Economic concepts

So, what is economics?....

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1 The nature of economics

a) Economics as a social science: inability to conduct scientific experiments.

b) The development of models in economics based on assumptions.

c) The use of the ceteris paribus assumption in building models and drawing conclusions based on them.

Economics is seen as a social science, and perhaps one of the more 'sciencey' of social sciences - it likes to use observations to test hypotheses, or theories, and try to explain why we as humans organise our resources in the ways that we do.... In order to run these tests, models or scenarios need to be used and debated, with each of these models needing to use assumptions to be created.

This means we, as economics students, have to understand that all economic theory allows us to spot patterns and trends in human economic behaviour, but these trends can never be 100% infallible or perfect - there's always an evaluation to be made about any economic argument, a possible weakness or counter-argument that has to be considered. It is this evaluation that holds the key for your progress in ASA2 economics........

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2 Positive and normative economics

a) The distinction between positive statements and value judgements on economic issues.

b) The role of value judgements in influencing economic decision making and policy.

These observations, explanations and even evaluations all require economics students to master certain uses of language and identify what type of argument is being presented. The use of facts and evidence is central to any economics argument, and is called positive economics - it can be identified with the use of statistics alongside absolutist language and statements of fact - 'is', 'will lead to', 'is the same as', 'matches' etc etc....

These 'statements of fact' often report economics observations, which are then used in more detailed explanations about what will likely happen, or what caused things to happen. These explanatory sentences are more often opinion based and use more open-ended, qualified language such as 'might', 'could', possibly', 'should', is likely to', 'may' etc etc; and although they may use statistics, the language around those statistics suggests possibilities rather than just statements of fact. Arguments using these sorts of sentences are referred to as 'normative economics'

What is the basic economic problem?

However, regardless of the type of argument being used, economics students need something to argue about - the basic economic problem. This can be seen by looking at how we organise our societies and what priorities we have - our wants and our needs. What we want has no limit, is infinite, whereas what we need is limited + is finite. These wants and needs can be met with the use of resources, which like our desires are either infinite (renewable) or limited + finite (non-renewable). How we choose to use which resources, and in the pursuit of what, is the argument at the heart of economics as a subject.

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3 Scarcity

a) The problem of unlimited wants and finite resources.

b) The distinction between renewable and non-renewable resources.

c) The link between scarcity and opportunity cost.

d) The distinction between free goods and economic goods.

Those resources that are limited (finite, non-renewable), are also described as being 'scarce'. This 'scarcity' applies to all microeconomic and macroeconomic theory as it means we have to make a choice - if we choose this need to be met with these resources, then that other need can't be satisfied. This choice is referred to as the 'opportunity cost' of any economic decision about resources that is made, and measures what the next best alternative use of those resources could have been. In this way, we can keep track of the possible use of resources, and measure our decision making.

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4 Production possibility frontiers

a) The use of production possibility frontiers to depict:

• the maximum productive potential of an economy

• efficient or inefficient allocation of resources

• possible and unobtainable production

• opportunity cost (using marginal analysis)

• economic growth and decline.

b) The distinction between movements along, and shifts in, production possibility frontiers, and their possible causes.

c) The distinction between capital goods and consumer goods.

d) The significance of capital goods for productivity and economic growth.

Opportunity cost and the use of resources is obviously most easily managed on a day to day level by individuals, working within their domestic or business budgets. However, how do we keep track of these types of concepts when we look at economies as a whole? One way to simplify this extremely complicated process is with the use of visual aids, such as production possibility frontiers.

These diagrams allow us to measure how the production of one type of good impacts the production of another. For instance, how the production of consumer goods (goods designed for consumers who want to purchase phones, cars, cheeseburgers etc) can impact the production of capital goods (goods designed for producers who want to make + supply goods using machinery, transport, infrastructure etc..)

Any point within, on or outside the line can be used to indicate how efficient an economy is, with points inside indicating inefficiency, points on the line indicating maximum efficiency, and points outside the line targetting a level of production not yet possible. Points moving along the line indicate changes in an economy's production values and targets, and also the opportunity cost of the decisions taken to change those values/targets.

Any shift of the PPF itself can likewise demonstrate the changing capacity or limit of what an economy can produce, with lines shifting inwards towards the axes showing a shrinkage in the economy (natural disasters, war etc), whilst a shift outwards away from the axes shows economic growth (discovery, technological advance). Obviously, economies strive for growth, but why and how this is achieved needs examining further, later on.

Solutions to the problem I : Key Ideas

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Syllabus content

5 Specialisation;

a) The advantages and disadvantages of specialisation and the division of labour in organising production; Adam Smith’s views on the division of labour.

Coming back to the basic economic problem, before we get sidelined by exploring what we mean by economic growth, it is clear that the choices and decisions we make about resources need some kind of guidance. If we just make random guesses we will use resources unwisely, and never get close to meeting our needs or wants, wasting vital resources along the way.

As a result, there have been a number of economic theories that have emerged over the centuries, with Adam Smith, JM Keynes and Friedrich Hayek all responsible for ideas that continue to shape 21stC ideas. The father of modern economics was an 18thC philosopher from Edinburgh in Scotland whose ideas about the Industrial Revolution created economics as a subject - Adam Smith.

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5 The role of money and financial market

b) The function of money as a medium of exchange, a measure and store of value, and a method of deferred payment; the significance of these functions for specialisation.

c) The role of financial markets:

• to facilitate saving

• to make funds available to businesses and individuals

• to facilitate the exchange of goods and services

• to provide forward markets in commodities and currencies

• to provide a market for equities.

Smith's basic idea was...

For all of this to work however, money had to evolve from what it had been to something new...

Solutions to the problem II : Systems

6 Free market, mixed and command economies

a) The distinction between free market, mixed and command economies.

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6 Free market, mixed and command economies

b) The advantages and disadvantages of free market and command economies.

c) The role of the state in a mixed economy.

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