ECONOMIC METHODOLOGY,

THE ECONOMIC PROBLEM

8 SEPT 2015

A-LEVEL ECONOMICS

Lesson Objectives
1. Analyse the economic problem

2. Establish a working
understanding of basic
economic concepts

A-LEVEL ECONOMICS

Economics as a Social Science

Economics studies the choices people take under the

conditions of scarcity and uncertainty

As Economics is a social science we can never be sure

of the way in which people and businesses will respond
to the changing circumstances around them

Traditional economic theory has assumed that

consumers seek to maximise their own satisfaction and
that businesses aim to maximise profit

Consumer Behaviour

But new theories including Behavioural Economics

suggest alternatives and focus on the social aspect of
our behaviour in day to day life
Business behaviour
A-LEVEL ECONOMICS

The economic problem

The basic economic problem is said to exist because
as humans we have infinite (unlimited) wants and
needs but scarce (limited) resources to satisfy them
Needs are the things we need as humans to survive;
whereas wants are things we dont need to survive
but that make life so much more enjoyable
Make a list of your purchases over the last month sort
them into needs and wants!

A-LEVEL ECONOMICS

Introduction to Microeconomics

Microeconomics is the study of economics at the

level of the individual firm, industry or
consumer/household

We study how prices and wages are determined in

markets; how consumers decide what to buy; how
businesses determine what is produced and how
it is supplied

Consumer Behaviour

Microeconomics also involves analysing the

effects of government regulations, subsidies, taxes
and maximum and minimum prices on the prices
and quantities of goods and services
A-LEVEL ECONOMICS

Business behaviour

Number of people receiving three days' worth of

emergency food by Trussell Trust food banks in UK

Real World: The Economics of

Food Banks in Britain

1000000
913,138

900000

Food bank use in Britain has grown rapidly.

800000
700000

1.
2.

3.
4.
5.

Higher global food prices have made food less affordable for
low-income households
High levels of long term unemployment since the recession
have hit family budgets
Declining real incomes for many people on lower wages
Welfare reforms including a maximum welfare cap and
tighter rules for claiming benefits
More food banks have been set up in the UK perhaps this
is a question of supply responding to rising demand?

Number of people

Make a list of the reasons why you think this is?

600000

In the UK, food banks are run

by a range of volunteer-based
organisations, redistributing
food donated by consumers,
retailers and the food industry

500000
400000

346,992

300000
200000
128,697

100000
25,899

40,898

61,468

0
2008/09 2009/10 2010/11 2011/12 2012/13 2013/14

A-LEVEL ECONOMICS

Assumptions about the Objectives of Agents

For most of the AS microeconomics course we assume that
1.

Rational consumers wish to maximize their satisfaction or

utility from consumption by correctly choosing how to
spend their limited income.

2.

Producers/firms wish to maximize profits, by producing at

lowest cost the goods and services that are desired by
consumers. Profit = total revenue total costs.

3.

Government wishes to improve the economic and social

welfare of citizens.

Do we always
engage in rational
behaviour?

Behavioural economics theories challenge the

assumption of rationality in our decisions

A-LEVEL ECONOMICS

Are all businesses

looking to maximise
their profits?

Opportunity Cost
Opportunity cost measures the cost of a choice made in terms of the next best alternative
foregone or sacrificed.

1.

Work-leisure choices: The opportunity cost of deciding not to work an extra ten hours a
week is the lost wages given up.

2.

Government spending priorities: The opportunity cost of the government spending an

extra 10 billion on investment in National Health Service might be that 10 billion less is
available for spending on education or defence equipment.

3.

Investing today for consumption tomorrow: The opportunity cost of an economy

investing resources in new capital goods is the production of consumer goods given up for
today.

4.

Use of scarce farming land: The opportunity cost of using farmland to grow wheat for biofuel means that there is less wheat available for food production, causing food prices to
rise.

What opportunity costs do you experience on a weekly basis?

A-LEVEL ECONOMICS

Factors of Production (Factor Inputs)

Factors of production are the inputs available to supply goods and
services in an economy.
Natural resources
available for
production

Entrepreneurs
organise factors of
production and
take risks

A-LEVEL ECONOMICS

Land

Enterprise

Labour

Capital

The human input

into the production
process

Goods used in the

supply of other
products e.g. tech

Factors of Production (Factor Inputs)

Factor rewards describe the incomes that flow to each of the main
factors of production when they are brought into productive use.

Land

Labour
Wages and salaries
from employment

Rental income to
owners of land

Enterprise
Profits
A-LEVEL ECONOMICS

Capital
Interest from
savings + dividends
from shares

Different Ways of Rationing Scarce Resources

By Market Price

By Consumer
Income

By Assessment of
Need

By Household
Postcode

By Education Level

By Age

By Gender

By Nationality

Rationing is a way of allocating scarce goods and services when

market demand outweighs the available supply.
A-LEVEL ECONOMICS

Capital & Consumer Goods

Capital goods
Goods that are used to make consumer goods and services
Capital inputs include fixed plant and machinery, hardware, software, new factories and
other buildings
Consumer goods and services
Goods and services which satisfy our needs and wants directly
There is a sub-division between:
i) Consumer durables: Products that provide a steady flow of satisfaction / utility over their
working life (e.g. a washing machine or using a smartphone).
ii) Consumer non-durables: Products that are used up in the act of consumption e.g.
drinking a coffee or turning on the heating)
iii) Consumer services: E.g. a haircut or ticket to a show
A-LEVEL ECONOMICS

Non-Renewable Resources
Non-renewable resources are finite in supply
With plastics, crude oil, coal, natural gas and
other fossil fuels, no mechanisms exist at
present to replenish them.

Deforestation is an
example of the Tragedy
of the Commons

The rate of extraction of finite resources

depends in part on the current market price
for example, businesses with rights to extract
will have a greater incentive to do so when
prices are high because of the profit motive
A-LEVEL ECONOMICS

Have we reached peak

oil? If so, why are global
oil prices falling?

Renewable Resources and Free Goods

Renewable resources:
Renewable resources (in theory) are replaceable
over time providing that the rate of extraction of
the resource is less than the natural rate at which
the resource renews itself
Examples of renewable resources are solar energy,
oxygen, biomass, fish stocks and forestry

Renewable resources

Free Goods
Free goods do not use up any factor inputs when
supplied
Free goods have a zero opportunity cost i.e. the
marginal cost of supplying an extra unit of a free
good is zero
A-LEVEL ECONOMICS

Free goods

Free Market, Mixed and Command Economies

A-LEVEL ECONOMICS

Mix of state
and private
ownership
Government
intervention
in markets
Mix will vary
from country
to country

Command economy

Markets
allocate
resources
Driven by the
profit motive
Limited role
for state
Private sector
dominates

Mixed economy

Free market

An economic system is a network of organisations used to resolve

the problem of what, how much, how and for whom to produce

Most
resources are
state owned
Planning
allocates
resources
Little role for
market prices

Advantages of Free Market Competition

What do you think are the advantages of competition within markets
Competitive markets help to bring about
1. An efficient allocation of scarce resources resources tend to go where the market return is
highest
2. Competitive prices for consumers and suppliers look to increase and protect their market
share
3. Competition drives innovation and invention in markets which can bring higher profits for
businesses and better products for consumers
4. The profit motive stimulates capital investment which encourages economies of scale and
lower prices in the long run
5. Competition in the form of international trade in goods and services helps to reduce domestic
monopoly power and increases choice

A-LEVEL ECONOMICS

The Role of the Government in a Mixed Economy

A mixed economy has a mix of private and public (Govt) sectors
State-Owned
Industries

Businesses wholly or part stateowned for example: Royal Bank of

Scotland, Network Rail

Welfare State

Broad range of welfare benefits

Universal e.g. state pension
Means-tested e.g. housing benefit

Government spending
on public services

Spending on education & health

Capital spending on infrastructure

A-LEVEL ECONOMICS

Over to you: Key Questions/Tasks

Read the Beat the teacher passage and highlight any errors

State and explain the specific factors of production that are used
within The Kings Academy (i.e. those used to set-up and run it)

Complete the The Economic Problem Task located in the SSA

for Next Lesson

A-LEVEL ECONOMICS