost examples Microeconomics Topic 1: The Economic Problem 1.1.4 PPF and opportunity cost examples If we were producing 12000 bushels of grain and then changed to produce 15000 bushels of grain what is the opportunity cost? 12,000 bushels grain -> _________ bottles wine 15,000 bushels grain -> _________ bottles wine Opportunity cost = ________ bottles of wine What is the opportunity cost of 12000 bottles of wine? It is ______ bushels of grain June 2010

1.1.4 Straight line PPF Sometimes PPFs are shown as straight lines. If they spent half their time on each what would A produce? What would B produce? What would the total production be? When would output be maximised?

1.1.4 PPF and economic growth Microeconomics Topic 1: The Economic Problem 1.1.4 PPF and economic growth Why might the economy be able to shift to the right of its PPF in the future? What is economic growth?

1.1.4 Reasons for economic growth Microeconomics Topic 1: The Economic Problem 1.1.4 Reasons for economic growth How can an economy grow?

1.1.4 Economic growth – new or more resources How could an economy ‘find’ new resources? How could an economy improve the quantity of resources? How could an economy improve the quality of existing resources?

Microeconomics Topic 1: The Economic Problem 1.1.4 PPF and inward shifts When might an economy shift to the left of its PPF? Sketch this.

1.1.4 PPF – change in shape If efficiency and productivity increases in the production of one good rather than all goods then the PPF can change shape. E.g. technological improvements can mean that one good can be produced more easily without impacting on the other. Sketch this

1.1.4 Consumer and capital goods Often a PPF is used to show the different combinations of consumer goods and capital goods that the whole economy can produce. Consumer goods are items used by consumers to meet their needs or wants (e.g. ___________). They are also known as final goods. They can be divided into consumer durable goods and non-durable consumer goods.

1.1.4 Capital goods and economic growth Microeconomics Topic 1: The Economic Problem 1.1.4 Capital goods and economic growth Capital goods are goods used to produce other goods (e.g. ____________________). They are also known as producer goods or intermediate goods. Capital goods are very important for economic growth as they are used to increase the future capacity of the economy. Why is education a capital good?

1.1.4 Investment and consumption Microeconomics Topic 1: The Economic Problem 1.1.4 Investment and consumption The purchase of capital goods (by firms) is known as investment. The purchase of consumer goods (by individuals or households) is called consumption. In general, if an economy decides to produce capital goods rather than consumer goods, will the economy grow at a faster or slower rate?

Microeconomics Topic 1: The Economic Problem 1.1.4 Marginal cost The marginal cost of a good is the opportunity cost of producing one more unit of it. This is not the same as the total opportunity cost.

1.1.5 Specialisation and the division of labour - syllabus Microeconomics Topic 1: The Economic Problem 1.1.5 Specialisation and the division of labour - syllabus Students should be able to: Define specialisation and the division of labour (with reference to Adam Smith) Assess the advantages and disadvantages of specialisation and the division of labour Analyze the advantages and disadvantages of specialising in production Evaluate the functions of money (as a: medium of exchange, measure of value, store of value, method of deferred payment)

Microeconomics Topic 1: The Economic Problem 1.1.5 Productivity Productivity is defined as Increasing productivity means that a firm can E.g. if a firm makes 100 cakes with 4 workers, it could use specialisation so that each worker only does one part of the process (e.g. one worker could mix ingredients, one could prepare the cake tins etc.). This would mean that the firm might produce 200 cakes with the same 4 workers (they are more productive now).

1.1.5 Division of labour and specialisation Microeconomics Topic 1: The Economic Problem 1.1.5 Division of labour and specialisation What is division of labour? What is specialisation?

Microeconomics Topic 1: The Economic Problem 1.1.5 What are the advantages of division of labour and specialisation?

Microeconomics Topic 1: The Economic Problem 1.1.5 What are the disadvantages of division of labour and specialisation?

Microeconomics Topic 1: The Economic Problem 1.1.5 exam hints To ____________ from specialisation it is necessary to have an ____________ means of exchanging goods and ____________. Specialisation should ____________ labour ____________ but it can occur even when production is low e.g. for very _____________ jobs. benefit, complicated, efficient, increase, productivity, services June 2011

1.1.5 What are the functions of money? Microeconomics Topic 1: The Economic Problem 1.1.5 What are the functions of money? A medium of exchange – A measure of value – A store of value – A method of deferred payment – e.g.

1.1.6 Free market, mixed and command economy - syllabus Microeconomics Topic 1: The Economic Problem 1.1.6 Free market, mixed and command economy - syllabus Students should be able to: Distinguish between free market, mixed and command economies (with reference to Adam Smith, Friedrich Hayek and Karl Marx) Assess the advantages and disadvantages of a free market economy and a command economy Evaluate the role of the state in a mixed economy

economic, increase, needs, produced, system, whom 1.1.6 Economic systems An economic system tries to answer three questions: What should be _____________? How should it be produced? For _______ should it be produced? If we could organise a ____________ that would meet wants and __________ more effectively then overall __________ welfare would __________. economic, increase, needs, produced, system, whom

1.1.6 Free market and mixed economies Microeconomics Topic 1: The Economic Problem 1.1.6 Free market and mixed economies Free market economies are where resources are allocated by market forces (demand and supply and the price mechanism). Command economies are where resources are allocated by the state. Mixed economies are where resources are partly allocated by the market (price mechanism) and partly by the government

1.1.6 Free market and mixed economies Microeconomics Topic 1: The Economic Problem 1.1.6 Free market and mixed economies What are the advantages and disadvantages of free market, command and mixed economies? Why are there mixed economies?