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Micro Economics (3.1.1 Economic methodology and the economic problem. (3.1…
Micro Economics
3.1.1 Economic methodology and the economic problem.
3.1.1.1 Economic Methodology
Economics as a social:
The study of economics concerns investigating the relationships that humans have with the economic resources of land, labour, capital and enterprise. These resources within are in scarce supply, and so decisions must be made about how to allocate those resources within a society. Other social sciences include geography, history and psychology.
Similarities to and differences in methodology from natural and other sciences:
Whilst economics is not science like chemistry or physics, where there are absolute laws that be proven or disproven, people can make hypothesis about the relationship that humans have with scarce resources and test these hypotheses against economic data.
Stage 1:
A hypothesis (a theory or an assumption) is made and clearly defined.
Stage 2:
The hypothesis is tested using current real - world data.
Stage 3:
Based on the evidence collected, the hypothesis is either accepted or, rejected or modified.
The difference between positive and normative statements:
In economics we make both positive and normative statements. Positive statements are about what is and can be proven i.e. they are facts. Where as normative statements tend to be based on facts, but they cannot be proven i.e. they are opinions.
How value judgements influence economic decision making and policy:
Politicians would often like to believe that they are independent and make evidence - based decisions. For example, a decision to build a new airport in an area suffering from economic decline may be made with the intention of creating jobs as well as raising people out of poverty. But if the decision is made despite the negative impact that the airport will have on the environment, a value judgement has been implicitly or explicitly made that value jobs and wealth creation above the protection of the natural environment. Despite the desire for economic decisions entirely on fact, value judgements are always being made that will influence poverty.
People's views concerning the best option are influenced by the positive consequences of different decisions and by moral and political judgements:
The 'positive consequences' of political decisions are the measurable impacts that have been made. Taking the example above the new airport may create 20,000 new jobs at the cost of 100,000 tonnes of carbon dioxide being emitted into the atmosphere each year. Your view of the 'success' or otherwise of the decision to build the airport will be determined by your moral and political judgements about humanity and the environment.
3.1.1.2 The nature and purpose of economic activity
The central purpose of economic activity is the production of goods and services to satisfy needs and wants:
Traditional economic theory assumes that the central purpose of economic activity is the production of goods and services to satisfy peoples' unlimited wants and needs.
Wants are the goods and services that people desire, whereas needs are the goods and services people require to survive. It seems that there is a clear distinction between wants and needs, but these concepts change overtime and depend on the level of economic development. For example, is broadband a 'need' in the UK in the modern age?
In traditional economic theory, each economic theory, each economic agent is considered to have a different economic objective.
Economic Agent
Consumers
Objective
Utility maximisation
Explanation
Consumers are assumed to gain utility as they consume goods and services. A rational consumer is expected to consume until the point they can gain no further benefits from consumption.
Examples of Decisions Made
Should I buy product X or product Y?
If the price of product X rises, how much more of product Y should I buy?
Economic Agent
Businesses
Objective
Profit maximisation
Explanation
Businesses are assumed to want to make the maximum amount of surplus after costs have been subtracted from revenues.
Examples of Decisions Made
What goods should we produce?
Should we buy new machinery or employ new workers?
Economic Agent
Government
Objective
Welfare maximisation
Explanation
Welfare maximisation occurs when society's scarce production resources are allocated to producing the goods and services that are most beneficial to that society, and the point of production where consumer and producer surplus is maximised.
Examples of Decisions Made
Should farmers producing organic vegetables be subsidised?
Should fast food restaurants pay an additional 'fat tax'?
The key economic decisions are: what to produce, how to produce, and who is to benefit form the goods and services produced:
In other words, decisions need to be made about how to allocate society's scarce resources (economic goods) among alternative uses:
What should be produced?
How should it be produced?
Whom should we produce for?
The economic system within a national economy is the way in which that society has chosen to coordinate the way in which a country's resources are allocated.
Economic System
Market economy
Definition
Market forces guide the allocation of resources within a society.
Description
The prices of goods and services dictate how resources are allocated. As consumers' demand for a product increases so does its price and firms, who own the means of production (capital), respond to price rises by producing more of these goods and services. The role of government is to protect property rights for the owners of capital. This is known as capitalism.
Economic System
Centrally planned economy
Definition
Decisions on resource allocation are guided by the state.
Description
This is where decisions about what and how much should be produced is taken by government based on their view of peoples' wants. The government owns the means of production. This is known as communism.
Economic System
Mixed economy
Definition
Resources are allocated partly through price signals and partly based on direction by the government.
Description
This is where some of society's resources are owned by the government (public sector) and some of society's resources are owned by individuals (private sector). The government tends to provide infrastructure and merit goods and attempts to maximise welfare. Most of the wold's economies are mixed.
3.1.1.3 Economic resources
The economists' classification of economic resources into land, labour, capital and enterprise, which are the factors of production.
Factors of Production
(CELL)
These are the inputs that are used in the production of goods and services in the attempt to make an economic profit.
Factor
Land
Explanation
The
natural resources
in the production process. E.g.oil and water. These resources can be either renewable (such as energy generated by wind turbine) or non-renewable (like oil).
Factor Payment
Rent
Factor
Labour
Explanation
This is the
human resource
put into production, and includes both high and low skilled technical work, manual, adminstrational and professional workers.
Factor Payment
Wages/salaries
Factor
Capital
Explanation
This is the
man-made products
which are used to aid production. Examples include commercial properties (like factories and offices), machinery, and computers.
Factor Payment
Profits
Factor
Enterprise
Explanation
This is
another human resource
and is considered the
organising factor
that brings together the other factors with the aim of making profit.
Factor Payment
Profits
In contrast to economic goods, which are scarce, free goods are available in as great a quantity as desired with
zero opportunity cost
to society.
Economic Goods
Resources that are
scarce
and
valuable
. Therefore, decisions need to be made about how to allocate these goods. Every time a decision is made about how to allocate the goods, an opportunity cost is incurred.
Examples
land, labour and enterprise.
Free Goods
Resources that are available in as greater quantity as desired. Therefore, no decisions need to be made about to allocate these goods. In other words, free goods have
zero opportunity cost
.
Examples
Oxygen
In addition, society might produce the following goods:
Type of good
Private good
Definition
A product that is both rivalry and excludable. Most of the goods and services you consume every day will be private goods. These are the goods that once you are consuming the, your use of it deteriorates its quality or prevents someone else from using it.
Examples
Food, a car journey, a hair cut, electricity
Type of good
Public good
Definition
A product that is non-rivalrous and non-excludable. This means that the product is not deteriorated by your use of it and the product is still available for others.
Examples
Street lighting, Armed forces, a park, a road.
Type of Good
Capital goods
Definition
These are
man-made products
which are used to aid production. In other words, these are industrial goods that enable the production of other goods and services.
Examples
Food, household appliances, hairdressing
The environment is a scarce resource:
The Earth's natural resources are categorised as 'land' in economics. 'Land' refers to any natural resource. It is obvious that the environment is a scarce resource in some contexts. For example, once a piece of land is used for farming crops, it can not be simultaneously used to build houses on. Once the tin in a mine has been extracted, there is no tin left for the future. This shows how the environment can be a scarce resource - there is a opportunity cost of using it up.
3.1.1.4 Scarcity, Choice and the allocation of resources
The fundamental economic problem is scarcity and it results from limited resources and unlimited wants:
The basic economic (fundamental) economic problem
is that 'economic resources are scarce, whilst human wants are infinite'.
Scarcity means that choices have to be made about how scarce resources are allocated between different uses
Scarcity
is a situation that arises because people have limited resource to fulfil their unlimited wants. In other words, the are unable to satisfy all of their desires with the resources that they have. Therefore, all economic decision makers face a choice about how to allocate their resources in order to maximise their satisfaction. They have to prioritise their desires and allocate their resources in the manner that will lead to the most benefits.