Economics Foundations of Economics Syllabus

State two advantages and two disadvantages of a command economy.

Advantages: can reduce inequality, provide public/merit goods, avoid wasteful competition. Disadvantages: lack of incentives and innovation, inefficiency, shortages/surpluses from planning errors, limited consumer choice.

What is a mixed economy?

An economy that combines features of both market and command systems: the private sector operates through the price mechanism while the government intervenes to correct market failures, provide public goods, and redistribute income.

Most real-world economies are best described as which type, and why?

Mixed economies — because they rely on markets for most allocation but include government intervention (taxes, regulation, public services) to address market failure and equity concerns.

What is the 'price mechanism' (invisible hand)?

The system by which prices, driven by the forces of supply and demand, act as signals and incentives that allocate resources without central direction — Adam Smith's 'invisible hand'.

Give three key economic roles of government in a mixed economy.

Correcting market failures (externalities, public goods), providing public and merit goods, redistributing income/wealth, maintaining competition, and stabilizing the macroeconomy.

What are public goods, and why do markets under-provide them?

Public goods are non-rival and non-excludable (e.g., national defence, street lighting). Markets under-provide them because of the free-rider problem — people can benefit without paying, so private firms have no profit incentive.

Why do economists use models and make assumptions?

Models simplify complex reality to isolate key relationships and make analysis and prediction tractable. Assumptions strip away less relevant detail so the essential mechanism can be studied.

What does the assumption 'ceteris paribus' mean and why is it used?

'Ceteris paribus' means 'all other things being equal/held constant.' It lets economists isolate the effect of changing one variable at a time while holding others fixed.

What is the 'rational economic agent' assumption?

The assumption that individuals act rationally to maximize their own utility (consumers) or profit (firms), making consistent choices given their preferences and constraints.

Distinguish microeconomics from macroeconomics.

Microeconomics studies individual decision-making units — households, firms, and specific markets. Macroeconomics studies the economy as a whole — aggregates like national output, unemployment, inflation, and growth.

Classify each as micro or macro: (a) a firm setting the price of bread; (b) national inflation rate.

(a) Microeconomics — a single firm/market. (b) Macroeconomics — an economy-wide aggregate.

Name two key variables studied in macroeconomics.

Examples include gross domestic product (GDP)/national output, unemployment, the general price level/inflation, economic growth, and the balance of payments.

What does the circular flow of income model show?

It shows the flow of money, resources, goods, and services between households and firms: households supply factors and receive income; firms supply goods/services and receive spending.

In the two-sector circular flow, what do households and firms exchange in the factor and product markets?

In the factor market, households sell factors of production to firms for factor incomes. In the product market, firms sell goods and services to households for consumption spending.

List the injections and leakages (withdrawals) in the circular flow of income.

Injections: investment (I), government spending (G), and exports (X). Leakages/withdrawals: saving (S), taxation (T), and imports (M).

State the condition for equilibrium national income in terms of injections and leakages.

Equilibrium occurs when total injections equal total leakages: $$I + G + X = S + T + M$$

What is the division of labour?

The specialization of workers, each performing a specific task or part of the production process rather than the whole, first analysed by Adam Smith using the pin factory example.

State three advantages of the division of labour.

Higher productivity/output, workers become more skilled at their task, time saved (no switching between tasks), and it enables the use of specialized machinery.

State three disadvantages of the division of labour.

Work becomes monotonous/boring (lower morale), workers become deskilled and less flexible, and over-reliance means a breakdown in one stage can halt the whole process.

What is specialization, and at what levels can it occur?

Specialization is concentrating on a narrow range of tasks or products. It occurs at the level of individuals (division of labour), firms, regions, and whole countries (international specialization/trade).

Define absolute advantage.

A country (or producer) has an absolute advantage when it can produce a good using fewer resources — i.e., more output per unit of input — than another producer.

Define comparative advantage.

A country has a comparative advantage in a good when it can produce it at a lower opportunity cost (in terms of forgone alternative output) than another country.

According to the law of comparative advantage, what should each country do to gain from trade?

Each country should specialize in producing the good in which it has the lower opportunity cost (its comparative advantage) and trade for the other good, raising total output and mutual gains.

Country A produces either 10 wheat or 5 cloth; Country B produces either 6 wheat or 6 cloth. What is A's opportunity cost of 1 cloth?

For Country A, giving up 5 cloth means giving up 10 wheat, so 1 cloth costs $\frac{10}{5} = 2$ wheat. (B's cost is 1 wheat per cloth, so B has the comparative advantage in cloth.)

Can a country with an absolute advantage in both goods still benefit from trade? Explain.

Yes. As long as opportunity costs differ, each country has a comparative advantage in one good. Specializing according to comparative advantage and trading raises total output and benefits both.

State the four main functions of money.

1) Medium of exchange, 2) Unit of account (measure of value), 3) Store of value, 4) Standard of deferred payment.

Explain money's function as a 'medium of exchange' and the problem it solves.

Money is generally accepted in exchange for goods and services, eliminating the need for barter and the 'double coincidence of wants' it requires, thus lowering transaction costs.

Explain money's function as a 'unit of account'.

Money provides a common measure of value in which the prices of all goods and services can be expressed and compared, making economic calculation possible.

Explain money's function as a 'store of value' and what undermines it.

Money can be saved and used to make purchases in the future, transferring purchasing power over time. High inflation undermines this by eroding money's real value.

List the desirable characteristics money should have.

Durability, portability, divisibility, uniformity/homogeneity, limited/controlled supply (scarcity), and general acceptability.