Economics Magic Notes! Explain These Essential Theories Economics SL Topic 1.1

Table of Contents

Explain the econ concept of economic well-being. 

  • Quality of life and prosperity of population.
  • Includes: past-present-future financial security, able to meet basic needs, able to make economic choices, achieve personal satisfaction, ability to sustain reasonable income levels.

Explain the form of PPC with increasing OC. 

  • PPC with increasing OC is curve.
    • As some factors more efficient producing on good over the other.
    • More common as OC not normally constant due to factor immobility (not all factors equally well suited to production of both goods, so cannot be transferred proportionally from production of one good to the other).
    • For each additional unit of good produced, OC of other good increases, thus the shape.

Use PPC to illustrate and explain efficiency.

A point on the PPC is the point at which a country cannot increase the production of one good without decreasing the production of another good (shows actual output).

This is by definition a situation of economic efficiency and recognises the fact that the resources of any country are finite and scarce.

Understand (explain) the social nature of economics.

  • Lot in common with other social sciences (soc, psy, his, anthro).
  • ‘Social’ as it deals with human society, interdependence, behaviour.
  • ‘Science’ as it uses scientific method to explain economic events and predict outcomes of the future (make conclusions and knowledge by obervation, analysis, data testing).
  • Propose hypothesis of how variables relate to each other, observe data groups to find patterns, compare prediction of hypothesis with real-world outcome, to see if can make generalised conclusion.
  • Deals with a lot of subjectivity, so critical thinking and development of evaluation skills is important.

What are the assumptions made in a two sector economic model of a closed economy?

  • Households own all the factors of production.
  • Firms produce all goods and services.
  • There is no government.
  • There are no other countries to trade with (it is a closed economy).
  • There are no banks or commercial institutions.

Explain the implications of a five-sector economic model of an open economy.

Some income will leave economy, reducing the circulating flow, some income will enter and increase the circular flow (explain Injections and Leakages).

Explain the concept of leakages. 

  • Found in five-sector model.
  • D: The flows of money that leave the economy: savings, taxation and imports.
  • Part of household income that is not spent on domestic g/s.

Explain the relationship between leakages and injections.

  • Economy in equilibrium and will not grow if leakages = injections.
  • If L > I = more money flows out than in, so national income fall and less income circulate economy and it will shrink.
  • If I > L = more money flow in that out, so national income rise and economy grows.
  • Give ex.
  • Extent to which L is greater than I determine if economy grows or not.

Explain what is meant by the econ concept of equity.

  • Being fair and just.
  • Different from equality (equal to others with respect to something).
  • Normative concept.
  • Everyone has the same oppotunities.
  • Inequity and inequality mean same thing when applied to: income, wealth, human opportunities.
  • Extent of GOVT intervention to increase equity is debatable.

Describe and give examples of the factors of production: land, labour, capital and entrepreneurship.

  • Land refers to natural resources that can be extracted from the earn. Ex: minerals, oil reserves, natural gas, forests, rivers and lakes.
  • Whereas, labour refers to physical and mental effort that people contribute to the production of goods and services. Ex: construction worker, a teacher, and a carpenter.
  • Whereas, capital refers to physical capital stock used to produce goods and services. It includes all manufactured (human-made) resources. Physical capital is also referred to as capital goods or investment goods. Ex: machines, factories, roads and tools.
  • Whereas, entrepreneurship refers to the ability to develop new businesses by organising the other three factors of production – land, labour and capital – to produce goods and services, and taking the risks of success or failure of the business, as profit is not guaranteed and investment may be lost. 

Use PPC to illustrate and explain actual growth.

If the point moves closer to the PPC, this shows that the country has achieved actual growth, meaning they can produce greater amount of good and services in one period of time than in a previous one.

What causes the increase in the potential output of a country?

  • An increase in the quantity of factors of production
  • An increase in the quality of factors of production
  • An improvement in technology

Use a five sector model of open economy to explain economic concepts and relationships between economic agents. 

  • 5 sectors: households, firms, GOVT, financial institutions, foreign countries.
  • Firms sell products to other economic agents and households have different uses of income.
  • Households still receive income in exchange for FOP and buy domestically produced goods.
  • But now they can buy imported goods, pay taxes to GOVT, save part of income in financial institution for future consumption. (leakages).
  • Firms have more potential buyers like GOVT, export to foreign countries, not just domestic households. (injections).
  • Explain GOVT provided g/s, bank loans, export & imports.

Explain the assumptions made in a five-sector economic model of an open economy. 

  • Households own the factors of production.
  • Firms produce goods and services.
  • Government collects taxes to provide public and merit goods to society.
  • There are foreign countries, that both produce goods and services that they export to other countries, and consume goods and services that they import from other countries.
  • There are financial institutions where households can save their income, and from which firms can take out loans to make investments and grow their businesses.

Explain the concept of injections.

  • Found in five-sector model.
  • D: The flows of money that come into the circular flow of income from outside: investment, government spending and exports.
  • All the money received by domestic firms that does not come directly from domestic households.

Explain the econ concept of intervention.

  • Government intervening with market freedom with policies, regulations, taxes, subsidies.
  • Produce different market outcomes.
  • Market considered most efficient mechanism to organise economic activity but produce less optimal outcome for equity, sustainability or economic wellbeing.
  • So, GOVT intervention is a solution.
  • The extent of this is a big debate between policymakers and economist.

Explain the problem of scarcity and choice. 

  • When the available resources or factors of production are finite, while human wants and needs are infinite. There are not enough resources to produce everything that is necessary to satisfy human beings’ needs and wants.
  • As people cannot have everything they need and want, they must make choices.

Use PPC to illustrate and explain opportunity cost and choice.

  • Define opportunity cost.
  • PPC helps to explain OC concept as when country wants to increase production of one good, need to reduce production of another as resources ares scarce and it is producing them in the most efficient ways since standing on its PPC.
  • Every choice has an OC which can be illustrated on the PPC, give example.

Explain what is meant by the econ concept of efficiency. 

  • Making best possible use of resources.
  • From society POV, economics efficiency also known as allocative efficiency.
  • Allocative efficiency = using scarce resources to produce combination of goods and services that most optimal for society, thus less wasting resources.

Explain the econ concept of change.

  • Economy is in permanent state of change so economist must be aware of it when analysing situations.
  • Economic theory looks at how variables that change more than specific values suggest when investigating an issue.
  • So, economist calculate, compare rates of change of many variable all the time.

Explain the concept of opportunity cost and its relationship with scarcity and choice.

  • Opportunity cost refers to the second best alternative. The opportunity cost of the government paying a subsidy to a profit-making firm is all the other uses for that money, such as health care or education.
  • It is related to scarcity and choice since scarcity forces society to make a choice between available alternatives and each decision has an OC.

Explain the basic economic questions: what to produce?, how to produce? and for whom to produce? 

  • What to produce? Choice of which goods and services are going to be produced with the scarce resources that are available.
  • How to produce? Choosing the combination of resources and production methods that will be used to produce each of the chosen goods and services.
  • For whom to produce? Deciding the distribution of the goods and services that the society is going to produce. Because of scarcity, not everyone’s wants can be satisfied. 

Use PPC to illustrate and explain potential growth.

If a change in the economy caused an increase in the maximum amount of goods that can be produced, known as the potential output, the PPC would shift outwards. This is known as potential growth.

Explain the form of PPC with constant OC.

  • PPC with constant OC is straight line.
    • As sometimes all FOP equally efficient at producing each good.
    • FOP can produce both goods indistinctly as they are well suited for both goods (maybe similar goods ‒> both need similar specialised FOP to produce them).
    • Can be transferred proportionally from production of one good to the other.

Explain what is meant by the econ concept of scarcity. 

  • Starting point of economics.
  • Refers that world has finite resources to be used to produce goods and services to satisfy unlimited needs and wants of society.
  • So, economics is study of how to allocate these scarce resources to fulfil the infinite human material needs and wants.

Explain what is meant by the econ concept of choice.

  • Due to scarce resources, there is finite goods and services, so society must choose, as not all needs and wants can be satisfied.
  • Choice implies OC, leave something behind when deciding between alternative options.
  • Economics studies present, future consequences produced by these choices.

Explain the econ concept of sustainability.

  • Ability to present generations to meet needs without preventing future generations from meeting theirs.
  • Prevent harmful effects of economic activities on environment.
  • Societies should pursue product of goods/services without depleting natural resources, so that there is enough for future generations.

Explain the econ concept of interdependence.

  • Economy composed of interdependent economic agents to achieve their economic goals.
  • High interdependent economic world.
  • Decisions and actions of one actor cause consequences for another.
  • Important to evaluate possible effect of this interdependence during analysis. 

Give examples of, and distinguish between, goods and services, needs and wants, economic goods and free goods.

  • Goods are physical objects (tangible things) like cars, bread or mobile phones.
  • Whereas, Services are intangible, such as haircuts, gardening services or motorcycle repairs.
  • Whereas, needs things that people must have for survival such as food, shelter and clothing.
  • Whereas, wants are goods and services that people would like to have but are not necessary for survival, such as TVs, computers and cars.

Use PPC to illustrate and explain unemployment of resources. 

At any point inside the PPC, not all the factors of production in the economy are being used or they are being used inefficiently.

The greater the UOS, the further point is from the PPC.

An economy producing goods at this point has the potential to increase production of both goods, and it is possible for them to move towards the PPC.

Use a two sector model of closed economy to explain economic concepts and relationships between economic agents.

  • Households are owners and providers of all FOP and offer them to firms in exchange for income in different ways (L-rent, La-wages, C-interest, Entre-dividends).
  • Firms organise FOP to produce g/s which is then consumed by households.
  • Household income = wages + rents + interest + dividends.
  • Income use to buy g/s that they need and want.
  • Define consumer expenditure.
  • Shows interdependence between households and firms.

What are the implications of a two sector economic model of a closed economy?

  • Since no foreign countries, everything consumed is produced by domestic firms.
  • So, all consumer expenditure goes back into firms in exchange for g/s that they supply.
  • Since no other income use and it cannot be saved in banks for future consumption, household spend everything they earn.
  • National income doesn’t change overtime.
  • Value of g/s produced same from period to another, so national output doesn’t change.
  • So no economic growth.
  • Since consumer spend all their income, national expenditure = total income.
  • NATIONAL INCOME = NATIONAL OUTPUT = NATIONAL EXPENDITURE.

Explain the interdependence between decision-makers interacting and making choices in an economy: households, firms, government, financial institutions and foreign countries.

  • GOVT collects taxes from households and firms. Spent to provide public & merit g/s like education, healthcare, infrastructure, law & order.
  • Money leaves circular flow when households pay taxes and enters when GOVT funds and provide those g/s from domestic firms.
  • Financial institutions like banks, stock markets and pension funds receive households and firms savings. Savings leave flow of income but re-enter economy when financial institutions give loans to firms to buy capital goods (investment is capital investment).
  • Foreign sector = foreign countries that sell g/s to domestic household and firms and that also buy domestic products. When we buy imports, money flow out of economy. When we sell exports, money flows in which increases the circulating income. 

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