SEAB GCE A-Level Economics

Economics as a social science

Economics studies how people, firms and governments choose to use limited resources to satisfy wants. It is a social science: like the natural sciences it builds models, tests them against evidence and revises them, but its subject is human behaviour, and that makes it different in three ways.

• People cannot be placed in a laboratory and held constant, so economists rely on observation of real economies, natural experiments and statistical analysis, and results are rarely as clean as those from a chemistry experiment.
• People respond to the theories themselves. A forecast that interest rates will rise can change what firms and households do, and so change what happens.
• The relationships being studied shift over time, because tastes, technology and institutions change. A relationship that held in Singapore in one decade may be weaker in the next.

To get round the first problem, economists use the assumption of ceteris paribus, which means "all other things remaining equal". A demand curve, for instance, shows how quantity demanded responds to price when income, tastes and other prices are held constant. The assumption is a way of isolating one cause at a time, and a model built on it is a simplification that has to be checked against what else changes in practice.

Positive and normative statements

A positive statement is about what is, was or will be, and can be tested against evidence, whether or not it turns out to be true. "A rise in the price of petrol reduces the quantity of petrol demanded" is positive, and so is "the unemployment rate fell between two named years" (it can be checked against the figures, and is true or false).

A normative statement contains a value judgement about what ought to be, and cannot be settled by evidence alone. "The government should tax sugary drinks" and "income inequality is too high" are normative, because they depend on what the speaker thinks matters. Normative economics applies value judgements to policy; positive economics describes how the economy works. Policy choices usually need both: evidence on what a tax will do, and a judgement on whether that outcome is worth having.

Microeconomics and macroeconomics

Microeconomics studies the choices of individual economic agents (households, firms, workers) and how they interact in particular markets, so it asks why the price of a good changes, how a firm sets output, or why a market fails to allocate resources well. Macroeconomics studies the economy as a whole and deals with totals and averages: national output, the general price level, unemployment, the balance of trade. The two are linked, since the whole economy is the sum of its markets, but a problem can look different at each level. If every household saves more, each household becomes better off in the short run, yet the fall in total spending can lower national income.

The central economic problem

The central economic problem is scarcity: resources are limited, while human wants are unlimited. Because of this, no society can produce everything its members would like, and choices have to be made.

Resources

Resources, also called factors of production, are the inputs used to make goods and services.

Resources are limited in supply, at least at any given moment, and many have alternative uses. A hectare of land can be used for housing, farming or a park; a worker's hour can be spent in a factory or a classroom. Wants are unlimited because satisfying one want leads to another, and because new goods appear and tastes change. A want backed by the ability to pay is what appears in a market as demand.

Scarcity is not the same as shortage

Scarcity is permanent and applies to every good that uses resources, including goods that are plentiful on the shelves. A shortage is a situation in a particular market where quantity demanded exceeds quantity supplied at the going price, and it can be removed if the price adjusts. Scarcity cannot be removed, only managed.

Choice and allocation

Because resources are scarce, an economy has to decide how to allocate them between competing uses. Every economy faces three questions:

• what to produce, and in what quantities;
• how to produce it, meaning which combination of resources and methods;
• for whom to produce, meaning how the output is shared out among people.

How those questions are answered depends on the economic system. In a market economy, prices set by demand and supply direct resources; in a command economy, the state decides; most real economies, including Singapore, are mixed, with markets doing most of the allocation and the government intervening where it judges outcomes to be inefficient or unfair.

Opportunity cost and trade-offs

Choosing one option means giving up others. The opportunity cost of a choice is the value of the next best alternative that is given up. The idea is about the best forgone alternative only, not the sum of all alternatives.

A student who spends Saturday afternoon at a part-time job rather than studying has not "paid" the study time in money, but the opportunity cost is the study (or the leisure, whichever was the next best use). The cost also need not be financial at all: a government that spends a limited budget on a new hospital gives up the school, road or tax cut that the same money would have bought.

A trade-off is the same idea seen as a pair: getting more of one thing means getting less of another. A firm that is choosing between running a night shift and not running it trades higher output for higher wage bills and wear on machinery. Opportunity cost is the measure of what is lost in the trade-off.

Opportunity cost explains why an item with a price of zero is still costly. A "free" school meal uses food, labour and kitchen space that could have served another purpose, so society bears the cost even if the pupil does not pay.

Scarcity, choice and opportunity cost for different economic agents

The same three ideas apply to each of the economic agents, with different resources and different aims.

Consumers face a budget constraint, so they choose which goods give them most satisfaction for their limited income. Producers face limited inputs and decide what to make and how, to earn as much profit as they can. Governments have finite revenue and have to rank competing demands for it, and decisions on taxation also involve choices, since a tax changes the incentives of everyone it falls on. The opportunity cost for a government is often measured in the benefit that society would have received from the best alternative use of the funds.