DP Economics HL 1.1 What is Economics?

DP Economics HL 1.1 What is Economics? - Full notes

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DP Economics HL | 1.1 What is Economics?

DP ECONOMICS · UNIT 1: INTRODUCTION TO ECONOMICS

1.1

What is Economics?

Full notes for HL · IB-style

Contents

1	Economics as a social science
2	Scarcity and choice
3	Opportunity cost
4	The factors of production
5	The basic economic questions and economic systems
6	The production possibilities curve
7	The circular flow of income
8	Sustainability and the central concepts
9	Applying opportunity cost to real decisions
10	Calculating opportunity cost from a PPC
11	Positive and normative statements in context
12	The circular flow and leakages
13	Economics and sustainability
14	Additional exam-style practice
15	Common misconceptions and links
16	Exam-style question with markscheme
17	Check your understanding
18	Summary and topic map

These are full teaching notes. Read each section in order, try the Think about it question before you read on, and do every Quick check before moving to the next section.

Before you start

Rate yourself on each statement now, and again after you've worked through the notes. Shade R (not yet), A (getting there) or G (confident).

I can…	R	A	G
explain what economics studies and why it is a social science
distinguish between microeconomics and macroeconomics, and positive and normative statements
explain scarcity, choice and opportunity cost with examples
identify the four factors of production and their rewards
explain the three basic economic questions and how different systems answer them
draw and interpret a PPC, including points inside, on and outside the curve
explain shifts of the PPC and the difference between actual and potential growth
explain the circular flow of income with leakages and injections
explain sustainability and the nine central concepts of the course

There is no additional HL content in 1.1. SL and HL students study the same material.

Guiding questions

What is economics, and why does every society face the same basic problem? How can a simple diagram show the choices a whole country must make? How does money flow around an economy?

How this topic is examined

This topic sets up the vocabulary for the whole course. You are unlikely to get a full essay on it, but the ideas appear everywhere: opportunity cost and the PPC are used to explain choices in every unit, and the circular flow is the starting point for macroeconomics.

In Paper 1 the PPC is a common diagram in part (a) questions on growth, development or opportunity cost. In Paper 2 you may be asked to define scarcity or opportunity cost, or to draw a PPC to illustrate a situation described in a text.

Command term	What the examiner wants
Define	the precise meaning, ideally in the IB wording, in one or two sentences
Draw / Sketch	a fully labelled diagram with every axis, curve, equilibrium and change labelled
Explain	a causal chain linked to economic theory, usually supported by a diagram
Analyse	break a situation into its parts and trace the effects of each
Evaluate / Discuss	weigh up arguments, question assumptions and reach a justified conclusion using real-world examples

How to use these notes

Each section teaches one part of the syllabus in full. You'll see these boxes throughout; each has one job:

Box	What it's for
Think about it	a question to get you thinking before a section; the answer comes in the section
Key point	the one idea you must not forget
Common mistake	an error examiners see every year, and how to avoid it
In the real world	where the economics shows up outside the classroom
Try this	something quick you can do yourself to test the idea
Worked example	full solutions with IB-style marks (M1 method, A1 answer, R1 reasoning)
Quick check	short questions to test yourself at the end of each section

1 Economics as a social science

Economics studies how people make choices when resources are scarce.

Think about it

Your school has a fixed budget. It could spend it on a new science lab, more teachers or a sports hall. Who should decide, and how? Is there one 'right' answer?

1.1 What economics is about

Economics is the study of how individuals, firms, governments and societies choose to use scarce resources to satisfy their needs and wants. Every economic question, from the price of a cup of coffee to the causes of a global recession, comes back to the same starting point: there are not enough resources to produce everything that people want, so choices must be made.

Economics is a social science. It is a science because economists try to explain the world systematically: they build theories, make predictions and test them against evidence. It is a social science because it studies human behaviour, and people are not as predictable as atoms or planets. Consumers change their minds, firms react to rumours and governments respond to elections. Economists cannot usually run controlled experiments on a whole economy, so their conclusions are always more tentative than those of a chemist or a physicist.

To cope with this complexity, economists use models: simplified representations of reality that focus on a few variables at a time. A model deliberately leaves things out. The demand and supply model, for example, ignores almost everything about a market except price and quantity. Models are judged by whether they help us explain and predict, not by whether they include every detail. You will learn much more about economic methodology in 1.2.

1.2 Microeconomics and macroeconomics

The subject is divided into two main branches. Microeconomics studies the behaviour of individual decision-makers, consumers, firms and workers, and how they interact in particular markets. Questions such as 'Why has the price of coffee risen?' or 'Should the government tax sugary drinks?' are microeconomic.

Macroeconomics studies the economy as a whole: total output, the general level of prices, unemployment, economic growth and the balance of trade with other countries. 'Why is unemployment rising?' and 'Should the central bank raise interest rates?' are macroeconomic questions.

The two branches are closely linked. A rise in the price of oil (micro) can raise inflation across the whole economy (macro), and a recession (macro) changes the demand for thousands of individual products (micro). The IB course also includes a third area, the global economy, which looks at international trade, exchange rates and economic development.

	Microeconomics	Macroeconomics
Studies	individual consumers, firms and markets	the economy as a whole
Example question	why has the price of rice risen?	why has the inflation rate risen?
Key tools	demand and supply, elasticity, market failure	aggregate demand and supply, GDP, unemployment, inflation
IB unit	Unit 2	Unit 3

1.3 Positive and normative statements

Economists make two very different kinds of statements, and you must be able to tell them apart.

A positive statement is a statement about what is, was or will be. It can be tested against evidence, at least in principle, and shown to be true or false. 'Unemployment rose by 2% last year' and 'A tax on sugary drinks will reduce consumption' are positive statements. The second might turn out to be wrong, but it can be checked with data.

A normative statement is a statement about what ought to be. It contains a value judgement, and cannot be proved true or false by evidence. 'The government should reduce income inequality' and 'Unemployment is too high' are normative. Words such as should, ought, fair, too high and better are clues that a statement is normative.

Economics as a discipline tries to be as positive as possible, but policy decisions always involve normative judgements about what society values. Economists can tell a government what is likely to happen if it raises taxes; they cannot tell it whether the result is 'fair'.

Key point

A positive statement can be tested with evidence; a normative statement contains a value judgement. Whether a positive statement is true doesn't matter: it is positive because it can be tested.

Common mistake

Thinking that a positive statement must be correct. 'Raising the minimum wage will cause no job losses' is positive even if the evidence later shows it is wrong, because it can be tested.

Quick check

1. Why is economics called a social science?

2. Is 'the price of petrol rose by 10% this year' micro or macro?

3. Classify: 'The government ought to spend more on education.'

4. Give a word that often signals a normative statement.

Answers: 1. it studies human behaviour scientifically 2. micro (one market) 3. normative 4. should, ought, fair, too high

2 Scarcity and choice

Scarcity is the basic economic problem. Choice is the unavoidable result.

Think about it

Even the richest person on Earth faces scarcity. What could be scarce for someone with unlimited money?

2.1 Needs and wants

Needs are the things we must have to survive: food, water, shelter, clothing, basic health care. Wants are things we would like to have but can survive without: a new phone, a holiday, a bigger home. In practice the line is blurred and changes over time and between societies; internet access, for example, is now treated as close to a need in many countries.

Human wants are effectively unlimited. As soon as one want is satisfied, another appears. A family that buys its first car soon wants a second, or a better one. As societies get richer, their wants grow rather than disappear.

2.2 Scarcity

Scarcity is the situation in which resources are limited relative to the unlimited wants they could satisfy. It is the fundamental economic problem, and every society faces it, rich or poor. There are only so many workers, so much land, so many machines and so many hours in a day.

Scarcity does not mean that something is rare. Water is plentiful in some countries, yet it is still scarce in the economic sense if more is wanted than can be supplied at zero cost. It also applies to time: even someone with unlimited money cannot be in two places at once, so time is scarce for everyone.

Because resources are scarce, choices must be made about how to use them. A country that uses land for housing cannot use the same land for farming. A student who spends the evening studying cannot spend it at the cinema. Every choice involves giving something up, which leads directly to the idea of opportunity cost.

2.3 Free goods and economic goods

A few things are not scarce. A free good is one that is available in such quantity that using it does not reduce the amount available for others, so it has no opportunity cost. Air in most places and sunlight are the usual examples. Most goods are economic goods: they are scarce, they use resources to produce, and they have an opportunity cost.

Free goods can become economic goods. Clean air was once taken for granted, but in heavily polluted cities clean air now has an opportunity cost: resources must be used to filter it, or other activities must be limited to protect it.

Key point

Scarcity is about resources being limited relative to wants, not about things being rare. It is the reason economics exists.

Quick check

1. Define scarcity.

2. Why are human wants described as unlimited?

3. What is a free good? Give an example.

4. Why is time scarce even for a billionaire?

Answers: 1. limited resources relative to unlimited wants 2. satisfying one want creates others 3. a good with no opportunity cost, e.g. air 4. there are only 24 hours in a day; using time one way rules out others

3 Opportunity cost

Every choice has a cost: the next best thing you gave up.

Think about it

You have a free Saturday. You could work a shift for $60, revise for an exam, or go to a friend's party. If you choose the party, what did it cost you?

3.1 The meaning of opportunity cost

Opportunity cost is the value of the next best alternative that is given up when a choice is made. It is not the money price of what you chose, and it is not the sum of every alternative: it is only the single best option you did not take.

In the Saturday example, if working the shift was your next best option, the opportunity cost of the party is the $60 you could have earned. If revising was your next best option, the opportunity cost is the revision (and perhaps a better exam grade). Only one of these is the opportunity cost: the one you valued most after the party.

Opportunity cost explains why even 'free' things have a cost. A free concert ticket still costs you the evening you could have used for something else. A government that provides free health care uses doctors, nurses and buildings that could have been used elsewhere, and that is its opportunity cost.

3.2 Opportunity cost for different decision-makers

Decision-maker	Choice	Opportunity cost
Consumer	spends $50 on a concert ticket	the next best thing the $50 could have bought, e.g. a new pair of trainers
Student	goes to university for three years	the wages from working instead, plus the experience gained in a job
Firm	uses its factory to make cars	the electric bikes it could have made with the same factory
Government	spends $2 bn on a new airport	the hospitals, schools or tax cuts it could have funded instead

WORKED EXAMPLE 1 Identifying opportunity cost

A government has $10 bn. It ranks its options: (1) a high-speed railway, (2) new hospitals, (3) a tax cut. It chooses the railway. (a) State the opportunity cost. (b) Explain why the tax cut is not part of the opportunity cost.

Solution

(a) The opportunity cost is the new hospitals: the next best alternative given upA1

(b) Opportunity cost is only the single next best alternative, not every alternative forgoneR1

The tax cut was ranked third, so it is not the opportunity costR1

In the real world

When countries increased military spending sharply after 2022, budget debates in several countries focused on the opportunity cost: what health, education or climate spending would have to be cut, or which taxes raised, to pay for it.

Common mistake

Giving the price as the opportunity cost: 'the opportunity cost of a $20 ticket is $20'. The price is not a forgone alternative. Name what the $20 could otherwise have bought.

Quick check

1. Define opportunity cost.

2. What is the opportunity cost of going to university for a student who could have worked?

3. Why do 'free' things still have an opportunity cost?

4. Why is only one alternative counted?

Answers: 1. value of the next best alternative forgone 2. the wages and experience forgone 3. they use time or resources that have other uses 4. it is the next best, by definition

4 The factors of production

Everything is made from four kinds of resource.

Think about it

Think about a smartphone. List everything that was needed to make it: materials, people, machines, ideas. Can you sort your list into groups?

The resources used to produce goods and services are called factors of production. Economists group them into four categories, and each earns a particular kind of reward or income.

Factor	What it includes	Reward
Land	all natural resources: soil, minerals, oil, forests, fish, water	rent
Labour	human effort, physical and mental, used in production	wages and salaries
Capital	man-made goods used to produce other goods: machinery, factories, roads, computers	interest
Entrepreneurship (management)	organising the other factors and taking the risk of starting and running a business	profit

4.1 Land

In economics, land means much more than the ground. It includes every natural resource: the fertility of the soil, mineral deposits, oil and gas, forests, rivers and fish in the sea. Some natural resources are renewable (forests, fish, solar energy) if they are managed carefully; others are non-renewable (oil, coal, metals) and will eventually run out. This distinction is central to sustainability.

4.2 Labour

Labour is the human effort, both physical and mental, used in production: a farm worker, a software engineer and a teacher all supply labour. What matters is not only the quantity of labour (the number of workers and hours) but also its quality. Education, training and good health raise the productivity of labour. The knowledge and skills that workers have are called human capital, and improving human capital is one of the most important sources of economic growth.

4.3 Capital

Capital means man-made aids to production: machines, tools, factories, office buildings, roads, ports and computers. Creating capital requires giving up consumption today, because resources used to build a factory cannot be used to make consumer goods. This is called investment.

Be careful: in economics, 'capital' does not mean money. Money is used to buy capital, but the money itself does not produce anything. A firm that has $1 million in the bank has financial capital; only when it buys machinery does it have physical capital.

4.4 Entrepreneurship

Entrepreneurship (sometimes called management or enterprise) is the ability to organise land, labour and capital to produce goods and services, and the willingness to take the risk that the business may fail. Entrepreneurs spot opportunities, bring resources together and innovate. Their reward is profit, which is also the incentive to take the risk.

Common mistake

Listing 'money' as a factor of production. Money is not productive in itself. Capital means physical capital such as machines and buildings; writing 'money' costs the mark.

Quick check

1. Name the four factors of production and their rewards.

2. Why is a fishing boat capital but the fish are land?

3. What is human capital?

4. Why is entrepreneurship rewarded with profit?

Answers: 1. land-rent, labour-wages, capital-interest, entrepreneurship-profit 2. the boat is man-made; the fish are natural 3. the skills and knowledge of workers 4. profit compensates for risk and organisation

5 The basic economic questions and economic systems

Every society must decide what to produce, how, and for whom.

Think about it

In a small village with no money and no government, how would people decide who farms, who builds houses and who gets the food?

5.1 The three basic economic questions

Because resources are scarce, every society must answer three questions, whether it realises it or not.

What to produce? Which goods and services, and in what quantities? More hospitals or more shopping centres? More cars or more public transport?

How to produce? Which combination of resources and which methods? A good can be made with lots of workers and few machines (labour-intensive) or with few workers and lots of machines (capital-intensive). The choice depends on the cost and availability of each factor.

For whom to produce? How is the output distributed among the population? Who gets the goods and services, and on what basis: income, need or something else? This is the question of equity.

5.2 Economic systems

An economic system is the way a society organises the answers to these questions. There are three broad types.

In a free market economy, the questions are answered by the interaction of buyers and sellers through the price mechanism. Resources are privately owned, and producers make what consumers are willing to pay for. Prices act as signals: if consumers want more of a good, its price rises, producers earn more profit, and more resources move into producing it. The government's role is limited to protecting property rights and enforcing contracts.

In a planned (command) economy, the government owns most resources and decides what to produce, how and for whom. Central planners set production targets and prices. The former Soviet Union and North Korea are examples. Planning can direct resources to national priorities and reduce inequality, but planners lack the information that prices provide, so shortages, surpluses and waste are common.

In a mixed economy, both markets and the government play a role. Most goods are allocated by markets, but the government provides some goods directly (education, defence, health care), regulates markets and redistributes income through taxes and benefits. Almost every economy in the world today is mixed; they differ in how large the government's role is.

	Free market	Planned	Mixed
Who decides?	consumers and firms through prices	the government	both
Ownership of resources	private	state	private and state
Main advantage	efficiency, choice, innovation	can pursue equity and national goals	combines market efficiency with intervention
Main disadvantage	inequality, market failure	shortages, waste, little choice	balance is hard to get right

Key point

The price mechanism answers the basic questions automatically: prices signal what consumers want, give producers an incentive to supply it, and ration goods to those willing and able to pay.

Quick check

1. State the three basic economic questions.

2. What is a capital-intensive method of production?

3. How does a free market decide what to produce?

4. Why are almost all economies today mixed?

Answers: 1. what, how, for whom 2. using many machines relative to workers 3. through prices and profit signals 4. markets are efficient but fail in some areas and do not ensure equity

6 The production possibilities curve

One diagram shows scarcity, choice, opportunity cost and growth.

Think about it

A country can produce only two goods, food and machines. If it puts every worker into food, how many machines can it make? What happens as it moves workers from food to machines?

6.1 What the PPC shows

The production possibilities curve (PPC), also called the production possibilities frontier, shows the maximum combinations of two goods that an economy can produce in a given period when all its resources are fully and efficiently employed, with a given level of technology.

The model makes three assumptions: the economy produces only two goods (or two groups of goods, such as capital goods and consumer goods); the quantity and quality of resources are fixed; and technology is fixed. These simplifications let one diagram show some of the most important ideas in economics.

Figure 1. A PPC for capital goods and consumer goods. A and B are efficient; C is inside the curve; D is unattainable.

Read the diagram point by point. Every point on the curve, such as A or B, is attainable and productively efficient: all resources are fully employed and none could be reallocated to produce more of one good without producing less of the other.

A point inside the curve, such as C, is attainable but inefficient. Some resources are unemployed (for example, workers are out of work in a recession) or are being used wastefully. The economy could produce more of both goods by moving towards the curve.

A point outside the curve, such as D, is unattainable with current resources and technology. This is scarcity shown on a diagram: society wants combinations it cannot produce.

6.2 Opportunity cost and the shape of the PPC

Moving along the PPC shows opportunity cost. If the economy moves from A to B, it produces more capital goods but must give up some consumer goods. The consumer goods given up are the opportunity cost of the extra capital goods.

The PPC is usually drawn concave (bowed outward from the origin). This shape means that the opportunity cost of each extra unit of a good increases as more of it is produced. The reason is that resources are not equally suited to producing every good. When a country first shifts resources from consumer goods into capital goods, it moves those best suited to making capital goods (engineers, machinery). As it continues, it has to move resources that are less and less suitable (farmers, textile workers), so it must give up more and more consumer goods for each extra unit of capital goods.

If resources were equally good at producing both goods, opportunity cost would be constant and the PPC would be a straight line. This is sometimes used in simple examples and in the theory of comparative advantage (Unit 4).

WORKED EXAMPLE 2 Opportunity cost from a production table

An economy's production possibilities are shown below. (a) Calculate the opportunity cost of increasing capital goods from 10 to 20 units, and from 30 to 40 units. (b) Explain what your answers show about the shape of the PPC.

Solution

Combinations (capital, consumer): (0, 100), (10, 95), (20, 85), (30, 70), (40, 50), (50, 25)

(a) From 10 to 20 capital goods: consumer goods fall from 95 to 85, so the opportunity cost is 10 consumer goods (1 per capital good)A1

From 30 to 40: consumer goods fall from 70 to 50, so the opportunity cost is 20 consumer goods (2 per capital good)A1

(b) The opportunity cost of each extra capital good rises as more are producedR1

so the PPC is concave to the origin, because resources are not equally suited to both goodsR1

6.3 Economic growth and the PPC

Economists distinguish two kinds of growth, and the PPC shows the difference clearly.

Actual growth is an increase in real output. If an economy is inside its PPC (point C) and puts unemployed resources back to work, it moves towards the curve. Output rises, but the curve itself has not moved.

Potential growth is an increase in the economy's productive capacity: the PPC shifts outward. This happens when the quantity or quality of factors of production increases, or technology improves. Examples are a larger labour force (through population growth or migration), investment in new capital, improvements in education and health, discoveries of natural resources, and new technology.

Figure 2. An outward shift of the PPC from PPC to PPC1: potential economic growth.

The PPC can also shift inward. Natural disasters, wars, the depletion of natural resources or a large fall in the working population reduce productive capacity. A pandemic that kills or disables part of the workforce would shift the PPC inward; a temporary lockdown that leaves workers idle would move the economy inside an unchanged PPC.

Finally, the choice of where to produce on the PPC today affects where the curve is tomorrow. A country that chooses point B, producing more capital goods and fewer consumer goods now, sacrifices current living standards, but the extra capital will shift its PPC further out in the future. A country that chooses point A enjoys more consumption now but grows more slowly.

Change	How it appears on the PPC
Unemployment falls	movement from inside towards the PPC (actual growth)
More or better factors of production	outward shift (potential growth)
Better technology in one industry only	the curve pivots outward along that good's axis
Natural disaster destroys capital	inward shift
Reallocation of resources	movement along the PPC

Common mistake

Showing a fall in unemployment as an outward shift of the PPC. Unemployed resources are already part of the economy's capacity. Putting them back to work moves the economy from inside the PPC towards it.

Quick check

1. What does a point inside the PPC show?

2. Why is the PPC usually concave?

3. Distinguish actual and potential growth.

4. Why might choosing more capital goods now lead to faster growth later?

Answers: 1. unemployed or inefficiently used resources 2. increasing opportunity cost: resources not equally suited 3. actual: more output from existing capacity; potential: capacity increases (PPC shifts) 4. more capital raises future productive capacity

7 The circular flow of income

Income, output and spending flow round the economy in a circle.

Think about it

When you buy a sandwich, where does your money go? Follow it: who receives it, and what do they do with it?

7.1 The simple two-sector model

The circular flow of income model shows how money, goods and resources flow between the main groups in an economy. In the simplest version there are only two sectors: households and firms.

Households own the factors of production. They sell the services of land, labour, capital and entrepreneurship to firms, and in return receive factor incomes: rent, wages, interest and profit. Firms use these factors to produce goods and services, which they sell to households. Households spend their incomes on these goods and services, and the money flows back to firms.

There are therefore two flows going in opposite directions. The real flow is the flow of factor services from households to firms and of goods and services from firms to households. The money flow is the flow of incomes from firms to households and of spending from households to firms.

Figure 3. The simple circular flow: factor incomes flow to households, and spending flows back to firms.

This model shows a very important idea: national income = national output = national expenditure. Every dollar spent on output becomes income for someone. The three are simply different ways of measuring the same flow, which is why GDP can be measured in three ways (you will meet this in 3.1).

7.2 Leakages and injections

In a real economy, not all income is spent on domestic goods, and not all spending comes from household incomes. Money can leave the circular flow, and new money can enter it.

Leakages (withdrawals) are flows of money out of the circular flow. There are three: saving (income not spent), taxes (income paid to the government) and imports (spending on foreign goods, which goes to foreign firms).

Injections are flows of money into the circular flow from outside the household–firm loop. There are three: investment (firms' spending on capital goods), government spending and exports (spending by foreigners on domestic goods).

Adding the financial sector, the government and the foreign sector gives the four-sector model. The size of the circular flow, and therefore national income, depends on the balance between leakages and injections. If injections exceed leakages, national income rises; if leakages exceed injections, national income falls. National income is in equilibrium when leakages equal injections.

Leakage (withdrawal)	Matching injection	Sector
Saving (S)	Investment (I)	financial sector
Taxes (T)	Government spending (G)	government
Imports (M)	Exports (X)	foreign sector

WORKED EXAMPLE 3 Leakages and injections

In an economy, saving is $200 bn, taxes $300 bn and imports $150 bn. Investment is $180 bn, government spending $320 bn and exports $200 bn. (a) Calculate total leakages and total injections. (b) State what will happen to national income, and explain why.

Solution

(a) Leakages = 200 + 300 + 150 = $650 bnA1

Injections = 180 + 320 + 200 = $700 bnA1

(b) Injections exceed leakages by $50 bn, so more money is entering the circular flow than leaving itR1

National income will rise until leakages equal injectionsA1

Key point

Injections raise national income; leakages reduce it. Equilibrium national income is where total leakages equal total injections.

Quick check

1. Name the two sectors in the simple circular flow.

2. Why does national income equal national output?

3. List the three leakages and three injections.

4. What happens to national income if leakages exceed injections?

Answers: 1. households and firms 2. every expenditure on output is someone's income 3. S, T, M; I, G, X 4. it falls

8 Sustainability and the central concepts

The IB course is built around nine concepts. Sustainability is one you will meet everywhere.

8.1 Sustainability

Sustainability means meeting the needs of the present generation without compromising the ability of future generations to meet their own needs. In economics this applies most obviously to the environment: using fish stocks, forests, water and fossil fuels faster than they can be replaced reduces what future generations will have.

Sustainability is also a question of opportunity cost over time. Consuming more natural resources today means less is available tomorrow. A PPC that shifts outward today because forests are cleared for farmland may shift inward later as soils erode and the climate changes. You will return to sustainability in Units 2, 3 and 4.

8.2 The nine central concepts

Concept	Meaning in this course
Scarcity	limited resources relative to unlimited wants
Choice	the decisions made because of scarcity
Efficiency	making the best use of scarce resources
Equity	fairness in the distribution of income, wealth and opportunity
Economic well-being	the prosperity and quality of life of individuals and societies
Sustainability	meeting present needs without harming future generations
Change	how economies and economic thinking evolve over time
Interdependence	how economic agents depend on each other, locally and globally
Intervention	government action in markets and the economy

These concepts are not separate topics to memorise. They are lenses for looking at any economic issue. In evaluation answers, using a concept explicitly ('this policy improves equity but may reduce efficiency') is one of the most effective ways to show depth.

Quick check

1. Define sustainability.

2. Which central concept is about fairness?

3. Give an example of interdependence.

Answers: 1. meeting present needs without harming future generations' ability to meet theirs 2. equity 3. e.g. a factory closure abroad affects suppliers at home

9 Applying opportunity cost to real decisions

Every choice has a cost.

Opportunity cost is the value of the next best alternative forgone. It applies to individuals (studying instead of working), firms (investing in one project rather than another) and governments (spending on health rather than defence). It need not be measured in money: time and enjoyment are also costs.

WORKED EXAMPLE 4 University (standard)

A student chooses three years at university instead of a job paying $25 000 a year. Tuition is $9000 a year. Identify the opportunity cost.

Solution

Forgone earnings 3 × $25 000 = $75 000 (plus the alternative use of $27 000 tuition)M1 A1

The opportunity cost is the next best alternative: the job and what the tuition money could have boughtR1

Quick check

1. A council spends $2 million on a new park instead of road repairs. State the opportunity cost.

2. Why is the opportunity cost of a 'free' concert ticket not zero?

Answers: 1. the road repairs forgone 2. the time could have been used for something else

10 Calculating opportunity cost from a PPC

Gradients and trade-offs.

On a production possibilities curve, the opportunity cost of producing more of one good is the amount of the other good given up. A bowed-out (concave) PPC shows increasing opportunity cost because resources are not equally suited to both goods.

Combination	Cars	Computers
A	0	100
B	10	90
C	20	75
D	30	50
E	40	0

Figure 4. A production possibilities curve showing increasing opportunity cost.

WORKED EXAMPLE 5 PPC calculation (exam level)

Using the table, calculate the opportunity cost of increasing car production from 20 to 30 and from 30 to 40.

Solution

20 → 30: 25 computers (2.5 per car)A1

30 → 40: 50 computers (5 per car)A1

Opportunity cost increases: resources less suited to carsR1

Quick check

1. What is the opportunity cost of the first 10 cars?

Answers: 1. 10 computers

11 Positive and normative statements in context

Facts versus value judgements.

Positive statements can be tested against evidence ('The unemployment rate is 5%'); normative statements contain value judgements ('The government should reduce unemployment'). Good evaluation in essays separates them clearly.

WORKED EXAMPLE 6 Classifying (standard)

Classify: (a) 'A rise in the minimum wage will reduce employment of young workers.' (b) 'The minimum wage is unfair to employers.'

Solution

(a) positive (testable, even if disputed)A1

(b) normative (value judgement)A1

12 The circular flow and leakages

A simple model of the economy.

In the circular flow model, households supply factors of production to firms and receive incomes; firms supply goods and services and receive spending. Leakages (savings, taxes, imports) remove income; injections (investment, government spending, exports) add it.

Figure 5. The circular flow of income.

WORKED EXAMPLE 7 Equilibrium (exam level)

Explain what happens to national income if injections exceed leakages.

Solution

More spending enters the flow than leaves itR1

National income rises until leakages equal injectionsR1

13 Economics and sustainability

A central concept.

Sustainability means meeting present needs without compromising the ability of future generations to meet theirs. Economic activity uses scarce resources; overuse of non-renewable resources and pollution threaten future welfare. The IB course links sustainability to externalities, common pool resources and development.

Quick check

1. Give one example of an unsustainable economic activity.

Answers: 1. overfishing; burning fossil fuels; deforestation

14 Additional exam-style practice

Paper 1 style.

WORKED EXAMPLE 8 Paper 1 part (a) (exam level)

Using a PPC diagram, explain the concept of opportunity cost. [4]

Solution

Correctly labelled PPC with two goodsA1

Movement along the curve shows more of one good means less of the otherR1

The amount given up is the opportunity cost; increasing along a concave PPCR1 R1

Quick check

1. Explain how a PPC can show economic growth.

Answers: 1. outward shift due to more or better resources or technology

15 Common misconceptions and links

Students often think…	Actually…
economics is about money	economics is about choices under scarcity; money is only a means of exchange
scarcity means rare	scarcity means limited relative to wants
opportunity cost is the price paid	it is the next best alternative given up
money is a factor of production (capital)	capital means physical capital such as machinery
a fall in unemployment shifts the PPC outward	it moves the economy from inside the PPC towards it
a positive statement must be true	it only needs to be testable
leakages are bad for the economy	saving finances investment; imports give access to cheaper and better goods

How 1.1 connects to the rest of the course

Topic	Connection
1.2 How economists approach the world	models, ceteris paribus and the history of economic thought
2.1 Demand and 2.3 Equilibrium	the price mechanism in detail
2.8 Market failure	when markets fail to answer the basic questions well
3.1 Measuring economic activity	the circular flow is the basis of GDP measurement
3.3 Macroeconomic objectives	growth is an outward shift of the PPC
4.1 International trade	PPCs and opportunity cost explain comparative advantage

16 Exam-style question with markscheme

Try this under exam conditions (about 15 minutes) before reading the markscheme.

Figure 6. PPC for an economy.

Text A. In 2020 a pandemic forced many firms to close, and unemployment rose from 4% to 9%. The government has announced a major programme of investment in education and digital infrastructure.

(a) Define the term opportunity cost. [2]

(b) Using the PPC, explain the effect of the rise in unemployment described in Text A. [4]

(d) Explain why the government's programme involves an opportunity cost. [2]

Markscheme

Part	Answer	Marks
(a)	the value of the next best alternative	A1
	forgone when a choice is made	A1
(b)	diagram: point inside the PPC (e.g. Y)	A1
	unemployed labour means resources are not fully employed	R1
	output of both goods falls below potential	R1
	the PPC itself does not shift	R1
(c)	education raises the quality of labour (human capital)	R1
	infrastructure adds capital and raises productivity	R1
	productive capacity increases	R1
	PPC shifts outward (diagram)	A1
(d)	resources used for the programme cannot be used elsewhere	R1
	e.g. other spending, tax cuts or current consumption forgone	A1

Examiner's comments. In (b), many candidates shifted the PPC inward. Unemployment does not destroy productive capacity; it leaves it unused, so the economy moves inside the curve. In (c), the best answers separated the two channels: better labour and more capital.

17 Check your understanding

Section A: multiple choice

1. Economics is best described as the study of

A. how scarce resources are allocated to satisfy wants B. how to make money C. how firms set prices only D. government spending

2. Opportunity cost is

A. the price paid B. the total cost of production C. the value of the next best alternative forgone D. the cost of all alternatives

3. Which is a factor of production?

A. money B. entrepreneurship C. profit D. shares

4. The reward to capital is

A. rent B. wages C. profit D. interest

5. A point inside the PPC shows

A. unattainable output B. unemployed or inefficiently used resources C. potential growth D. full employment

6. The PPC is concave because

A. resources are not equally suited to all uses B. resources are unlimited C. prices rise D. opportunity cost is constant

7. Which statement is normative?

A. unemployment is 5% B. a tax raised prices C. inflation was 3% last year D. the government should reduce inequality

8. Which is an injection into the circular flow?

A. saving B. taxes C. exports D. imports

9. An outward shift of the PPC is caused by

A. a fall in unemployment B. a rise in prices C. a recession D. an improvement in technology

10. In a planned economy, resources are allocated mainly by

A. the price mechanism B. the government C. consumers D. tradition

Section B: structured

11. Explain the relationship between scarcity, choice and opportunity cost. [4]

12. Using a PPC diagram, distinguish between actual and potential economic growth. [4]

13. Explain how the price mechanism answers the question 'what to produce?' [4]

14. Explain why national income equals national output in the circular flow. [3]

15. Distinguish between microeconomics and macroeconomics, with an example of each. [4]

Answers

1. A 2. C 3. B 4. D 5. B 6. A 7. D 8. C 9. D 10. B

11. Scarcity means resources cannot satisfy all wants, so choices must be made; every choice means giving up the next best alternative, which is the opportunity cost.

12. Actual growth: movement from inside the PPC towards it as unemployed resources are used. Potential growth: an outward shift caused by more or better factors or technology. Diagrams.

13. Consumers signal demand through what they buy; higher prices raise profits; producers move resources into those goods (signalling, incentive, rationing).

14. Firms pay factor incomes to households for producing output; households spend income on output; every expenditure is income for someone.

15. Micro: individual markets, e.g. the price of coffee. Macro: the whole economy, e.g. the inflation rate.

18 Summary and topic map

Idea	Remember
Economics	how scarce resources are allocated to satisfy wants
Scarcity	limited resources relative to unlimited wants
Opportunity cost	next best alternative forgone
Factors of production	land (rent), labour (wages), capital (interest), entrepreneurship (profit)
Basic questions	what, how, for whom
PPC	on = efficient; inside = unemployment; outside = unattainable; concave = rising opportunity cost
Growth	actual: towards the PPC; potential: PPC shifts out
Circular flow	income = output = expenditure; leakages S, T, M; injections I, G, X
Positive / normative	testable / value judgement

Before the exam, make sure you…

•name a specific alternative whenever you give an opportunity cost
•label PPC axes with two goods and mark points clearly
•never show a fall in unemployment as a PPC shift
•explain why the PPC is concave using unequal suitability of resources
•spot normative words such as should and fair in data texts
•use the central concepts explicitly in evaluation

What is Economics? on one page

Cover this page with a sheet of paper and try to rebuild it from memory. Whatever you can't recall is what to revise next.

Figure 7. Topic map for What is Economics?.

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