Summary Economics for IB
Chapter 1: Thinking Like an Economist
Economics: is the study of how people make choices under conditions of scarcity and of the results of
those choices for society.
Scarcity principle: explains that although people have unlimited wants and needs, the resources which
are available to us are limited.; Having more of one good thing usually means having less of another
Positive economics: Independent of the ethical value system of the economist
Normative economics: Reflects the ethical value system of the economist (implicitly, explicitly or by
omission)
The Cost-Benefit Principle
Economic Surplus: The economic surplus from taking any action is the benefits of taking that action minus
the costs
● The benefit of taking an action
○ Value
● minus the cost of taking that action
○ Monetary cost
○ Opportunity cost
■ The net value of the next best alternative that must be foregone in order to undertake
that activity
● Only undertake those actions that create additional surplus
Opportunity Costs: The opportunity cost of an activity is the value of the next best alternative that must be
forgone in order to undertake the activity
Rationality demands that an individual (or firm or other decision maker) takes an action if, and only if, the
extra benefits (marginal benefits) from taking that action are at least as great as the extra costs (marginal
costs).
Four important decision pitfalls:
Pitfall 1: Measuring costs and benefits as proportions rather than absolute money amounts
Pitfall 2: Ignoring opportunity (i.e. implicit) costs
Pitfall 3: Failure to ignore sunk costs
➔ Sunk costs are costs that are beyond recovery at the moment a decision must be made
Pitfall 4: Failure to understand the distinction between average and marginal
➔ The focus should always be on the benefit and cost of an additional unit of activity
Marginal and Average Cost and Benefit
Marginal benefit: The increase in benefit that results from carrying out one additional unit of an activity
Average benefit: The total benefit of undertaking n units of an activity divided by n
Marginal cost: The increase in total cost that results from carrying out one additional unit of an activity
, Average cost: The total cost of undertaking n units of an activity divided by n
The Role of Economics Models
● Economists use the cost-benefit principle as an abstract model of how an idealized rational decision
maker would choose among competing alternatives
● Any model is a simplified representation of reality
Economics: mircro and macro
Macro-economics: The study of the performance of national economies and the policies that governments
use to try to improve that performance
Micro-economics: The study of individual choice under conditions of scarcity, and its implications for
society; Standard economic theory assumes decision makers are rational
Statements may be positive or normative
Positive: positive economics consists in the conclusions of economics that are independent of the ethical
Valier system of the economist
Normative: Normative economics consistent statements in economics that reflect or a based on the ethical
values system of the economist
Chapter 2: Markets, specialization, and economic efficiency
Scarcity principle: the opportunity cost of spending more time on any one activity is having less time
available to spend on other activities. This principle helps explain why everyone can do better by
concentrating on those activities at which they perform best relative to others.
Absolute Advantage: One party has an absolute advantage over another if an hour spent in performing a
task earns more than the other party can earn in an hour at the same task.
Comparative Advantage: One party has a comparative advantage over another in a task if his or her
opportunity cost of performing a task is lower than the other party’s opportunity cost of performing the same
task.
The Principle of Competitive Advantage
Everyone does best when each person concentrates on the activities for which her or his opportunity cost is
lowest.
Sources individual level (micro): Inborn talent, education, training, experience
Sources national level (macro): Land, labor, capital, entrepreneurship, knowledge, natural resources,
cultural, legal and political institutions
Chapter 1: Thinking Like an Economist
Economics: is the study of how people make choices under conditions of scarcity and of the results of
those choices for society.
Scarcity principle: explains that although people have unlimited wants and needs, the resources which
are available to us are limited.; Having more of one good thing usually means having less of another
Positive economics: Independent of the ethical value system of the economist
Normative economics: Reflects the ethical value system of the economist (implicitly, explicitly or by
omission)
The Cost-Benefit Principle
Economic Surplus: The economic surplus from taking any action is the benefits of taking that action minus
the costs
● The benefit of taking an action
○ Value
● minus the cost of taking that action
○ Monetary cost
○ Opportunity cost
■ The net value of the next best alternative that must be foregone in order to undertake
that activity
● Only undertake those actions that create additional surplus
Opportunity Costs: The opportunity cost of an activity is the value of the next best alternative that must be
forgone in order to undertake the activity
Rationality demands that an individual (or firm or other decision maker) takes an action if, and only if, the
extra benefits (marginal benefits) from taking that action are at least as great as the extra costs (marginal
costs).
Four important decision pitfalls:
Pitfall 1: Measuring costs and benefits as proportions rather than absolute money amounts
Pitfall 2: Ignoring opportunity (i.e. implicit) costs
Pitfall 3: Failure to ignore sunk costs
➔ Sunk costs are costs that are beyond recovery at the moment a decision must be made
Pitfall 4: Failure to understand the distinction between average and marginal
➔ The focus should always be on the benefit and cost of an additional unit of activity
Marginal and Average Cost and Benefit
Marginal benefit: The increase in benefit that results from carrying out one additional unit of an activity
Average benefit: The total benefit of undertaking n units of an activity divided by n
Marginal cost: The increase in total cost that results from carrying out one additional unit of an activity
, Average cost: The total cost of undertaking n units of an activity divided by n
The Role of Economics Models
● Economists use the cost-benefit principle as an abstract model of how an idealized rational decision
maker would choose among competing alternatives
● Any model is a simplified representation of reality
Economics: mircro and macro
Macro-economics: The study of the performance of national economies and the policies that governments
use to try to improve that performance
Micro-economics: The study of individual choice under conditions of scarcity, and its implications for
society; Standard economic theory assumes decision makers are rational
Statements may be positive or normative
Positive: positive economics consists in the conclusions of economics that are independent of the ethical
Valier system of the economist
Normative: Normative economics consistent statements in economics that reflect or a based on the ethical
values system of the economist
Chapter 2: Markets, specialization, and economic efficiency
Scarcity principle: the opportunity cost of spending more time on any one activity is having less time
available to spend on other activities. This principle helps explain why everyone can do better by
concentrating on those activities at which they perform best relative to others.
Absolute Advantage: One party has an absolute advantage over another if an hour spent in performing a
task earns more than the other party can earn in an hour at the same task.
Comparative Advantage: One party has a comparative advantage over another in a task if his or her
opportunity cost of performing a task is lower than the other party’s opportunity cost of performing the same
task.
The Principle of Competitive Advantage
Everyone does best when each person concentrates on the activities for which her or his opportunity cost is
lowest.
Sources individual level (micro): Inborn talent, education, training, experience
Sources national level (macro): Land, labor, capital, entrepreneurship, knowledge, natural resources,
cultural, legal and political institutions
