1

Basic economic ideas

Basic economic ideas Core

Self-assessment task 1.1 (page 16)

1 Summarise the projected changes in the population of Barbados from 2000 to 2025. The population pyramids show that the population of Barbados is expected to increase by a small percentage. The more signicant projected change is the change in the age structure of the population. It is predicted that as birth rates fall and people live longer there will be an ageing population. There will be a smaller proportion of the population under 45 and a higher proportion of the population aged over 50. 2 Discuss the likely effects of these changes on decisions concerning: a what to produce A rise in the average age of the population, with more older people and fewer younger people will alter the types of products being produced. It is likely, for instance, that more resources will be devoted to providing health and residential care for elderly people and there will be more focus on providing forms of entertainment for the over-50s. It is also possible that fewer resources will be used for making products such as childrens toys and for building affordable housing. b how to produce Because there will be more retired people and proportionately fewer workers, capital-intensive methods of production will increasingly be used. In other words, more machines and other capital goods may be used relative to labour. In addition, the Barbadian government may decide to raise the retirement age or provide tax incentives for workers to continue working past the retirement age. c for whom to produce. In the light of an ageing population the Barbadian government may try to inuence who receives these products. To ensure that the growing number and percentage of elderly people receive an adequate supply of products, the government may increase the taxes levied on the comparatively smaller proportion of workers and spend more on pensions. Such actions would transfer some purchasing power from the labour force to the retired. 3 Comment on ethical problems over the use of scarce resources facing the government of Barbados in meeting the needs of its changing population. Providing for a slightly larger population with fewer workers may mean that Barbados will be faced with a number of ethical problems over the use of its scarce resources. National output would be increased by requiring workers to work longer hours but such a change could increase stress and reduce the quality of workers lives. Output may also be increased, at least initially, by for instance building hotels in areas of natural beauty and areas rich in wildlife. These hotels may attract more tourists, but such an approach would have to be considered carefully. Such building might damage the environment and endanger wildlife and might even make the area less attractive for tourists. The arrival of more tourists into the country may also pose ethical issues, such as overuse of natural resources like water. The native culture could also be threatened.

Original material Cambridge University Press 2010

Basic economic ideas

Self-assessment task 1.2 (page 20)

The article expresses the view that, through economic growth, people may actually be worse off. 1 What other examples can you think of which might support the views of these economists? Other examples include: People owning and driving more cars has led to congestion in many cities throughout the world which, in turn, has increased stress and reduced the quality of peoples lives. Eating more convenience food and being driven to school instead of walking or cycling has increased obesity levels among children. Industrialisation in many countries has damaged the environment. 2 Do you see any conict between these views and your understanding of the economic problem? The views may at rst appear to conict with our understanding of the economic problem. This is because it might be thought that as more of our wants are met, the economic problem may become less of an issue. Closer examination of the article, however, indicates that the economic problem continues because our wants continue to grow and continue to outstrip our resources.

Self-assessment task 1.3 (page 24)

1 Sketch a production possibility curve (PPC) to show the choices that are now facing Caribbean sugar farmers.
% 100 90 Sugar cane for food and rum 80 70 60 50 40 30 20 10 0 10 20 30 40 50 60 70 80 90 100 S Sugar cane for ethanol

2 On your diagram show how a reduction in sugar cane production for food and rum products from 80% to 50% of total production affects the amount that is going to produce ethanol. Use the concept of opportunity cost to explain this trade-off. The above diagram shows that a decision to reduce the sugar cane production for food and rum from 80% to 50% would increase the proportion devoted to producing ethanol from 20% to 50%. What the economy would be doing in this case would be to trade off sugar cane production for food and rum for that for ethanol. The opportunity cost of raising the proportion of sugar cane grown for ethanol by 30% points is 30% points of output grown for food and rum.

Original material Cambridge University Press 2010

Basic economic ideas

3 Modify your diagram to show how the PPC changes due to: better cultivation methods that result in more sugar cane being produced the damaging effects of a tornado that result in less sugar cane being produced. Note: for clarity, this is drawn as a separate diagram.

Sugar cane for food and rum

PP

ith

be

tte

rig O te rt

rc

F PP

ul

al in

tiv

af

at

F PP ado n or

io

Sugar cane for ethanol

4 On your diagram, show and explain points where production is efcient and inefcient. Note: for clarity, this is drawn as a separate diagram.
% 100 Sugar cane for food and rum A

C F D G E 100 Sugar cane for ethanol

Any point on the PPC is an efcient production point as it means that resources are being fully used and it is not possible to produce any more. On the above diagram, points A, B, C, D and E are all productively efcient points. In contrast, production points F and G are inefcient, with G being the more inefcient point. Any point inside the curve is inefcient as it means that there are unemployed resources or ineffective use of resources and output is lower than possible.

Original material Cambridge University Press 2010

Basic economic ideas

Self-assessment task 1.4 (page 26)

Explain the choices facing decision-makers in the developing economy shown in Figure 1.7. Discuss the difculties they face and suggest possible solutions to their problems. Figure 1.7 shows that the developing country is facing a difcult choice. If it produces a amount of capital goods it will replace those capital goods which have worn out in the productive process. This would keep the capital stock unchanged. It would, however, mean that the output of consumer goods would be below the level needed to keep the population alive. If, on the other hand, production point b is selected then, whilst sufcient consumer products will be made for the subsistence of the population, there will be a reduction in the capital stock. Having fewer capital goods will shift the production possibility curve to the left.
50 b

Consumer goods Subsistence 0

20

Capital goods

Capital consumption

Figure 1.7

Capital consumption in a developing economy

Self-assessment task 1.5 (page 27)

1 Using the information in Table 1.3 compare the economic structure of Pakistan with that of India. In both Pakistan and India, more workers are employed in the primary sector than in either the secondary or tertiary sector. The percentage of the labour force employed in the primary sector is greater in India than in Pakistan. More than half of all Indian workers work, or seek work, in agriculture whereas it is just under half of all Pakistani workers. The smallest proportion of workers in both countries work in the secondary sector. Pakistan has a higher proportion of workers than India in both the secondary and tertiary sectors. 2 In which country: a is agriculture more efcient? Agriculture is more efcient in Pakistan than in India. b are services more efcient? The services (tertiary) sector is more efcient in India than in Pakistan. 3 Explain how you have arrived at your answers. Agriculture is more efcient in Pakistan than in India because a smaller proportion of Pakistans labour force accounts for a larger proportion of the countrys output than in India. The services (tertiary) sector is more efcient in India than in Pakistan. A smaller proportion of Indias labour force than Pakistans produces a similar proportion of the countrys output.

Original material Cambridge University Press 2010

Basic economic ideas

4 Discuss whether countries such as Pakistan and India might be concerned if a large proportion of the labour force got new employment in industry or in the service sector (such as call centres). If under-employed agricultural workers move into the industrial, or the service, sector where there is a labour shortage, there will be a rise in output and incomes. There is the possibility, however, that if a large number of workers move out of agriculture quickly, agricultural output may fall signicantly. Such a fall could lead to a shortage of foodstuffs, a rise in their price and an increase in the imports of foodstuffs. A large number of workers, shifting from the primary to the secondary and tertiary sectors, would also be likely to be accompanied by rural to urban migration. This, in turn, may result in pressure on education, health and housing facilities in cities and may result in slums developing.

Self-assessment task 1.6 (page 31)

1 Think carefully about the ways in which your own economy allocates resources. Make a few notes on the ways in which: the government the market mechanism are responsible for decision making.

Sample answers based on the UK

The UK government, through its spending, determines how many of the countrys resources are devoted to state education, health care and defence among other areas. It also inuences how resources are allocated between basic necessities and luxuries through taxation and the provision of state benets. In the UK the market mechanism determines the allocation of a range of resources. Consumers indicate their preferences for particular brands of clothing, models of cars and different forms of entertainment in different ways, such as through the price mechanism. The prot motive encourages producers to respond to what consumers are willing and able to buy. 2 Use the above information to insert your own economy into the scale shown in Figure 1.10. How has its relative position changed in recent years?
UK Former Soviet Union before 1986 North Korea Hungary Albania Pakistan France Singapore USA

Command economy

Market economy

Weak

Market as a means of allocating resources Government control over the allocation of resources

Strong

Strong

Weak

Figure 1.10 Mixed economic systems

Original material Cambridge University Press 2010

Basic economic ideas

The UK economy comes relatively close to being a market economy although the state still plays a noticeable role in the economy. In the last two decades, the UK has been moving closer to a market economy with most state enterprises having been privatised. There was, however, a slight reversal of this trend in 2008 with the effective nationalisation of a number of banks although this measure was expected to be only temporary. 3 What information might an economist use to quantify the relative importance of the government and the market mechanism within an economy? There is a range of information an economist might use to quantify the relative importance of the government and the market mechanism within an economy. These include the proportion of workers employed by the state in comparison to the proportion employed by the private sector, government spending expressed as a percentage of total spending and what proportion of industries are state owned.

Self-assessment task 1.7 (page 31)

1 Assume that an economy undergoes the process of reform shown in Figure 1.11.

Large flow of funds for investment and losses Government

FROM GOVERNMENT CONTROL

Public sector Utilities Public enterprises Savings 510% GDP Subsidies Consumers DOMINANT PUBLIC SECTOR WEAK FINANCIAL SYSTEM Financial system

Private sector Agriculture

Marketing boards DISCOURAGING BUSINESS ENVIRONMENT

Public expenditure Government

Public sector TO COMPETITIVE MARKETS Utilities Remaining public enterprises Infrastructure Education Health Environment REFORMED PUBLIC SECTOR

Privatisation receipts Financial system

Private sector Utilities Manufacturing Services Agriculture

Savings 2030% GDP Consumers STRONG FINANCIAL SYSTEM ATTRACTIVE BUSINESS ENVIRONMENT

Figure 1.11 The broad process of economic reform Source: World Bank, 1995 (adapted)

a Give an example of an organisation which will disappear with a move to competitive markets. Public enterprise b Give an additional source of revenue for the government. Privatisation receipts
Original material Cambridge University Press 2010

Basic economic ideas

c Give a source of expenditure for the government which is no longer appropriate. Government investment in public enterprises. 2 Briey describe how the roles of government and the private sector will change after the implementation of economic reforms. After the economic reforms, the government will no longer be concerned with running public enterprises but may regulate them in the private sector. Its role in the economy will decline. The private sector will operate more industries and will play a larger role in the economy. 3 Discuss the extent to which it is appropriate for your country to adopt the market-based system shown in the lower part of the diagram. An increase in savings as a percentage of GDP will provide more nance which rms can borrow to nance investment. Higher investment can increase actual and potential economic growth. There are a range of factors which will inuence whether it is appropriate for a country to adopt a market-based system. These include how developed the nancial system currently is, whether the public enterprises are efcient or not, whether they are natural monopolies, whether the private sector would be interested in buying the public enterprises and how effective state regulation of the private sector would be.

Practice questions (page 34)

1 a Dene the following terms: i scarcity Scarcity in economics means a lack of resources to produce everything that people want. The problem of scarcity arises because wants are innite (unlimited) whereas resources are nite (limited). ii opportunity cost. Opportunity cost is the best alternative foregone. For instance, the opportunity cost of a hospital treating road accident victims might be carrying out non-emergency operations. [2]

[2]

b Draw a production possibility frontier diagram to illustrate increasing opportunity cost.

[2]

80 Capital goods 70 60 50 40 30 20 10 0 10 20 30 40 50 60 70 80 90 Consumer goods

Original material Cambridge University Press 2010

Basic economic ideas

The opportunity cost of increasing the output of capital goods from 30 to 40 is 9 consumer goods. The opportunity cost of making an extra 10 capital goods increases to 16 consumer goods when the output of capital goods rises from 70 to 80. 2 a Copy the production possibility frontier diagram below [see Coursebook, page 34] and indicate the following: an inefcient production point a production point that is unattainable.

[2] [2]

A = an inefficient point 6 Shirts (000s per year) 5 4 3 A 2 1 B = an unattainable prodution point

4 2 3 Bananas (000s per year)

b What is the additional cost, in shirts, of increasing the production of bananas from 1000 pounds per year to 2000 pounds per year? The additional cost of increasing the production of bananas from 1000 per year to 2000 per year is 750 shirts.

[2]

6 Shirts (000s per year) 5 4 3 2 1 0 1 2 3 4

Bananas (000s pounds per year)

3 a State one reason why it is necessary to make economic choices. It is necessary to make economic choices as there are not enough resources to produce everything we want.

[1]

Original material Cambridge University Press 2010

Basic economic ideas

b State three major questions that must be asked when deciding what goods and services should be produced. When deciding what goods and services should be produced, it is necessary to answer the following questions: what products to make how to produce the products who will get the products.

[3]

c Susan uses the two hours available to her to answer her emails rather than study for her Economics examination. What is the cost to her of choosing to read her emails rather than study for her Economics examination? Briey explain your answer. [2] The opportunity cost to Susan of reading her emails is studying for her Economics examination. She is missing out on the opportunity to work towards a good grade. In the longer term, if she regularly spends time answering emails rather than studying, the cost may be a university place and a good career. 4 a Use the information in the following table to construct a production possibility frontier (PPF). [3]

Pineapples 0 200 350 425 475 500 b Mark the point (300, 300) on your diagram. a and b

Mangoes 500 450 350 275 125 0 [1]

500

400 Pineapples

300 Production point 200

100

100

200

300 Mangoes

400

500

Original material Cambridge University Press 2010

Basic economic ideas

c State why this point does not represent an efcient use of resources. This point does not represent an efcient use of resources because the point is inside the PPC (PPF) and so represents unemployed resources and/or failure to use the most efcient methods of production possible.

[1]

d What does the shape of the PPF you have drawn say about the opportunity costs of producing one more unit of pineapples or mangoes? [1] The shape of the PPF indicates that as the production of mangoes increases, the opportunity cost in terms of loss of production of pineapples increases. Similarly, as the production of pineapples increases, the opportunity cost of producing one more pineapple increases. For instance, whilst the opportunity cost of increasing the output of pineapples from 200 to 300 is only approximately 50 mangoes, a higher number, nearly 100, have to be relinquished to raise output from 300 to 400. The reason why opportunity cost rises with output is because the best resources are used rst to produce the product. As more is made, resources less suitable to the production of a product will have to be used.

Original material Cambridge University Press 2010

10

Basic economic ideas

KEY TERMS

Denitions of key terms can be found in the glossary.

barter capital capital consumption cheque choice coincidence of wants command economy consumption developing economy division of labour economic goods economic growth economic problem enterprise entrepreneur factor endowment factor mobility free goods inefciency interest investment labour land liquidity macroeconomics markets market economy market system measure of value medium of exchange needs normative economics planned economy positive economics primary sector production production frontier production possibility curve product transformation curve resources reallocation of resources risk scale of preference scarcity secondary sector Smith, Adam specialisation standard deferred payment store of wealth tertiary sector Tiger economics unit of account value judgement wants

Original material Cambridge University Press 2010

11