Flashcards · 9708 · AS Topic 1

Basic economic ideas and resource allocation (AS Level) flashcards

33 cards on AS Topic 1, subtopics 1.1 to 1.6. Pick a subtopic or study them all.

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1.1 Scarcity, choice and opportunity cost

Scarcity: Unlimited wants set against limited resources. The fundamental economic problem.
Opportunity cost: The sacrifice made by a choice, valued as the best option passed over.
Scarcity versus a shortage: Scarcity is permanent and applies to rich and poor alike (and to time as well as money). A shortage is a market event at one particular price, when quantity demanded exceeds quantity supplied.
A farm can grow 50 tonnes of wheat or 20 tonnes of barley. What is the opportunity cost of 1 tonne of barley, and of 1 tonne of wheat?: 1 tonne of barley costs 50 ÷ 20 = 2.5 tonnes of wheat. 1 tonne of wheat costs 20 ÷ 50 = 0.4 tonnes of barley.
What, how and for whom to produce: what each question asks: What: which goods and services, in what quantities. How: which method, e.g. labour-intensive or capital-intensive. For whom: how output is shared among people. A market shares it by ability to pay, which raises (normative) questions of fairness.

1.2 Economic methodology

Positive statement and normative statement: Positive: a statement of fact that can be tested against evidence (it may be false and still be positive). Normative: a value judgement about what ought to be. Watch for should, ought, fair, too much, better.
Ceteris paribus: All other things being equal: change one variable, hold the rest constant and observe its separate effect. It is an assumption, not a claim that other things never change.
Short run, long run and very long run: Short run: one or more factors of production cannot be changed. Long run: all factors can vary. Very long run: technology and the quality of factors can also change. They are defined by flexibility, not by calendar time.
Economics as a social science: method and limits: It uses scientific method (observe, model, hypothesise, test against data, refine) to study human behaviour in society. Limits: few controlled experiments, behaviour changes with expectations, and values enter policy advice.
Classify: "A subsidy raises output" and "The subsidy is unfair": "A subsidy raises output" is positive: it can be tested with evidence. "The subsidy is unfair" is normative: it rests on a value judgement.

1.3 Factors of production

Land, labour, capital and enterprise: definitions and rewards: Land: all natural resources used in production (rent). Labour: the physical and mental effort of people in production (wages). Capital: man-made goods used to produce other goods and services (interest). Enterprise: taking risks and organising the other factors (profit).
Human capital and physical capital: Human capital: skills, knowledge and health built up in workers; it cannot be sold and leaves with the worker. Physical capital: machines, tools and buildings used in production; it can be sold and stays if a worker leaves.
Division of labour: two benefits and two costs: Benefits: higher output per worker and lower unit costs (repetition builds speed; machines become worthwhile). Costs: boredom and lower motivation; narrow skills, so a risk of structural unemployment and a stoppage if one stage fails.
The role of the entrepreneur, and why profit is a residual: The entrepreneur takes risks and organises land, labour and capital. Profit is paid after everyone else, so it can be negative and a fall in sales hits it hardest. Rent, wages and interest are usually agreed in advance.
A stall has fixed costs of 900, a price of 4 and a variable cost of 1.50 per unit. Find the break-even output.: Break-even output = fixed costs ÷ (price − variable cost per unit) = 900 ÷ 2.50 = 360 units. At 500 units profit = 500 × 2.50 − 900 = 350.

1.4 Resource allocation in different economic systems

Market economy: Private owners decide through the price mechanism.
Planned economy: The state owns resources and decides through a central plan.
Mixed economy: Market and state both allocate resources. Real economies sit at different points between market and planned; none is pure, so the useful question is how far the state intervenes.
Market, planned and mixed economies: one strength and one weakness each: Market: responsive and efficient, but ignores those without income and under-provides public goods. Planned: can focus on national priorities, but suffers from poor information and weak incentives. Mixed: combines price signals with state correction, but government can also get it wrong.
Planners fix a price of 5 when demand is 450 units and the plan produces 350. What happens?: A shortage of 450 − 350 = 100 units, 22.2% of demand. Without a price rise, it appears as queues, rationing or an illegal market.
How does a market reallocate resources when demand for a product rises?: Shortage at the old price → price rises → profit per unit rises → firms offer more and bid for labour and materials → resources move in from less profitable uses. Nobody orders it: the price signal does the work.

1.5 Production possibility curves

Production possibility curve (PPC): The largest output pairs of two goods an economy can make in a period when every resource is fully and efficiently used and technology is fixed.
Straight-line PPC versus a PPC bowed out (concave to the origin): Straight: constant opportunity cost, because resources are equally good at both uses (rare). Bowed out: increasing opportunity cost, because resources are not equally suited to both uses; later units draw in poorly suited resources (typical).
What shifts a PPC outward, and what shifts it inward?: Outward: more resources (discoveries, labour force growth, investment), better quality (education, training, health), better technology. Inward: war or disaster destroying capital, emigration or illness, depleted resources. A pivot: capacity changes for one good only.
What does a point inside, on and outside a PPC show?: Inside: unemployment or inefficiency; both goods can rise with no opportunity cost. On: full employment and productive efficiency. Outside: unattainable until the curve shifts. A PPC cannot show the best point, which depends on preferences.
At 20 capital goods the PPC allows 72 consumer goods, but the economy makes 60. How much spare capacity is there?: 72 − 60 = 12 consumer goods, 12 ÷ 72 × 100 = 16.7% of the maximum. Moving to the curve gains 12 consumer goods with no loss of capital goods.
Potential growth versus actual growth on a PPC: Potential growth is an outward shift of the curve (more capacity). Actual growth needs the economy to produce more, moving towards or onto the new curve. Choosing more capital goods now costs consumer goods today but can raise future capacity.

1.6 Classification of goods and services

Free good and private (economic) good: Free good: no opportunity cost of supply; not scarce, no price. Private good: scarce, with an opportunity cost, normally priced, rivalrous and excludable.
Public good: A good that is non-excludable and non-rivalrous. It needs both properties.
Free rider, and why the market provides no public good: A free rider benefits from a good without paying for it. Because non-payers cannot be excluded, households wait for others to pay, the firm cannot earn revenue, and the market provides none or too little; government provides it from tax.
Merit good and demerit good: Merit good: under-consumed in a free market because consumers do not fully appreciate its benefits (imperfect information), e.g. education. Demerit good: over-consumed because consumers do not fully appreciate its harm, e.g. tobacco.
Exam trap: is a state school place a public good?: No. It is rivalrous and excludable. A good provided by the state is not necessarily a public good; education is a merit good.
Merit good: private demand P = 40 − 2Q, marginal social benefit P = 52 − 2Q, supply P = 4 + 2Q. Find the under-consumption.: Market: 40 − 2Q = 4 + 2Q, so Q = 9 (P = 22). Optimum: 52 − 2Q = 4 + 2Q, so Q = 12 (P = 28). Under-consumption = 3 units.