Economics SL

1. Economics: the study of choices leading to the best possible use of scarce resources in order
to best satisfy unlimited human needs and wants

2. Scarcity: the situation in which available resources or factors of production, are finite, whereas
wants are infinite. There are not enough resources to produce everything that we need and
want. The basic economic problem that arises because people have unlimited wants but
resources are limited. Because of scarcity, various economic decisions must be made to
allocate resources efficiently.

3. Finite: limited

4. Infinite: unlimited

5. Needs: something we must have in order to survive (e.g. water, food, housing)

6. Wants: something we desire (e.g. pens, computers, automobiles)

7. Opportunity cost: the next best alternative foregone when making a choice, what we give up
when we make a choice

- because we cannot have everything we want as a result of scarcity, every choice that must be
made between two or more options has an opportunity cost. 

8. Production possibility frontier

- a curve depicting all maximum output possibilities for two or more goods given a set of inputs
(resources, labor, etc.). The PPF assumes that all inputs are used efficiently

- Points A and B on the PPF shows the maximum that can be produced with existing resources
and technology, the point of productive efficiency (Point A = inefficient, Point B = most efficient)

- Point C = unattainable if the factors of production stays the same

- The negative slope of the PPF reflects basic scarcity

- The law of diminishing returns implies a convex PPF: as resources are transferred from one use
to another, the increment in output becomes smaller, the opportunity cost larger

9. Basic economic problem

- The basic economic problem occurs because resources are scarce - but our wants are infinite.
As resources are scarce and our wants are never-ending, we have to allocate resources. When
we allocate resources, we ask the following questions:

• What goods and services should we produce?

• How should the economy use its resources to operate schools or hospitals?

• What is the best way to produce goods and services?

• What is the best use of scarce resources?

• Who is to receive goods and services?

10. Water diamond paradox

- Water has a high demand but is extremely cheap. Diamonds have a low demand but is
expensive. How can something with so little demand be so expensive?” Solution: the value of a
good is not just based on the demand for it, but also on its supply. Scarcity, in other words, is a
function of both supply and demand. Diamonds are incredibly expensive because, despite their
 limited demand, their supply is so extremely limited that they are deemed to have great value.
Water, despite its high demand, is in such abundant supply that it is very cheap.

11. 4 factors of production: the available resources used to produce goods and services

- Land (rent): the natural resources available for production. Some nations have a large amount of
a particular natural resource, and so are able to specialise in the extraction and production of it

- Labour: the human input into the production process. Not all labour is of the same quality.
Every person has different skills and qualifications - we call this human capital. When people
have more human capital, they are likely to be more productive. This means they can produce
more in the same amount of time.

- Capital: investment in goods that are used to produce other goods in the future. Ex. machinery,
plant and equipment, new technology, factories and buildings

- Enterprise(profit): the idea of having ideas and taking risks in setting up or running a business.
entrepreneur: involved in taking those risks, perhaps by putting in their money, or having the
ideas and the drive to set up or run the business. The reward for being an entrepreneur is profit.

12. Advantages and disadvantages of planned and free market economies

- Planned Economy

Advantages Disadvantages

The government can influence the distribution of In order to function well, requires an enormous
income amount of information which is difficult to obtain

The government can determine which goods are No real incentive for individuals to be innovative.
supplied Goods are of poor quality since there is a lack of
profit motive

Equally distributed May not need lead to allocative efficiency or

productive efficiency due to lack of competition and
profit motives

Corruption - the government has the ability to

abuse its absolute power

The economy does not respond as well to supply

and demand, firms are simply told to produce a
certain number of goods or services

- Free Market Economy

Advantages Disadvantages

Resources allocated more efficiently by the price Instability

mechanism

The profit motive is a great incentive, and forces Market failure

producers to reduce costs and be innovative

With no imperfections, the free market maximize Monopolies and corruption - the natural goal of all
community surplus firms is to attain monopoly, as this eliminates
competition, eliminating the associated costs and
thus maximizing profit. If the market structure does
not include limiting social forces, financial forces
will cause firms to externalize costs such as
pollution to gain monopoly.
In order to build a firm foundation in economics, you need to make sure that you understand how
the economy functions in terms of finite economic resources and the insatiability of humans
(wants and needs). The bottom line is that, economic agents are always trying to maximize the
benefits they are getting from meager and deplete-able economic resources. To do this, humans
choose an appropriate rationing system (mechanism for allocating scarce resources).

1. What is meant by scarcity in economics

It is the situation wherein wants, being infinite, cannot be met due to the available resources being
finite. Thus causing the basic economic problem to worsen as people’s wants cannot be satisfied
due to the limited resources. Therefore, economic decisions must always ensure the resources are
allocated efficiently.

2. Why do we always have to incur an opportunity cost when making economic decisions?

As the available resources stay limited, people’s wants cannot always be satisfied. Therefore,
every choice that is being made have two or more alternatives, that being the opportunity cost.
Opportunity costs must be recognized when making economic decisions as it frames costs and
benefits into choosing what is more important at the time. It may relate these decisions to saving
or consuming. Choosing to save means giving up the opportunity to a possible valuable
consumption. Choosing to consume may cause a loss of opportunity to a future greater, more
valuable consumption. Thus putting to perspective why decisions need to be made with a lot of
thought.

3. Distinguish between needs and wants

Needs are things that people must have in order to survive, while wants are things people desire.

4. Explain how the basic economic questions (problems) answers under a market and planned
economies

Market economy: The market economies bases its decisions on the mutual beneficial exchange
between producers and consumers, therefore allocating resources through markets efficiently.

Planned economy: In planned economies, the government authorizes where, how and to whom
resources are allocated.

5. State the factors of production and their rewards

- Land: includes all the natural resources used in production, nations rich with natural resources
specialise in their extraction and production

- Labour: the human input into production, an increase in size and quality of labour force is
necessary to establish to ensure a country’s growth.

- Capital: the investment of goods that are used to produce other goods in the future, capital
goods are used to improve the productivity of labour

- Enterprise: the idea of having ideas and taking risks in running a business, entrepreneurs are
individuals who invests their own financial capital into the business and therefore taking risks,
the reward being their profit from running the business

(6-12 same question)

6. Assume that a country has just one factor of production, labour, to produce butter and guns.
Suppose there are 100 people (labour) in this country and it takes 1 person to produce butter
while it takes 5 people to produce a gun. Using this information answer the following question:

Draw a table showing different combinations of butter and guns a country can produce

Butter Guns

0 20

20 16

40 12

60 8

80 4
Butter Guns

100 0
7. Using the information in the table, draw thee PPF —>

8. What does it mean if the country is producing inside the

PPF?

It means that the country is not fully making use of their

resources, resulting in inefficiency.

9. At what point is production said to be efficient?

Production is at its most efficient when the level of

production reaches the lowest possible average cost. Any
point on the curve is said to have efficient production.

10. Is a point of production outside the PPF possible?

Explain your answer.

No, the points outside the curve are unattainable with the
resources that are already available. If more inputs become
available, the curve will move outwards, therefore more
outputs are produced in the process.

11. What would happen to the PPF if there is technological development in favour of the
production of butter?

The PPF would move outwards, representing the increase in efficiency of attaining available
resources.

12. Show in the diagram what would

happen to the PPF if there was an
increase in the labour force from
100 to 200

13. What does it mean when we say

that rational economic agents are
always thinking at the margin?
Relate your answer to the concept
of utility

Thinking at the margin is to

consider the effect of doing an
additional action which could either be a benefit or a cost. This is important to allow economic
agents to think ahead, therefore working out the marginal cost and benefit of each decision.

14. Explain the circular flow of income

The circular flow of income and spending shows the connections between different sectors of an
economy. It shows the flow of goods and services and the factors of production between firms
and households. It also shows how the GDP (Gross Domestic Product) is calculated. As
businesses produce their goods and services, they generate income for factors of production.
Although not all income will flow from households to businesses directly. These are called
leakages (withdrawals). The circular flow shows that some part of household income will be put
aside for future spending (i.e. savings), paid to the government in taxation, or spent on foreign-
made goods and services. This would reduce the circular flow of income and lead to a multiplied
contraction of production. Injections into the circular flow are additions to investment, government
spending or exports, boosting the circular flow of income and lead to a multiplied expansion of
output. When the rate of injections is equal to the rate of withdrawals, the economy is in
equilibrium.

15. Using an example, explain the meaning of the ceteris paribus assumption

Ceteris paribus means “all other things being equal” or all other variables stay constant. For
example, in the law of demand, it states that a price of a good increases, ceteris paribus, quantity
demanded will decrease. This means that all the other variables remain equal and is not involved
in the relationship between the price of a good and the quantity of a good. So, ceteris paribus is
used when economists want to test the effect of one variable on another, isolating the effect of the
on variable by assuming that there is no change in any of the other variables.

16. How do economists build economic models?

Economic models are used by economists to explain or make predictions about economic issues
and problems. When they identify an economic issue or problem, they go through a number of
possible theories to see if they can find one that fits. Then they use the theory to understand more
about the issue. Theories are then expressed in models as diagrams or graphs.

17. Distinguish between a positive and normative statement in economics

Positive statements are objective statements that can be tested, amended or rejected by referring
to the available evidence. It is fact-based and has no value judgement attached to it. Normative
statements are subjective statements that are value-based, originating from personal
perspectives, feeling or opinions involved in the decision-making process.

18. How the two rationing systems differ

A positive economic statement is one that has to be proven as right or wrong by look at the facts.
A normative economic statement is a matter of opinion and cannot be conclusively proven to be
right or wrong.

19. Explain the advantages and disadvantage of planned and market economies

Planned Economies

In a planned economy, the government authority controls the means of production. Thus, they
control who works where and for how much pay, so more people will be employed and there is
less inequality. On the other hand, planned economies lack of competition, resulting to a lack of
productivity and efficiency. This also means the quality of goods and services cannot improve.

Market economies

In a market economy, people can buy and sell freely as the buying and selling of goods and
services are not under the control of the government. In this type of economy, there will be a lot of
competition, which then drives innovation and brings higher profits for business and better
products for consumers. The resources are also allocated very efficiently and tend to go where
the expected profit is highest. Although, the free market activity could lead to wealth inequality as
it causes upward pressure on wages of highly educated people and downward pressure on those
of low-skilled people which also increases income inequality.

20. What is the difference between economic growth and economic development?

Economic growth is the increase in output in an economy measured by an increase in GDP over a
period of time. Economic development is the efforts that seek to improve the economic well-being
and quality of life for a community by offering more job opportunities and supporting or growing
incomes.

21. What is the meaning of sustainable development?

Sustainable development means that each generation should pass on at leas as much “capital”
as it inherits. It integrates economic, environmental and social components at all levels without
destroying resources held in trust for future generations.

26 August 2020

Economic agents assumed to rational

Rational: refers to a decision-making process that is based on making choices that result in the
optimal level of benefit of utility for an individual,economic agents are rational but their rationality
is bounded (limited)

Mixed Economy:

Free Market Economy

- what to produce: based on demand and supply

- How to produce: allocating resources efficiently

- For whom: whoever can pay

Planned Economy:

- what to produce: based on government authority

- How to produce: no efficiency required, wasteful of resources

- For whom: for everyone

Production possibility frontier

- shows different combinations of products that can be produced given the available resourcs

- Examples:

—> 10 workers

—> butter = 1 worker 1 butter

—> guns = 2 workers 1 gun

- When line is closer to 0, poorer country, since there is less resources

- Optimum level?