Economics SL 2024-2025 - Unit 1 and 2 Notes

Economics SL 2024-2025 Vivian Park Unit 1: Introduction to Economics

Scarcity

• Economics:
  • Social science studying resource allocation to satisfy needs/wants.
  • Deals with unlimited wants/needs and limited resources (scarcity).
• Scarcity:
  • Limited resources vs. unlimited wants.
  • Forces economies to decide:
    • What to produce.
    • How to produce.
    • For whom to produce.

Resource Allocation

• Resource allocation: Assigning resources to specific uses.
  • Involves reallocation, overallocation, and underallocation.
• Distribution of income: How output/income is divided among individuals.
• Redistribution of income: Changes in income distribution among social groups.
• Factors of production (FOP):
  • Inputs (land, labor, capital, enterprise) used to produce goods/services.
  • Land: Natural resources.
    • Ex: crude oil, coal, water, metal ores
  • Labour: Human effort (physical/mental).
    • Ex: accountant, miner, doctor, clown
  • Capital: Man-made resources.
    • Ex: machinery, infrastructure, tools, vehicles
  • Enterprise: Innovation and risk-taking.
    • Ex: Innovators and risk-takers

Choices

• Choice: Ability to decide due to scarcity.
  • Economics studies choices and their consequences.
• Economic decision-makers:
  • Microeconomics (individual markets).
  • Macroeconomics (national economy).
  • Global economy (international trade).
• Opportunity cost: Value of the next best alternative given up.

Sustainability

• Sustainability: Meeting present needs without compromising future generations.
  • Requires using resources without depletion over time.
  • Intergenerational Equity
• Unsustainable activities lead to greater scarcity.
• Renewable resources: Replenish naturally.
  • Ex: forest, air, wildlife, fish, water resources, biodiversity
• Non-renewable resources: Finite, not sustainably used.
• Circular economy: Sustainable use of resources and renewable energy.

Efficiency

• Efficiency: Optimal use of resources without waste.
  • Allocative efficiency: Optimal combinations of goods/services for society.
  • Productive efficiency: Largest output with optimal input combinations.
• Pareto efficiency: Impossible to reallocate resources without making someone worse off.

Production Possibilities Curve (PPC)

• PPC: Maximum combinations of two goods an economy can produce.
  • Also called Production Possibility Frontier (PPF).
  • Downward sloping, concave due to increasing opportunity costs.
• PPC Assumptions:
  • Fixed resources, scarcity, efficiency, constant technology.
• Expanding the PPC: Improved FOP, trade, technology, R&D, population growth.
• Shrinking the PPC: Major disaster, war, economic depressions, lower efficiency.
• Marginal rate of transformation: Slope of the PPC, representing opportunity cost.

Economic Well-being

• Economic well-being: Prosperity and living standards.
  • Financial success, material goods, income, GDP, life expectancy.
• Indicators:
  • Basic needs, financial security, adequate income, economic choices.
• Economic growth: Increasing quantity of output (GDP).
  • $GDP = C + I + G + NX$ where $NX = Exports - Imports$
• Economic development: Raising living standards.
• Private sector: Production to meet customer needs.
• Public sector: Government supply of goods/services.

Intervention

• Intervention: Government involvement to correct market failures.
• Economic system: Organization and management of an economy.
• Planned economy: Government controls economic decisions.
• Market economy: Decisions made by consumers and firms.
• Mixed market economy: Combination of market and command elements.

Equity

• Positive economics: Study of how the economy works.
  • Relies on evidence and uses testable statements.
• Normative economics: Study of how the economy should work.
  • Subjective and includes value judgments.
• Equity: Fairness in resource distribution.
• Equality: State of being equal.
• Inequality: Uneven distribution of economic opportunities.

Interdependence

• Interdependence: Economic agents depend on each other (households, firms, governments).
  • Highlights circular flow of income.
• Circular flow of income: Model of economic activity and national income determination.
  • Two-sector model (households and firms).
  • Four-sector model (includes foreign purchases and government).
• Leakages: Savings, taxation, imports.
• Injections: Government spending, export earnings, investment.

Change

• Change: Constant state of flux in the economic world.
  • Requires economists to adapt their thinking.
• Economic theory studies changes between situations.
• 18th Century: consumers and producers act in their own self-interest by Adam Smith.
• 19th Century:
  • The Law of Diminishing Marginal Utility.
  • Say's Law where supply creates its own demand.
  • Marxist critique of classical economic thought.
• 20th Century:
  • Keynesian economics: some conditions require a government response.
  • Monetarist: Market will find full employment.
• 21st century: Dialogue with other disciplines and increasing awareness.

Economic Way of Thinking

• 6 core economic concepts:
  1. People choose: Scarcity, costs and benefits
  2. All choices involve costs: opportunity cost
  3. People respond to incentives in predictable ways
  4. Economic systems influence individual choices and incentives
  5. Voluntary trade creates wealth: Specialisation.
  6. The consequences of choices lie in the future.

Unit 2: Microeconomics Demand

• Microeconomics: Small scale decision-making and use of resources
• Demand: Quantity consumers buy at different prices (ceteris paribus).
• Demand schedule: Table listing quantity demanded at various prices
• Demand curve: Graph of price-quantity relationship.
• Law of demand: As price increases, quantity demanded decreases (inverse relationship).
• Individual demand: Demand by a single consumer.
• Market demand: Total demand by all consumers.

Determinants of Demand

• Non-price determinants shift the demand curve.
  • TRIBE (Tastes, Related goods, Income, Buyers, Expectations).
  • Tastes and preferences.
  • Price of related goods (substitutes and complements).
  • Income of buyers (normal and inferior goods).
  • Number of buyers.
  • Expectations of future prices.

Supply

• Supply: Quantity sellers offer at different prices (ceteris paribus).
• Law of supply: As price increases, quantity supplied increases (positive relationship).
• Individual supply: Supply by a single producer.
• Market supply: Total supply by all producers.
• Vertical supply curve: Quantity is independent of price.

Determinants of Supply

• Non-price determinants shift the supply curve (SEATING).
  • Sellers (number of).
  • Expectations (business).
  • Alternative activities prices.
  • Technology.
  • Input costs.
  • Natural events.
  • Government actions.

Competitive Market Equilibrium

• Equilibrium: Where quantity supplied equals quantity demanded.
  • “Market clearing” price.
• Surplus: Excess supply (Qs > Qd).
• Shortage: Excess demand (Qd > Qs).

The Price Mechanism

• Price mechanism: Supply and demand determine resource allocation.
  • Answers: What to produce, how to produce, and for whom.
  • Functions: Resource allocation (signaling and incentive) and rationing.

Allocative Efficiency

• Allocative efficiency: Resources produce desired quantities.
• Marginal Benefit Curve: Consumers buy if price decreases.
• Marginal Cost Curve: Producers produce if price increases.
• Consumer surplus: Benefit to consumers paying less than they're willing to.
• Producer surplus: Benefit to producers charging more than they're willing to accept.
• Social surplus: Consumer + producer surplus, maximized at equilibrium.

Price Elasticity of Demand

• Elasticity: Measure of a variable's responsiveness to change.
• Price elasticity of demand (PED): % change in quantity demanded / % change in price.
  • $PED = \frac{\% \Delta Q_d}{\% \Delta P}$
• Perfectly inelastic demand: PED = 0 (no change in quantity demanded).
• Perfectly elastic demand: PED = ∞ (infinite change in quantity demanded).
• Inelastic demand: 0 < PED < 1 (smaller change in quantity demanded).
• Elastic demand: 1 < PED < ∞ (greater change in quantity demanded).
• Unit elastic demand: PED = 1 (equal change).
• Firms and governments consider PED in pricing and taxation decisions.
• Determinants of PED:
  • Necessities vs. luxury items.
  • Proportion of income spent.
  • Addictive products.
  • Number and closeness of substitutes.
  • Time.

Income Elasticity of Demand

• Income elasticity of demand (YED): % change in quantity demanded / % change in income.
  • $YED = \frac{\% \Delta Q_d}{\% \Delta Y}$
• YED < 0: Inferior goods (demand falls as income rises).
• YED > 0: Normal goods (demand rises as income rises).
  • 0 < YED < 1: Necessity goods (income-inelastic).
  • 1 < YED < ∞: Luxury goods (income-elastic).
• Engel curve: Relates demand for a good to income.

Price Elasticity of Supply

• Price elasticity of supply (PES): % change in quantity supplied / % change in price.
  • $PES = \frac{\% \Delta Q_s}{\% \Delta P}$
• Perfectly inelastic supply: PES = 0 (no change in quantity supplied).
• Perfectly elastic supply: PES = ∞ (infinite change in quantity supplied).
• Inelastic supply: 0 < PES < 1 (smaller change in quantity supplied).
• Elastic supply: 1 < PES < ∞ (greater change in quantity supplied).
• Unit elastic supply: PES = 1 (equal change).
• Determinants of PES:
  • Length of time.
  • Mobility of factors of production.
  • Spare capacity of firms.
  • Ability to store stocks.
  • Rate which costs increase.

Price Ceilings

• Reasons for Interventions
  • Doesn't always work as intended
  • Can result in: socially undesirable outcomes, economic inefficiency, poor environmental sustainability
• Price controls: Government sets min/max prices.
• Price ceiling: Legal maximum price below equilibrium.
  • Creates shortages, non-price rationing, underground markets, welfare lost.
• Consequences for customers: Lower prices but less quantity.
• Consequences for workers: Unemployment.

Price Floors

• Price Floor: Legal minimum price above market equilibrium price
• Market consequences: Surpluses, Inefficient/ overallocation of resources, and welfare loss
• Consequences for customers: Higher prices, and less quantity.
• Consequences for producers: Higher prices, higher quantity, and less competition (+), decreased motivation to seek efficiency (-)
• Consequences for workers: Job creation
• Consequences for government: Costly.

Minimum Wage

• Minimum wage: Price floor for labor.
  • Creates labor surplus, unemployment, illegal employment.

Subsidies

• Subsidies: Government assistance to firms.
  • Increase output, make goods affordable, support industries.
• Market consequences: Increased production, welfare loss.
• Consequences for foreign producers: Increased subsidised competition (-)
• Controversial: Inefficiencies vs benefits.

Indirect Taxes

• Indirect taxes: Taxes on spending, paid by firms.
  • Decrease consumption, redistribute income, improve allocation.
• Market consequences: Decreased quantity, increased price, welfare loss.

Market Failure

• Socially optimal output: MSC=MSB
• Private benefits: Advantages to producers / consumers
• Private costs: Actual expenses to consumers / producers
• Social benefits: Total amount of benefits, including positive externalities
• Social costs: Total amount of costs, including negative externalities

Common Pool Resources

• Common pool resources: Scarce resources without exclusive ownership.
  • Rivalrous and non-excludable, leads to overuse.
  • Tragedy of the commons: Incentive for overuse.

Negative Externalities of Production

• Negative externalities of production: External costs created by producers.
  • MSC > MPC.
• Solutions: Legislation, self-governance, education, international agreements, taxes, permits.

Negative Externalities of Consumption

• Negative externalities of consumption: External costs created by consumers.
  • MSC > MPB.
• Solutions: Taxes, legislation, education.

Positive Externalities of Production

• Positive externalities of production: External benefits created by producers.
  • MSB > MSC.
• Solutions: Direct provision, subsidies.

Positive Externalities of Consumption

• Positive externalities of consumption: External benefits created by consumers.
  • MSB > MPB.
• Solutions: Legislation, education, direct provision, subsidies.

Unit 3: Macroeconomics

National Income Accounting

• Macroeconomics: Studies the economy as a whole focused on economy growth.
• Objectives: economic growth, low unemployment, stable inflation, sustainable debt.
• National income accounting: Measures economic activity and total output.
• Purpose: Assess performance, compare countries, establish policies.
• Approaches:
  • Expenditure: GDP = C + I + G + Xn.
  • Income: Wages + rent + interest + profits (GNI).
  • Output: Value of final products.
• Circular flow: Macroeconomic model of income and activity.

Nominal v Real Income

• GDP = Total spending ($)

• Nominal GDP: Output values at current prices.

• Real GDP: Output adjusted for inflation, uses constant year or base year for comparison.

• GDP deflator:$\frac{Nominal GDP}{Real GDP} \times 100$

Per Capita Income

• GDP per capita: GDP / Population.
• Purchasing power parity: Exchange rate that equalizes purchasing power.

Business Cycle

• Business cycle: Fluctuations in economic activity (real GDP).
• Phases: Peak, recession, trough, recovery, boom.
• Output gaps: Positive (inflationary), negative (deflationary).

Evaluation for Stats

• National income statistics may not measure true output value due to non-market output.
• Economic well being:
  • No distinction between merit goods vs demerit goods, military goods, etc
  • Can’t reflect the COL or levels of education, housing and life expectancy
  • No information on distribution of income/output; doesn't measure leisure
  • Rate fluctuations; no consideration of social welfare or healthcare

Measuring Welfare

• OECD Better Life Index:

  • housing conditions and, income, employment, community, education, environment, governance.

• Happy planet index, GDP per capita, perceptions of corruption, generousity

• HPI = (Life Expectancy) * (Well-being) * (Inequality Outcomes) / (Ecological Footprint)

Aggregate Demand AD

*AD: Willingness and ability of all buyers to pay for product
*Expressed by Wealth effect

• The AD Curve shows inverse relationship between real output (X) and average price level (Y)
  *AD is expected / planned output, whereas Real GDP = actual expenditure
  *curve shifting / response determined by consumption, Investment, Government Spending, Net exports

Short and Long Run Supply

• Short Run Aggregate Supply Occurs in SR because cost of faction inputs are inflexible
• Determinants in Supply: Changes in wages , non-labour sources, indirect taxes or bureaucracy
• The AD-AS Model short run creates new Equilibrium and Real GDP, with firms matching demand

Monetaristic v New classical Model

• Belief: The economy is moving towards full employment output and LR LRAS curve is a vertical, perfectly inelastic output independent of price level
  • There is the price elasticity of supply PES, either elastic where increasing quantities is ease or inelastic, Qs are difficult to change

Keynesian vs Long Run Equilibrium

*economy always move towards employment via wages eliminating recessionary and inflation via intervention

• This can only exist as full potential output due to wage and price inflexibility
  • Which the government is responsible for to correct with policy. This results in either recessionary or inflationary gaps

Shifts to long Run / aggregate supply

• There must be change to quantity in FOP. efficiency or institutional changes

Unemployment

*Low unemployment: Complement economic growth and increase tax revenues; prevent skills drain
*Employment: the use of FOP, and everyone willing should have a work.
*Unemployment: the state of people not able to find employment despite them search for jobs. Measured against an age, ability, and willingness to work.
*Consequences of Unemployment: Loss of GDP and increased crime and stress + debt