Economics: Positive and Normative Statements

Economics as a Social Science

• Economists make assumptions, such as ceteris paribus, assuming other things are held equal or constant.
• Economists can't conduct scientific experiments like natural sciences, so they devise models and build them upon real-life scenarios, making assumptions.

Positive and Normative Statements

• It's important to distinguish between fact and fiction.
• Positive statements are objective and can be tested with factual evidence, leading to acceptance or rejection, look for words such as 'will', 'is'.
• "Raising the tax on alcohol will lead to a fall in the demand of alcohol and a fall in the profits of pub landlords" is a positive statement.
• "Higher temperatures will lead to an increase in the demand for sun cream" is also a positive statement.
• The key is statements can be tested, results examined, and then the statement can be rejected or accepted.
• Normative statements rely on value judgments and are subjective, based on opinion rather than factual evidence.
• Look for words like 'should', indicating a suggestion that one action is more credible than another.
• "The free market is the best way to allocate resources" is a normative statement, suggesting one method is superior.
• “The government should increase the tax on alcohol" is another normative statement.
• Value judgments can influence economic decision-making and policy, with different economists possibly drawing different conclusions from the same statistic, like the inflation rate.

The Economic Problem

• The basic economic problem is scarcity, where unlimited wants meet finite resources, requiring choices and resources to be used and distributed optimally.
• If you have £1, you can buy a chocolate bar or crisps. Scarcity means you must choose.
• This leads to opportunity cost, defining the value of the next best alternative forgone. Choosing crisps means the chocolate bar is the opportunity cost.
• If a £15,000 car depreciates by £5,000 after 5 years, then keeping the car has an opportunity cost of £5,000 (the money from selling it).
• Opportunity cost affects consumers, producers, and governments.
• Producers choose between hiring staff or investing in machinery
• The government can split funds between healthcare and education.

Factors of Production (CELL)

• Capital: Physical goods used in production. Fixed includes machines, buildings and working includes finished or semi-finished consumer goods, earning interest from investment
• Entrepreneurship: Managerial ability shown when the entrepreneur takes risks, innovates, and uses factors of production to make profit
• Land: Natural resources like oil, coal, wheat, water, also the physical space for fixed capital, earning rent
• Labour: Human capital or the workforce, earning wages
• These factors are inputs that produce outputs as goods and services forming the economy.

Renewable and Non-Renewable Resources

• Renewable resources can be replenished, maintaining their stock level over time, such as oxygen, fish, or solar power.
• Resources are only renewable if consumption is less than replenishment; otherwise, the stock declines.
• Managing deforestation and fishing quotas is important in environmental economics for renewable resource sustainability.
• Currently, resources are being consumed faster than the planet can replace them.
• The Worldwide Fund for Nature says two planets would be needed to meet global demand by 2050 if this trend continues.
• Non-renewable resources cannot be renewed, such as fossil fuels (coal, oil, natural gas); stock levels decrease over time
• Recycling and renewable substitutes like wind farms can slow down the resource decline.

Production Possibility Frontiers

• Production possibility frontiers (PPFs) depict maximum productive potential using a combination of two goods or services, resources are fully and efficiently employed.

• PPF curves show the opportunity cost of using scarce resources.

• With milk as a scarce resource, a PPF can illustrate the trade-off between producing more cheese or yogurt.

• Producing at points A and B are the most efficient combinations of output on the PPF. Producing at B so more yoghurt than cheese is produced, incurs an opportunity cost of producing more cheese.

• The law of diminishing returns states that the opportunity cost of producing more yoghurt increases, in terms of the lost units of cheese that could have been produced.

• Producing at C or D is inefficient and resources are not used to their full productive potential. There is the potential to use these resources more efficiently, which would shift production closer to the curve.

• Producing at E is not yet attainable with the current resources.

• A PPF shows the opportunity cost of producing products.

• Producing 100 cheese units means only 40 yogurt units can be made instead of 90. The opportunity cost is 90 - 40 = 50 yogurt units.

• PPFs can depict economic growth or decline.

• Only production under and on the PPF is attainable, production outside of the PPF isn't obtainable. Resources are used efficiently on the PPF (A and B) and its inefficient below (point C).

• Economic growth shifts the PPF outward from point A to point B; decline shifts it inward. The original curve assumes:

  • A fixed amount of resources are used
  • There is a constant state of technology

• Increased resources shifts the PPF, increases economy productive potential, which is achieved with supply side policies.

• A PPF shifts inwards with decreased resources due to natural disasters like flooding, or brain drain.

• Moving along the PPF shifts production between consumer and capital goods while using the same resources, an opportunity cost

• Shifting the PPF outward uses more or improved resources which reduces the opportunity cost of either capital or consumer goods.

• Capital goods are used to produce other goods, like machinery.

• Consumer goods cannot be used to produce other goods, like clothing.

Specialisation and the Division of Labour

• Specialization: each worker completes a specific task in production, leading to increased productivity and lower average production costs via division of labor, Adam Smith stated.

• Dividing pin production into 18 tasks significantly raised output.

• Specialization is achieved by individuals, businesses, and regions.

• Advantages:

  • Higher output and quality, from focus on what each person/business is best at producing
  • Greater variety of goods/services available
  • More opportunities occur for economies of scale, which increases market size
  • More competition encourages firms to lower costs, and lowers prices

• Disadvantages:

  • Work becomes repetitive, lowers worker motivation, and potentially affects product quality; workers may become dissatisfied
  • More structural unemployment may occur because skills may not be transferable, especially for employees who have only focused on single tasks for a long time
  • Variety decreases for consumers because production is focused of one type of good through specialisation
  • Worker turnover increases as employees become dissatisfied and leave, which also increases firms’ costs

The Functions of Money

• Money is a medium of exchange: Before money, people bartered, but they didn't always get what they wanted/needed. Exchanged goods weren't always equal in value, either. An exchange could only occur if wants coincided between both parties. Money fixes these problems.
• Money is a measure of value (unit of account): Money provides means to measure relative values of different goods/services. Jewellery is valued higher than a table because it’s relatively more expensive. Money puts value on labour.
• Money is a store of value: Money has to hold its value to be used for payment. It can be kept a long time without expiring. The amount a person can buy with money fluctuates slightly to forces of supply and demand.
• Money is a method of deferred payment: Money allows people to create debts, and pay later for things without having it in the present, and relies on its stored value.

Free Market Economies

• Also known as laissez faire economies; the market forces of supply and demand allocate scarce resources, so governments leave markets to their own devices.

• Private individuals and firms make economic decisions and private individuals own everything.

• Governments intervene by implementing laws and public services like property rights and national defence.

• Adam Smith and Friedrich Hayek were free market economists.

• Adam Smith's invisible hand of the market influenced free markets and the price mechanism, where consumers/businesses spending determines prices.

• Smith identified monopoly issues and Hayek believed government intervention makes markets worse.

• Hayek said the Fed caused the 1930s crash by keeping interest rates low, encouraging ‘malinvestments.’

• What to produce: determined by what the consumer prefers

• How to produce it: producers seek profits

• For whom to produce it: whoever has the greatest purchasing power in the economy that can buy the good

• Advantages:

  • Firms must efficiently provide goods and services demanded by consumers, lowering their average costs and using resources better
  • Overall economy output increases and government intervention bureaucracy is avoided

• Disadvantages:

  • The free market ignores inequality and benefits those with the most wealth.
  • There are no social security payments for those on low incomes.
  • Monopolies can exploit the market by charging more.
  • There could be overconsumption of demerit goods and the negative externalities (i.e. tobacco). Public and merit goods lack supply, such as national defence or education.

Command Economy

• The government allocates scarce resources in an economy to where they think needs are greater, also known as central planning.

• Karl Marx saw free markets as unstable, where profits happened from labour exploitation by not paying workers enough and argued for "common ownership of the means of production.”

• What to produce: determined by government preferences

• How to produce it: governments and their employees

• For whom to produce it: who the government prefers

• Advantages:

  • Easier to coordinate resources during crises like war, and governments compensate for market failure by reallocating resources
  • They make sure people can access basic necessities
  • Inequality decreases and society might maximise welfare, preventing monopolies

• Disadvantages

  • Governments fail just like markets and may be uninformed, so they may not properly meet consumer preferences, limits democracy/personal freedom

Mixed economy:

• This has command/free economy features, but with different balances between command and free economies.
• The UK is considered quite central where the US is slightly more free (though the government spends 35% GDP), and Cuba is centrally planned.
• The market is controlled by both government and supply/demand forces
• Governments provide public/merit goods (i.e. street lights, roads, police, healthcare and education) -What to produce: consumer and government preferences -How to produce it: producers making profits and the government -For whom to produce it: government preferences combined with private individuals’ purchasing power