A Level Economics - Edexcel Exam Board PDF

1.1.1 The nature of economics A LEVEL ECONOMICS EDEXCEL EXAM BOARD THEME ONE MICROECONOMICS LEARNING PACK THESE NOTES BELONG TO: INSTRUCTIONS: 1....

1.1.1 The nature of economics A LEVEL ECONOMICS EDEXCEL EXAM BOARD THEME ONE MICROECONOMICS LEARNING PACK THESE NOTES BELONG TO: INSTRUCTIONS: 1. Read the information in the pack and annotate, where relevant. 2. Look at PowerPoints (when relevant). 3. Make short key-point notes in the spaces provided. 4. Provide written answers to the questions that follow – write this in the spaces provided. 5. Be prepared to read your answers out and justify them. 6. Answers will be discussed, and you can ask questions. FOLLOWING THIS YOU WILL: 7. Be assessed on your knowledge, understanding and answering skills in WRITTEN assessments. 8. Review your understanding and your skills in answering. 1  1.1.1 The nature of economics What is economics? The word economics is derived from the Ancient Greek word oikonomia which translates to: ‘.the study of how people manage their household - how they earn and spend their income and use resources to purchase ‘necessities, comforts, and luxuries’. (Commonly attributed to Aristotle) While modern economics includes much more than this, the fundamental basis remains the same – economics looks at how resources are best managed. Since the early 19th Century, economics has been classified as a social science, along with sociology, psychology and political science. Social sciences attempt to apply the methods of science to analysing and explaining aspects of human behaviour. When did economics start? An interest in 'economics' can be traced back to the poets and philosophers of Ancient Greece, including Aristotle, who wrote about Ancient Greek society and how resources were used. However, it was not until the 18th Century that the first systematic attempt to understand economic behaviour emerged in Europe out of what was called 'political philosophy', with Scottish philosopher, Adam Smith, widely acknowledged as the founding father of economics. By the early 20th Century, the social sciences had become distinct subjects, with economics emerging as a separate and increasingly popular and influential subject. What do economists look at? Economists study ‘economic systems’, and the behaviour of economic agents interacting within these systems. The economic agents are individuals, businesses and organisations, and governments. The role of the economist is to study and explain how these agents make best use of available resources to achieve their objectives, and how they choose between alternative uses of those resources. The term economics is, therefore, derived from the idea of ‘making best use’ of limited, or ‘scarce’ resources. Classification of economics Modern economics is broken down into two main categories: 1. 'Micro' economics, which looks at how individuals, households and businesses interact to 'solve' the economic problems they face, and how they make decisions in allocating their own resources; and: 2. 'Macro' economics which considers how whole systems are organised and how they try to achieve 'large scale' (macroeconomic) objectives. Macroeconomic objectives include maximising employment, keeping average process under control, and balancing payments relating to international trade. 2  1.1.1 The nature of economics How do economists work? Economists attempt to observe and explain the behaviour of economic agents through the application of scientific methods. Adam Smith is recognised as much for his method of work as for his interest in developing theories when he recognised the importance of being an impartial spectator – just like any other scientist. Why do economists propose hypotheses, use models and make assumptions? Pure science employs a method based on continuous observation, creating a hypothesis about something, gathering data (evidence) from the ‘field’ or through experiments to test the hypothesis, and then supporting or rejecting the hypothesis. A hypothesis is a proposition about identifying the cause of ‘something’ or about its possible effects. Once hypotheses are tested they can help develop a ‘theory’ of ‘something’. Variables A variable is a distinct element, phenomenon or event that can change, and has an effect on something else. The independent variable is the cause of an event or a reaction and the dependent variable is the resulting effect. Example – chemistry In chemistry, a chemical can be tested to see the effects of heat or the effects of combining two chemicals. From this experiment chemists can develop and test a hypothesis about the precise reaction observed. In the chemistry experiment, heat is the independent variable, and the reaction is the dependent variable. If a chemical reacts to heat, the cause - the independent variable - is the heat, the effect is the reaction is the dependent variable. This can be stated as ‘a change in heat causes chemical X to change its chemical structure’. In economics, a single element can be both an independent and a dependent variable. For example, a change in the price of a good – such as a change in the price of a brand of smartphone (e.g. Apple) – can be dependent on a change in consumer incomes, and the change in the price can alter the demand for an alternative smartphone (e.g. Samsung). In economics, the factors that affect a variable are called determinants. Is economics a ‘pure’ science, like chemistry? While social sciences do not claim to be pure sciences, the approach adopted in economics shares many of the same steps and methods. Let’s compare a pure science with economics. 3  1.1.1 The nature of economics Pure science Economics Impartial approach Something of ‘interest’ is observed A hypothesis is made to start the process Possible causes (and effects) are identified Independent and dependent variables are identified Assumptions are made Experiments are undertaken, and repeated Evidence is gathered Models are built and tested Theories are developed Predictions are made Assessment - Can new events or evidence be explained by exiting theories, or are new ones needed? So, as a social science, economics ‘ticks’ a lot of the boxes, but, like other social sciences it is limited in the methods it can use – especially as economists cannot easily conduct experiments, and they must rely on building simple models and using reasoning. Why not undertake experiments? For ethical and practical reasons experimentation with people is generally not how economists gather information and generate theories. For example, it would not be possible, acceptable, ethical or lawful to conduct a controlled experiment in which individuals are subjected to price increases of a particular food just to observe the effects. The economist cannot say ‘lets raise the price of bread to test how consumers deal with that price rise’. What about ‘behavioural’ economics? Over the last 20 years economic theory has successfully used methods first developed in psychology to understand consumer behaviour. For example, human behaviour is often influenced by biases towards particular choices – called ‘cognitive biases’. Examples include the status quo bias – if I have bought and used product X I’ll carry on buying it (even if, rationally, it is not the most suitable); or the anchoring bias, such as relying on the first piece of information were receive, which is the anchor to judge other information. These biases can be tested through experimentation; hence economists can use experiments in limited situations. How do economists use models? Economists have developed ways of working to test hypotheses which do not rely on experiments. They do this by building representations of the world - called ‘models’ - which can be tested without experimentation. For this to happen, economists substitute assumptions for controlled experiments. 4  1.1.1 The nature of economics For example, the economist might have an interest in mobile phone prices and starts with a hypothesis that an increase in the price of Apple phones by 5% will reduce demand by only 2%, on average and in all geographical regions. The economist will then gather data from a variety of sources (retail outlets from a range of countries, from online suppliers, research organisations, and the manufacturers themselves) to see how true this is. The economist can then draw up another hypothesis about the cause of the relationship discovered, and so on. Different variables can be tested to see how important they are – for example, a person’s income, their general preferences, the alternatives and, of course, the price, can all be tested to see how significant each variable is. Eventually, the results of the testing and verification can help build a picture which can lead to the development of a model of what determines demand. The model can then be applied to other products, which can then lead to a theory of demand. Any hypothesis will have to include assumptions about these other factors (determinants) – namely, the assumption that there is no change to other factors, such as consumer incomes. This is referred to as the ceteris paribus rule. The ceteris paribus rule The ceteris paribus rule states that all other things remain the same. This is used whenever attempting to demonstrate the link between economic variables. Without this assumption it is impossible to develop and test a hypothesis. Use the ceteris paribus rule when explaining the effects of any change in an economic variable Economists are always making and testing assumptions in order to develop models to explain connections. All economic theory relies upon assumptions – commonly called ‘if…then’ assumptions. My notes: 5  1.1.1 The nature of economics My notes: 6  1.1.1 The nature of economics Questions (Write your answers in the spaces in this learning pack on the following pages) 1) According to Ancient Greeks, what is economics? 2) True or false: Economics does not use any of the methods of a pure science, such as chemistry. 3) How ‘scientific’ is economics as a subject? 4) With reference to the information on page 2, explain the role of the economist? 5) Who is regarded as the founding father of economics? 6) Who are ‘economic agents’? 7) What is a hypothesis? 8) Give one example of a hypothesis related to how people allocate their income. 9) How would you test this hypothesis? 10) Pick a pair of one possible independent and one possible dependent variable from the list below, and write a sentence explaining the connection: a. Spending b. Receiving an income c. Unemployment d. Employment e. Profits f. Costs g. The weather [Clue – if the pairs are ‘holidays’ and ‘half-term’, the sentence could be “..at half-term students can go on holiday..” ] 11) Explain the difference between a dependent and an independent variable in economics. 12) Create your own example of a statement related to the possible linkage between two economics variables (such as those in the previous question) which included the ceteris paribus ‘condition’ to enable a hypothesis to be tested. (e.g. If Team X scores more goals than Team Y, then Team X wins.) 7  1.1.1 The nature of economics My answers: Q 8  1.1.2 Positive and normative economics My answers: Q 9 1.1.2 Positive and normative economics 10  1.1.2 Positive and normative economics 1.1.2 Positive and normative economic statements Positive statements The scientific approach adopted by economists involves making positive statements that can be tested. Positive statements are those that can be verified or rejected. For example, stating that “.. house prices have risen in London by 6% over the last year..” is a statement that can be tested. The most ‘useful’ positive statements contain variables that can be measured (or quantified). This is because quantifying is the way that statements can be tested and verified. Normative statements In contrast, normative statements are based on value judgements which cannot be verified or falsified. A value judgement is a judgement based on what a person believes to be true, or should happen. For example, statements suggesting that something ‘ought to’ happen, or that something is ‘unfair’, are normative because they are based on value judgements. For example, stating that ‘..the recent rise in house prices is unfair to the poorest..’. is a normative one. This statement cannot be tested because it is not based on anything testable. If there is an agreed definition of fairness, and it can be measured, then it might be possible to test a statement about ‘fairness’. For example, a rise in house prices might alter the distribution of income between different income groups. However, as it stands, this statement is normative, because it is impossible to verify and based on a value judgment. Unlike positive statements, normative statements do not tend to contain any reference to the possibility of measurement. Like all sciences, economics can only move forward by adopting a positive approach and by generating hypotheses that can be tested and scrutinised. Do not say that normative statements are ‘matters of opinion’ – this will earn no marks. Saying they are based on a ‘value judgement’ will earn marks. My notes: 11  1.1.2 Positive and normative economics My notes: Questions 1) Distinguish between a positive and a normative statement and give one example of each. 2) With reference to the information, explain why positive statements refer to phenomena that can be measured. 3) True or false? a. Saying that the rate of inflation in the USA in 2024 was 18% is an example of a positive statement. b. Is it correct to say that normative statements are matters of ‘opinion’? c. Saying that raising income tax is unfair on the poor is an example of a normative statement. 12  1.1.2 Positive and normative economics My answers: Q 13