Questions for Review with Answers
Chapter 2. The Subject of Economics I. Scientific Status.
Subjects of Investigation. Subdivisions. Models
I. The Discipline's Name
Chapter 2– Question 1
What do oikonomia and oikomene mean?
* Oikonomia means the art of household management. Oikomene means the inhabited world.
Chapter 2– Question 2
What is the difference between economics and political economy?
* Broadly speaking, economics investigates how the economy works without the government while political economy focuses on the role of the government in the economy.
Historically, political economy was replaced by economics in the early 20th century. This change reflected an increasing belief in individualism and liberalism and the concomitant opposition to government regulation.
II. Its Status as a Science
Chapter 2– Question 3
Explain what a scatter diagram is.
* A scatter diagram illustrates correlation between two variables. A scatter of points is plotted into a co-ordinate system. The points reflect collected data on the observed behaviour of the variables that are on the two axes. A trend line is then fixed into the graph. If deviations are minimal, correlation is significant.
Chapter 2– Question 4
Explain Popper's falsifiability criterion.
* It requires that it must either theoretically or empirically be possible to falsify a theory.
Chapter 2– Question 5
Explain the difference between normative and positive statements.
* A positive theory describes what a phenomenon is like. A normative theory states what it should be like.
Chapter 2– Question 6
Comment on Hume's dictum "There is no way from is to ought".
* It implies that the properties of the human body do not entail that a room's windows should be at the level of man's eyes. They could as well be at the level of his feet.
Chapter 2– Question 7
Economic efficiency is maximum output. Is this a positive or a normative statement?
* It is a normative statement in disguise. The "must" or "should" is hidden. It implies that, to be effective, an economy must produce maximum output. By the same token one could say that, to be effective, an economy must not cause environmental damage.
Chapter 2– Question 8
"All swans are white." This is the classic example of a theory that can be falsified. Explain why.
* It can be falsified because it is possible that a non-white swan is seen, which has, in fact, happened.
Chapter 2– Question 9
"Man is a selfish maximiser of utility." Can this theory also be falsified? If so, how?
* No, it cannot be falsified. Even the most helpful, friendly and generous people are covered by the theory. They derive maximum utility from their altruistic behaviour.
Chapter 2– Question 10
What is the essence of scientific models?
* The essence of scientific models is that they analyse the essential properties of a phenomenon and ignore less important properties or minor exceptions.
Chapter 2– Question 11
Why is economics a social science?
* Because, unlike medicine or physics, it deals with a human collective, the economy.
III. Definitions of Its Subject
Chapter 2 – Question 12
Repeat the standard definition of economics (the one with the allocation of resources).
* Economics investigates an economy's allocation of resources, production of goods and services, and the distribution of incomes.
Chapter 2– Question 13
What is meant by the allocation of resources?
* The allocation of the three factors of production (land, capital, labour) to the production of goods.
Chapter 2– Question 14
What are the three basic economic questions that must be answered by any economy?
* (1) The what-question. Which goods should be produced? (2) The how-question. Which factors of production should be employed to produce goods? (3) The for-whom-question. Which markets or market segments should be targeted?
Chapter 2– Question 15
How do capitalist systems answer the three basic questions?
* By and large, western capitalist countries let free enterprise give the answers to the three fundamental economic questions. There are, however, some government attempts to influence decisions. The how-question is influenced by labour legislation to protect labour and by various subsidies to encourage R&D, investment and employment. The what-question is subject to some restrictions, mostly aimed at environmental or consumer protection. The for-whom-question is almost completely left to free enterprise; the government only helps to open up export markets or imposes embargoes on some countries.
Chapter 2– Question 16
Draw the PPF and explain why it illustrates "the management of scarce resources that have alternative uses".
* Scarce resources are the assumption on which the PPP is based. They are givens, i.e. they are the quantities of labour, land and capital that a society is able and willing to devote to the production of two goods. The alternative uses are butter and guns, the two goods on the axes.
Chapter 2– Question 17
Explain how the PPF illustrates costs and growth.
* Costs are depicted as opportunity costs. The PPF shows how much butter additional guns cost and vice versa.
Growth is illustrated by an outward shift of the PPF.
Chapter 2– Question 18
Define productive efficiency.
* It means that the economy or an industry is on the PPF.
IV. Subdivisions
Chapter 2 – Question 19
Explain what microeconomics and macroeconomics deal with.
* Microeconomics explains the interaction of supply and demand - or of firms and households, which means the same - on markets with perfect competition. This interaction determines prices and generates equilibrium.
Macroeconomics investigates aggregates that the micro agents, households and firms, produce between them. Also called macroeconomic indicators, such aggregates include unemployment, inflation, growth rates, GDP, etc. They are used to assess an economy' performance. Macroeconomics also analyses business cycles.
Chapter 2 – Question 20
Give a definition of economics that comprises both microeconomics and macroeconomics.
* Economists establish principles which are then used to explain interactions on markets and the behaviour of economic aggregates.
Chapter 2– Question 21
What are micro foundations of macroeconomics? Give an example.
* Micro foundations of macro stand for the approach to explain macro phenomena with the help of the major micro instruments: demand, supply, price and equilibrium. An example is the view that unemployment is an excess of supply over demand, which must be remedied by lowering wages.
Chapter 2– Question 22
Draw a circular-flow diagram and explain how it illustrates the transactions between microeconomic agents.
Inner set of arrows: flow of money
Outer set of arrows: flow of commodities
* Households buy goods from firms and sell work or land to firms. Firms sell goods to households and buy work or land from them. The diagram suggests that households sell factors to firms on the factor market. This is only partly correct. Households do sell work and land, but they do not sell capital such as machinery, which is sold to firms by other firms. The diagram assumes that households lend money for capital investment to firms (via the banks, which lend their savings to firms).
Chapter 2– Question 23
What do econometricians do?
* They make forecasts and simulate the effects of alternative policies.
Chapter 2– Question 24
Explain how econometric models are built.
* To build models, econometricians feed data into theories. The latter are expressed with the help of equations. If the theory states that demand for new cars rises when incomes rise, actual income changes are fed into the model.
Chapter 2– Question 25
What do economists mean by development?
* The way to maximum GDP and prosperity.
Chapter 2– Question 26
Explain the term convergence.
* Convergence stands for the idea that poor regions and wealthy regions converge with time, i.e., that growth disparities between them gradually disappear, because firms shift investment to poorer regions, where land and labour are cheaper.
V. Two Schools of Economic Thought and Their Models
Chapter 2– Question 27
What are the most important elements of the standard micro model?
* The centrepiece of the micro model is the competitive firm on the competitive market. This firm must be small without market power; it is price-taking but output-setting as it is faced with infinite demand. It is part of an industry with low entry barriers and easy exit and entry. The interaction between such firms and utility-maximising consumers leads to equilibrium, i.e. to market clearance. Equilibrium is a state that cannot be improved.
Chapter 2– Question 28
Please outline the essence of new Keynesianism and neo-liberalism.
* The hallmarks of new Keynesianism are: mistrust in the micro model; new Keynesians think that firms have some power to set prices but are faced with limited demand. Moreover, a new Keynesian theory is by definition a disequilibrium theory. This is due to the belief that prices and wages are sticky, which means not flexible enough in the short-term. New Keynesians do not advocate complete laissez-faire; they believe, for instance, that business fluctuations should be prevented or evened out by government policies.
The hallmarks of neo-liberalism are: a strong conviction that the small competitive firm is suited to serve as the linchpin of the entire micro model; a rigorous laissez-faire recommendation based on the belief that, owing to flexible prices and wages, economies always speedily restore equilibrium. Unemployment is considered voluntary, which means it is due to workers' refusal to work for lower wages. Business cycles are viewed as "real", which means they are due to exogenous shocks like changes in technology. As a result, they cannot be alleviated by government policies. Another reason for the neo-liberal opposition to government intervention is a firm belief in rational expectations, which allow people to anticipate and counteract government measures before they have been enforced.
Chapter 2– Question 29
Explain where the leakage in the circular flow that Keynes detected occurs.
* The leakage consists in savings that are not borrowed for investment, because demand has not risen by the same amount as incomes.
Chapter 2– Question 30
List today's major macro issues.
* (1) Do markets automatically restore equilibrium or are prices and wages sticky? (2) Is unemployment voluntary? (3) Is there a trade-off between inflation and unemployment? (4) What are the causes of business cycles? (5) Is economic policy ineffective because people have rational expectations? (6) Should economic policy-makers be given discretion to stabilise the economy and prevent recessions?
VI. Economists and the Government
Chapter 2– Question 31
On which government responsibilities are all economists agreed?
* The enforcement of contracts, the enforcement of law and order, the protection of private property.
Chapter 2– Question 32
Which government interventions are most controversial?
* Labour and welfare legislation, stabilisation policies to prevent or even out business cycles.
VII. Economics and Capitalism
Chapter 2– Question 33
Distinguish free-enterprise economies, free-market economies and capitalist economies.
* Free enterprise economies are identical with capitalist economies; they give entrepreneurs the right of ownership and control over the means of production. Free-market economies exist in textbooks only. All economies are subject to government interference, though to varying degrees. Moreover, capitalist systems tend to give political sway to the owners of large amounts of capital, which does not eliminate markets but makes it difficult to describe an economic system as a genuinely "free" market economy.
Chapter 2– Question 34
What are the hallmarks of Anglo-Saxon capitalism?
* Its hallmarks are laissez-faire, emphasis on profit maximisation and self-reliance, a high degree of inequality in the distribution of incomes and wealth, poor quality of social-security, welfare and health-care schemes.
VIII. An Excursus on Pre-Capitalist Economic Systems
Chapter 2– Question 35
What are the major differences between a feudal order and a capitalist system?
* The major hallmarks of feudalism are incompatible with capitalism: the absence of private property, the maxim of subsistence, which led to stagnant economies, the local nature of life, which was due to enforced immobility and the non-existence of media, the total transparency of life, which was a result of its local nature, the regulation of economic life through traditions, customs and loyalty.
Chapter 2– Question 36
What are the major differences between the medieval guilds and today's trade unions?
* They can hardly be compared. The guilds comprised employers and employees, while trade unions are intended to protect employees against employers. The means of production were owned by artisans while the trade unions try to counter the power of capital owners. Membership in the guilds was compulsory. They exerted influence on the whole of urban life while trade-union influence is mostly confined to negotiating pay and working conditions.
Chapter 2 – Question 37
What is today's equivalent of mercantilism?
* Protectionism. They have two aims in common: a favourable trade balance and the protection of domestic industries.
If you like, print this page for offline comparison or studying.