What is economics? IB Economics 1.1 notes

Scarcity: the basic economic problem

Economics exists because of scarcity. Human wants are effectively unlimited, but the resources available to satisfy them are finite, so no society can produce everything everyone wants. That gap between limited means and unlimited wants is the basic economic problem, and it applies to a subsistence farmer, a multinational firm and the Norwegian government alike.

Because resources are scarce, they have to be allocated. Every economic system, whether a free market, a command economy or a mix of the two, is really a mechanism for deciding what gets produced and who gets it. Scarcity is also the first of the nine key concepts, so examiners expect you to connect almost any topic back to it.

The three basic economic questions

Scarcity forces every economy to answer three questions. What to produce: given finite resources, should a country build hospitals or motorways, wheat or steel? How to produce: labour-intensive methods with many workers, or capital-intensive methods with machines? For whom to produce: how is the output shared out, and on what basis, income, need, or effort?

In a market economy these questions are answered mainly by the price mechanism and the profit motive. In a planned economy the government decides. In practice every real economy is mixed, so the interesting question is usually where the line between market and government should sit, which is why the key concept of intervention runs through the whole course.

Factors of production

The resources used to produce goods and services are grouped into four factors of production. Land is all natural resources, including minerals, forests and fish stocks. Labour is human effort, both physical and mental. Capital is manufactured goods used to make other goods, such as machines, tools and factories. Enterprise is the entrepreneur who combines the other three factors and takes the risk of production.

Each factor earns a reward: land earns rent, labour earns wages, capital earns interest, and enterprise earns profit. When an economy acquires more or better factors, for example through investment or education, it can produce more, which is exactly what an outward shift of the production possibilities curve shows.

Opportunity cost and choice

Because resources are scarce, choosing one thing means giving up another. Opportunity cost is the value of the next best alternative forgone. It is not the money price; it is what you sacrifice. If a government spends a fixed budget on a new hospital, the opportunity cost might be the school it could have built instead.

Opportunity cost applies to time and to whole economies, not just money. An hour spent studying economics is an hour not spent on maths. A country that devotes more resources to armaments has fewer left for consumer goods, the classic guns versus butter trade-off. Thinking in terms of opportunity cost is the core habit that separates economic reasoning from everyday reasoning.

The PPC: your first model

The production possibilities curve (PPC), also called the production possibilities frontier, shows the maximum combinations of two goods an economy can produce when all its resources are fully and efficiently employed. It is your first economic model and it makes scarcity, choice, opportunity cost and efficiency visible in one diagram.

Worked example: suppose an economy produces only wheat and steel, and to keep the arithmetic clean take a straight-line frontier. On that frontier it can make 100 units of wheat and 0 steel, or 0 wheat and 50 steel. Moving from 100 wheat and 0 steel to 80 wheat and 10 steel means giving up 20 wheat to gain 10 steel, so the opportunity cost of one unit of steel is a constant two units of wheat. A point at 60 wheat and 10 steel lies inside the curve, because at 10 steel the frontier allows 80 wheat, so producing only 60 signals unemployed or inefficiently used resources. A point at 100 wheat and 30 steel lies outside the curve and is unattainable until the economy grows.

A real PPC is usually bowed outward (concave to the origin) because resources are not equally suited to both goods, so opportunity cost rises as you specialise: this is the law of increasing opportunity cost. The straight-line frontier in the worked example is the special case of constant opportunity cost, which is why its numbers stay at two wheat per steel throughout. If a new fertiliser raises wheat yields, or the workforce grows, the whole curve shifts outward, which represents economic growth.

Positive versus normative economics

A positive statement is a claim about what is, and it can in principle be tested against evidence. For example, a 10 percent rise in the minimum wage will reduce teenage employment. A normative statement is a claim about what ought to be, and it rests on a value judgement that cannot be settled by data alone. For example, the government should raise the minimum wage.

The distinction matters because economists agree far more about positive questions than normative ones. In an exam, part (a) and (b) answers are largely positive analysis, while the evaluation you add in longer answers often involves normative judgement. Signalling which is which, and not smuggling a should into a supposedly factual claim, is a mark of a careful answer.

Common Paper mistakes

Confusing a movement along the PPC with a shift of it. A move along the curve is a reallocation between the two goods, so more of one means less of the other. A shift of the whole curve is a change in the economy's productive capacity, caused by more or better factors of production or new technology.

Defining opportunity cost as the money cost. It is the next best alternative forgone, not the price paid. Also avoid treating a point inside the PPC as impossible: it is attainable but inefficient, which is a common way to illustrate unemployment or a recession.

How this is examined

• This topic anchors Paper 1 part (a) definitions and diagrams: a labelled, correctly shaped PPC with a clearly marked opportunity cost earns the diagram marks even before your explanation.
• When the question mentions unemployment or a recession, show it as a point inside the PPC; when it mentions growth, shift the whole curve outward. Mixing these up loses easy marks.
• Examiners reward answers that name the key concept explicitly. Tie your PPC analysis back to scarcity, choice and opportunity cost by name.
• If asked to distinguish positive from normative, give one testable statement and one value judgement rather than only defining the terms abstractly.

Key terms

scarcityopportunity costproduction possibilities curvefactors of productionallocative efficiencyproductive efficiency