IB Notes
Foundations of economics
THE BASIC ECONOMIC PROBLEM
- What and how much goods and services to produce?
- How to produce the goods and services? (Through a labor or capital intensive production?)
- For whom do we produce the goods and services for? (For the rich or poor?)
SCARCITY
- Needs are necessary to survive and they stay the same.
- Wants are unlimited and they are changing all thetime.
- Price is a signal to consumers.
Biological needs
- Food
- Water
- Shelter
- Clothing
Societal needs
- Comfort
- Security
- Entertainment
- Love
- Acceptance
- Luxury
- Scarcity is the infinte wants and and finite resources we have. This forces us to make rational choices, if not, there will be consequences.
- The invisible hand refers to the self-regulating nature of the marketplace in determining how resources are allocated based on individuals acting in their own self-interest.
- When dealing with scare resources, every economic action has an opportunity cost. This is the benefit lost from not choosing the next best alternative.
- The economy allocates resources through using a free market system, planned economies or mixed economies.
Economic goods
- These goods are limited.
- Requires factors of production to produce.
- Limited and must be rationed. There is an opportunity cost.
Free Goods
- Goods which are not used up in consumption.
- There is no opportunity cost.
- Marginal cost of supplying an extra unit is near 0.
FACTORS OF PRODUCTION
Land
- It is all natural resources that could be used in the production of an economic good.
- Includes raw materials (coal and oil) and cultivated products (rice and pineapples).
- These resources are either renewable or non-renewable.
Labor
- The physical and mental contribution of each worker.
Capital
- Physical capital is the stock of manufactured resources (factories and machines) used to produce goods and services.
- Human capital (investment through education or improved health care).
- Infrastructure is the large scale of public systems and services (hospitals and schools) usually accumulated by the governement.
- Investment in capital plays a big role in raising productivity and resulting in economic growth.
Entrepreneur
- Manages, organizes and plans the factors of production to produce goods and services.
- Take risks (use their own money or borrow large sums of money) to make an investment.
- They are responsible for any losses and they are rewarded if they make a profit.
POSSIBILITY PRODUCTION FRONTIER
- The PPF shows the maximum combinations of goods and services that can be produced by an economy in a given time period if all the resources in the economy are being used fully and efficiently and the state of technology is fixed. This is known as the potential output.
- Demonstrates the idea of an opportunity cost.
- Points B, D and C are only attainable if the economy is working at full capacity.
- Point A is achieveable but there will be wastage in resources.
- Point X is unachievable at the moment. If there is economic growth and the PPF shifts outwards, point X may be attainable.
- If new resources (new coal mines and reclaimed land) is found, the PPF could also shift outwards.
- If there was a war or natural disaster, the PPF could shift inwards.
- The PPF is concave because there is an increasing opportunity cost the more time you spend on doing or producing something. If we focus on making more cameras, skilled phone makers will not be as productive since they do not specialize in this field.
- There is an increasing opportunity cost when you make too many cameras, hence the steeper tangent.
UTILITY
-This is a measure of usefullness or pleasure a consumer recieves when they consume a product.
- Consumers will choose the good with the biggest utility.
- Marginal utility is the extra utility gained from consuming one more unit of the product.
- In most cases, marginal utility decreases as more units are consumed. This is the diminishing return.
- A disutility occurs when marginal utility becomes negative.
POSITIVE ECONOMIC STATEMENTS
- This statement is certain and can be prove right or wrong by looking at the facts.
NORMATIVE ECONOMIC STATEMENTS
- This statement is a matter of opinion and there is no correct answer. A conclusive outcome is unlikely.
PLANNED ECONOMY
- Government decides what to produce, how to produce and who to produce for.
- All resources are collectively owned.
- Government bodies arrange all production, set wages and set prices.
- Decisions are made by the government on behalf of the people, and in theory, in their best interests,
- Quantity of decisions to be made, data to be analysed, FOP to be allocated are immense.
Disadvantages:
- Total production, investment, trade and consumption even in a small economy will be too complicated to plan efficiently. There will be mislocation of resources, shortages and surpluses.
- Because there is no price system in operation, resources will not be used efficiently. Arbitary decisions will not be able to make the best use of resources.
- Incentives tend to be distorted. Workers with guarenteed employment and managers who gain no share of profits are difficult to motivate. Output and / or quality will definitely suffer.
- The dominance of the government may lead to a loss of personal liberty and freedom of choice.
FREE ECONOMY
- Prices are used to ration goods and services. It is a signal to consumers.
- All production is in private hands.
- Demand and supply are left free to set wages and prices in the economy.
- The economy should theoretically, work efficiently and there should be few cases of surpluses and shortages.
- The free market is a self-correcting system.
- Sometimes it may take a while for resources to be re-allocated from one production to another, creating consequences for the stakeholders involved.
Disadvantages:
- Demerit goods will be over-provided, driven by high prices and thus a high profit will be made.
- Merit goods will be underprovided since they will only produced for those who can afford them and not for all. Non-profit making parts will be abandoned.
- Resources may be used up too quickly and the environment may be damaged by pollution as firms seek to make high profits and to minimize costs.
- Some members of society will not be able to look after themselves, such as orphans, the sick, the long-term unemployed, and will not survive.
- Large firms may grow and dominate industries, leading to high proces, a loss of efficiency and excessive power.
MIXED ECONOMY
- All economies are mixed economies.
- Government involvement is essential since there are some dangers that will exist if the free market is left to operate without interference.
