IB Economics

What is Economics?
 Section One Structure
Unit one has four core sub-topics and one HL extension

• The foundation of Economics is an introduction to the study of

Economics and to many topics that will be explored in depth in later chapters.
So concepts introduced here will be re-visited later in the syllabus and can be
assessed in the context of the areas of the syllabus in which they re-appear.
Economics is the study of…
 Wealth
 Money
 Politics
 How to become rich?
 How to economize?

CHOICES
Explain that scarcity exists because factors of production
are finite while needs and wants are infinite

Resources Needs and wants

 Human beings have unlimited needs and wants.
 The Earth has limited resources, which are inputs or
factors of production (FOPs) used to produce GOODS
and SERVICES that satisfy people’s needs and wants.
 TheResult: People can’t have everything they want
because there are not enough resources.
 The Solution: There must be a system to rationally
use these scarce resources. (the field of Economics arises to provide this
system)
Economics is
The study of how scarce resources
can be allocated in the best possible
way among alternative uses to meet
unlimited human needs and wants
Scarcity
 The scarcity issue arises whenever there is
not enough of something in relation to the
need for it
 To the economist, all goods and services that
have a price are relatively scarce.
 Price is used to ration available goods
 Any good or service that has a price and is
thus being rationed is an Economic Good
Explain that as a result of scarcity, CHOICES has to
be made
Choice
 The conflict between unlimited needs and wants and
scarce resources has an important consequence, people
can’t have everything they want and therefore must make
CHOICES
 For example, since people have limited financial resources, they
need to make choices when they purchase goods and services.
Therefore, they need to choose between alternatives.

 Ifthere were no resource scarcity, a choice would not be

necessary. More of everything can always be produced and
bought by human beings.
Explain the three basic economic questions that
must be answered by an economic system.

The Basic Economic Questions

Scarcity forces every economy in the world to make choices
through answering 3 basic questions:
What to produce and in what quantities
How to produce (Labor-intensive techniques vs.
Capital-intensive techniques)
For whom to produce (Affordability vs. need)
The Basic Economic Questions
Resource allocation
 The first 2 questions deal with resource allocation, which is assigning available
resources to specific uses choses among many possible alternatives.
 For example, if the answer to the what to produce question was 2 tons of
food and 1 weapon; this means that resources will be allocated
accordingly to produce this combination of output.
 If a decision was made to change the amount of food produced relative to
weapons, such as more weapons and fewer food, this involves a
reallocation of resources
 Sometimes, the economy produces a wrong amount of goods and services
relative to what is socially desirable. For example, if too many weapons
are being produced , we say that there is an overallocation of resources
to the production of weapons.
 If too few tons of food are being produced relative to the population size,
we say that there is an underallocation of resources to the food
production.
The Basic Economic Questions
Income distribution
 The third basic economic question involves the
distribution of output/income among individuals in
the economy.
 This could be based on financial ability or need
and equity.

 when the distribution of income changes so that

individuals receive more or less income than
previously; this is referred to as redistribution of
income,
Answering The Economic Questions
 The system used to allocate resources must answer
these questions

 There
are two theoretical rationing systems, free
market and planned economy

 In reality all economies are mixed economies

Resources/FOPs
 Resources,also known as Factors of Production
(FOPs), are goods and services that could be
used to produce other goods and services
 Economist group FOPs under four broad
categories:
 Land
 Labor
 Capital
 Entrepreneurship/Management
Resources/ FOPs
 Land
 Includes all natural resources also known as “gifts
of nature” such as basic raw materials, cultivated
products, renewable and non renewable
 Labor
 physical and mental contribution of the existing
workforce to production
 Capital
 is a man-made factor of production such as
investment in physical and human capital
 Management (entrepreneurship)
 the organizing and risk taking factor of production
Payments to the Factors of Production
 Land  rent
 Labor  wage
 Capital interest rate
 Entrepreneurship / management  profit
Explain that when an economic choice is made, an alternative is
always foregone
Scarcity=> Choice => Opportunity Cost
The opportunity cost is the value of the next best
alternative forgone or sacrificed when a choice is made
to obtain something else.
A few examples:
 If the government chooses to spend more on health care, this
means less spending on housing. The reduction in housing is the
opportunity cost.
 The opportunity cost of working overtime is the leisure time
that you have sacrificed.
 You were given $400 as an 18th birthday present. You buy a
CD instead of purchasing lunches for a week. The opportunity
cost of the CD is the lunches given up.
Explain that the PPC/PPF model may be used to show the
concepts of scarcity, choice, opportunity cost and a situation of
unemployed resources and inefficiency.
Our very first economic model
The Production Possibilities Frontiers (PPF)
 In this simple economic model used to show concepts of
scarcity, choice, and opportunity cost…etc. The following
assumptions are made:
 The economy produces 2 goods only: food and
tractors
 Resources are fixed (unchanging) in quantity and
quality and technology (the method of production) is
fixed.
The PPF
 The production possibilities frontier is a graph that shows all the possible
combinations of the maximum amounts of two goods that can be
produced by an economy, given its resources and technology, such that all
available resources are used efficiently (productive efficiency is achieved)
 For the economy to produce the greatest possible output and operate on
the PPC, two conditions must be met:
 All resources must be fully employed, this means that all resources must
be fully used. If some resources were not used, the economy would not be
producing the maximum it can produce.
 All resources must be used efficiently, this means that productive
efficiency is achieved. “Efficiency” means no waste. Productive efficiency
means that output is produced by use of the fewest possible resources or output
is produced at the lowest possible unit cost. Alternatively, if output were not
produced using the fewest possible resources, there economy would be wasting
some resources.
The PPF
 If either of the two conditions is not met…
 Simply, the economy will not operate at a point on the
PPC; it will be somewhere inside the PPC, such as point H.
 Inthe real world, NO ECONOMY IS
OPERATING ON ITS PPC.
 An economy’s actual output is always inside the PPC
because all economies have some unemployment of
resources and some productive inefficiencies.
 The greater the unemployment or inefficiencies, the further
away the economy is from its PPC.
The PPF
 The scarcity of resources forces the economy to make a choice
about what particular combination of goods it wishes to
produce

 The choices made by an economy involve opportunity costs.

Why? Because if the economy were at any point on the PPC,
it would be impossible to increase the quantity produced of
one good without giving up or sacrificing or decreasing the
quantity produced of the other good

 Let’s see an example…

An example:
 If all the economy’s resources are used to produce15 tractors, 0 tons of food
will be produced (point A on the PPC)
 On the other hand, if all resources are used to produce 12 tons of food, 0
tractors will be produced (point G on the PPC)
 All the points on the curve between A and G represent other production
possibilities where some of the resources are used to produce tractors and the
rest to produce food. For example, at point B, all the resources can be used to
produce 14 tractors and 2 tons of food. HOW does that happen?
 If the economy is currently at point A and would like to move to point B,
given the resources it has, it’s impossible to have more food without
sacrificing the production of tractors. So, to produce 2 tons of food instead of
0 tons of food, the economy had to reduce tractors production from 15 to 14 at
point B.
 The sacrifice of 1 tractor is the opportunity cost of 2 extra tons of food
(increasing food by 2 tons)
The Production Possibilities Frontier
FoodThe
Tractors
PPF
16
A 0 15
B
14
2 C 14
12 D
4 12 E
Tractors

10
8
6
H
6 10 F
4
2 8 7 G
0
0 2 104 64
Food
8 10 12 14

12 0
 To sum up…
 The PPF illustrates the concept of opportunity cost.
 To produce more of one good, less is produced of the other
due to the scarcity of the resources.
 Points on the PPF exhaust all of society’s resources.
 Points outside the PPF are unattainable given the
available resources.
 Points inside the PPF are inefficient as some
resources are unemployed or are not used to their
full potential.
 In this case, an economy can produce more of both
goods with no sacrifice, hence no opportunity cost,
simply by making better use of its resources: reducing
unemployment or increasing productive efficiency.
 The shape of the PPC
 The PPF could be curved (bowed out) or straight line
 When the PPC is curved, this means that the opportunity costs change as the economy
moves from one point on the PPC to another.
 For example, for each additional ton of food produced, the opportunity cost, which
is the amount of tractors given up changes and increases. For the first 2 tons of food
produced, the economy gave up 1 tractor and for the second 2 tons of food the
economy gave up 2 tractors. WHY?
 This is because of specialization of factors of production which makes them not
equally suitable for the production of different goods and services. For example, as
production switches from tractors to more food, the economy must give up
increasingly more tractors to produce extra unit of food because factors of
production suited to tractors will be less suited to food production. So, as more is
produced of food, resources which are best suited to food production are exhausted
and less productive resources, which better suit the tractors production, will be used
in the food production leading to more losses in the tractors production.
 The shape of the PPC
 By contrast, when the PPC is a straight line, opportunity costs
are constant and don’t change as the economy moves from one
point on the PPC to another
 Constant opportunity costs arise when the factors of
production are equally well suited to the production of both
goods such as the case of basketballs and volleyballs, which
are very similar to each other, therefore, needing similarly
specialized factors of production to produce them.
Economics is a Science
 Economics is a social science. Scientific methods are used to
study this subject

 As a social science, it tries to explain in a systematic way why

the economic events happen the way they do

 Dataabout an economic issue is collected  identify

variables needed to tackle the issue formulate theories about
how the variables are related to each other Test the theory
against empirical data
Economists and model building
Goods & Services

Consumer Expenditures

Payments

Factors of production

A model is a simplified representation of something in the real world

used by scientists to understand real world situations through focusing
on important relationships an ignoring unnecessary details.
Two assumptions in economic model-
building…
Ceteris Paribus
A Latin expression meaning all else equal
When studying the relationship between 2 variables, other
variables should be kept constant
In a scientific setting, this is equivalent to keeping the control
variables constant
Rational economic decision-making
Individuals are assumed to act in their best self-interest, trying
to maximize the satisfaction they expect to receive from their
economic decision. For example, workers will want to secure the
highest possible wage when they get a job.
Positive & Normative Concepts
Positivevs. Normative Concepts
Positive statements are descriptive and
could be tested
• The unemployment rate in Egypt is 13%
• As the price of a good increases, its
quantity demanded decreases
Normative statements are subjective
• The government should spend more on
education
Microeconomics vs. Macroeconomics
• Economics is studied on two levels:

 Microeconomics focuses on details and studies part of the

economy
• Decisions made by one firm (what to produce), or by one
individual (demand and expenditure)

 Macroeconomics studies issues pertaining to the whole

economy
• Unemployment, Inflation, economic growth
Central themes
 There are some central economic themes that will run
through your study of economics. There is no single right
or wrong answer to the issues posed.
1. The distinction between economic growth and economic
development
2. The threat to sustainability as a result of the current patterns
of resources allocation
3. The extent to which the government should intervene in the
allocation of resources
4. The extent to which the goal of economic efficiency may
conflict with the goal of equity
The distinction between economic growth and
economic development
 Economic growth is an increase in real national output/income/Gross Domestic
Product (GDP) over time.
 Economic growth is an increase in actual output, graphically represented by
a movement from a point inside the PPF to a point closer to the curve
 If actual output produced in an economy decreased, this is called negative
economic growth or economic contraction
 Economic development refers to raising the standard of living and social well-
being of people.
 This means not only increasing incomes and output, but also reducing poverty,
redistributing income to narrow down the gap between the rich and the poor,
increasing provision of important goods like sanitation, education, healthcare
and shelters so that they can be enjoyed by everyone.
 Economic growth is important to achieve economic development, but this is not
always the case. Sometimes growth may not be reflected on the poor people’s
living standards due to income inequalities.
 Human Development Index (HDI) is used to measure development.
Human Development Index (HDI)
 HDIrank countries based on their real
GDP/Capita, adult literacy rate and life expectancy

 Itgives countries values between 0 and 1, with 0

being the worse and 1 being the best
Examples of issues to evaluate…
 Should growth be a priority since it is required to achieve
development? Or should development be the priority?

 What are the best policies to achieve growth and

development?
Using PPC to show economic growth
Economic growth is depicted graphically by a rightward
shift of the PPF. This happens if resources increase or if
technological advancements occur
Schools

Cars
Relaxing Assumptions
Future Consumption

Capital Goods
Tractors

Food Goods
Consumer
Present Consumption
 Capital Goods
Capital Goods

Consumer
Goods

Consumer
Goods
 Growth vs. Development

Luxury Goods
Growth
Luxury Goods

Necessary
Goods

Growth
and Development
Necessary
Goods
The threat to sustainability as a result of the current
patterns of resources allocation
 Growth in output very often comes at the expense of natural
resources and environment
 Growth may result in air and water pollution, destruction of
forests, depletion of non renewable resources and the ozone
layer and the like. This is referred to as unsustainable
development or uneconomic growth.
 Sustainable development is defined as “development the
meets the needs of the present generation without
compromising the ability of the future generations to meet
their own needs”. This occurs when economies grow an
develop without leaving behind fewer or lower quality
resources for future generations.
Examples of current patterns of resources allocation
that result in threats to sustainability
 Enjoying the benefits of production and consumption today that cause
the change in the global climate, use up clean water, forests, and damage
the ozone layer means that we are putting the future generations at a
disadvantage
 Unsustainable resource use means that resources are used at a very fast
rate that does not give them enough time to reproduce themselves so that
they can be maintained over time and not be destroyed or depleted
 In rich economies, consumption patterns that rely strongly on burning
fossil fuels that pollute the environment like excessive use of private cars
and home heating are examples of resource allocation that threatens
sustainability in rich economies
 In poor economies, poverty itself causes threats to sustainability as it
drives the very poor to destroy their natural environment to survive like
cutting down forests to sell the trunks or build shelters or picking up
plants before they ripe to eat which destroy the plant’s ability to
reproduce in the future.
The extent to which the government should intervene in the
allocation of resources
 There are two main economic systems that economies adopt
to make their economic choices:
1. The market economy
2. The command economy
 In the real world, there is no economy that is entirely a
market economy or entirely a command economy. Real
world economies combines features of both economies and
are thus referred to as:
3. The mixed economy
Free market Economy
 Private ownership of capital
 Freedom of choice
 People are free to buy what they want and firms can enter
any market they want responding to price signals
 Markets
 Prices are determined by the forces of supply and demand
without government intervention
The Basic Questions
 How are the basic economic questions addressed
in a free market economy?
1. What?
 Thefreedom to choose ensures that consumer
sovereignty prevails so that producers produce
what consumers want
2. How?
 Theprice of FOPs will induce entrepreneurs to
produce in the most efficient way
3. For Whom?
 The price system rations goods
Centrally Planned Economy (CPE)
 Capital is owned by the government

 The government makes all decisions

 The central planner decides what to produce, which
technology to use (how) and how the output is to be
distributed (for whom)

 Prices are controlled by the government

 Disadvantages of Pure FMEs and CPEs
Pure FMEs CPEs
Demerit goods, like cigarettes and drugs, Total production and consumption are too
will be over-produced, driven by high complicated due to the immense amount
profit motives of data required for planning, and there
will be misallocation of resources
Merit goods, like education and healthcare, Prices are not the main element used to
will be underprovided, since they will only ration the use of scarce resources,
be produced for those who can afford therefore, resources won’t be used
them and not for all efficiently
Resources may be used up too quickly and No incentive system, as workers with
the environment may be damaged as firms guaranteed employment are difficult to
seek to make high profits and minimize motivate. Quality of output will deteriorate
costs
Orphans, sick people, handicapped and The dominance of government may lead
long-term unemployed won’t be able to to a loss of personal liberty and freedom
look after themselves and won't survive
Large firms may grow and dominate Governments may not share the same
industries, leading to high prices, loss of aims as the majority of the population and
efficiency and excessive power yet , by power, may implement plans that
are not appealing to the majority or are
even corrupt
 Mixed Economy
 Most economies are mixed, combining some features of free
markets and some features of CPEs
 In the last 30 years, there have been a trend around the world
for economies to move towards becoming free market
economies
 In mixed economies, the command method of making resource
allocation is referred to as government intervention. Examples
of government intervention include provision of public and
merit goods, minimum wage legislation, tax collection among
other regulatory and supervisory roles
 The market economy offers important benefits, yet it does not
always produce the best answers to the what, how and for
whom questions; therefore, government intervention is needed
to guarantee effective operation of the market economy
The extent to which the goal of economic efficiency may
conflict with the goal of equity
 Economic efficiency involves making the best use of
resources and avoiding waste; this happens by answering the
what and how questions by allocating resources in the best
possible way to producing only goods that society needs
most to avoid wasting resources
 Equity is interpreted as greater equality and less inequality in
the amount of income received by individuals in in a society
 The aim is not to distribute income equally but to ensure that
people with little or no income in a market economy will be
able to survive and have access to food, shelter, healthcare
and other basic needs.
The extent to which the goal of economic efficiency may
conflict with the goal of equity

 According to many economists, there is a trade-off between

efficiency and equity; more income equality involves less
efficiency and vice versa.

 For example, government intervention to achieve equity may

result in a less efficient resource allocation; for instance,
“government subsidizing bread to make it affordable may
result in people misusing it”
The extent to which the goal of economic efficiency may
conflict with the goal of equity
 It is widely believed that government intervention to achieve
equity results in many of the following:
 Changes in the work effort
 Changes in saving and investment patterns
 No or less incentive to learn and acquire new skills to become more
productive

 Contrarily, other economists believe that government intervention

to achieve equity will improve efficiency since it will increase
people’s ability to work and make them more productive as it will
provide them with money needed for better education and medical
services, appropriate shelters…etc.
Free Goods
 There are few things that are unlimited in supply i.e
air and salt water and therefore have no opportunity
cost.

 Sincethese goods are not relatively scarce and have

no price they will be known as Free Goods
Free Goods vs. Economic Goods
 A free good is a good, which does not have
an opportunity cost because it is abundant
 e.g. sea water, sand, etc.
An economic good is a good, which has an
opportunity cost
Consider the following…
You buy a Wilson racket because it
advertises a set of tennis balls for
free. Is the advertised gift a free
good?
No, because scarce resources were
used to produce it.
Technology
 The
technology available sets a limit on how resources can be
combined to produce a given amount of output.
 If it takes 1 ton of steel to produce a car, and society has 10 tons
of steel, then a maximum of 10 cars could be produced.
 Technology improvements allow society to use its resources
more efficiently. i.e. to produce more output with a given
amount of resources.
 Goods vs. services
 Goods are physical (tangible) objects that satisfy
people’s needs and wants, ex. food, cars, books,
computers, houses…etc.

 Servicesare non-physical (intangible) activities that

satisfy human’s needs and wants such as education,
health care, food delivery, car repair, banking…etc.
The End