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.
 The
Result: 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

 If
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.
there 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
categories:
group FOPs under four broad

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
 the
(entrepreneurship)
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.
 In
the 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
A
16
14
Tractors
12
10
8
6
4
2
0
0
0
B
2
4
H
6
8
104
2
12
C
15
14
D
12 E
10
7
64
Food 8
0
F
G
10
12
14
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
 Data
about 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 modelbuilding…
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 selfinterest, 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
Positive
vs. 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.
2.
3.
4.
The distinction between economic growth and
economic development
The threat to sustainability as a result of the
current patterns of resources allocation
The extent to which the government should
intervene in the allocation of resources
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)
 HDI
rank countries based on their real
GDP/Capita, adult literacy rate and life
expectancy
 It
gives 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
Schools
Economic growth is depicted graphically by a
rightward shift of the PPF. This happens if
resources increase or if technological
advancements occur
Cars
Capital Goods
Tractors
Future Consumption
Relaxing Assumptions
Food Goods
Consumer
Present Consumption
Capital Goods
Capital Goods
Consumer
Goods
Consumer
Goods
Luxury Goods
Luxury Goods
Growth vs. Development
Growth
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?
 The
freedom to choose ensures that
consumer sovereignty prevails so that
producers produce what consumers
want
2.
How?
 The
price 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,
will be over-produced, driven by high
profit motives
Total production and consumption are too
complicated due to the immense amount
of data required for planning, and there
will be misallocation of resources
Merit goods, like education and
healthcare, will be underprovided, since
they will only be produced for those who
can afford them and not for all
Prices are not the main element used to
ration the use of scarce resources,
therefore, resources won’t be used
efficiently
Resources may be used up too quickly and
the environment may be damaged as
firms seek to make high profits and
minimize costs
No incentive system, as workers with
guaranteed employment are difficult to
motivate. Quality of output will deteriorate
Orphans, sick people, handicapped and
long-term unemployed won’t be able to
look after themselves and won't survive
The dominance of government may lead
to a loss of personal liberty and freedom
Large firms may grow and dominate
industries, leading to high prices, loss of
efficiency and excessive power
Governments may not share the same
aims as the majority of the population and
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.
 Since
these 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.
 Services
are non-physical (intangible) activities that
satisfy human’s needs and wants such as education,
health care, food delivery, car repair, banking…etc.
The End