Economic models and the economic problem
Economic models and the economic problem
This domain tests whether you can build, manipulate and criticise simple models. CB1 asks you to state the assumptions, derive a result, and say when the result breaks - not to recite definitions.
Core rules
- Scarcity forces choice, and every choice carries an opportunity cost measured by the value of the best alternative foregone, not by the money paid.
- Models abstract deliberately. Ceteris paribus holds other variables constant so a single effect can be isolated, and the assumption is judged by predictive usefulness, not by realism.
- Positive statements are testable claims about what is; normative statements involve values and cannot be settled by evidence alone.
- Decisions are taken at the margin: compare marginal benefit with marginal cost, not totals or averages.
- Efficiency takes three forms: allocative (P = MC, absent externalities), productive (minimum cost for a given output) and Pareto (nobody can be made better off without making someone worse off).
- The production possibility frontier (PPF) marks the feasible outputs of two goods from given resources. Its slope is the marginal rate of transformation, i.e. the opportunity cost.
Worked example
An economy can produce 120 tonnes of food or 60 units of clothing, with a straight-line PPF. The opportunity cost of one unit of clothing is 2 tonnes of food. A technology shock that raises both maxima shifts the whole PPF outwards - it is not a movement along the frontier. If the PPF is bowed out, its slope steepens as clothing output rises, so each extra unit of clothing costs more food: the law of increasing relative cost.
Traps
- Mixing up a movement along the PPF with a shift of the frontier.
- Writing 'demand' where the answer needs 'quantity demanded'.
- Asserting an efficiency condition when externalities or market power are present.
- Using average cost where a marginal condition is required.