Educerie · IB Diploma · Economics
Unit 1 Introduction to economics · 1.1 What is economics?
What you must be able to do
| You must be able to | Level | What it looks like in the exam |
|---|---|---|
| Explain why economics is a social science, and tell microeconomics from macroeconomics | SL, HL | A definition, or the opening lines of a longer answer |
| Name the nine key concepts and use the right one in an answer | SL, HL | Where the evaluation marks in Paper 1 part (b) and in Paper 2 are earned |
| Name the four factors of production, with an example of each | SL, HL | "Define…", 2 marks, and inside most longer answers |
| Explain scarcity as unlimited wants met by limited resources, and link scarcity to sustainability | SL, HL | "Explain why scarcity is the central problem of economics" |
| Define opportunity cost, apply it to a decision, and say what a free good is | SL, HL | 2 marks for the definition, more for using it on a real choice |
| State the three basic economic questions, and compare how free market, planned and mixed economies answer them | SL, HL | Paper 1 part (b), "evaluate", 15 marks |
| Draw a PPC and use it to show choice, opportunity cost, scarcity, unemployment of resources, efficiency, actual growth and growth in production possibilities | SL, HL | Paper 1 part (a) diagram, AO4. Every label carries marks |
| Draw a PPC with increasing opportunity cost and one with constant opportunity cost, and explain the difference | SL, HL | AO4, usually beside an explanation of the factors of production |
| Draw the circular flow of income with leakages and injections, and explain the interdependence of the five decision-makers | SL, HL | AO4, and Paper 2, where an extract describes one of the six flows |
Before you start
Nothing. This is the first subtopic of the course and it assumes no economics at all. What it does assume is that you take its vocabulary seriously, because every later unit is written in it: a Unit 3 question about unemployment is a question about idle factors of production, and a Unit 4 question about trade is a question about opportunity cost.
1The idea in one paragraph
There is not enough of anything to satisfy everyone who wants it. That single fact is where economics starts. Because there is not enough, every society has to decide what to make, how to make it and who gets it, and every one of those decisions means giving something else up. Economics is the study of how people, firms and governments make those decisions, and of whether the decisions leave people better or worse off.
2The economic problem
Human wants have no limit. Ask anyone what they would do with twice their income and they will have an answer. Resources are finite: only so much land, so many hours of work, so many machines, so many people with the nerve to start a business.
Put those two facts together and you get scarcity: unlimited wants and needs, and only limited resources with which to meet them. Scarcity is not poverty. A rich country has more resources than a poor one, but it also has larger wants, and it still cannot have everything at once.
Scarcity forces choice, because resources put into one use cannot go into another. And once you have chosen, what you turned down is gone, which gives the third link: opportunity cost. Figure 1 is the whole of economics in four boxes.
3Economics as a social science
Economics is a social science: it uses evidence, logic and models like a science, but what it studies is people.
People are not particles. They have habits, values and expectations, and they change their behaviour when they are taxed, watched, or told what an economist has predicted. You cannot run an economy twice under the same conditions to check an explanation. So an economist's conclusions always come with conditions attached: true given these assumptions, on this evidence, for these people, at this time.
The subject splits in two, and both halves are on your course.
- Microeconomics looks at the parts: one consumer, one firm, one market, one industry. Why is bread the price it is? Should sugary drinks be taxed? Unit 2 is micro.
- Macroeconomics looks at the whole: total output, total employment, the general price level, growth across a country. Why are prices rising everywhere at once? Unit 3 is macro.
That is a division of labour, not two subjects. Both use the same nine concepts and both begin with scarcity.
4The nine key concepts
The guide names nine concepts and expects you to think with them rather than recite them. Figure 2 is worth copying onto one page and keeping.
Two are worth pinning down now, because students mix them up all year. Efficiency is getting the most output from the resources available, with none wasted. Equity is fairness in how the output is shared. They are separate questions: a market can produce exactly what buyers are willing to pay for, and be efficient, while half the population can afford none of it.
Sustainability needs the same care. It means meeting the needs of today without leaving future generations unable to meet theirs. It is scarcity looked at across time rather than across people.
5Scarcity, and what we are actually short of
The resources that are scarce have a collective name: the factors of production. There are four, and an answer that names all four with an example each is answering the question the way the guide wrote it.
| Factor | What it is | An example | What it earns |
|---|---|---|---|
| Land | everything supplied by nature | the sea a fishing fleet works, farmland, iron ore | rent |
| Labour | human effort, physical and mental | the boatbuilders, the accountant, the nurse | wages |
| Capital | goods made in order to make other goods | the boatyard's tools, a delivery van, a factory | interest |
| Entrepreneurship | organising the other three and carrying the risk of loss | the person who starts the boatyard and signs the leases | profit |
Two traps sit in that table. Capital here means equipment, not money: the cash in a firm's account is finance, not a factor of production. And land covers all natural resources, not just the ground.
Scarcity and sustainability. Some factors renew and some do not. A forest felled faster than it regrows, a fishery netted faster than it breeds, an oil field with only so much in it: each shrinks the resource base the next generation inherits. Using more today carries a cost no receipt shows, and it is paid by people who are not yet in the market. That is why sustainability sits beside scarcity in the guide rather than in a box of its own.
6Opportunity cost, and the goods that do not have one
Opportunity cost is the value of the next best alternative given up when a choice is made. Three words in that sentence do the work.
Value, because we are counting what the thing was worth to the chooser, not objects. Next best, because you count the single best option you turned down. Given up, because if you can still have it, you have not paid it.
A concrete case. You have three free hours on Saturday: revise economics, work a shift for 45, or sleep. You revise. If the shift was the better of the two you rejected, the opportunity cost of revising is the 45 you did not earn. It is not "45 plus the sleep". Adding the rejected options together is the most common way this is got wrong.
Opportunity cost is the value of the next best alternative given up, and never the sum of all the alternatives.
Opportunity cost is not the same as money spent. A hospital given a building for nothing still bears its opportunity cost, because the building could have been a school; and an afternoon, which has no price at all, still has one.
Free goods. A free good is a good that is not scarce: it exists in such abundance that consuming it costs nobody anything forgone, so it has no opportunity cost and commands no price. Air to breathe is the standard case. Everything else is an economic good: scarce, therefore carrying an opportunity cost, therefore priced.
"Free" in ordinary speech means something else, and the exam plays on it. Free delivery, a free school meal and free healthcare are not free goods; resources were used and somebody else paid. The test is simple. If your using more of it leaves anyone with less of anything, it is not a free good.
7The production possibilities curve
The production possibilities curve (PPC) models an economy that makes only two goods. It shows every combination of the two the economy could produce with all its resources fully and efficiently employed, and it carries most of this subtopic.
Like every model it holds some things still. Learn its assumptions as a list, because a question can ask for them.
- The economy produces only two goods, or two categories of goods.
- The quantity and quality of the factors of production are fixed.
- The state of technology is fixed.
- On the curve itself, all resources are fully employed and used efficiently.
- The picture refers to one fixed period, usually a year.
Our economy is the island of Kavala, which produces olive oil and fishing boats. Worked flat out, its resources could produce any of these combinations in a year.
| Fishing boats built | Olive oil, thousand litres |
|---|---|
| 0 | 100 |
| 10 | 98 |
| 20 | 92 |
| 30 | 80 |
| 40 | 60 |
| 50 | 0 |
Plot them and join them, and you have Kavala's PPC. Figure 3 marks two combinations and the move between them.
Every point on the curve is a choice. Moving from A to B gets Kavala 20 more boats, and the price of them is the 32 thousand litres of oil no longer made: that sacrifice is the opportunity cost of the boats, and it is what the downward slope means. Any point beyond the curve shows scarcity, because the resources to reach it do not exist. Figure 4 sorts the three regions out.
- On the curve, like C: the economy is efficient. Everything is employed, and there is no way to get more of one good without less of the other.
- Inside the curve, like U: there is unemployment of resources. Boatyards stand empty and groves go unpicked. The economy could have more of both goods and is choosing neither.
- Outside the curve, like Z: unattainable, with today's resources and today's technology.
Point U also explains why an economy can grow in two quite different ways, and the exam tests the difference constantly. Figure 5 puts them side by side.
Actual growth is an increase in output that comes from employing resources that were idle. On the diagram it is a move from a point inside the curve towards or onto it. The curve stays where it is, because nothing has changed about what the economy is capable of; it has stopped wasting what it has.
Growth in production possibilities is an increase in what the economy is capable of, caused by more resources or better ones: more workers, more machines, better training, better technology. The whole curve shifts outward, and points that were unattainable become attainable.
The sentence that earns the mark names the cause as well as the picture. "Kavala trains its boatbuilders, so the quality of its labour rises and the PPC shifts outward from PPC₁ to PPC₂" is worth more than "the curve moves right".
8Increasing versus constant opportunity cost
Look again at Kavala's numbers. The first ten boats cost 2 thousand litres of oil, the next ten cost 6, the next ten cost 12. Each extra batch costs more oil than the batch before, and that is increasing opportunity cost. It is why the curve is drawn bowed outwards, or concave to the origin.
The reason is in section 5: factors of production are not equally suited to every job. Kavala moves its worst olive growers into the boatyards first and loses little oil for the boats it gains. To keep building it must move its best growers, who are poor boatbuilders, and the oil given up per boat climbs.
Sometimes that does not happen. Picture a workshop printing plain t-shirts, 400 a day in any mix of black and white. Every machine and worker is equally good at both, so a hundred more black shirts always costs exactly a hundred white. That is constant opportunity cost, and it draws a straight-line PPC.
In the exam, draw the bowed-out curve unless the question tells you opportunity cost is constant or gives numbers that say so. The shape is an argument, not decoration: bowed out says resources are specialised, straight says they are interchangeable.
9The three basic questions, and who answers them
Scarcity leaves every society with the same three questions, whatever its politics.
- What to produce, and how much of it? Boats or oil, hospitals or motorways.
- How to produce it? By hand or by machine, in large firms or small, cleanly or cheaply.
- For whom to produce? Who gets the output, and on what basis.
There are two mechanisms for answering them, and the argument between them runs through the whole course. One is the market, where prices and the pursuit of profit direct resources with nobody deciding on behalf of everyone. The other is government intervention, where the state directs resources itself, or changes the rules and prices so that markets direct them differently. Naming which mechanism a policy uses earns marks in Paper 1 part (b).
Those two give the three economic systems in Figure 7.
A free market economy leaves all three questions to prices, profit and private ownership. A planned economy leaves them to the government, which owns the resources and sets output by plan. A mixed economy does both, and every real economy is one; countries differ in how much their government intervenes and where.
Evaluation runs along the concepts. Markets are quick and tend towards efficiency, because prices carry information no planner could collect, but they answer "for whom" by ability to pay and can serve equity badly. Planning can pursue equity directly and can protect sustainability from short-term profit, but it has to guess what people want and gives producers little reason to control costs. Neither side is a settled winner, which is why the exam asks you to weigh them.
10The circular flow of income
The last model here shows how the decision-makers depend on one another. Start with two of them. Households own the factors of production and sell their services to firms. Firms hire those factors, produce goods and services, and sell them back to households. Money goes one way, goods and factor services the other, and the whole thing closes into a loop.
Read Figure 8 in each direction and the point appears: one side's spending is the other side's income. That is interdependence, and it is why a decision taken by one group is never contained within it.
Two sectors are not an economy, though. The guide names five decision-makers, and the other three each open a door in the side of the loop. The banks and the financial sector take in what households do not spend and lend it to firms. The government takes tax and spends on public services, benefits and infrastructure. The foreign sector, meaning firms and households abroad, sells us imports and buys our exports.
Money that leaves the flow is a leakage, also called a withdrawal: saving (S), taxes (T) and spending on imports (M). Money that comes back in is an injection: investment (I), government spending (G) and export revenue (X). Figure 9 is the full model, and the one the guide names as a required diagram.
They come in pairs, and learning them as pairs stops you losing one: households save, banks lend it back as investment; households pay tax, government spends it back; households buy imports, foreigners buy our exports.
Now the point of the model. If injections are larger than leakages, more comes into the flow than leaves it, so the flow of income grows. If leakages are larger, it shrinks. If the two are equal, the flow holds steady. Unit 3 builds its whole account of booms and slumps on that sentence.
11Where marks are lost
Treating scarcity as poverty. Scarcity is the gap between unlimited wants and limited resources, and the richest country on earth has it. "Not having enough money" scores nothing.
Adding up the alternatives. Opportunity cost is the next best option forgone: one thing, not the total of everything rejected.
Calling anything with a zero price a free good. A free good is one that is not scarce. Free healthcare is an economic good that somebody else paid for.
Listing money as a factor of production. The four are land, labour, capital and entrepreneurship, and capital means tools and machines, not the finance that bought them.
Confusing the two kinds of growth. Inside the curve to the curve is actual growth and the curve stays put. A shift of the whole curve is growth in production possibilities. Drawing a shift when the question describes idle workers going back to work loses the diagram marks and usually the explanation with them.
Getting inside and outside the wrong way round. Inside means resources unemployed; outside means unattainable. Label both in words so the examiner cannot mistake which you meant.
A straight-line PPC by accident. If your explanation says resources are better suited to one good than the other, your curve must bow outwards, or the picture contradicts the words.
Losing a leakage or an injection. There are three of each and they pair up. Saving and taxes with no import spending is an answer with a hole in it.
12Draw it right
Every PPC in an exam should carry all of the following, and examiners look for them in this order.
- A title, or a caption in your text: "Figure 1: production possibilities for Kavala".
- Both axes labelled with the good and its unit: "Fishing boats built per year", not "boats".
- The curve labelled PPC, and if it shifts, the new one labelled PPC₂ with an arrow showing the direction.
- Every point you discuss named, with dotted lines to both axes and the values marked.
- One change per diagram. Actual growth and growth in production possibilities are two diagrams.
- A sentence that uses the diagram: "As Figure 1 shows, moving from A to B costs 32 thousand litres of oil." A diagram nobody refers to earns less than one that is used.
For the circular flow the list is shorter: both boxes labelled, the direction of every arrow marked, all three leakages and all three injections shown, and the leakages leaving the flow while the injections enter it.
Draw in pencil, large, taking up about a third of the page. Figure 10 is the finished thing with each item pointed out.
13Try it
Marks in brackets. Answers and marker's notes are at the end. Do them before you look.
Q1. Define the term opportunity cost. 2 marks
Q2. Using a production possibilities curve diagram, explain the difference between actual growth and growth in production possibilities. 4 marks
Q3. Explain, with reference to the factors of production, why a production possibilities curve is usually drawn bowed outwards rather than as a straight line. 4 marks
Q4. Using the circular flow of income model, explain what happens to the size of the flow of income if households save more while government spending, exports and investment are unchanged. 4 marks
14In one breath
Wants are unlimited and resources are limited, which is scarcity, which forces choice, and every choice costs the next best thing given up. The resources are land, labour, capital and entrepreneurship. A free good is one that is not scarce; everything else is an economic good. Every society answers the same three questions, what, how and for whom, through markets, through government intervention, or through the mixture every real country uses. The PPC draws all of it: on the curve is efficient, inside means resources unemployed, outside is unattainable, inside to the curve is actual growth, and the whole curve shifting outward is growth in production possibilities. It bows outward because resources are not equally good at every job. The circular flow shows five decision-makers depending on one another, with saving, taxes and imports leaking out and investment, government spending and exports coming back in.
Answers
Q1. Opportunity cost is the value of the next best alternative that is given up when a choice is made. one mark for "next best alternative", one for "given up" or "forgone". "What you lose when you choose" scores 1; adding up every rejected option scores 0.
Q2. Actual growth is an increase in output that comes from employing resources which were previously idle. On the diagram it is a movement from a point inside the PPC, such as U, to a point on the curve, such as V; the curve itself does not move, because the quantity and quality of resources have not changed. Growth in production possibilities is an increase in the economy's productive capacity, caused by more or better factors of production or improved technology. It is shown as an outward shift of the whole curve, from PPC₁ to PPC₂, so combinations that were unattainable become attainable. 1 for a labelled diagram showing the movement from inside to the curve, 1 for a labelled diagram showing the outward shift with both curves named, 1 for idle resources as the cause of actual growth, 1 for more or better resources or technology as the cause of the shift. One diagram showing both, with no distinction made, is capped at 2.
Q3. A bowed-out curve shows increasing opportunity cost: each extra unit of one good costs more of the other than the unit before. This happens because the factors of production are not equally suited to producing both goods. Shifting resources into boat building moves the least suitable olive growers first, so little oil is given up per boat. To keep expanding boat production the economy must move progressively better growers, who are poorer boatbuilders, so the oil sacrificed per additional boat rises and the curve steepens. A straight line would mean every resource was equally productive in both uses. 1 for saying the shape shows increasing opportunity cost, 1 for resources not being equally suited, 1 for the order in which they are transferred, 1 for linking the rising sacrifice to the steepening slope. "It is bowed because opportunity cost increases" is circular and scores 1.
Q4. Saving is a leakage from the circular flow: income received by households that is not passed on to firms as spending. If households save more while investment, government spending and export revenue are unchanged, leakages rise while injections stay the same. Leakages now exceed injections, so more money is leaving the flow than entering it and the size of the flow of income falls. Firms receive less revenue, pay out less in factor incomes, and household income falls in turn. 1 for identifying saving as a leakage, 1 for injections being unchanged, 1 for leakages now exceeding injections, 1 for the flow of income falling. Saying saving is "bad for the economy" without comparing leakages and injections is capped at 2.
Educerie · written from the published IB Diploma Programme Economics guide, first assessment 2022, section 1.1 What is economics? Original text, examples and questions. Diagrams drawn by Educerie. Last reviewed 10 September 2026.