The study of Economics

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This booklet covers the basics of economics and introduces you to various concepts such as scarcity, choice, opportunity cost, etc.
1. IB Economics
What is Economics?
2. 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.
3. Economics is the study
 Wealth
 Money
 Politics
 How to become rich?
 How to economize?
4. Explain that scarcity exists because factors of
production are finite while needs and wants are
Resources Needs and wants
 Human beings have unlimited needs and wants.
 TheEarth 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)
5. 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
6.  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
7. Explain that as a result of scarcity, CHOICES
has to be made
 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
 Ifthere were no resource scarcity, a choice would
not be necessary. More of everything can always be
produced and bought by human beings.
8. Explain the three basic economic questions that
must be answered by an economic system.
The Basic Economic
Scarcity forces every economy in the world to make
choices through answering 3 basic questions:
What to produce and in what
How to produce (Labor-intensive
techniques vs. Capital-intensive techniques)
For whom to produce (Affordability vs.
9. The Basic Economic
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.
10. The Basic Economic
Income distribution
 Thethird basic economic question
involves the distribution of
output/income among individuals in the
 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,
11. Answering The Economic
 The
system used to allocate resources must
answer these questions
 Thereare two theoretical rationing systems,
free market and planned economy
 In reality all economies are mixed economies
12.  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
13. Resources/ FOPs
 Land
 Includes all natural resources also known as
“gifts of nature” such as basic raw materials,
cultivated products, renewable and non
 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
14. Payments to the Factors of
 Land  rent
 Labor  wage
 Capital interest rate
 Entrepreneurship / management  profit
15. Explain that when an economic choice is made, an
alternative Choice
is always => Opportunity
The opportunity cost is the value of the
next best alternative forgone or sacrificed
when a choice is made to obtain something
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.
16. Explain that the PPC/PPF model may be used to
show the concepts of scarcity, choice,
opportunity cost and a situation of unemployed
Our and inefficiency.
very first economic model
The Production Possibilities Frontiers
 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
 Resources are fixed (unchanging) in quantity
and quality and technology (the method of
production) is fixed.
17. 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.
18. 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
 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.
19. 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
 Let’s see an example…
20. 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)
21. The Production Possibilities
A 0 15
2 C 14
12 D
4 12 E
6 10 F
2 8 7 G
0 2 104 64
8 10 12 14
12 0
22. 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
 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
23. 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.
24. 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
25. Economics is a
 Economics is a social science. Scientific methods
are used to study this subject
 Asa 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
26. Economists and model
Goods & Services
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.
27. Two assumptions in economic
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.
28. Positive & Normative
Positivevs. Normative Concepts
Positive statements are descriptive
and could be tested
• The unemployment rate in Egypt is
• As the price of a good increases, its
quantity demanded decreases
Normative statements are subjective
• Thegovernment should spend more on
29. Microeconomics vs.
• 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
 Macroeconomics studies issues pertaining to the
whole economy
• Unemployment, Inflation, economic growth
30. 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
31. 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
32. Human Development Index
 HDIrank countries based on their real
GDP/Capita, adult literacy rate and life
 Itgives countries values between 0 and
1, with 0 being the worse and 1 being
the best
33. Examples of issues to evaluate…
 Should growth be a priority since it is required
to achieve development? Or should
development be the priority?
 Whatare the best policies to achieve growth
and development?
34. Using PPC to show economic
Economic growth is depicted graphically by a
rightward shift of the PPF. This happens if
resources increase or if technological
advancements occur
35. Relaxing Assumptions
Future Consumption
36. Capital
r Goods
r Goods
37. Growth vs. Development
Luxury Goods
Luxury Goods
y Goods
and Development
y Goods
38. The threat to sustainability as a result
of the current patterns of resources
 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.
39. 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
 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.
40. 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
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
41. Free market
 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
42. The Basic Questions
 Howare the basic economic
questions addressed in a free market
1. What?
 Thefreedom to choose ensures that
consumer sovereignty prevails so that
producers produce what consumers
2. How?
 The price of FOPs will induce
entrepreneurs to produce in the most
efficient way
3. For Whom?
 The price system rations goods
43. Centrally Planned Economy
 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
44. Disadvantages of Pure FMEs and
Pure FMEs CPEs
Demerit goods, like cigarettes and Total production and consumption
drugs, will be over-produced, driven are too complicated due to the
by high profit motives immense amount of data required for
planning, and there will be
misallocation of resources
Merit goods, like education and Prices are not the main element used
healthcare, will be underprovided, to ration the use of scarce resources,
since they will only be produced for therefore, resources won’t be used
those who can afford them and not efficiently
for all
Resources may be used up too No incentive system, as workers with
quickly and the environment may be guaranteed employment are difficult
damaged as firms seek to make high to motivate. Quality of output will
profits and minimize costs deteriorate
Orphans, sick people, handicapped The dominance of government may
and long-term unemployed won’t be lead to a loss of personal liberty and
able to look after themselves and freedom
won't survive
Large firms may grow and dominate Governments may not share the
industries, leading to high prices, loss same aims as the majority of the
45. 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
46. The extent to which the goal of economic
efficiency may conflict with the goal of
 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.
47. The extent to which the goal of economic
efficiency may conflict with the goal of
 According to many economists, there is a trade-
off between efficiency and equity; more income
equality involves less efficiency and vice versa.
 Forexample, 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”
48. The extent to which the goal of economic
efficiency may conflict with the goal of
 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.
49. Free Goods
 Thereare 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
50. Free Goods vs. Economic
 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
51. Consider the
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.
52.  Thetechnology 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.
53. 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.
54. The End