Download Chapter 2 – Essays

Chapter 1 – Practice Exam Answers
1. Scarcity is about the mismatch of resources and demand. Demand is
often in excess of supply of resources, thus society has to decide, as a
whole, how best to allocate these scare resources. This is done by
asking and then trying to answer the following three questions: what is
to be produced? how is it to be produced? And for whom is it to be
produced? Students may also want to consider the different ways in
which the economy’s attempt to address these three different
questions, namely a mixed economy, a planned economy and free
market economy. Once this is done, students should then note that
since resources are limited the only effective way to decide what to do
is to consider the opportunity cost, which is the foregone alternative.
From a number of alternatives, you simply choose the one that is the
best for you at that moment in time.
2. This question requires the student to define and explain a planned
economy, a mixed economy and a free market economy. Example of
all should be provided, which shows understanding, i.e. Cuba, USA
and UK respectively. Though students should note that all economies
are effectively mixed. It is the degree of ‘mix’ that differs! Students
should then proceed to consider the advantages and disadvantages of
each. The key here is to understand that a planned economy,
irrespective of degree, provides the necessary social, legal and
financial framework, where as the free market economy provides the
incentives, the pursuit of profit, etc. thus when working to together, i.e.
in a mixed economy, the whole economy moves forward as best it can!
3. Positive economics deals with scientific explanation of how the
economy operates, where as normative economics deals with what
ought to happen based on personal judgement values. Economics is
aided substantially by the understanding of positive and normative
economics as both support each other and thus provide the necessary
and acceptable rigour of economic analysis.
4. Macroeconomics is the study of the whole economy, where as
microeconomics is the study of the individuals components that make
up the whole economy. The link between the two is that both influences
upon each other and thus are inter-related. For example if there is an
observed changed at the micro level as a result of a macroeconomics
change then there is a link. I.e. the current reduction in the VAT rate
from 17.5% to 15% (2009) was initiated at a macroeconomic but yet
has microeconomics effects. The hope and intention is that by reducing
the VAT rate this should encourage expenditure at local levels, which
when aggregated should result in an increase in total aggregate
demand in the economy.
5. Economic data and economic modelling building aid the economist in
understanding what is happening in the economy and why and then be
able to predict, as best as possible, the effects of what is happening
and their likely outcomes. Once this known the economist is able to
devise policies which counter balance the negative effects whilst
implementing those policies which provide positive outcomes to society
as a whole. Model building provides the economist with the ability to
predict the outcome of change, should they actually occur or be those
which have been simulated. This increases the economist’s
understanding of how the economy works and the model is then tested
against actual and observed data!
Chapter 1 - Short answer question solutions
1. Economics attempts to study how society allocates its resources by
asking three very simple questions, namely, what to produce, how to
produce it and for whom to produce it for.
2. Scarcity is basically where the quantity demanded at zero price would
exceed the available supply, or in other words where demand is infinite
and resources are finite. Opportunity cost is the forgone alternative and
it helps address the problem of scarcity by allowing goods and services
which are scare to be ranked in order of preference and this then helps
in the decision making process.
3. Positive economics deals with scientific explanation of how the
economy works, whereas normative economics is based on
recommendations of a personal nature/value.
4. Microeconomics examines the individual aspect of the market, whereas
the macroeconomics examines the economy as a whole. The link is
that changes in either microeconomics or macroeconomics affect each
other and thus are constantly influence the other whilst at the very
same time being influence by the other.
5. Economists use economic models to test theories of how the economy
ought to work and use economic data in the economic models to test
the validity of the models. All this in the hope of being able to predict
the future. If the models work, this will help policy makers, planners,
governments etc., to implement policy so that desired outcomes are
observed, i.e. full employment, low inflation, economic growth, etc.