IB Economics

5 Key Economic Assumptions

1. Society’s wants are unlimited, but ALL resources

are limited (scarcity).
2. Due to scarcity, choices must be made. Every choice
has a cost (a trade-off).
3. Everyone’s goal is to make choices that maximise
their satisfaction. Everyone acts in their own ‘self-
interest’.
4. Everyone makes decisions by comparing the
marginal costs and marginal benefits of every
choice.
5. Real-life situations can be explained and analysed
through simplified models and graphs.
Thinking at the Margin

# Times Benefit Cost

Watching Movie

1st $30 $10

2nd $15 $10
3rd $5 $10
Total $50 $30

Would you see the movie three times?

Notice that the total benefit is more than
the total cost but you would NOT watch
the movie the 3rd time.
 Marginal Analysis

In economics the term marginal = additional

“Thinking on the margin”

additional benefit vs. the additional cost.

For Example:
You have been shopping in Rundle Mall for half an hour, the
additional benefit of shopping for an additional half-hour
might outweigh the additional cost (the opportunity cost).
After three hours, the additional benefit from staying an
additional half-hour would likely be less than the additional
cost.
 Marginal Analysis

Notice that the decision making process wasn’t

“should I go to town for 3 hours or should I stay
home?”

In reality the decision making process started with

“should I go to the mall at all.”
Once you are there you thought “should I stay for
an additional half hour or should I go?”

The marginal analysis approach to decision making

is more commonly used than the “all or nothing”
approach.
 Trade-offs and Opportunity Cost
ALL decisions involve trade-offs.
Trade-offs are all the alternatives that we
give up whenever we choose one course of
action over others.
(Examples: going to school)
The most desirable alternative given up as a
result of a decision is known as opportunity cost.
What are trade-offs of deciding to go to University?
What is the opportunity cost of going to University?
 How is Economics used?

• Economists use the scientific method to make

generalisations and abstractions to develop
theories. This is called theoretical economics.
• These theories are then applied to fix problems
or meet economic goals. This is called policy
economics.

Positive vs. Normative

Positive Statements- Based on facts. Avoids

value judgements (what is).
Normative Statements- Includes value
judgements (what ought to be).
 Opportunity Cost

The cost of the next best alternative

foregone (given up).
 Production Possibilities Curve

• A production possibilities curve

(PPC) is a model that shows
alternative ways that an economy can
use its scarce resources
• This model graphically demonstrates
scarcity, trade-offs, opportunity
costs, and efficiency.
 Production “Possibilities” Table

A B C D E
Bikes 14 12 9 5 0
Computers 0 2 4 6 8

NOW GRAPH IT: Put bikes on y-axis and

computers on x-axis
 Production Possibilities
How does the PPC graphically demonstrates scarcity, trade-
offs, opportunity costs, and efficiency?

Impossible/Unattainable
A (given current resources)
14
B
12
G
10 C
Bikes

8
Efficient
6 D

4 Inefficient/
Unemployment
2
E
0
0 2 4 6 8 10
Computers
 Opportunity Cost

Example:
1. The opportunity cost of
moving from a to b is… 2 Bikes
2.The opportunity cost of
moving from b to d is… 7 Bikes

3.The opportunity cost of

moving from d to b is… 4 Computer

4.The opportunity cost of

moving from f to c is… 0 Computers
5.What can you say about point G?
Unattainable
 Production Possibilities
A B C D E
PIZZA 20 19 16 10 0
ROBOTS 0 1 2 3 4
• List the Opportunity Cost of moving from a-b,
b-c, c-d, and d-e.
• Law of Increasing Opportunity Cost-
• As you produce more of any good, the
opportunity cost (forgone production of
another good) will increase.
Why would this be?
• Result is a bowed out (Concave) PPC
 Production Possibilities

A B C D E
CALZONES 4 3 2 1 0
PIZZA 0 1 2 3 4
• List the Opportunity Cost of moving from a-b,
b-c, c-d, and d-e.
• Constant Opportunity Cost- Resources are
easily adaptable for producing either good.
• Straight line PPC (not common)
 Constant vs. Increasing Opportunity Cost

Identify which product would have a straight

line PPC and which would be bowed out?
Corn Cactus

Wheat Pineapples
 The Production
Possibilities Curve and
Efficiency
 Efficiency

Productive Efficiency-
• Products are being produced in the
least costly way.
• This is any point ON the Production
Possibilities Curve
Allocative Efficiency-
• The products being produced are the
ones most desired by society.
Where would this be on a PPC?
 Efficiency
Which points are productively efficient?
Which are allocatively efficient?

A
14
B G
12

10
Bikes

8
C
6 E

4
F
2
D
0
0 2 4 6 8 10
Computers
Why two types of efficiency?

Is combination “A” efficient?

Size 20 running
shoes

Size 10 running shoes

Shifting the Production
Possibilities Curve
 Production Possibilities

What if there is a change?

Three Shifters of the PPC
1. Change in resource quantity
2. Change in resource quality
2. Change in Technology
Production Possibilities

What happens if
there is an increase
in population?
Robots

Pizzas
22
Production Possibilities

What if there is a
technology improvement
in pizza ovens?
Robots

Pizzas
23
 Capital Goods and Future Growth
Countries that produce more capital goods will have
more growth in the future.
Panama – Favors Mexico – Favors
Consumer Goods Capital Goods
Current Future
PPC PPC
Capital Goods

Future

Capital Goods
PPC
Current
PPC

Consumer goods Consumer goods

Panama Mexico
 PPC Practice
Draw a PPC showing changes for each of
the following:
Pizza and Robots (3)
1. New robot making technology
2. Decrease in the demand for pizza
3. Mad cow disease kills 85% of cows
Consumer goods and Capital Goods (4)
4. Destruction of power plants leads to
severe electricity shortage
5. Faster computer hardware
6. Many workers unemployed
7. Significant increases in education
Question #1
New robot making technology
Q

A shift only for Robots

Robots

Q
Pizzas 26
Question #2
Decrease in the demand for pizza
Q
The curve doesn’t shift!
A change in demand
doesn’t shift the curve
Robots

Q
Pizzas 27
 Question #3
Mad cow disease kills 85% of cows
Q

A shift inward only for

Pizza
Robots

Q
Pizzas 28
Question #4
Destruction of power plants
Q
Decrease in resources
decrease production
Capital Goods

possibilities for both

Q
Consumer Goods
Question #5
Faster computer hardware
Q
Quality of a resource
improves shifting the
Capital Goods

curve outward

Q
Consumer Goods 30
Question #6
Many workers unemployed
Q
The curve doesn’t shift!
Unemployment is just a
Capital Goods

point inside the curve

Q
Consumer Goods 31
Question #7
Significant increases in education
Q
The quality of labor is
improved. Curve shifts
Capital Goods

outward.

Q
Consumer Goods
Scarcity Means There Is Not Enough For Everyone

Government must step in to help allocate

(distribute) resources
 Every society must answer three questions:

The Three Economic Questions

1. What goods and services should be
produced?
2. How should these goods and services be
produced?
3. Who consumes these goods and services?

The way these questions are answered

determines the economic system
An economic system is the method used by a
society to produce and distribute goods and
services.
Economic Systems

1. Centrally-Planned
(Command) Economy
2. Free Market Economy
3. Traditional Economy
4. Mixed Economy
Centrally-Planned
Economies
(aka Communism)
 Centrally Planned Economies
In a centrally planned economy (communism) the
government…
1. owns all the resources.
2. answers the three economic questions
Examples:
Cuba, North Korea, former Soviet Union, and
China

Why do centrally planned economies face

problems of poor-quality goods, shortages,
and unhappy citizens?
NO PROFIT MEANS NO INCENTIVE TO WORK
HARDER
 Irrational Soviet Production
Soviet companies were not guided by prices or profit. Gov’t
officials determined output quotas based on quantitative
measurements.
Businesses were paid based on meeting these quotas.
1. Why did a business make desk lamps that were filled with
lead that were almost too heavy to carry?
Production quota based on weight

2. Why did light bulb producers only make tiny night light
size bulbs?
Production quota based number of bulbs produced
3. Why did oil companies drill many shallow holes when
they knew that oil deposits are usually found in deep
holes that require slower drilling?

Production quota based number of feet drilled

38
 Irrational Soviet Production

4. Why did a construction superintendent order his workers

to remove bathtubs from the first floor and install them in
the third floor while he slowly lead inspectors through
apartment building.
Quota on # of apartments complete at inspection

5. Why did black market vendors sell burned out light

bulbs?

Business got resources before the public so workers would steal good
light bulbs from work and replace them with burnt out bulbs
 Advantages and Disadvantages

What is GOOD What is BAD about

about Communism? Communism?
1. Low unemployment- 1. No incentive to work harder
everyone has a job 2. No incentive to innovate or
2. Great Job Security-the come up with good ideas
government doesn’t go 3. No Competition keeps
out of business quality of goods poor.
3. Equal incomes means no 4. Corrupt leaders
extremely poor people 5. Few individual freedoms
4. Free Health Care
 Planned economies – Four resource types

No private ownership of resources. Commonly owned

(commonly  communist)

Land – Government decides what land is to be used for

Labour – Government decides what labour is worth (you

cannot sell your labour to the highest bidder)

Capital – Government controls what is to be used for

Entrepreneurship – does not exist in a planned economy

 Planned economy – Three economic questions

What, How and For Whom?

What to produce – Decided centrally

How to produce - Decided centrally

For whom to produce – Decided centrally

 Free Market System
(aka Capitalism)

44
 Characteristics of Free Market

1. Little government involvement in the economy.

(Laissez Faire = Let it be)
2. Individuals OWN resources and answer the
three economic questions.
3. The opportunity to make PROFIT gives people
INCENTIVE to produce quality items
efficiently.
4. Wide variety of goods available to consumers.
5. Competition and Self-Interest work together to
regulate the economy (keep prices down and
quality up).
 Example of Free Market

Example of how the free market regulates itself:

If consumers want computers and only one
company is making them…
Firms enter market

Competition

↓ prices, ↑ quality, ↑ variety

productive efficiency, allocative efficiency

 Example of Communism

Example of why communism failed:

If consumers want computers and only one
company is making them…
Firms can’t enter market

No competition

High prices, low quality limited variety

Rely on government action

Productive inefficiency, allocative inefficiency

 The Invisible Hand
The concept that society’s goals will be met as
individuals seek their own self-interest.
Example: Society wants fuel efficient cars…
How will this occur in the free market?

Competition and self-interest act as an invisible hand

(pictured below) that regulates the free market.
 Attacks against capitalism
1. Companies are greedy and do anything to screw over
consumers!
Companies have an incentive to satisfy the needs of
consumers. If they don’t they will go out of business.
2. Capitalism causes companies to outsource Australian jobs
overseas. Australia suffers because companies want more
profit!
How many of you benefit in the form of lower prices?
3. Capitalism only helps the rich. Large companies enslave
and exploit third-world workers in sweatshops!
Sweatshop workers are not forced labor. They make the
decision to work there voluntarily.
Why?
Sweatshops
Question: Who is to blame for
these people being so poor?
Answer: Low productivity.
If a country doesn’t produce very
much, it can’t afford to pay its
workers very much.
Why do these countries have
such low productivity?
Corrupt governments,
inadequate physical capital and
infrastructure, and
underdeveloped human capital.
What does foreign investment
bring to poor countries?
 Productivity Creates Wealth

3rd World Countries Developed Countries

 Link to the PPC

Communism in the Free Markets in the

Long Run Long Run

Capital Goods
CURRENT
Capital Goods

FUTURE
CURVE
CURVE
FUTURE
CURVE
CURRENT
CURVE

Consumer goods Consumer goods

Cuba Costa Rica

The difference between North and South Korea at
night. North Korea's GDP is $40 Billion
South Korea's GDP is $1.3 Trillion (32 times greater).
 Market economy – Four resource types

Private ownership of resources.

Land – Owners can sell to the highest bidder - rent

Labour – Owners can sell to the highest bidder - wages

Capital – Owners can sell to the highest bidder - interest

Entrepreneurship – organises land, labour and capital to

make profit. The profit incentive exists.
 Market economy – Three economic questions

What, How and For Whom?

What to produce Consumers

How to produce Producers

For whom to produce Market value of resources

 Traditional economy

Individuals produce goods and services for their

own use, not for exchange.
Neither the market nor the government decides
the ‘what’, ‘how’ and ‘for whom’ of production.

Examples:
 Mixed economies
The three previous systems are simplified
models. In reality, economies are a mixture.

e.g. Child seats are mandatory  

 The govt decides ‘what’ is produced

We always buy Easter eggs  

 Tradition decides ‘what’ is produced

Welfare payments are made to people with

disabilities  
  The government deciding ‘For whom’
 Economies in transition

Most economies are tending to the right

Socialism Capitalism
Privatisation
https://youtu.be/B43YEW2FvDs