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AQA A Level Economics Your notes

1. Economic Methodology & the Economic Problem

Contents
Economic Methodology
Economic Activity
Economic Resources
Scarcity, Choice & the Allocation of Resources
Production Possibility Diagrams

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Economic Methodology
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Economics as a Social Science
Economics is a social science
Social sciences study societies and the human interactions within those societies
Human interactions are complex and are influenced by many variables
Social sciences also include subjects such as Psychology, Politics, Geography and Business
Studies
Due to the complexities within societies, economists build models so as to better understand certain
interactions
A model is a simplified version of reality
Some models are more complex than others. Examples of models include, the circular flow of
income, production possibility curves, demand and supply
All models make a range of assumptions. These are often generalizations about behaviour,
choices and likely outcomes
These assumptions are necessary so as to account for complex human behaviour and constantly
changing variables
When evaluating different models, the underlying assumptions should always be considered
To think like an economist involves identifying which variables will be studied and which ones will be
excluded
This way of thinking considers the type of relationship between variables (causal or correlation).
E.g. Data shows that when ice cream sales increase, so do car thefts. Correlation, yes. Causation,
no
Some economists will build an argument to include certain variables in a study and others will
argue to exclude them. They will each provide a justification for their decision
Two economists analysing the same data may end up with vastly different interpretations. This is
often due to the different variables that each economist chooses to focus on
This is the complexity found within social sciences

The Social Scientific Method

As a social science, Economics deals with complex and continuously changing human interactions

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It is hard to examine a relationship between two variables and always come to the same
conclusion (as can be done in Science or Maths)
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There are a variety of tools used in economic analysis to help ensure that positive (factual)
statements can be made with a degree of reliability
1. The use of logic
When analysing markets, a range of assumptions are made about the rationality of economic agents
involved in the transactions
In classical economic theory, the word 'rational' means that economic agents are able to consider the
outcome of their choices and recognise the net benefits of each one
Rational agents will select the choice which presents the highest benefits
Consumers are assumed to act rationally. They do this by maximising their utility
Producers are assumed to act rationally. They do this by selling goods/services in a way that
maximises their profits
Workers are assumed to act rationally. They do this by balancing welfare at work with
consideration of both pay and benefits
Governments are assumed to act rationally. They do this by placing the interests of the people
they serve first in order to maximise their welfare

2. The use of hypotheses, models and theories

The social sciences use a variation of the scientific method of research, which is called the social
scientific method
There is an inability to make scientific experiments, the results of which can be proven time and time
again
This is due to the complexity of human nature and the significant number of social interactions
that are taking place in any economy at any given point in time

The steps in the social scientific method are similar to the scientific method but there is a key
difference

Diagram: The Social Scientific Method

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Your notes

The method uses empirical research to gather data

Empirical research is collected through observations, surveys, opinion polls etc.
The results of the same hypothesis can vary significantly when conducted by different
researchers at different time periods and between different places and cultures

Refutation is the act of a statement or theory being proved to be wrong by the empirical evidence
Refutation helps to determine if an economic statement is positive

Economic models are developed by economists once a hypothesis has been repeatedly proven or
rejected in different circumstances
A model is a simplified version of reality

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All models make a range of assumptions. These are often generalisations about behaviour,
choices and likely outcomes
Your notes
These assumptions are necessary so as to account for complex human behaviour and constantly
changing variables
When evaluating different models, the underlying assumptions should always be considered
3. The ceteris paribus assumption
Due to the large number of variables that can influence any particular economic interaction in society,
economists create models using the principle of ceteris paribus
Translated from Latin, ceteris paribus means 'all other variables remain constant'
It allows economists to simplify and explain causes and effects, even if the explanation is
somewhat limited by the assumptions
E.g. There are many factors that affect the level of unemployment in an economy (interest rates,
consumer confidence, firms' investment, government policies, etc.). Using ceteris paribus,
economists can simplify the economic model to analyse just two variables (e.g. unemployment
and interest rates)

Positive & Normative Statements

What is positive economics?
Positive economics is concerned with objective statements of how a market or an economy works
These positive economic statements are based on empirical evidence and tend to be statements of
fact
They can be proven to be true or false
Examples of positive economic statements include
The unemployment rate in India has fallen from 8% to 7.3% in the past twelve months
Increasing the minimum wage last year in the UK resulted in improvements to wage inequality
Prices in the EU have risen dramatically, partly due to the 20% increase in the price of oil

What is normative economics?

Normative economics focuses on value judgements
These judgements are built around opinions and beliefs as to what the best economic policies or
solutions may be
These judgements are called normative economic statements

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Normative economic statements are often the basis for the manifestos of political parties and the
different economic agendas they put forward
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Examples of normative economic statements include
Every economy should aim to provide free healthcare for its citizens
Corporation taxes in an economy should be higher than personal income taxes
The best way to deal with a rise in crime is to employ more police

Examiner Tips and Tricks

In short answer questions, should you wish to provide an example of a positive or normative
statement ensure that normative statements have the word 'should' in them. Positive statements
usually include data that is hard to challenge.

The Role of Value Judgements

Value judgements influence governments' choices with regards to the economic policies they
choose to adopt and spend money on
The USA spends more money on imprisoning drug users than rehabilitating them
In the UK, the government has recently increased its spending on rehabilitation
To say the UK approach is better would be a normative statement
To say that the UK government spends more per head on rehabilitation would be a positive
statement
Value judgements will impact economic decision-making because they are influenced by how the
public will react to economic policies and what they see as a favourable outcome

Factors Affecting People's Choices

Individual decision-making is influenced by positive outcomes and the morality of choices
Postivie outcomes tend to be focussed on self and not ' the benefit of society'
Moral judgements are a normative concept, as 'the right thing' means different things to different
people
Consumers have different moral judgements about equity and equality
Equity is concerned with the idea of fairness

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Individuals and societies have different views on what is fair and this influences government
policy
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E.g. Some countries believe it is fair for all of their citizens to be able to access healthcare,
irrespective of their ability to pay, whereas other countries believe that 'no pay, no access'
is fair
Equality is concerned with everyone being equal and having equal recognition
Equality is often a normative concept. When are all people equal? When do people all have equal
opportunities?
Statistics on inequality would be considered to be positive economic statements
E.g. In 2018, women in the USA were paid 12% less than men in comparable jobs
The degree to which markets versus governments should, or are able to, create greater equity or
equality in an economy is an area of much debate

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Economic Activity
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The Purpose of Economic Activity
The central purpose of economic activity is the production of goods and services to satisfy needs and
wants
Needs are essential for survival, eg. food and shelter
Wants are desires for goods and services that are not essential, eg. electronics
The demand for needs and wants are infinite, while the supply of resources needed to produce them is
finite

Diagram: The Purpose of Economic Activity

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The purpose of economic activity is to take inputs, add value to them, and create products which meet
customer needs and wants
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To produce goods or services
The primary purpose of business activity is to produce goods or services that satisfy a need or
demand in the market
Goods are physical products, such as bicycles and T-shirts
Services are non-physical items such as hairdressing, tourism and manicures

Meeting customer needs

The ultimate goal is to create products that meet the needs and preferences of customers and
provide value to them
By meeting customer needs, businesses can build customer loyalty, increase brand awareness, and
generate revenue

To add value
The third purpose of business activity is to add value to products or services
Value-added features can differentiate products from competitors, create a unique selling point, and
increase customer satisfaction
E.g. a product that is easier to use, has a better design, or is of higher quality than competitors can
create a competitive advantage for a business

The Three Fundamental Economic Questions

In order to solve the basic economic problem of scarcity, economic systems emerge or are created
by different economic agents within the economy
These agents include consumers, producers, the government, and special interest groups (e.g.
environmental pressure groups or trade unions)
Any economic system aims to allocate the scarce factors of production
The three main economic systems are a free market system, a mixed economy, and a planned
economy

Diagram: Three Fundamental Economic Questions

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Your notes

How the three questions are answered determines the economic system of a country
Each economy has to answer three important economic questions
1. What to produce? As resources are limited in supply, decisions carry an opportunity cost. Which
goods/services should be produced, e.g. better rail services or more public hospitals?
2. How to produce it? Would it be better for the economy to have labour-intensive production so that
more people are employed, or should goods/services be produced using machinery?
3. Who to produce it for? Should goods/services only be made available to those who can afford them,
or should they be freely available to all?

How These Questions are Answered Determines the Economic System

Type of What to Produce? How to Produce? For Whom?

System

Demand and supply Most efficient, profitable Those who can afford it
Market (the price way possible.
System mechanism)

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Demand, supply and Some efficiency but also Those who can afford it,
Mixed the Government a focus on welfare/well- plus some provision to
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System being those who cannot afford it

The Government Ensure everyone has a Everyone

Planned job
System

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Economic Resources
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The Factors of Production
Factors of production are the resources used to produce goods and services
Land, labour, capital and enterprise
The production of any good/service requires the use of a combination of all four factors of
production
Goods are physical objects that can be touched (tangible) e.g. mobile phone
Services are actions or activities that one person performs for another (intangible) e.g manicure,
car wash

The Four Factors of Production

Land Labour Capital Enterprise

Non man-made The human input Capital is any man- Enterprise involves
natural resources into the made resource taking risks in setting
available for production that is used to up or running a firm
production process produce
goods/services An entrepreneur
Some countries Labour involves decides on the
have a vast mental or E.g. Tools, combination of the
amount of a physical effort. buildings, machines factors of production
particular natural Not all labour is and computers necessary to produce
resource and so of the same goods/services with
are able to quality. It can be the aim of generating
specialise in its skilled or profit
production e.g. unskilled
oil

Some of the Factors of Production Required to Produce a Motor Car

Land Labour Capital Enterprise

iron ore car designer robotic arms CEO

rubber production director conveyor belt

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oil production line staff rolled steel

sand supply chain staff computers
cows seats Your notes

In a free market economic system, the factors of production are privately owned by households or
firms
Households make these resources available to firms that use them to produce goods/services
Firms purchase land, labour, and capital from households in factor markets
Households receive the following financial rewards (factor income) for selling their factors of
production
The factor income for land → rent
The factor income for labour → wages
The factor income for capital → interest
The factor income for entrepreneurship → profit

The Environment as a Scarce Resource

Environmental resources are raw materials that come from nature, e.g. gas, water, soil, wood
It is the land used to produce goods and services as part of the factors of production
Increased economic activity causes the degradation of environmental resources.This is where current
generations overconsume and produce, resulting in resources becoming scarce. They are being
destroyed for use for future generations
Non-renewable resources (eg. coal or oil) are already limited in supply and will run out quickly
Renewable resources (e.g. water and air) should be infinite in supply
Resources such as clean water will eventually run out if not treated properly by current
generations. This makes the supply scarce
This gives rise to the concept of sustainability, which means meeting the needs of current generation
without compromising the needs of future generations

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Scarcity, Choice & the Allocation of Resources

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The Basic Economic Problem: Scarcity
The basic economic problem is that resources are scarce
In economics, these resources are called the factors of production
There are finite resources available in relation to the infinite wants and needs that humans have
Needs are essential to human life, e.g. shelter, food, and clothing
Wants are non-essential desires, e.g. better housing, a yacht, etc.
Due to the problem of scarcity, choices have to be made by producers, consumers, workers and
governments about the best (most efficient) use of these resources
Economics is the study of scarcity and its implications for resource allocation in society
All Stakeholders in an Economy face the Basic Economic Problem

Consumers Producers Workers Government

In a free Producers selling Workers may want a Governments have to

market, products made from more comfortable decide if they will
scarcity has a scarce resources will and safer working provide certain
direct find their costs of environment but goods/services or if
influence on production are their employers they will allow private
prices higher than if they may not have the firms to provide them
were selling products resources to create instead
The scarcer a made from more it
resource or abundant resources Their decision
product, the influences the
higher the allocation of
price resources in society
consumers will
pay

Opportunity Cost Defined

Opportunity cost is the loss of the next best alternative when making a decision
Due to the problem of scarcity, choices have to be made about how to best allocate limited
resources amongst competing wants and needs

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There is an opportunity cost in the allocation of resources

E.g. When a consumer chooses to purchase a new phone, they may be unable to purchase new Your notes
jeans. The jeans represent the loss of the next best alternative (the opportunity cost)
Opportunity Cost in Decision Making
An understanding of opportunity cost may change many decisions made by consumers, workers,
firms and governments
Factoring the opportunity cost into a decision often results in different outcomes and so a different
allocation of resources
Examples of how the Consideration of Opportunity Costs can Change Decisions

Stakeholder Example

Consumer Ashika is wanting to visit her best friend in Iceland

She looks at flight prices from London to Reykjavík
On Friday night it costs £120 whereas Thursday night is only £50
She is about to book the Thursday flight but then realises that the opportunity cost
of saving £60 on a flight is the inability to work on Friday (loss of £130 income)
Ashika books the more expensive flight. If she had booked the cheaper flight, it
would have cost her the income from the missed day of work (£130) + £50 for the
ticket

Ric has been offered two jobs and is deciding which one to accept
Worker
Job A offers £400 a month more in salary than Job B, but Job B offers the flexibility of
working from home
Most people would only consider the actual cost of commuting before they make a
decision, which in Ric's case is £40 a week or £160 a month
Ric values his free time and decides that each hour he can save in commuting is worth
£20 to him (£180 a week), he is considering the opportunity cost of commuting
Ric decides to take Job B as the cost of monthly travel (4 x £40) and value of the
lost hours spent commuting (4 x £180) adds up to £880 a month

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Examiner Tips and Tricks

Opportunity cost is about the loss of the next best alternative. It is not a monetary amount. Money Your notes
may well be a factor but opportunity cost is about the loss of the next best choice when making a
decision.

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Production Possibility Diagrams

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An Introduction to Production Possibility Diagrams
The Production Possibility Curve (PPC) is an economic model that considers the maximum possible
production (output) that a country can generate if it uses all of its factors of production to produce
only two goods/services
Any two goods/services can be used to demonstrate this model
Many PPC diagrams show capital goods and consumer goods on the axes
Capital goods are assets that help a firm or nation to produce output (manufacturing). For
example, a robotic arm in a car manufacturing company is a capital good
Consumer goods are end products and have no future productive use. For example, a watch

Diagram: Production Possibility Curve (PPC)

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A PPC for an economy demonstrating the use of its resources to produce capital or consumer goods
Diagram Explanation Your notes
The use of PPC to depict the maximum productive potential of an economy
The curve demonstrates the possible combinations of the maximum output this economy can
produce using all of its resources (factors of production)
At A, its resources are used to produce only consumer goods (300)
At B, its resources are used to produce only capital goods (200)
Points C and D both represent full (efficient) use of an economy's resources as these points fall on
the curve. At C, 150 capital goods and 120 consumer goods are produced
The use of PPC to depict opportunity cost
To produce one more unit of capital goods, this economy must give up production of some units
of consumer goods (limited resources)
If this economy moves from point C (120, 150) to D (225, 100), the opportunity cost of producing
an additional 105 units of consumer goods is 50 capital goods
A movement in the PPC occurs when there is any change in the allocation of existing resources
within an economy such as the movement from point C to D

Productive & Allocative Efficiency on a PPC

Efficiency is a key concept in economics
Economists generally identify two types of efficiency - productive and allocative efficiency
An Explanation of Productive and Allocative Efficiency

Type of Efficiency Explanation

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Producing at any point on the PPC represents productive efficiency, as it

is the maximum output that can be produced from the available factors of
Your notes
Productive Efficiency production to produce goods and services
There is no wastage of scarce resources
Any point inside the curve represents inefficiency (point E)
It does not use all possible combinations of factors of production to
produce goods and services

Makes the best possible use of scarce resources to produce the

Allocative Efficiency combinations of goods and services that are optimal for society, thus
minimising resource waste
Not all points on the PPC are allocatively efficient
This is because more of one good or service cannot be produced without
reducing output of another good/service
Any change to the allocation of resources in this market will make either
the consumer or producer worse off (excess demand or excess supply
would occur)

Changes in Production Possibilities

As opposed to a movement along the PPC described above, the entire PPC of an economy can shift
inwards or outwards, thereby changing its production possibilities

Diagram: Inward & Outward Shift of PPC

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Your notes

Outward shifts of a PPC show potential economic growth and inward shifts show economic decline

Diagram explanation
Economic growth occurs when there is an increase in the productive potential of an economy
This is demonstrated by an outward shift of the entire curve. More consumer goods and more
capital goods can now be produced using all of the available resources
This shift is caused by an increase in the quality or quantity of the available factors of production
One example of how the quality of a factor of production can be improved is through the impact
of training and education on labour. An educated workforce is a more productive workforce and
the production possibilities increase
One example of how the quantity of a factor of production can be increased is through a change
in migration policies. If an economy allows more foreign workers to work productively in the
economy, then the production possibilities increase
Economic decline occurs when there is any impact on an economy that reduces the quantity or
quality of the available factors of production
One example of how this may happen is to consider how the Japanese tsunami of 2011 devastated
the production possibilities of Japan for many years. It shifted their PPC inward, resulting in
economic decline

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