chapter 1 – IB Economics HL: Scarcity, Resources, and PPC
What is Economics?
Economics is the study of scarcity and choices. It is the science that examines how societies allocate limited resources to satisfy unlimited wants.
Scarcity forces us to make choices about how to use resources efficiently.
Also described as: Economics is the study of choice and marginal analysis.
Textbook definitions highlighted:
Economics is a social science concerned with the efficient use of scarce resources to achieve the maximum satisfaction of economic wants.
Marginal analysis (thinking on the margin): decisions are made by comparing additional benefits and costs.
Core idea: you continue to do something as long as the marginal benefit exceeds the marginal cost.
Key terms:
Price: the amount buyers pay to obtain a good.
Cost: the amount sellers must pay to produce a good.
Investment: money spent by businesses to expand or improve production.
Capital Goods: goods produced for future production (indirect consumption); e.g., ovens, blenders, tractors, factories.
Consumer Goods: goods produced for direct consumption (e.g., pizza).
Demerit goods: bad goods (e.g., harmful or unhealthy items like junk food, drugs).
Merit goods: good goods (e.g., medicine, education) with societal benefits.
Four factors of production: land, labor, capital, entrepreneurship.
Entrepreneurship: individuals who combine other factors, bear risk, innovate, and reap rewards.
Productivity: a measure of efficiency; outputs per unit of input.
The Four Factors of Production
Land: All natural resources used to produce goods/services (water, air, minerals, forests, etc.).
Labor: Human effort used in production (physical and mental work).
Capital:
Physical capital: human-made resources used to produce other goods (tools, machinery, factories).
Human capital: skills and knowledge possessed by workers (education, training, experience).
Entrepreneurship: visionaries who organize the other factors to create goods/services; they take initiative, innovate, bear the risk of failure, and reap rewards.
Entrepreneur responsibilities:
Take the initiative
Innovate
Bear the risk of failure
Reap rewards of success
Productivity and Growth
Productivity: a measure of efficiency; the amount of output produced per unit of input.
Relationship: Because resources are scarce, improving productivity means producing more with the same resources.
Formula:
\text{Productivity} = \frac{\text{Output}}{\text{Input}}
Higher productivity leads to greater wealth and economic growth.
Resource Allocation and Economic Systems
An economic system is the method a society uses to produce and distribute goods/services.
Society’s three fundamental questions:
What goods and services should be produced?
How should these goods and services be produced?
Who consumes these goods and services?
How these questions are answered determines the economic system.
Allocation vs Distribution:
Allocation: assigning factors of production to scarce resources and desired outputs.
Distribution: how much output individuals receive; concerns the third question (who gets what).
Reallocation: changing how output is distributed.
Economic systems:
Centrally Planned (Command) Economies:
Government owns the factors of production (land, labor, capital).
Government plans production and consumption through quotas and directives.
Consumers have fewer options; profit motive is curtailed by directives.
Free Market (Capitalist) Economies:
Individuals own the factors of production.
Minimal government intervention (laissez-faire).
Profit motive drives production and innovation.
Wide variety of goods; competition helps regulate the economy.
Mixed Economies:
Combines market mechanisms with government intervention.
Individuals own resources but government provides public goods and regulates to correct market failures.
Competition and self-interest operate alongside bureaucratic governance.
Productivity and wealth:
Countries with free markets, secure property rights, and rule of law tend to experience higher growth and productivity.
Public goods and taxes:
Public goods are provided or subsidized by the government; taxes finance such provisioning.
Subsidies and taxes influence incentives and distribution of resources.
Supply, Demand, and Markets (Resource vs Product Markets)
Resource Market (Factors of Production):
Interaction of resource suppliers (land, labor, capital, entrepreneurship) and resource users (businesses).
Prices (rents, wages, returns to capital, profits) allocate resources.
Product Market (Goods and Services):
Interaction of producers (firms) and consumers.
Prices coordinate demand and supply of consumer goods and services.
Public goods and welfare policies influence the market outcomes.
Production Possibility Curve (PPC) and Frontier (Topic 1.03)
A PPC (frontier) is a model showing the alternative combinations of two goods that an economy can produce given scarce resources and fixed technology.
It demonstrates scarcity, trade-offs, opportunity costs, and production efficiency.
Assumptions (the PPC framework):
Only two goods are being produced.
All resources are fully utilized (full employment).
The quality of resources and the level of technology are fixed.
New technology represents a newer version of production capabilities (the most recent technology becomes the baseline).
Points on the PPC:
Points on the line are production-efficient (full employment of resources).
Points inside the line indicate underutilized resources or unemployment.
Points outside the line are unattainable with current resources/technology.
Example setup (two goods): bikes and computers (illustrative):
The PPC line represents all feasible combinations of bikes and computers with given resources.
If you move along the line, you trade off producing more of one good for less of the other.
If you move outside the line, production is not possible with current resources.
Opportunity cost and production points:
When moving from one point to another on the line, the opportunity cost is the amount of the other good that must be forgone.
Example of constant opportunity cost (linear PPC):
If the PPC is linear, the opportunity cost per unit is constant.
Example data (pizza vs calzones): if 1 pizza costs 2 calzones, then moving along the line shows a constant trade-off.
Statements from the slides (illustrative):
1) Opportunity cost of moving a to b is 2 calzones.
2) Opportunity cost of moving b to c is 2 calzones.
3) Opportunity cost of moving c to d is 2 calzones.
4) This continues consistently along the line.
Increasing opportunity cost (bowed-out PPC):
As you produce more of one good, the opportunity cost of producing additional units increases.
This occurs when resources are not perfectly adaptable for producing both goods.
Shifts of the PPC:
Outward shift: economy can produce more of both goods (economic growth) due to
Increased quantity/quality of resources,
Advancements in technology,
Improvements in trade allowing higher consumption possibilities.
Inward shift: economy can produce less of both goods (decreases in capacity) due to
Destruction of capital, natural disasters, or loss of resources.
Shifts vs Movements:
Movements along the PPC reflect changes in the allocation of existing resources between the two goods.
Shifts reflect a change in the total available resources/technology.
Per-unit opportunity cost (illustrative calculation):
If producing more of good X requires sacrificing units of good Y, the per-unit opportunity cost is:
\text{OC}_{X} = \frac{\Delta Y}{\Delta X}
Interpreting comparative advantage requires comparing these per-unit costs across producers.
Shifting the PPC (practice concepts):
A shift outward can occur with significant capital investment in capital goods or a surge in educated/skilled labor.
A shift inward can occur due to capital destruction or resource depletion.
A shift can also occur due to population changes that alter the scale of production possibilities.
Absolute Advantage, Comparative Advantage, and Specialization & Trade
Absolute Advantage: When a person, business, or country can produce more of a good or service with the same amount of resources (or produce with fewer resources) than others.
Comparative Advantage: When a person, business, or country can produce a good or service at a lower opportunity cost than others.
Specialization and trade:
Countries should specialize in goods where they have a comparative advantage and trade for others.
Trade allows nations to consume beyond their own PPC by exploiting differences in opportunity costs.
Practice example (Radios vs Pineapples): India vs Kenya
Data (illustrative):
India: 1 pineapple = 1 radio (in terms of opportunity cost for pineapples, India sacrifices 1 radio per pineapple).
Kenya: 1 pineapple = 3 radios (Kenya sacrifices 3 radios per pineapple).
Conclusions:
India has a comparative advantage in pineapples (lower opportunity cost in producing pineapples).
Kenya has a comparative advantage in radios.
Trade recommendation:
Kenya should import pineapples and export radios.
Terms of Trade (mutually beneficial exchange rate):
Example: trading 1 radio for 2 pineapples can benefit both countries.
If Kenya produced radios alone, they would have to give up 3 pineapples to obtain 1 radio; if India produced pineapples alone, they would give up 1 radio to obtain 1 pineapple.
The terms of trade concept:
The mutually beneficial exchange ratio that enables both countries to gain from trade.
Example: trading 1 radio for 2 pineapples can be advantageous to both if each country specializes according to comparative advantage.
Specialization, Efficiency, and Efficiency Metrics
Allocative Efficiency: Producing what society wants (allocating resources to goods that society values more highly).
Productive Efficiency: Producing on the production possibility frontier (the line); resources are fully and optimally utilized.
Specialization: Focusing on a specific task or good to maximize output given comparative advantages.
Practice Scenarios and Insights
Common PPC questions:
Output questions: which outputs (e.g., planes vs cars) can be produced given the resources; differences between two countries in possible outputs.
Input questions: given outputs, how many inputs are required in each country; which country has absolute advantage in production given resource requirements.
Example discussions:
A decrease in pizza demand affects the allocation of resources to pizza production or consumer demand, but the PPC itself (as a representation of resource constraints) does not shift due to demand prices alone; a shift occurs with changes in resources or technology.
If unemployment exists (point inside the PPC), resources are not being used efficiently; moving toward the frontier would increase production.
If there is a major destruction of capital (e.g., power plants destroyed), the PPC shifts inward, reducing potential output.
Special Notes on Economic Systems and Policy Implications
Mixed economies reflect real-world economies, combining market mechanisms with government intervention to correct market failures and provide public goods.
The profit motive in free markets incentivizes efficient production and innovation but may require government intervention to ensure fair competition and social welfare.
Public goods require funding via taxation, since they are non-excludable and non-rivalrous in consumption, leading to potential market under-provision if left to private markets.
Quick Reference Formulas and Concepts
Productivity: \text{Productivity} = \frac{\text{Output}}{\text{Input}}
Opportunity Cost (per-unit): \text{OC}_{X} = \frac{\Delta Y}{\Delta X}
Comparative Advantage: a good is produced where its OC is lower in that country than in others.
Terms of Trade: the negotiated exchange ratio that makes both trading partners better off (e.g., 1 radio = 2 pineapples).
PPC interpretations:
On the curve: efficient
Inside the curve: inefficient/unemployed
Outside the curve: unattainable with current resources/technology
Shifts in PPC are driven by:
Changes in resources (quantity/quality)
Changes in technology
Changes in trade that affect consumption possibilities
Final Takeaways
Economics is about choice under scarcity and the trade-offs that arise from resource limitations.
The PPC provides a concise framework to visualize scarcity, opportunity costs, and productive efficiency.
Comparative advantage explains how and why trade can make all parties better off, even when one party is less productive in every good (the law of absolute vs comparative advantage).
Economic systems differ in how they answer the three core questions, and mixed economies reflect the real-world blend of markets and government policy.
Productivity growth and capital investment are crucial for future economic growth and the expansion of possible production.