1.1 Key Concepts:

Definition

• is a social science that studies the relationship between humans and the economy using past experiences and observations

• studies how humans make decisions with the limited resources at their disposal to satisfy their unlimited needs and wants

Key concepts (WISE CHOICES)

• 9 interlinked central concepts of IB econ (WISE CHOICES (Well-being, Interdependence, Scarcity, Efficiency, CHOices, Intervention, Change, Equity, Sustainability)) 

• Scarcity: limited availability of resources in relation to our unlimited wants,
  - fundamental concept of opportunity cost (what you forego to gain something else) and choices

  • efficiency → input < output, optimal use of resources to minimize resource waste

  • equity → fair distribution of resources, rather than equal. Fair is normative (subjective)                   

• Economic Well-Being → multidimensional concept relating to the prosperity level and quality of living standards of people (financial security, ability to meet basic needs, make economic choices for personal satisfaction, maintain adequate income levels)

• Sustainability: using resources such that needs of future generations aren’t compromised

• Change: economic world is constantly changing (institutional, structural, technological, economic, and social level), and economists need to be wary of that in their models.

• Interdependence: instead of being self-sufficient, economic actors interact with each other and thus are interdependent

• Intervention: generally market powers organize economic activity but when they fail to meet social goals governments intervene to control choices

1.2 Central Economic Problem (Scarcity):

Definition

• Friction between unlimited needs and limited resources

  • Exacerbated by mindless use of resources since these are diminishing

  • Depends upon product as well as location (affects availability of resource) and circumstances (poverty; higher scarcity)

  • Gives rise to need for choices on how to allocate the 4 factors of production

Associated Concepts (Wants/Needs, Resources)

• Wants: desires     vs   Needs: goods and services 

  • expressed as consumer demand in markets

• Resources: factors of production used to create goods to satisfy these wants

  • Land → resources needed to produce goods/services
    Labor → Skilled/unskilled human efforts
    Capital → machinery/tools or money used to make profit
    Entrepreneurship → combination of all factors; organise the planning and allocation

Resource Allocation

• [Central Problem] → rise to Basic Economic Questions: What, how much, how and for whom to produce

  • What/How Much → consumer demands {well being, sustainability, equity → what demands are prioritized efficiency, sustainability→ how much to produce}

  • How → labor (labour intensive) or machines (capital intensive) {efficiency, sustainability}

  • For Whom → depends upon economic system.

    • Pure market → for those who can buy

  • Intervention → whatever maximizes equity and well being

• Allocation of Resources: process of dividing factors of production to produce goods and services in an economy to answer the basic economic questions

  • 3 types of economies based on this: 

    • Planned (govt intervention)

    • Market (invisible hand of market)

    • Mixed (PPPP → public private partnership projects)

  • Associated Questions: What extent to which governments should intervene in this allocation?

Opportunity Cost

• arises from scarcity

  • what you are foregoing in order to obtain something

  • All economic  goods have an opportunity cost

  Economic goods	Free goods
  Cost resources to consume/produce	Free to produce/consume
  Have economic value	No economic value
  Opportunity cost levied	Not levied
  E.g; manufactured products, agricultural products etc	E.g;  air, sunlight:

1.3 Production Possibilities Curve (PPC)

Modelling

• Modeling: allows analysis of economic problems by narrowing down the focus to a few variables, keeping others constant (ceteris paribus)

  • diagrammatic or mathematical

PPC as a model

• PPC: Graphical model of a two products that an economy can produce given that all the resources in the economy are being used efficiently; time period and technology remains fixed 

  • illustrates scarcity, choice, opportunity cost and efficiency

    • concave curve from the origin

      • within curve → inefficient, on it → efficient, outside → unattainable (as resources are limited and tech is fixed)

• Assumptions;

  • No Wastage: max output is attained when operating on the curve

  • Fixed Production Possibilities; all resources dedicated to only two goods

  • Resource Availability; fixed amount of resources

  • Constant Technology at a given instance (change →shifts PPC)

• Conditions: (i.e. max efficiency)

  • Full Employment: assume all factors of production (incl. labor) completely used → full employment

  • Efficiency: all resources are being used optimally and there is no wastage, i.e max output

• Actual Growth:

  • increase in actual output (amount of goods a country is producing ⇒ indicated by where a country is standing)

  • Rightward movement

• Potential Growth = Curve Shifts

  • change in the amount of goods a country can produce

    • improvements in quantity or quantity of factors of production or tech can shift the ppc to the right

• Downward Slope → need to forego a certain quantiy of one good for more of another good. This shows increasing opportunity cost, as the slope gets tangentially steep

  • Linear Slope: opportunity cost ratio =1 (constant)/the max possible value of A and B is same

1.4 Circular Flow Model of Income

Fundamental Ideas

• graphical model to explain the flow of money in a closed economy

  • illustrates interactions b/w different sectors in an economy; thus showing interdependence

    • Fundamental principle: exchanges in an economy are voluntary and every actor benefits from them and market economies are not a zero-sum game ( ⇒ no win-lose situation)

2-Sector Model

• simplified version with only firms and households

  • Assumptions:

    • Firms: produce all goods

    • Households: own all factors of production

    • Closed Economy (no foreign investment/govt/financial institutions)

  • Households: 

    • 1. Supply Factors of Production: gain income → buy products → generate revenue for firms

    • 2. Supply to the Factor Market: demand from product market

  • Firms:

    • Household Productive resources (Labor) → produce output → sold in product market → revenue used for rent

Model Terminology

• Wages: Income earned by households = rent paid by firms

• Profit: Money earned by firms

• Rent: expenses paid by firms 

• Expenditures: Consumption of households = income earned factor market → [supplies] → product market demands 

• Firm spending: Land, Labor, Rent, Wages

• Money flowing in the model → Gross National Income

  • Rising:  economy is growing

  • Falling: economy is in recession

Five-sector Model

• includes government, foreign sector and financial sector

• Injections and Leakages: in/out flow of money into the model/economy

  • Injections → increase income 

    • government spending, financials sector incentivization (investments/loans) and foreign sector (exports bring revenue)

  • Leakages: withdrawal of money from the flow → taxes, savings, and/or imports