Fundamental

Positive economics

Positive economics deals with areas of the subject that can be proven to be right or wrong.

Normative economics

Normative economics deals with areas of the subject that are open to personal opinion and belief.

Ceteris paribus

All other things being equal (constant)”.

It holds all other variables unchanging, only the one examined in the model is changing. This allows economists to isolate a certain variable’s effect on another, thus easily examine the relationship between two variables.

Rational economic decision-making

An assumption that people behave rationally, i.e. consumers will seek to maximize their utility (benefits) and producers will seek to maximize their profits. This allows economists to make predictions about patterns of economic behavior.

Economics

A study of rationing systems. It studies the ways in which scarce resources are allocated to meet infinite needs and wants.

Microeconomics

Microeconomics studies the behaviours of individuals within an economy: consumers and producers in particular markets.

Macroeconomics

Macroeconomics takes a wider view and study an economy as a whole, i.e. economic variables affecting countries and governments.

Scarcity

Scarcity is the basic economic problem. Something is scarce when it is both limited in supply and desired. Scarcity exists because resources are finite and wants are infinite.

Sustainable development

It is defined as development which meets the needs of the present without compromising the ability of future generations to meet their own needs. Sustainability or sustainable resource use involves using resources in ways and at rates that do not reduce their quantity or quality over time.

Factors of production

The resources of land, labor, capital and management (entrepreneurship) that are used in the production of an economy’s outputs.

• Land is natural resources that an economy is endowed with, i.e. all raw materials used in the production.
• Labor is the human work used in the production, including both physical and mental (intellectual) contribution to production.
• Capital is the tools and technologies that is made by humans and is used to produce goods and services. It occurs as a result of investment.
• Management (entrepreneurship) is the factor of production that brings together the other three factors of production with the aim of making profit.

Payment of FoPs

• Land: rent
• Labour: wage
• Capital: interest
• Management: profit

The three basic economic questions

• What to produce?
• How to produce?
• For whom to produce?

Rationing system

The way that scarce factors of production (land, labour, capital and management) are used (allocated) to meet unlimited demand.

Planned economy

An economy in which the state determines prices and output of goods and services.

• All FoP are owned by the state.
• Profits, incentives, competition, role of prices in allocating resources are absent in the economy.
• Motive for production is social welfare, rather than profit.
• All decisions about what to produce, how to produce and for whom to produce are made by central planners (governments).
• Governments arrange all production, set prices and wages.

Free market economy

An economy in which markets, i.e. the interaction of consumers and producers, determine prices and output.

• All decisions about what to produce, how to produce and for whom to produce are made (by markets) according to price mechanism.

Price Mechanism = forces of D&S (buyers and sellers)

• There is no government intervention.
• Most FoP are privately owned.
• Profit motive provides incentives for production.
• The existence of market failure.

Mixed economy

An economy in which economic decisions are determined by both market forces and the state. It is a combination of a free-market system and a planned economy.

Advantages of free market

• Resources can be used efficiently, few shortages/surpluses: (Consumers and producers set prices.)
• Economic growth
• Freedom of economic choice

Disadvantages of free market

• Over-provision of demerit goods (cigarettes, alcohol, hard drugs): driven by high profit motive.
• Under-provision of merit goods (education, healthcare): produced only for who can afford, not for all.
• Damage to environment by pollution: resources used up too quickly.
• Some society members won’t survive: orphans, the very old/young, the sick, the long-term unemployed.
• Large firms dominate industries: high prices, efficiency loss, and excessive power.

Advantages of planning economy

• Merit goods can be provided by governments. (Governments invest in healthcare and education)
• Demerit goods can be limited by governments.
• Care for orphans, the sick, and the unemployed: (Governments provide social safety net.)

Disadvantages of planning economy

• Resource misallocation, shortages/surpluses: complicated to plan.
• Inefficient resources use: arbitrary decisions, no PM.
• Distorted incentives: hard to motivate workers, output/quality suffer.
• Loss of personal liberty and choice freedom: government dominance.
• Unpopular plans/corruption: government not share same aims as population majority.

Opportunity cost

The next best alternative foregone (sacrificed) when an economic decision is made.

Economic goods

Goods whose production involves the sacrifice of scarce resources and so have an opportunity cost. They are relatively scarce and so will have a price.

Free goods

They do not have an opportunity cost. They are not relatively scarce and so will not have a price, e.g. air, sea (salt) water, sand, sunlight.

A production possibilities curve

It shows the maximum combinations of goods and services that can be produced by an economy in a given time period, if all the resources in the economy are being used fully and efficiently and the state of technology is fixed.

Assumptions:

• Only two goods are produced in an economy (TWO-goods model)
• All resources are used fully and efficiently.
• Technology is fixed.

Shows the concepts of:

• Scarcity, choice, opportunity cost
• Unemployed resources and inefficiency
• Economic growth

The circular flow of income model

A simplified model of the economy that shows the flow of money through the economy.

The circular flow of income model

A simple model of the economy showing flows of goods and services and factors of production between firms and households.

Leakage

Income not passed on by households to domestic firms in circular flow of income.

Injections

Addition to income of domestic firms besides expenditure of households