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A) Thinking Like an Economist: Developing Models in Economics

1. Introduction to Economic Models

Economics is the study of how we make choices when we have limited

resources (like time or money) but unlimited wants (we always want
more).

Economists use models to make this study easier — just like architects use
blueprints before building a house.

✅ Example:
Imagine you want to plan a party. You only have Rs. 1,000. You can either
buy pizza or burgers. A model will help you figure out how many pizzas and
burgers you can buy and what trade-offs you face.

2. The Role of Assumptions

To build a model, economists make assumptions — simple rules that help

focus only on the most important details.

✅ Example:
In the Production Possibility Frontier (PPF) model, we assume that:

 There are only two goods (e.g., computers and phones).

 Technology stays the same.

 Resources are fully used.

This helps us understand the trade-offs: If we produce more computers, we

must produce fewer phones.

3. Advantages of Economic Models

Economic models are like maps — they are not fully realistic but help us find
the way.

✅ Example:
The supply and demand model helps us see what happens when prices
change.
If the price of petrol goes up:

 Demand goes down (people buy less).

 Supply might go up (companies want to sell more).

This model helps governments and businesses make better decisions.

4. Limitations of Economic Models

Models are not perfect because:

 People don’t always behave logically.

 Real life is messy and has many changing parts.

✅ Example:
Some models assume people always make the best decisions (rational
behavior). But in real life, people often make emotional or wrong choices —
like buying expensive clothes just for fashion.

🔹 B) The Use of the Ceteris Paribus Assumption in Building Models

1. Definition of Ceteris Paribus

Ceteris Paribus is a Latin phrase meaning “all other things remain

constant.”

Economists use it to focus on just one change at a time.

✅ Example:
When studying how price affects demand, we say:
“If price goes up, demand goes down — ceteris paribus (assuming income,
trends, and other factors stay the same).”

2. Application in Demand and Supply Analysis

Ceteris Paribus is very useful in the demand and supply model.

✅ Example:
If the price of smartphones rises:
  Ceteris paribus — we assume people’s income, taste, and the price of
other products like tablets do not change.

 Then we can study how this price increase alone affects demand.

3. Importance in Economic Analysis

This assumption makes economic analysis clearer and simpler.

✅ Example:
If the government increases minimum wage, economists want to know:

 Will companies hire fewer workers?

Ceteris paribus helps isolate the effect of this change without worrying about
other things (like new technology or business taxes) changing at the same
time.

4. Critique of Ceteris Paribus Assumption

In real life, we can’t freeze other factors. They all move together.

✅ Example:
If prices rise (inflation), it also affects:

 People’s salaries

 Their buying habits

 Government policies

So the assumption doesn’t always hold — and predictions may be wrong.

🔹 C) The Inability in Economics to Make Scientific Experiments

1. Characteristics of Scientific Experiments

In science (like physics or chemistry):

 Experiments are done in labs.

 Variables can be controlled.

  The same test can be repeated.

✅ Example:
In chemistry, you can heat water to 100°C and observe boiling every time.

2. Challenges in Economics

Economics is about people and society, not chemicals or machines.

We can’t control people’s behavior, income, or world events easily.

✅ Example:
If a tax is cut, it’s hard to know if people spend more because of the tax cut
— or because:

 They just got a salary raise.

 Prices dropped.

 Their mood changed.

3. Use of Natural Experiments

Instead of lab experiments, economists use real-life events as

experiments.

✅ Example:
If only one province introduces a sales tax, economists can compare what
happens there to other provinces — like a natural experiment.

4. Importance of Empirical Analysis

Economists use data and statistics (empirical analysis) to study patterns.

✅ Example:
They may study past data to see how interest rates affect economic growth
using econometric models.

So even if we can’t do lab experiments, we can still learn from the real
world.
 2.

A) Distinction Between Positive and Normative Economic

Statements

1. What Are Positive Economic Statements?

Positive economic statements are based on facts.

They describe what is happening or what will happen in the economy —
without personal opinions or emotions.

They can be:

 Tested

 Proven true or false

 Backed up by data

These statements are used for analysis and understanding real-life

economic situations.

✅ Examples of Positive Statements:

 “An increase in the minimum wage leads to a decrease in

employment for low-skilled workers.”

o This can be tested with data from countries where minimum

wage increased.

 “Inflation in the UK was 3.1% in 2023.”

o This is a factual statement. We can check this in government

reports.

 “Reducing taxes increases consumer spending.”

o Economists can use past data to confirm this relationship.

➡️Think of it like this:

Positive statements are like reporting facts in a news article — no
opinions, just information.

2. What Are Normative Economic Statements?

Normative statements are based on opinions, beliefs, or value
judgments.
They talk about what should happen, not what actually happens.

They cannot be tested or proven right or wrong in the same way as

positive statements, because they depend on morals, ethics, or political
views.

✅ Examples of Normative Statements:

 “The government should increase spending on education.”

o This reflects a belief that more education is important.

 “Income inequality is wrong, and it should be reduced through

higher taxes.”

o This is a moral judgment. Some people may agree, others may

disagree.

 “Healthcare should be free for everyone.”

o It’s an opinion. It can’t be tested like a scientific claim.

➡️Think of it like this:

Normative statements are like editorials or opinion pieces in a
newspaper.

3. Why This Distinction Matters

Understanding the difference helps you:

 Analyze economic problems more clearly.

 Know the difference between facts and opinions.

 Debate policies more effectively (because now you can say: “That’s a
normative statement, not a proven fact”).

✅ Example:
Two people might debate taxes:

 Person A says: “Increasing income tax on the rich reduces

inequality.” (→ Positive statement: Can be tested.)

 Person B says: “The rich should pay more taxes.” (→ Normative

statement: An opinion.)
🔹 B) The Role of Value Judgements in Influencing Economic Decision
Making and Policy

1. What Are Value Judgements in Economics?

Value judgments are personal or societal beliefs about what is good or

bad, fair or unfair.

Economic policies often reflect these values.

✅ Example:
A government may give subsidies (financial support) to farmers.
Why? Because it values food security or wants to protect rural
communities.

2. How Value Judgements Create Conflicts

Different groups in society have different opinions and different goals.

So, when it comes to making decisions like:

 Should we spend more on military or education?

 Should we tax the rich more?

There will be disagreements — not because of facts, but because of

different value systems.

✅ Example:

 Environmentalists: “We should protect nature even if it slows down

economic growth.”

 Industrialists: “We should allow development even if it causes

pollution.”

3. Economists and Value Neutrality

Economists try to stay neutral and focus on positive analysis.

They try not to say what should happen — they just show what will happen
based on data.
✅ Example:
An economist might say:

 “A carbon tax will increase energy prices by 10% and reduce emissions
by 5%.”

But they won’t say whether the tax is good or bad — that’s for politicians or
the public to decide.

4. Ethical Considerations in Economic Decisions

Some economic decisions are not just about money — they are about
morality and fairness.

✅ Examples:

 Who should get limited hospital beds during a health crisis?

 How should we distribute vaccines during a pandemic?

 Should we help the poor by giving them monthly cash?

These are not only economic questions — they are ethical questions.

5. Public Opinion and Its Role in Economic Policy

Policies are often shaped by what people believe is right or fair.

✅ Example:
If most people believe that education is a right, the government may:

 Increase the education budget.

 Make schools free.

Even if this costs more, it reflects public values.

Politicians usually support such policies to win votes or keep the public
happy.

🔍 Summary Table:
 Can Be
Type Based On Example
Tested?

Positive “Unemployment rose by 2% last

Yes Facts, data
Statement year.”

Normative Opinions, “Unemployment is unfair and should

No
Statement values be fixed immediately.”

3.
🧠 A) The Problem of Scarcity – Unlimited Wants and Finite Resources

1. 🔍 What is Scarcity?

Scarcity means there aren’t enough resources to satisfy everyone’s

unlimited wants.
It’s the central problem in economics. If there were infinite resources, we
wouldn’t need economics at all.

2. 📌 Key Characteristics of Scarcity

 Limited Resources:
We only have a limited amount of land, labour, capital, and
entrepreneurship.

 Unlimited Wants:
People always want more — more money, better healthcare, faster
phones, luxury holidays, etc.

3. ⚖️Implications of Scarcity: Choices, Trade-offs, and Opportunity

Costs

Because we can’t have everything, we must choose, which leads to trade-

offs.
Choosing one thing often means giving up something else — this is called
opportunity cost.
4. 🧾 Real-World Scenarios of Scarcity

🔹 Government Level

 A government has a $10 billion budget surplus. Should it:

o Build a new airport?

o Invest in public hospitals?

o Subsidise electric vehicles?

Whatever it chooses, the next best alternative it didn’t choose is the

opportunity cost.

✅ Example: Spending on defence might mean fewer funds for climate

change policies.

🔹 Business Level

 A car company has one production line. It can either produce:

o Electric SUVs

o Small budget cars

If it chooses electric SUVs, the opportunity cost is the profit and market share
it would’ve earned from selling budget cars.

🔹 Consumer Level

 A student has £30 and free time this weekend. They can:

o Buy a concert ticket

o Go for a short trip with friends

o Save the money

If they go to the concert, their opportunity cost is the trip experience or

the savings they could have made.

🔹 Agriculture
  A farmer has 100 acres of land. They can grow:

o Wheat (highly demanded)

o Cotton (higher profit margin)

Choosing one crop means giving up the benefits of the other — that’s
scarcity in action.

🔹 Healthcare Sector

 A hospital only has 10 ICU beds.

It must choose which patients get treatment first during a crisis.
This creates ethical and economic opportunity cost decisions.

🌍 B) Distinction Between Renewable and Non-Renewable Resources

1. 🔄 Renewable Resources

These are naturally replenished over time.

✅ Examples:

 Solar energy – sunlight is always available.

 Wind energy – wind keeps blowing.

 Forests – can regrow if managed properly.

 Fish stocks – can replenish if not overfished.

2. ⛽ Non-Renewable Resources

These do not renew within a human lifetime — once they are used,
they’re gone.

✅ Examples:

 Oil and coal – take millions of years to form.

 Natural gas – finite and being depleted.

 Minerals and metals – extracted faster than replenished.

3. 🧭 Why This Distinction Matters

🌱 Sustainability

 Overusing non-renewables leads to climate change, pollution, and

energy insecurity.

💸 Economic Impact

 As non-renewables become scarce, prices rise and inflation can

occur.

 Economies become more vulnerable if they rely heavily on oil, for

example.

4. 🧾 Real-World Scenarios

🌞 Germany’s Energy Policy

Germany is shifting to renewables like wind and solar after deciding to

phase out nuclear power.

Middle East Oil Exports

Countries like Saudi Arabia depend heavily on non-renewable oil exports.

They are now trying to diversify into tourism and technology.

🐠 Overfishing in Oceans

Fish is renewable, but if overfished, populations collapse — like cod

fisheries in Canada, which never recovered fully.

📊 C) Importance of Opportunity Cost to Economic Agents

1. 💡 Definition Recap

Opportunity cost = What you give up when you make a decision.

2. 👩‍💼 For Consumers

Consumers choose between products or experiences based on what they
value more.

✅ Scenario:

 You choose to buy an iPhone instead of a cheaper Android.

 Opportunity cost: the money saved or the trip you could have taken
with that extra cash.

3. 🏭 For Producers

Businesses must decide how to allocate resources efficiently.

✅ Scenario:

 A bakery has a limited number of ovens.

 If they bake only cakes, the opportunity cost is the income they
could’ve earned from cookies.

4. For Governments

Governments face tough choices in public spending.

✅ Scenario:

 Should Pakistan invest more in defence or education?

 Choosing defence means the opportunity cost is better education

outcomes (or vice versa).

5. 🧾 More Real-World Examples

🏫 Education vs. Healthcare

 A government allocates £20 billion to build new schools.

 The opportunity cost may be improved hospital services or reduced

waiting times.

📈 Tax Cuts vs. Infrastructure

 Cutting taxes boosts public spending.

  But the opportunity cost is less government revenue, which
could’ve been spent on roads, bridges, or internet access.

💰 Student’s Time Use

 A student chooses to work part-time instead of studying.

 Opportunity cost: lower grades or missed scholarship chances.

🏢 Office Space

 A company uses office space for admin work.

 Opportunity cost: renting that space out for extra income.

🧠 Summary Table:

Concept Definition Real-World Example

Limited resources vs. Choosing between building

Scarcity
unlimited wants schools or hospitals

Next best alternative Buying a phone instead of

Opportunity Cost
forgone saving for travel

Renewable
Replenish naturally Solar, wind, forests
Resources

Non-Renewable Cannot be replenished

Oil, gas, coal
Resources quickly
 4.

A) Introduction to PPFs

A Production Possibility Frontier (PPF) shows all the possible

combinations of two goods or services that an economy can produce using
all its resources efficiently.

🟦 For example, the graph above shows combinations of:

 Good A (Consumer Goods) on the X-axis

 Good B (Capital Goods) on the Y-axis

🔹 B) Opportunity Cost and Marginal Analysis

 Opportunity Cost: When you produce more of one good, you give up
some of the other. That “give-up” is the opportunity cost.

 The slope of the curve shows this trade-off. A steeper slope =

higher opportunity cost.

📌 Example: Moving from point A to point B on the curve means more capital
goods but fewer consumer goods. The amount of consumer goods lost is the
opportunity cost.

🔹 C) Economic Growth or Decline

 Growth = PPF shifts outward ➡️More can be produced.

o Shown by the dashed green curve in the graph.

 o Could happen due to better technology, more skilled labor, or
new natural resources.

 Decline = PPF shifts inward ⬅️Less can be produced.

o Happens in war, natural disasters, or economic collapse.

🔹 D) Efficient vs. Inefficient Resource Use

 Points on the curve (like the green dot) = efficient use of resources
(all labor, machines, etc., are fully used).

 Points inside the curve (orange dot) = inefficient use

(unemployment, underused machines).

 Points outside the curve (red dot) = unattainable with current

resources.

🔹 E) Movements Along vs. Shifts in the PPF

 A movement along the curve = changing production balance (e.g.,

more capital goods, fewer consumer goods).

o Example: Reallocating labor from farming to making machinery.

 A shift of the entire PPF = change in overall capacity.

o Example: New invention or discovery of oil reserves increases

maximum output.

🔹 F) Capital Goods vs. Consumer Goods

Type Description Examples

Used to produce more goods in Machinery, tools,

Capital Goods
future factories

Consumer Used for immediate Food, clothes, mobile

Goods consumption phones

📌 Trade-off Example:

 An economy investing in capital goods sacrifices current consumption

but grows faster in the future (outward PPF shift).
  Focusing too much on consumer goods may slow long-term growth.

🔹 Real-World Scenario

Imagine Pakistan:

 Has to decide between producing electricity generators (capital

goods) or refrigerators (consumer goods).

 Investing in generators now might mean fewer fridges today—but

better electricity and industrial output tomorrow.

5.

📘 A) Specialisation and the Division of Labour: Reference to Adam

Smith

1. Introduction to Specialisation

 Specialisation: When individuals, firms, or countries focus on a

narrow range of tasks or products to become more efficient.

 Division of Labour: Splitting production into smaller tasks so that

each worker focuses on one part.

🔄 Real-Life Example:

At a bakery:

 One person kneads the dough.

 Another shapes the bread.

 Another bakes it.

 Another packages it.

2. Adam Smith’s Contribution

 In The Wealth of Nations (1776), Adam Smith illustrated how dividing

pin-making into 18 distinct tasks increased productivity dramatically.

 Key Insight: “A country’s wealth increases when each person focuses

on what they do best.”
📊 B) Advantages and Disadvantages of Specialisation and Division of
Labour in Organising Production

✅ Advantages:

Advantage Explanation Example

Higher
Workers become experts Car assembly lines
Productivity

Time Saving Less switching between tasks Efficient workflows

Economies of Mass production reduces unit Smartphone

Scale cost manufacturing

Lower Training Call centres training in

Workers learn one task well
Costs scripts

❌ Disadvantages:

Disadvantage Explanation Example

Repetition Fatigue Workers may get bored Factory line jobs

If one task fails, the system If bakers go on strike, no

Overdependence
stops bread

Structural If an industry declines, workers’ Coal miners after the

Unemployment skills may be irrelevant coal industry shrank

🌍 C) Specialisation for Trade

✅ Advantages:

Advantage Explanation Example

Comparative Produce what you do best at the India – IT services,

Advantage lowest opportunity cost Brazil – coffee

Greater Output UK imports cars,

Efficient global production
and Trade exports medicines

Higher Living Access to cheaper and diverse Bananas in UK from

Standards goods Ecuador

❌ Disadvantages:
Disadvantage Explanation Example

External Natural disasters or conflicts in

War affecting oil supply
Vulnerability supply chain

Some regions/industries benefit Tech hubs grow, rural

Uneven Benefits
more areas lag

Countries may lose ability to UK stopped

Loss of Skills
produce certain goods manufacturing TV sets

💵 D) Functions of Money

Function Definition Example

Used to buy goods and Buy books with cash or

Medium of Exchange
services card

Prices show value in A car = £10,000, burger

Measure of Value
standard units = £5

Money keeps its value over Save £1,000 for next

Store of Value
time month

Method of Deferred Take a loan and repay in

Pay now or later
Payment future

🎯 Why This Matters:

Without money, we would have to barter (trade goods directly), which is

inefficient—imagine trading chickens for a haircut!

📉 Diagram: Specialisation & Productivity

Let’s imagine two workers producing pins:

Pins per
Scenario
day

No specialisation (each makes full

10
pins)
 Pins per
Scenario
day

With specialisation (each focuses on

40
1 step)

As shown, specialisation increases output massively by reducing time waste,

improving skill, and using tools efficiently.

A) Distinction Between Free Market, Mixed, and Command

Economies

Who Makes Economic Key

System Examples
Decisions? Thinker(s)

Individuals & private USA (to a large

Free Market Adam Smith
firms extent), Singapore

Command Government or central Karl Marx, North Korea, former

Economy authority Hayek (critic) USSR

Mixed Combination of market Modern UK, France, USA

Economy and government economists (realistically)

⚖️Diagram: Economic Systems Spectrum

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| Command Economy |———————|—————|———————| Free Market

Economy |

USSR China UK USA Singapore

💼 B) Advantages and Disadvantages of Free Market and Command

Economies

1. ✅ Free Market Economy

🔍 Advantages:

 Efficiency: Firms compete, reducing waste and lowering prices.

 Innovation: Incentives to invent (e.g. smartphones, AI).

 Consumer Sovereignty: Buyers have freedom of choice.

📌 Example: Apple's constant innovation in smartphones is driven by market
competition.

❌ Disadvantages:

 Inequality: Rich get richer without redistribution.

 Missing Markets: Underprovision of healthcare, education, etc.

 Instability: Booms followed by recessions.

📌 Example: 2008 Financial Crisis—poorly regulated banking led to global

recession.

2. ✅ Command Economy

🔍 Advantages:

 Equality: Everyone receives basic needs.

 Stability: Central control avoids random market crashes.

 Focus on Welfare: Can prioritize education, health, etc.

📌 Example: During the Cold War, USSR ensured full employment and basic
services for all.

❌ Disadvantages:

 Inefficiency: No profit motive → poor productivity.

 No Innovation: Lack of incentives to improve.

 Shortages and Surpluses: Price mechanism ignored.

📌 Example: Bread shortages in the Soviet Union due to poor planning.

C) Roles of the State in a Mixed Economy

1. 📏 Regulation

 Prevent exploitation, pollution, fraud.

 Example: Environmental Protection Agency (EPA) limits factory

emissions.

2. Provision of Public Goods

  Non-rival, non-excludable goods like street lighting, defense, public
education.

 Private sector won’t provide these efficiently.

📌 Example: Public roads funded by taxes.

3. 🤝 Welfare and Redistribution

 Taxing the rich to support the poor.

 Benefits include pensions, unemployment aid, food stamps.

📌 Example: Universal Credit in the UK; Social Security in the US.

4. 💹 Stabilisation and Economic Planning

 Government uses tools like interest rates and government

spending to fight inflation or unemployment.

📌 Example: During COVID-19, governments gave stimulus checks and

lowered interest rates.

📊 Diagram: Role of State in Mixed Economy

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Government Involvement

+-----------------------------------------------------+

| ▢ Regulation ▢ Welfare ▢ Stability |

| ▢ Public Services ▢ Redistribution ▢ Infrastructure|

+-----------------------------------------------------+

Private Sector Works Alongside

🧠 Conclusion

Understanding these systems helps explain:

 How resources are allocated

 Why governments intervene in some cases

  The trade-offs between freedom, equity, and efficiency

Modern economies lie on a spectrum, not in pure forms. The real-world is

about balance — too much government can stifle growth, too little can
create inequality and chaos.