The Basics

Rational Economic Man

Firstly, we need to clear a main assumption of pretty much all economic theory. That is ‘Rational Economic Man’ as John Kay called it in his bestseller ‘The Everlasting Lightbulb’.

This means that all in the economy are self maximising in every decision they make, and take the choice which brings them most reward or ‘utility’.

The economic problem-1: Satisfying infinite needs with finite(scarce) rescources and 2:What, where, for whom and how much to produce? This has plagued governments and firms for all time.

Ceteris Paribus

Us Economists love the phrase, Latin for ‘everything else constant’ to show how the changes in something such as the exchange or interest rate can feed through and affect something else.

Factors of Production

  1. Land is needed to produce
  2. Labour is the hiring of staff
  3. Capital is inanimate objects which are used to produce. Offices, factories, computers, machinery, vehicles etc.
  4. Enterprise is the organising of supply by those who seek to solve the economic problem for profit. Directors, executuves etc.


Productive Efficiency: Producing with lowest possible cost (same as Technical Efficiency ‘maximising output with given inputs’). Minimum factors production used to supply.

Allocative effiency: Goods supplied are what consumers want. ‘Nobody goes without and values something more than somebody whom has'(my def, ignore the Shakespeare language).

Dynamic Efficiency(used more in A2): Improvements in Prod and Allo efficiency over time. E.g technology means goods can be produced cheaper, and can inform traders what/how much etc to produce.

Pareto Efficiency Productive and Allocative efficiency combined. On PPF below, is on line.Rescources used to max potential mean least factors of production used per unit, lowest cost. Combo of ‘good X and good Y’ defined by price mechanism what people demand.

The Production Possibility Frontier

This is a simple diagram of a nations trade off, where deciding different combinations of each good. The typical trade off is between capital(for produce) and consumer(for consumer) goods, or the imaginative Good X to Good Y, or strangely enough Guns and Butter :S(seen in some books).

The line is the max the nation can produce, any combo. Inside is where factors of production are not used to their maximum potential.

Opportunity Cost: Where on line, to increase one good’s produce, other good’s produce decreases, and is because the rescources to produce it face a rivalry for use, when already fully utilised. When we have Pareto efficiency, an increase in production has an opportunity cost of rescources for other uses.


The great Adam Smith was the first to famously state that labour specialisation can enable much more effective production, studying a pin factory. Specialisation enables faster production as:

  1. Workers save time by not switching between tasks( e.g switching from cashier to organiser), instead do their bit and pass on to next stage.
  2. Workers become more skilled at their task, as it is their sole focus, saving time.

But…….workers may suffer boredom/morale issues doing one task allllll day *yawn*, decreasing speed.


One Response to The Basics

  1. Pingback: My Space. « Zahablog's Economic Page

Leave a Reply

Fill in your details below or click an icon to log in: Logo

You are commenting using your account. Log Out /  Change )

Google+ photo

You are commenting using your Google+ account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )


Connecting to %s

%d bloggers like this: