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Economics: SL Revision Notes

SL IB Economics

Revision Notes

Home / IB / Economics / SL / Revision Notes / 1. Introduction To Economics / 1.1 What Is Economics? / 1.1.2 The Problem of Choice


1.1.2 The Problem of Choice


The Factors of Production

  • Factors of production are the resources used to produce goods and services
    • Land, labour, capital and enterprise

  • The production of any good/service requires the use of a combination of all four factors of production
    • Goods are physical objects that can be touched (tangible) e.g. mobile phone
    • Services are actions or activities that one person performs for another (intangible) e.g manicure, car wash
       

The Four Factors of Production


Land

Labour Capital Enterprise

Non man-made natural resources available for production. Some countries have a vast amount of a particular natural resource and so are able to specialise in its production e.g. oil


The human input into the production process. Labour involves mental or physical effort. Not all labour is of the same quality. It can be skilled or unskilled


Capital is any man-made resource that is used to produce goods/services e.g. tools, buildings, machines and computers


Enterprise involves taking risks in setting up or running a firm. An entrepreneur decides on the combination of the factors of production necessary to produce goods/services with the aim of generating profit

 

Some of the Factors of Production Required to Produce a Motor Car


Land

Labour Capital Enterprise


iron ore
rubber
oil
sand
cows


car designer
production director
production line staff
supply chain staff



robotic arms
conveyor belt
rolled steel
computers
seats


CEO

  • In a free market economic system, the factors of production are privately owned by households or firms
    • Households make these resources available to firms who use them to produce goods/services
    •  Firms purchase land, labour, and capital from households in factor markets
       
  • Households receive the following financial rewards for selling their factors of production. This reward is called factor income
    • The factor income for land → rent
    • The factor income for labour → wages
    • The factor income for capital → interest
    • The factor income for entrepreneurship → profit

The Basic Economic Problem: Scarcity

  • The basic economic problem is that resources are scarce
    • In economics, these resources are called the factors of production

  • There are finite resources available in relation to the infinite wants and needs that humans have
    • Needs are essential to human life e.g. shelter, food, clothing
    • Wants are non-essential desires e.g. better housing, a yacht etc.

  • Due to the problem of scarcity, choices have to be made by producers, consumers, workers and governments about the best (most efficient) use of these resources

  • Economics is the study of scarcity and its implications for resource allocation in society
     

All Stakeholders in an Economy face the Basic Economic Problem


Consumers

Producers Workers Government

  • In a free market, scarcity has a direct influence on prices
  • The scarcer a resource or product, the higher the price consumers will pay

  • Producers selling products made from scarce resources will find their costs of production are higher than if they were selling products made from more abundant resources

  • Workers may want a more comfortable and safer working environment but their employers may not have the resources to create it

  • Governments have to decide if they will provide certain goods/services or if they will allow private firms to provide them instead
  • Their decision influences the allocation of resources in society

Opportunity Cost Defined

  • Opportunity cost is the loss of the next best alternative when making a decision

  • Due to the problem of scarcity, choices have to be made about how to best allocate limited resources amongst competing wants and needs

  • There is an opportunity cost in the allocation of resources
    • E.g. When a consumer chooses to purchase a new phone, they may be unable to purchase new jeans. The jeans represent the loss of the next best alternative (the opportunity cost)

Opportunity Cost in Decision Making

  • An understanding of opportunity cost may change many decisions made by consumers, workers, firms and governments
  • Factoring the opportunity cost into a decision often results in different outcomes and so a different allocation of resources

Examples of how the Consideration of Opportunity Costs can Change Decisions


Stakeholder

Example

Consumer

  • Ashika is wanting to visit her best friend in Iceland
  • She looks at flight prices from London to Reykjavík
  • On Friday night it costs £120 whereas Thursday night is only £50
  • She is about to book the Thursday flight but then realises that the opportunity cost of saving £60 on a flight is the inability to work on Friday (loss of £130 income)
  • Ashika books the more expensive flight. If she had booked the cheaper flight, it would have cost her the income from the missed day of work (£130) + £50 for the ticket 

Worker

  • Ric has been offered two jobs and is deciding which one to accept
  • Job A offers £400 a month more in salary than Job B, but Job B offers the flexibility of working from home
  • Most people would only consider the actual cost of commuting before they make a decision, which in Ric's case is £40 a week or £160 a month
  • Ric values his free time and decides that each hour he can save in commuting is worth £20 to him (£180 a week), he is considering the opportunity cost of commuting
  • Ric decides to take Job B as the cost of monthly travel (4 x £40) and value of the lost hours spent commuting (4 x £180) adds up to £880 a month

Exam Tip

Opportunity cost is about the loss of the next best alternative. It is not a monetary amount. Money may well be a factor but opportunity cost is about the loss of the next best choice when making a decision.

Economic Goods & Free Goods

  • Economic goods are scarce in relation to the demand for them
    • This makes them valuable
    • Due to their value, producers will attempt to supply them in order to make a profit
    • Anything that has a price tag on it is an economic good e.g. oil, corn, gold, trainers, watches and bicycles

  • Free goods are abundant in supply
    • Due to this abundance, it is not possible to make a profit from supplying free goods
    • Drinking water has been a free good for thousands of years, but as the population increases and water sources become more polluted, it has become an economic good
    • E.g. sunlight, the air we breathe, sea water

Economic Systems

  • In order to solve the basic economic problem of scarcity, economic systems emerge or are created by different economic agents within the economy
    • These agents include consumers, producers, the government, and special interest groups (e.g. environmental pressure groups or trade unions)
    • Any economic system aims to allocate the scarce factors of production
       
  • The three main economic systems are a free market system, mixed economy, and planned economy

What determines the economic system of a country? 
  

2-2-1-different-economic-systems

How the three questions are answered determines the economic system of a country
 

  • Each economy has to answer three important economic questions
  1. What to produce? As resources are limited in supply, decisions carry an opportunity cost. Which goods/services should be produced e.g. better rail services or more public hospitals?

  2. How to produce it? Would it be better for the economy to have labour-intensive production so that more people are employed, or should goods/services be produced using machinery?

  3. Who to produce it for? Should goods/services only be made available to those who can afford them, or should they be freely available to all?

  
How These Questions are Answered Determines the Economic System


Type of System

What to Produce?  How to Produce? For Whom?

Market System


Demand and supply (the price mechanism)

Most efficient, profitable way possible.

Those who can afford it

Mixed System


Demand, supply and the Government

Some efficiency but also a focus on welfare/well-being

Those who can afford it, plus some provision to those who cannot afford it

Planned System


The Government

Ensure everyone has a job

Everyone


  • 1. Introduction To Economics
    • 1.1 What Is Economics?
      • 1.1.1 Economics as a Social Science
        • 1.1.2 The Problem of Choice
          • 1.1.3 The Production Possibilities Curve Model (PPC)
            • 1.1.4 Modelling the Economy
            • 1.2 How Do Economists Approach The World?
              • 1.2.1 Economic Methodology
                • 1.2.2 Economic Thought
              • 2. Microeconomics
                • 2.1 Demand
                  • 2.1.1 Demand, Price & Quantity
                    • 2.1.2 Non-Price Determinants of Demand
                    • 2.2 Supply
                      • 2.2.1 Supply, Price & Quantity
                        • 2.2.2 Non-Price Determinants of Supply
                        • 2.3 Competitive Market Equilibrium
                          • 2.3.1 Market Equilibrium & Disequilibrium
                            • 2.3.2 Functions of the Price Mechanism
                              • 2.3.3 Consumer & Producer Surplus
                              • 2.4 Price Elasticity of Demand (PED)
                                • 2.4.1 Definition, Calculation & Determinants of PED
                                  • 2.4.2 The Significance of PED
                                  • 2.5 Income Elasticity of Demand (YED)
                                    • 2.5.1 Definition, Calculation & Illustration of YED
                                    • 2.6 Price Elasticity of Supply (PES)
                                      • 2.6.1 Definition, Calculation & Determinants of PES
                                      • 2.7 Role of Government In Microeconomics
                                        • 2.7.1 Reasons For Government Intervention In Markets
                                          • 2.7.2 Government Intervention: Indirect Taxes & Subsidies
                                            • 2.7.3 Government Intervention: Price Controls, Direct Provision & Regulation
                                            • 2.8 Market Failure: Externalities & Common Pool (Access) Resources
                                              • 2.8.1 Market Failure
                                                • 2.8.2 Negative Externalities
                                                  • 2.8.3 Positive Externalities
                                                    • 2.8.4 Common Pool (Access) Resources
                                                      • 2.8.5 Government Intervention to Address the Market Failure
                                                        • 2.8.6 Other Interventions to Address the Market Failure
                                                        • 2.9 Market Failure: Public Goods
                                                          • 2.9.1 Public Goods
                                                        • 3. Macroeconomics
                                                          • 3.1 Measuring Economic Activity
                                                            • 3.1.1 National Income & The Circular Flow of Income
                                                              • 3.1.2 National Income Terminology & Calculations
                                                                • 3.1.3 The Business Cycle
                                                                  • 3.1.4 Appropriateness of Using GDP/GNI to Measure Well-being
                                                                    • 3.1.5 Alternative Measures of Well-Being
                                                                    • 3.2 Variations in Economic Activity (AD & AS)
                                                                      • 3.2.1 Aggregate Demand (AD)
                                                                        • 3.2.2 Short-Run Aggregate Supply (SRAS)
                                                                          • 3.2.3 Alternative Views of Aggregate Supply (AS)
                                                                            • 3.2.4 Shifts of the Long-Run Aggregate Supply (LRAS)
                                                                              • 3.2.5 Macroeconomic Equilibrium
                                                                              • 3.3 Macroeconomic Objectives
                                                                                • 3.3.1 An Introduction to Macroeconomic Objectives
                                                                                  • 3.3.2 Economic Growth
                                                                                    • 3.3.3 Low Unemployment
                                                                                      • 3.3.4 Low & Stable Rate of Inflation
                                                                                        • 3.3.5 Potential Conflicts Between Macroeconomic Objectives
                                                                                        • 3.4 Inequality & Poverty
                                                                                          • 3.4.1 Measuring Inequality & Poverty
                                                                                            • 3.4.2 Causes of Inequality & Poverty
                                                                                              • 3.4.3 Using Taxation to Reduce Inequality & Poverty
                                                                                                • 3.4.4 Other Policies to Reduce Inequality & Poverty
                                                                                                • 3.5 Demand Management: Monetary Policy
                                                                                                  • 3.5.1 An Overview of Monetary Policy
                                                                                                  • 3.6 Demand Management: Fiscal Policy
                                                                                                    • 3.6.1 An Overview of Fiscal Policy
                                                                                                    • 3.7 Supply-Side Policies
                                                                                                      • 3.7.1 An Overview of Supply-Side Policies
                                                                                                        • 3.7.2 The Effectiveness of Supply-Side Policies
                                                                                                      • 4. The Global Economy
                                                                                                        • 4.1 Benefits of International Trade
                                                                                                          • 4.1.1 The Advantages of Free Trade
                                                                                                          • 4.2 Types of Trade Protection
                                                                                                            • 4.2.1 Tariffs
                                                                                                              • 4.2.2 Quotas
                                                                                                                • 4.2.3 Export Subsidies
                                                                                                                  • 4.2.4 Administrative Barriers
                                                                                                                  • 4.3 Arguments For & Against Trade Protection
                                                                                                                    • 4.3.1 Arguments For & Against Trade Protection
                                                                                                                    • 4.4 Economic Integration
                                                                                                                      • 4.4.1 Understanding Economic Integration
                                                                                                                        • 4.4.2 Types of Trading Blocs
                                                                                                                          • 4.4.3 The World Trade Organisation (WTO)
                                                                                                                          • 4.5 Exchange Rates
                                                                                                                            • 4.5.1 Types of Exchange Rate Systems
                                                                                                                              • 4.5.2 Causes & Consequences of Exchange Rate Fluctuations
                                                                                                                              • 4.6 Balance of Payments
                                                                                                                                • 4.6.1 Components of the Balance of Payments
                                                                                                                                • 4.7 Sustainable Development
                                                                                                                                  • 4.7.1 The Sustainable Development Goals
                                                                                                                                  • 4.8 Measuring Economic Development
                                                                                                                                    • 4.8.1 Single Indicators of Development
                                                                                                                                      • 4.8.2 Composite Indicators of Development
                                                                                                                                        • 4.8.3 Evaluating the Different Approaches
                                                                                                                                        • 4.9 Barriers to Economic Growth & Development
                                                                                                                                          • 4.9.1 Poverty Traps
                                                                                                                                            • 4.9.2 Economic, Political & Social Barriers
                                                                                                                                            • 4.10 Economic Growth & Development Strategies
                                                                                                                                              • 4.10.1 Trade Strategies, Diversification & Social Enterprise
                                                                                                                                                • 4.10.2 Market-Based & Interventionist Policies
                                                                                                                                                  • 4.10.3 Merit Goods & Inward Foreign Direct Investment
                                                                                                                                                    • 4.10.4 Foreign Aid & Development Assistance
                                                                                                                                                      • 4.10.5 Institutional Change
                                                                                                                                                        • 4.10.6 Evaluating Market Orientated Approaches Versus Government Intervention
                                                                                                                                                          • 4.10.7 Progress Towards Sustainable Development Goals

                                                                                                                                                        Author: Steve



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