BE-1101 Principles of Economics Tutorial Week 5

1. How is economics a science? What role does

assumptions and models play in economics?

2. What are the two most basic economic models?

Explain each of them.

3. Imagine a society that produces military goods

and consumer goods, which we’ll call “guns” and
“butter”.
a) Draw a production possibilities frontier for
guns and butter. Using the concept of
opportunity cost, explain why it most likely
has a bowed-out shape.

b) Show and explain a point that is impossible

for the economy to achieve and a point that
is feasible but inefficient.

4. What are the two subfields into which

economics is divided? Explain what each subfield
studies and give two examples of each subfield.

5. Explain the difference between a positive and a

normative statement.

6. Classify each of the following statements as

positive or normative. Explain.

a) Society faces a short-run trade-off

between inflation and unemployment.

b) Lower tax rates encourage more work and

more saving.

c) The central bank should reduce the

growth rate of money supply.

Answers:

1. Economics is a social science

because in order to efficiently
distribute scarce resources
economists need scientific methods to
 understand and analyse human
behaviour.

Assumptions help to simplify and

manage how complex real world
solutions can be, allowing for
manageable analysis in order to build
a model that can capture economic
dilemmas and solutions for them.
Models help to visualize and predict
economic problems, test hypotheses
and give insight to how different
factors affect the economy.

2. The two most basic economic models

are the Circular Flow Model and the
Production Possibility Frontier (PPF)
Model.

Circular Flow model:

It is a representation of the economy’s
flow of goods, services, and money
between households and businesses.
The purpose of the model is to ensure
that we are able to understand how
different sectors of the economy
interact and how resources and
incomes are distributed or exchanged.

Production Possibility Frontier (PPF)

Model:
The PPF model is used to represent
the tradeoffs that the economy faces
when they are distributing or allocating
the scarce resources between the
production of goods and services. The
model also shows the maximum
quantity of a good that can be
produced given a certain amount of
another good.

3. (a)
The PPF diagram above shows an
economy’s trade-offs between
producing two goods, guns and butter.
It’s bowed-out shape is due to an
increase in opportunity cost. As the
resources shift from one good to
another, the cost of producing said
good will rise. Initially, balanced
production was attainable, but as they
start to specialize, the resources lose
efficiency in the other good, which
causes the curve to bow outwards.
This shows that resources don’t work
the same for everything and we must
make choices on what to produce.

(b)
 The graph shows a point beyond the
curve, this means that the economy is
trying to product more guns and butter
than it currently can with the resources
and technology that’s available to
them. This point shows that resources
are limited and the economy cannot
reach high levels of production at the
moment.

4. The two subfields in which economics

is divided into are called
Microeconomics and
Macroeconomics. Microeconomics
focuses on individual players such as
consumers, firms and households. By
studying their behavior, it allows us to
shape the allocation of resources.
Macroeconomics is studying the
economy as a whole and how policies
and external factors cause
inefficiencies within the economy.

5. Positive statements are factual and

real based on data that cannot be
refuted. Normative statements are
based on opinions.

6. (a) Positive. This is a positive

statement because it does not give an
opinion whether the trade-off is
positive or negative. It only describes
the connection between inflation and
unemployment.

(b) Normative. It includes an opinion

and a believe system which may not
apply to real life situations once it
does occur. Vice versa, may occur
and spending will increase instead of
saving.

(c) Normative. This statement includes

an opinion of what the central bank
should do as it includes a
recommendation which means the
bank didn’t take that action and it’s all
just hypothetical