economics ib sl notes

YEW CHUNG INTERNATIONAL SECONDARY SCHOOL 2015 - 2016

YEAR 12 ECONOMIICS: INTRODUCTION

The Basic Economic Problem: Choice and the allocation of resources

COMMAND TERMS: You must know what these terms mean: they are telling you what you are required to do.

1. DEFINE- write a definition and give an example

2. DESCRIBE - write a definition and give an example

3. DEMONSTRATE - show, e.g. by drawing a fully labeled graph and explaining what your

graph shows.

4. EXPLAIN - define the key concepts; use a fully labeled economic model (and example) to

explain the concept. Refer to your model in your explanation.

5. ANALYSE - write a detailed explanation of how a particular situation explains an economic

concept.

6. EVALUATE

- identify the stakeholders (i.e. groups/individuals/sectors/resources that will be affected), and

- describe how they will be affected, including the benefits (advantages) and costs

(disadvantages)

- describe the short-term and the long term affects

- make relevant, explained suggestions of actions that could be taken

- give reasons why the economic theory may not accurately apply to, or explain, the given

situation

IMPLICATIONS: these are the likely effects of a certain action /event; things that are likely to happen

as a result of an event or action

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DEFINITIONS OF KEY CONCEPTS

KEY CONCEPT

DEFINITION

ECONOMICSEconomics is the study of how groups of individuals make decisions about the allocation of resources. It is the study of how individuals, or groups of individuals, optimize the satisfaction of their unlimited using their limited resources.

Economics uses concepts, ideas, theories and models to explain economic decisions and their implications.

ASSUMPTIONS

( 假設 ) MADE

IN

ECONOMICS

With economic theories and models assumptions are made. These assumptions limit the accuracies of these theories and models in applying them to an actual situation.

Assumptions include:- each consumer/firm has freedom of choice- each consumer/firm has makes rational decisions- each consumer aims to maximize utility (satisfaction/ benefit to oneself)- each firm has aims to maximize profits- each consumer/firm makes the best decision/choice- Ceteris paribus holds i.e. all factors are held constant (do not change)

We need to be aware of the limitations of economic theories and models.

RESOURCES

(FACTORS OF

PRODUCTION)

Definition: Resources are things used in the production of goods/services.

Resources are the inputs to, or factors of production.

There are FOUR categories of resources:

LAND

LABOUR

CAPITAL

ENTERPRISE

KEY ECONOMIC IDEA: Resources have alternative uses the same resources can be used to produce different goods.KEY ECONOMIC IDEA: Resources are relatively scarce: there are not enough resources to satisfy all our wants.

ECONOMIC

SCARCITY （缺

乏）:

THE BASIC

ECONOMIC

PROBLEM

ALLOCATION

（分配）OF

BECAUSE

- our wants are unlimited relative to our resources, AND

- resources have alternative uses. -

each economy must make economic decisions of:

WHAT TO PRODUCE with the scarce resources available; which output combination will be produced?

HOW TO PRODUCE THESE GOODS - what resource combination will be used. E.g. what methods of production are going to be used?

WHO will benefit from these goods? Which sectors of the economy will receive these goods?

This is referred to as the ALLOCATION OF RESOURCES, i.e. which use scarce resources will be put to. Producers allocate resources according to market (price) signals, producing goods that are relatively more profitable.

The BASIC ECONOMIC PROBLEM is WHAT, HOW and FOR WHOM?

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RESOURCES

ALLOCATION OF RESOURCES and CONSUMER SOVEREIGNTY

( 主權 )

The decisions of what output combination is to be produced and how resources are to be allocated/used is decided by consumers and buyers, i.e. by consumer sovereignty.

Changes in consumers’ choices are indicated to producers through changes in price signals. Goods consumers desire are relatively more profitable. Producers react by channeling resources into the production of goods consumers desire, in the quantity consumers desire.

ECONOMIC SCARCITY, CHOICE and OPPORTUNITY COST

As resources are relatively scarce economic decisions must be made on resource allocation.Every time an economic decision is made, other choices/options are given up.

KEY ECONOMIC IDEA: The next best choice/option/alternative given up when an economic decision is made is described as the opportunity cost of that decision.

OPPORTUNITY COST

Definition: This is the next best alternative (second best choice/ option) foregone when an economic decision is made.

Opportunity cost is the REAL cost of an economic decision.

Foregone means ‘given up’.Example

_________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________

PRODUCTIONThis is (two different meanings):

1. The process of producing goods/services.2. The quantity, or output, of goods/services produced

Examples:- The production of apples involves the growing of apple trees; the harvesting of (picking) apples; sorting and packaging apples for sale; transporting apples to market etc.- The production of apples was 2000 tones last year

PRODUCTIVITYDefinition: This is the output per unit of input per unit of time.

It is a measure of efficiency because it shows on average how much output is produced per resource unit (worker; machine; area of land etc.) in a given time period.

FORMULA :

Productivity = Total output per unit of time Total units of input of a resourceExample:

PRODUCTIVE CAPACITY

Definition: This refers to the ability of an economy to produce goods/services. It is the maximum production of different output combinations an economy can produce, given the limited resources available and the current state of technology.

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If the stock of resources, the quality of resources and/or the state of technology changes, then the productive capacity will also change: there will be a new maximum production of different output combinations. The economy’s potential to produce goods/services will change.

PRODUCTIVE EFFICIENCY

Definition: This means that all available resources are being put to optimal use: no resources are under-utilised or unemployed, given the current available state of technology.

The economy’s output cannot be increased as there are no more resources available and the state of technology is fixed.

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PRODUCTION POSSIBILITY CURVE (or FRONTIER)

PPC or

PPF

Definition: This is a graph (i.e. an economic model) showing the maximum (highest) possible output combination of two goods that can be produced with the available limited resoutces and current state of technology.

All output combinations represented by points on the PPC are productively efficient.

Other names: Production possibility frontier

Assumptions made with this model : - The resources available and the state of technology are fixed, i.e. cannot be changed. In reality,

these are continually changing.- The economy produces TWO GOODS only. In reality, the economy produces many goods at any one

time.- Units of both goods are of equal value (what makes up a ‘unit’ is not defined)

These assumptions limit the usefulness of this model in accurately explaining economic decisions.

This graph shows that when an economy producing two goods only ( tuberose and fruity bussie) puts ALL, its resources into producing toberone, the maximum possible output is 20 units. If all the resources are put into produceing fruity bussie, the maximum possible output is 15. The output of both goods is limited due to limited (scarce) resources.

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PRODUCTION POSSIBILITY CURVE: SCARCITY and OPPORTUNITY COST

1. An output combination represented by a point beyond the PPC is not possible/attainable as there are not enough resources available, given the current state of technology

Example: The output combination represented by the point W unattainable (18 toberone and 18 FB) as they are NOT ENOUGH RESOURCES, given the state of technology.

2. At any one time, only ONE output combination represented by a point on the PPC can be produced. If an economy is productively efficient, then in order to increase output of one good some output of the other good must be foregone.

The output of the other good that is given up is the opportunity cost of that decision.

Example:

This graph shows that this graph shows that if the economy is producing 18 toberone, the maximum output of FB is 8. In order to increase output of FB to 15, the economy will have to reduce output of toberone to 10 units. In other words, the OPPORTUNITY COST of increasing the output of FB from 8 to 15 unites is the 8 units of toberone given up.

PRODUCTION POSSIBILITY CURVE:

ALLOCATION of RESOURCES

When an economy is productively efficient, a change in the output combination will require a reallocation of resources: resources will be transferred from the production of one good to the production of the other good.

This would occur if the production of the second good became relatively more profitable than the production of the first good.

In the graph above, the production of FB has become relatively more profitable (e.g. consumer tastes have moved away from toberone in favour of FB, leading to an increase in the price of FB). Producers will move their resources away from the production of toberone into the production of FB: RESOURCES ARE REALLOCATED

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Evaluation: What are the implications of a reallocation of resources?

More FB will in this industry will rise, and employment in the toberone industry will fall. FB producers’ revenue and profitability will rise.


ECONOMIC GROWTH

An output combination represented by a point under the PPC illustrates that the economy is productively inefficient: not all available resources are fully utilized/ resources are under-utilized.

Output of one or both goods could be increased without incurring any opportunity cost.

If output increases then this represents economic growth: the economy is producing more.Example: ____________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________

Toberone

20 18 W

10

8 10 15 Fruity Bussie

This graph shows that __________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________


ECONOMIC PRODUCTIVE CAPACITY/ ECONOMIC DEVELOPMENT

If either- New resources are discovered

Or - existing resources are improvedor - new, improved technology is developedthen the maximum attainable output combinations will increase. The PPC will shift outwards.

Note: the PPC will shift in if the resources and or the technology declines.

Example: ____________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________

Toberone 25

20

15 20 Fruity Bussie

This graph shows that -________________________________________________________________________________________________________

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FUTURE ECONOMIC PRODUCTIVE CAPACITY

1. Producing relatively more consumer goods than capital goods will restrict future productive capacity/potential of an economy (and vise versa).

25

20

15 Fruity Bussie

This graph shows that there are new resources and/or technology available for the production of toberone only (e.g. new sources of coca are discovered). This means that the productive capacity for toberone increases (the PPC shifts out from 20 to 25) but not for FB

2. Producing relatively more producer/capital goods than consumer goods will increase future productive capacity/potential of an economy (and vise versa). The economy in the future will be able to produce capital AND consumer goods.

Going without consumer goods now so that future productive capacity increases is referred to as ECONOMIC SAVINGS.

Capital Goods

Consumer Goods

This graph shows that -_____________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________


ECONOMIC GROWTH vs. ECONOMIC DEVELOPMENT

Economic growth refers to an increase in an economy’s total output of goods and services over time. It does not tell us:

The size of the population the output is shared among The type of goods produced (i.e. will they improve living standards) The environmental damage incurred in the production of that total output.

Hence, economic growth is not an accurate indication of whether or not living standards have improved/ will improve in the future.

Merit goods are those that society/government consider beneficial for us and government encourages us to consume them.Examples: education; healthcare; immunization.Government encourages us to have them through:

- Subsidizing the provision of merit goods e.g. public transport

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- Directly providing merit goods free of charge e.g. education- Passing laws making them compulsory, e.g. seat belts in cars

Merit goods benefit the individual consumers but they also benefit society as a whole (the have positive side-effects on others), so they improve our standard of living.

Economic growth that leads to an improvement in the welfare of society is called ECONOMIC DEVELOPMENT

If an economy chooses to produce more merit goods then it will have to forego production/output of other goods, e.g. consumer goods such as personal electronic devices. There will be an opportunity cost.By giving up production of some consumers goods now and transferring resources to the production of merit goods, economic development will improve in the future,

This can be demonstrated on the PPC below:

This graph shows that if an economy produces relatively more merit than consumer goods it will lead to economic development in the future because merit goods are beneficial to society, improving living standards. Improved living standards will lead to better human resources and productivity, and hence economic growth.

GOOD Definition: This is a physical, tangible product.Examples: ______________________________________________________________________________

SERVICE Definition: This something a producer provides or does for a consumer and is intangible.Examples: ______________________________________________________________________________

FREE GOODDefinition: These goods are not economically scarce: there are more than enough of them to satisfy everyone’s wants.

The use of a free good does not involve an opportunity cost.

Examples: ______________________________________________________________________________

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ECONOMIC GOOD

Definition: These goods are economically scarce: there are not enough of them to satisfy everyone’s wants.

The use of an economic good involves an opportunity cost.

Examples: ______________________________________________________________________________

CONSUMER Definition: These are individuals or households who purchase goods and services for their personal use.Examples: ______________________________________________________________________________

PRIVATE SECTOR

Definition: This is the economy’s production units (businesses) that are owned by households,.

Examples: ______________________________________________________________________________

PUBLC SECTOR

Definition: This is the economy’s production units (businesses) that are owned by government (local or central government).

Examples: ______________________________________________________________________________

ECONOMIC GROWTH vs ECONOMIC DEVELOPMENT

Definition: Economic development is a measure of economy’s welfare. It considers both economic indicators as well as social indicators. Economic development is a measure of an economy’s well-being.Examples:Literacy rate; percentage of population that have access to clean water; infant mortality rate.

Human Development index (HDI): This is a measure of economic development that considers THREE factors:

- Real GDP per capita- Life expectancy- The average years of formal education/schooling

Whereas economic growth is an increase in total output in the economy, i.e. changes in Real GDP. It does not consider e.g. the size of the population; the types of goods produced (do they benefit society as a whole; do they improve society’s welfare).

Economists as SOCIAL SCIENTISTS: SCIENTIFIC METHOD

P7&8 steps 1-6

ECONOMIC MODELS AND THEIR ASSUMPTIONS

Economics uses models (e.g. graphs and diagrams) to explain economic ideas/theorles and to illustrate the impact of changesExamples – Demand, supply, equilibrium (market)graphs Circular flow diagramAssumptions made with economic models:

1. Certeris Paribus: this is a Latin term that means ‘other things equal’, or that all other things remain unchanged.When the relationship between TWO variables (e.g. price and quantity demanded) is being explained using an economic graph, ceterius paribus is assumed, i.e. all other factors affecting demand, other than price, are unchanged.

2. Rational economic decision-making: economic models that all decision are rationally (i.e. logically) made, based on the following assumption:a) Individual consumers make decisions aiming to maximize their personal benefit/satisfaction

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b) Individual firms make decisions aiming to maximize their profits/ minimize their loss

POSITIVE AND NORMATIVE STATEMENTS

Positive statement: is about something that is, or will be.- They describe something. E.g. the inflation rate is 3.5% per year- They maybe about a cause and effect relationship, e.g. if prices rise and incomes are

unchanged, purchasing power will fall.- They maybe about economic theory, e.g. if costs of production rise, production becomes

less profitable.

Normative statement: is about what should be/ or is expected to happen, usually based on economic theory, predicting, e.g. What is likely to happen because of an economic event.Government policy decision making is based on normative statements.

CENTRAL THEMES to the IB Economics SL courses

These central themes are very important in the ib course. You must refer to them when answering questions (particularly evaluation questions) in exams, even if you are not asked to do so.They are:1. The distinction between economic growth and economic development2. The threat to sustainability as a result of current patterns of resources allocation3. The extent to which governments should intervene in the allocation of resources4. The extent to which the goal of economic efficiency may conflict with the goal of equity.

RESOURCE ALLOCATION AND THE THREAT TO SUSTAINABILITY

Sustainability: this refers to the use of resources such that there will sufficient resources available for future generations to enjoy economic growth.Sustainable- We do not use resources at a rate such that they cannot regenerate to replace stocks used (e.g. fish stocks; tropical rain forest); we leave the environment improved..

QUESTION ONE:

1. World wheat prices have increased. On graph 1 show the effect of increasing wheat prices on pastoral land use in the world. Clearly label the opportunity cost of this changing land use.

2. Identify the economic concept this relates to : opportunity cost

Graph 1: Wheat

Other agricultural products

3. Explain how the increasing wheat price would cause this change in resource allocation.(Because the price of the wheat is getting expensive, people have less demand in wheat, demand for

other agricultural products would increase. Firms would transfer the resources to other agricultural

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F

Opportunity cost

products’ production.) When the price of wheat increase, this signals to farmers that wheat production is relatively more profitable . Farmers will take resources out of the production of other crops and reallocate them to the production of wheat.

4. Label as point ‘F’ on Graph 1 an output combination that is currently unattainable.

5. Explain why this output combination is unattainable, using the concept of economic scarcity. (Firms can’t produce at any point beyond the PPC, there are not enough resources for them to produce.) This output combination is not possible as there are not enough resources available, given the current state of technology , i.e. resources are relatively scarce.

QUESTION TWO:Graph 2: Timber

C Opportunity

coast

Wind turbinesThe economy is producing the output combination represented by the point ‘C’.

1. On Graph2, illustrate the effect of an increase in the price of electricity. Use labels, dotted lines and arrows.

2. Explain how the increasing electricity prices would cause this change.Less forestry production will occur: this may lead to unemployment in this industry. Forestry firms’ lose revenue

3. Evaluate the effects of this change in resource allocation.More sales and revenue,More profitable,More employment.

QUESTION THREE:

In 2012 the demand for smart phones in Asia increased considerably leading to an increase in the price of smart phones.

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B

Graph 3: Smart phones

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B

A

Clothing

1. On Graph3, point A represent e the 2012 position of the Asian economy. Labe a new point, ‘B’, to illustrate the effects of an increase in the price of smart phones. Use labels, dotted lines and arrows.

2. Explain how the increasing smart phone prices would act as a price signal to determine the allocation of resources.The production of smart phone will increase with no opportunity cost because at output A the resource under-utilized.

3. Describe how point A could illustrate an increase in production with no opportunity cost.

Because the working efficiency and the using of resources is not maximum, the point A is not on the product possibility curve. So increase in production of A is means to increase the workers’ efficiency and the using of resources instead of increasing the whole resources. So there is not opportunity cost which is give up one goods to produce the other in this increase in production,

QUESTION FOUR:Graph 4: Milk (units)

10

14

Opportunity cost

5

10 20 30 40 Mountain bikes (units)The above graph shows an economy that is productively efficient.

1. On Graph 4, show the effect of increasing mountain bike production from 10 to 30 units. Use labels, dotted lines and arrows.2. On graph 4, show the effect of an increase in the number of milk-producing cows.3. Describe how the production possibility curve illustrates scarcity.

If the economy is producing at an output combination that is productively efficient, it can only increase the output of one good (e.g. mountain bikes) by giving up some output of the other good (e.g. milk). There is an opportunity cost involved, as there aren’t enough resources to maintain the production of milk, i.e. there is economic scarcity.

4. If consumer demand for mountain bikes increased, describe why some producers might exit the market for milk and enter the market for mountain bikes. Describe the implications of this change.

QUESTION FIVE:Graph 5: Consumer goods

Capital goods

1. Label a point A on Graph 5 above to illustrate productive inefficiency.2. Use the above production possibility curve to explain the economic concept of choice.

____________________________________________________________________________________

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____________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________

3. Use the above production possibility curve to explain the concept of economic savings.________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________

HOMEWORK:1. The choice between military products and provision of healthcare faces several countries in the world today,

and illustrates the concept of ‘opportunity cost’. Explain the nature of this concept using a production possibility curve.

2. Use production possibility curve to explain the difference between actual economic growth and potential economic growth.

3. Syria has been in civil war for at least the last two years. Explain, using a production possibility curve, what is likely to have happened to Syria’s economic growth.

4. The choice between military products and the provision of healthcare faces several countries in the world today. A. Explain the concept of economic development, using a production possibility curve and the choice of producing military products or the provision of healthcare. B. What are the implications of Syria producing relatively more weapons than other goods. Ideas to consider: What will this mean for e.g. stock of resources (future output capacity); resource use; firms (revenue/sales; costs of production; business confidence and investment expenditure) households (employment; incomes; expenditure; savings; economic confidence); government (revenue/expenditure)

5. List the 10 most important things about a country that you would take into account if you were choosing to live in another country. Identify how these could be measured so that you could more accurately compare countries..

6.

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