📄 IB Economics HL Unit 1 - Introduction to Economics revision guide

Economics as a Social Science

Economics is a social science because it studies human behaviour in relation to the economy. It uses empirical evidence and models to understand choices made under conditions of scarcity.

• Microeconomics — decisions of consumers, producers, individual markets
• Macroeconomics — national-level output, employment, inflation, growth

Factors of Production

Resources used to produce goods and services. There are four:

Scarcity

The fundamental economic problem: unlimited human wants vs limited (scarce) resources. Scarcity means society cannot produce everything everyone desires — choices must be made.

• Free goods — not scarce; no opportunity cost (e.g. sunlight, air in most contexts)
• Economic goods — scarce; have an opportunity cost
• Scarcity applies to time, money, and resources
• Link to sustainability: unsustainable resource use worsens future scarcity

Opportunity Cost

Definition: The value of the next best alternative foregone when a choice is made.

• Applies to individuals, firms, and governments
• Example: A government spending $10bn on defence forgoes $10bn of healthcare
• Opportunity cost is the cost of choice — illustrated on the PPC
• Always express opportunity cost in terms of the next best alternative, not money

The Three Basic Economic Questions

PPC and Sustainability

A common PPC diagram sets consumer goods vs capital goods on the axes. An economy that produces more capital goods today can grow faster in the future (outward shift) — but sacrifices current consumption. Sustainability considerations ask: does growth today deplete resources that future generations need?

Evaluation points for economic systems

• No pure free market or pure planned economy exists in practice
• The appropriate level of government intervention is a normative question
• China is often cited as transitioning — increasingly market-oriented with significant state control
• The 2008 financial crisis prompted debate about the appropriate role of government vs markets

Equilibrium condition

National income is in equilibrium when total leakages = total injections: S + T + M = I + G + X. If injections > leakages, national income rises; if leakages > injections, national income falls.

Five key decision-makers in the model

• Households — supply factors of production, receive factor payments, consume goods/services
• Firms — hire factors of production, produce goods/services, pay factor incomes
• Government — collects taxes (leakage), provides public spending (injection)
• Banks & financial sector — channel savings (leakage) into investment (injection)
• Foreign sector — imports (leakage) and exports (injection)

Positive vs Normative Economics very commonly tested

Exam tip: Normative statements almost always contain "should", "ought", "better", "worse", or "fair". Policy recommendations are always normative.

Tools of Positive Economics

• Logic — building coherent arguments from premises
• Hypotheses — testable predictions (e.g. "if price rises, demand falls")
• Models & theories — simplified representations of reality. All models make assumptions.
• Ceteris paribus — "all other things being equal"; isolates the effect of one variable by holding others constant
• Empirical evidence — real-world data and observations used to test hypotheses
• Refutation — rejecting a hypothesis if it does not match empirical evidence; ensures only valid theories persist

Equity vs Equality key concept

History of Economic Thought

• 18th century — Adam Smith: "The Wealth of Nations" (1776). Laissez-faire economics; the "invisible hand" — markets self-regulate through price mechanism; division of labour increases efficiency; free trade benefits nations.
• 19th century — Karl Marx: critiqued capitalism; argued labour is the source of all value; predicted class conflict and eventual socialism.
• 19th–20th century — Alfred Marshall: formalised supply and demand; microeconomic foundations of neoclassical economics.
• 20th century — John Maynard Keynes: Keynesian revolution after Great Depression. Markets do not always self-correct; government should use fiscal policy (spending/taxation) to manage aggregate demand. Macroeconomic policy justified.
• 20th century — Monetarists / New Classical: counter-revolution led by Milton Friedman. Markets do self-correct in the long run; government intervention causes inflation; focus on money supply control.
• 21st century — Behavioural economics: incorporates psychology; challenges assumption of rational, self-interested agents (homo economicus). Key concepts: bounded rationality, heuristics, nudge theory.
• 21st century — Circular economy & sustainability: growing awareness of interdependence between economy, society, and environment; moving away from linear "take-make-dispose" models.

Behavioural Economics HL extended

Traditional economics assumes rational agents who maximise utility. Behavioural economics challenges this:

• Bounded rationality — people have limited information, cognitive ability, and time; decisions are "good enough", not perfectly optimal
• Heuristics — mental shortcuts that can lead to systematic biases
• Nudge theory — small changes in the choice environment ("choice architecture") can predictably alter behaviour without restricting freedom (Thaler & Sunstein)
• Loss aversion — people feel losses more strongly than equivalent gains (Kahneman & Tversky)
• Behavioural insights inform government policy: organ donation opt-out systems, pension auto-enrolment, sugar tax communication