Question

1. The text identifies three key ideas that are foundations to the study of economics. Identify and explain each.

2. Explain the differences between positive and normative analysis. Give an example of each that would be relevant in economics.

3. Explain the difference between productive and allocative efficiency. How do you think a centrally planned economy versus a market economy would perform under each measure of efficiency?

Please write as much as possible

Answer 1

Answer:

The three key ideas that are foundations to the study of economic are explained as below:

Economics refers to the study of choices made by consumers, businesses and government to attain their goals given their scare resources.

The problem of choice arises because wants of the individuals are unlimited but the resources to satisfy these wants are limited in the economy.

The three key economic ideas that are foundations to the study of economics are as follows:

1. People are Rational: Economists assume that people are rational as consumers and firms take all available information into account to take actions to achieve their goals.

The consumers take into consideration the benefits and costs of each decision and take the actions where the benefits of the actions outweigh the costs.

Thus, consumers and firms are rational.

2. People respond to incentives: It has been observed that people whether they are consumers, producers, workers, savers or investors respond to the incentives to allocate their scare resources in a way that highest possible return are provided to them in this case.

For instance, if price of the good increase, then consumers will reduce the consumption of that good and producers will increase the sale of the good in order to earn higher return.

3. Optimal Decisions are made at the margin : Margin in this case means extra.

The consumers and producers in order to make any decision regrading consumption or production of the good compare the marginal benefit and marginal cost of the good and the optimal decision is to continue any activity up to the point where the marginal benefit from the decision is equal to the marginal cost of the decision.

Thus, the three key ideas of economics are the foundation of economic study on which various models of economics are based.

The differences between positive and normative analysis and an example of each that would be relevant in economics:

Positive Analysis:

• It is based on facts i.e. these are verifiable claims.
• It can be tested or verified.
• It talks about cause and effects.
• Argument is objective in nature.
• Example- Decline in 1% of unemployment causes GDP to go up by 3%. This statement is based on fact and is verifiable.
• Increase in price of coffee leads to increase in demand of tea. This statement might look normative, but it is positive and can be tested on group of people by increasing the price of coffee and observing the change in trend of quantity demanded of tea.

Normative Analysis:

• It is based on values.
• It cannot be verified or tested.
• It talks about values and judgements.
• Argument is subjective in nature.
• Eg- very high tax is harmful for the society. This statement is based on values and cannot be tested. Further what rate of tax can be called as high rate, this question can also not be tested.
• Employment rate is very low. Or Government should invest in public sector, are normative statements.

While framing an economic policy we need both types of analysis. Facts needs to be combined with judgements to form a policy which can be beneficial for society.

3.The difference between productive and allocative efficiency:

Allocative efficiency is used in economics when the output of production is equal to the marginal cost of production.

In such a situation the consumers are willing to pay an amount which is equal to the marginal utility of the product.

Productive efficiency occurs when goods or services are produced at the lowest cost.All points on the PPF curve show productive efficiency.

centrally planned economy versus a market economy would perform under each measure of efficiency is :

Planned economies are less efficient in utilising economic resources than market economies .

Lower efficiency in planned economies has been agreed by all but the question of how much less has been under debate.