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Topic 2
In order to develop reasonably simple models, they have to make simplifying assumptions. But while they may assume that other things remain constant, unlike physics they cannot actually hold them constant.
But in recent years with research providing more and more information and with more sophisticated models having been developed, often with the aid of computers the predictions of economists have become more accurate.
A normative statement is a statement of value: a statement about what ought or ought not to be, about whether something is good or bad, desirable or undesirable.
For example economists may argue that a policy of increasing government expenditure will reduce unemployment and rise inflation, but they cannot decide whether such a policy is desirable.
How
Plan how to achieve the goals
For Whom
Distribute the goods and services produced
Households decide how much labour and other factors to supply, and what goods to consume. Firms decide what goods to produce and what factors to employ.
All industries are seen as users of inputs from other industries and as producers of output for consumer or other industries. For example steel industry uses inputs from the coal and iron-ore industries and produces output for the vehicle and consumption industries.
The government might enforce its plans even if they were unpopular.
If production is planned, but consumers are free to spend money incomes as they wish, then the government has the problem of avoiding shortages and surpluses, should consumer wishes changes. Most of these problems were experienced in the former USSR and the other Eastern bloc countries, and were part of the reason for the overthrow of their communist regimes.
It is assumed that individuals are free to make their own economic choices. Consumers are free to decide what to buy with their incomes.
Worker s are free to choose where and how much to work. Firms are free to choose what to sell and what production methods to use. The resulting supply and demand decisions of firms are households are transmitted to each other through their effect on prices.
The same analysis can be applied to factor markets. If the demand for a particular type of labour exceeded its supply, the resulting shortage would drive up the wage rate.
1. competition between firms is often limited. A few giant firms may dominate an industry. In these cases they may charge high prices and make large profits.
4. The practice of some firms may be socially undesirable. E.g. A chemical work may pollute the environment.
Mixed Economy Because of the problem of both the purely market and the purely command economies, all real world economies are a mixture of the two system.