IB Econ Intro Study Guide - Sunny Hills High School

Scarcity
lntroduction
The fu ndarnentd I prob enr allsoc et es face is that of scarcity, defined as the excess of
human wanh over what can actually be produced to fulf lthese wants Human wants are
un m ted. On the other hand the nleari of fu fil ng these human wants are mlt€d becalrse
the word has on y a inrted amount of resources.
As a resu t, choces have to be made. The opportunity €ost of a choice G defined as the
value ol the next best alternative sacll ced.
Resources
Land and raw materials {natural resoutcet
These are inputs into production that are prov ded by
'dr . e e.g. ,r . p'ov"d ard r,rd - e'dld€po( . ^
the ground, forests, pastures, elc The world3 and area
and raw materials are mited. Some r€sources are nonrenewable.
lf they.re used now, theywill not be availab e
n the fuiure, e.9 oil, coa deposits. Other reso!rces are
renewab e, e.q. foresrs (timber), rhe stock of fish
Labour (human resources)
This s al foms of hurnan nput, both physical and
menta, into.urrent producton. The aboLrr force s,
at any po nt n t me, I mited both ln number and n
skl s The total nlrmber of peop e ava abe for work s
'" p,eo .o.o ".
\ey d.-'" o.eo
"oo.r,
popu
^ortirs
dton. Note thatthe tem human capital refers to
the education, tra nlng and sk ls €rnbodied in the labour
useful
Normative economic 5tatements:they ar€ value
jldgements, opinions, statements that cannot be fasif€d,
or proven rght or wronq' statements that cannot be
rp.tFodgo r.. dL.'daLar Fq
"rt.ioli)r,no,o,
fasf or th€ ncome d nibuton is not fal. Key words n
normative statements inc ude: ought to be, shou d be,
too much, too tte, fair, unfa r.
Positive economic statemenls: stat€m€nts that can be
fa sifi€d, or proven, at e.st npdncip€,rghtorwrong
Th€y can be tesled .ga nst facts (data), €.9 'a m n mum
waq€ policyw ll n.reaEe unemploym€nt among unskiled
Economic goods:goods and servces that requ re
scarce resources to be sacrificed in orderfor them 10 b€
. capital
Physicalcapta incud€s manlfactured r€sources, n other
words, prodlrced means of prodLrctlon (or goods us€d to
produce oth€r goods). The world has a m ted stock C)l
cap tal: im ted suppy offactoies, machin€s, tools and
other equ pm€nt Note that the mean ng of captd in
economics is dlfferent from that used n ord nary sp€ech
where people refer to fioney as cap ta.
. Entrepreneu|ship
A t€rm that is related blt not ident ca to management.
When a newv€nture s being cons der€d, tsks exist
lh€/ rr o\" rLr-
.o-aorp r r. dsso\
these rsks and makejudqements aboutwhether or not
to undertake them. The people who do so are called
entrepreneurs. Entrepreneurship rcfers to the wil ngness
and abilityto take risks and mobilze the r€rnain nq
factols of prodrrction.
Free goods (in contrast to economic goods): goods
that have a zero oppoiruniiy cost of prodLrcton (ther€ ar€
veryfew rca -world examples, perhaps sea watef and alr)
No- t".Sood,"/" ab"" r"a.eno f-.r
".eop
the economist3 sense l scarce resources may have been
Competitive market:a market rs considered
competitlve f th€re are v€ry nrany smal firms, the good
s homogeneous ( i is consid€red ident ca acrcss frrms
by consumert and noth nq prevents a new f rm lrom
Factor endorsements:the quantity and qua ity of factors
of productlon ava ab€.

I
i.,.
E
i
E
The fundamental questions of economics
Economic : -::.-:
lj-.r.]ti.iil
scarcty n€cesstates choce. As a resu t, a lsocieties,
independently of the r eve ol econoril c deveopment or
the economic synem adopted, face and nrLrsi answer the
fo owing three quest ons:
. What (i.e. which Soods)w be prodlced and n what
. How wi each good be produced (us ng, say, a labouF
inlensive or capita intensive tech no ogy)?
. Fofwhom? {How w incorn€ be distdbuted?)
How a society goes about answer ng th€se qu€nons
d"oeldr o- .le elo orr' syter ' . ar
"dopl -.o o ni
sysrem can be broddly def ned as the nst turiona fra mework
wthln which economic act vity takes place. lt s easy to
distingu sh 1wo exveme cases but n ihe rea world the
*'1,
..]l
A producion posslbilites frontier {PPF)refe6 to an
econonry endowed w th a f xed a mounl of resources, s
characterzed by a giv€n level of tech no oqy as wellas
some nnitutional framework, and prodLrcing only two
goods. lt shows for ev€ry amo!nt produced of good X,
the max mum amount of good Y that it can prodLrce,
f il fu y uti zes its im ted resources us ng the available
technology. For examp e, ref€n ng to Fig. 1.1, lthe
economy decidesto produce Xl units of good Xthen it
can produce arthe most Y1 unlts of good Y assum ng
ihat it fu y utihz€s ts im ted rcsources with th€ ava ab e
technology. A PPF is a technolog cal relai onsh p and it
prov des us no information about choces. lt shows what
an econorny can do, not what t chooses to do.
The niere exist€nce of a PPF ref ects scarcity: an economy
s constra ned in production to only some comb nations
of output. lt fo ows that po nts oulslde a PPF (such
as po nt A in Fig I 1)denole output comb naton:
of the two goods that are unattainab e g ven the
amount of resources available and the present evel
of technoogy. Po nts lrslde the PPF (such as poinr B
1-g. l d.no.edddndbeb- reff.ier o,rrpL.
combinatons in the sense that resources are not {uly
uti zed, e.g. unemployment s pr€sent. Po nts on the PPF
(such as points F and H)denote attainab€ and €fficient
combinatons as no waste o{ scarce r€sources s present
and it s not possibe to produce more of one good
witholt sacll cinq some of the other
The negatve slope of the PPF ref ects thai in orderto
produce more of one qood, resources have to be diverted
dwayfrom the prodLrction ofthe other good sothat less
ol the atter can ,ow be at rro5r produced: there is th us
an 'opportun ty cost' nvolved in producing an extra unit
ol a good. lt s the arnount ofthe other good that hasto
B€cause scarce resolrrces are rot€qua ywe su ted ior
the prcduction of a goods (in otherwords, because
varatons are very many. Countries h storica ly develop
the r own set of institutons that answer these questons.
The c!ffent Chin€se experence s a case n point The two
extremes are market €conorn es and comrnand econorn es,
with mixed economies being in between.
. A market economy s an economywhere households
and firms each act ng n ihe I own sef-interest determ ne
answers to the three quenions abov€ throLrqh their
nteraction in markets.
. A command economy s on€ where the state prcvides
. A mixed e€onomy is one where both m.rkets and the
nate are responsible for the answers.
figurer,t The production possibilitiesfrontier
x2 x3 x4
Unitsofg@dY
resolrces tend 10 be specia zed)the PPF s bowed
towards the or qln. The slope (the tangent at €ach point,
, r.I as dr oo,tr, I and H\ becoreg. eppe, d,ld tFepFr.
reiecting that the opportunity cost of producing more
and more of good X lthe qood on the horzonta axt s
lncreasing n Fg. 1.1, the oppo(un ty cost of produc ng
X]X2 extra units of good X is the sacr f ce of Y1Y2 un t5
of good Y Th€ oppo(un ty con of X3X4 extra un ts ofX
(where X3X4 = X1X2) is thls b qq€r and equa to Y3Y4
units ot good Y Th s s the law of ncreaslng cons. The
typicalshape of ihe production poss bilties curve shows
that t b€comes more and more conly to produce ever
increasing quanijr es of a good as resources tend to be
specalzed. lf, on the other hand, resources were perlecty
substiiutabe ihen the PPF would be a negatvey soped
nfa ght ine refecting constant opportunity costs.

Growth
Growth of an economy can be ilustrated through an
outward sh ft of the PPF. We can d sting! sh between
Actual growth: th s ref€6 to an increas€ n the amounts
of good5 and servces actua yprodLrced. trelerstoan
ncrease if tota output. lt is lunrakd wth a movenreni
from a po nt ins de the PPF to another point towdrds lhe
northeanwith more of at least one good. Rea GDP (the
terrn used ater to refer to th e total output produced n an
economyl nas Incr€as€o.
PotentialgroMh:the terrn reiers to the rdte at whrdr
a country's ecorlomy could grow if all h resources werc
fu y empoyed. Potentalgrowth is lustrated wth an
oltwad shift of the PPF.
. In Fig.l.2a, actua groMh i5 llLrstrated as a movement
from pointAl to pointA2 wherc output m x A1 contains
X] and Y1 un ts ofthe two qoods whl€ output mlx Az
coniains more ofborh goods 1X2 units ot good X and
Y2 lnits of good Y). Actual groMh can thus be ach eved
by better uti zalon of exsting resources. Fgure 1.2b
lunrat€s potentia growth as the producton possib lites
of the economy have ncreased (expanded) from FF'to
HH'. Th s economy s now able to produce comb nations
of outputthat were in tia ly unatta nable. Potentia
growth is the resull of an ncrcas€ in resolrrc€s (mor€
labour and more captal)and/or better technology being
ava abe (wh ch may a so rcferto improved innitltiont.
More sp€cfcally groMh occurs if ther€ s an ifcrease n:
. Land {natural resources): e g. if new metal d€posilv
m nerals are discovered.
. Labour: labour can ;ncrease if: popu ation ncreases
(throLrgh a natura ncrease orthrough migration); fth€re
rs a. n.?aa o peop . or ro \irg doe
if there s an increas€ n the particpalon tai€ ofsonre
population grcup (e.g morewomen decidetojon the
abour force, or more teenagers).
Human capital: th€ skil s, edlcat on and training
embodied in the abour force of an econorny.
Capital: if the stock of capta (i.e. of machines, toos,
equ pment, build ngs, etc.) increases. An increase n the
stock oJ capital s defned as nvestment.
Technoogy and nsttutions imprcve (as the abilty of a I
faciors to produc€ w ll be enhanc€d)
Figure 1.2 (a) Actualgrowth (b) potenti6lgroMh
Tips
5
'E
Make sure thatthe PPF you drawtouches the two axes
and is no1'foat nq'in rn d-a r Draw it bowed (concave)
towards the oigin un ess you are us ng it to lunrat€
constant opportLrnity costs. Ako note that the axes may
be labe ed'consumption goods' and 'cap tal goodt in
order to lllrstrate the oppoirunity cost ol invenrnent. In
this case, the opportunity con ol prodlcing more capitaL
goods (i e. the opportun ty cost of nvestment) s the
sacrfice of present eves of consumpton