What is economics?

Welcome to Economics!

Hello future economist! You are starting one of the most exciting and relevant subjects in the IB Diploma Programme. Economics is all about making sense of the world around us—from the price of your favourite coffee to why countries trade with each other.

The goal of this first chapter is to establish the fundamental problem that drives all economic activity. Once we understand this core idea, the rest of the course becomes much clearer.

What you will learn: The definition of economics, the central problem of scarcity, and the essential concepts (like opportunity cost and efficiency) that economists use to analyze the world.

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Unit 1.1: What is Economics?

The Formal Definition

Economics is formally defined as a social science concerned with the way that society chooses to allocate its scarce resources among competing uses to satisfy unlimited human wants.

Don't worry if this sounds complicated. We can break it down into its core components:

1. The Unlimited Nature of Human Wants

In economics, we assume that human wants (goods, services, experiences) are virtually unlimited. We always want more or better things. This isn't just about survival (needs); it's about comfort, luxury, security, and advancement.

2. The Limited Nature of Resources (Factors of Production)

Resources—the inputs used to produce goods and services—are finite. Economists categorize resources into four main groups, often called the Factors of Production:

• Land: All natural resources (minerals, water, timber, actual land).
• Labour: The physical and mental effort used in production.
• Capital: Manufactured resources used to produce other goods and services (machinery, factories, infrastructure). (Note: This is physical capital, not money/financial capital.)
• Entrepreneurship (or Management): The special human skill that organizes the other three factors, takes risks, and innovates.

The Central Economic Problem: Scarcity

When unlimited wants meet limited resources, you get the fundamental problem that defines economics: Scarcity.

Scarcity occurs because the demand for goods and services is greater than the capacity of the economy to satisfy those demands with its available resources.

Analogy: Imagine a small island nation (the economy) with only enough wood (resources) to build five houses or one large hospital. The people want both the houses and the hospital (unlimited wants). Since they cannot have both, the resources are scarce relative to the wants.

Scarcity Forces Choice

Since scarcity is unavoidable, all economic agents (individuals, firms, and governments) must make choices about which wants to satisfy and which to leave unmet.

The study of economics is essentially the study of how these choices are made and what the consequences are.

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The Consequence of Choice: Opportunity Cost

Every time a choice is made, something must be given up. This "what you give up" is the most important foundational concept in the course:

Opportunity Cost is the value of the next best alternative that must be sacrificed when a choice is made.

It is not the value of ALL the things you gave up, just the single best alternative you could have had instead.

Opportunity Cost in Action

1. For an Individual: If you spend two hours studying Economics (choice), the opportunity cost is not the sleep you missed and the TV show you skipped. It’s only the next best thing you could have done—say, watching the TV show.
2. For a Government: If a government chooses to spend \$100 million building a high-speed railway (choice), and the next best project was funding teacher training, the opportunity cost is the teacher training program sacrificed.

Key Takeaway: Because all resources are scarce, every decision we analyze in economics has an associated opportunity cost.

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Unit 1.2: How Do Economists Approach the World? (The Key Concepts)

Economists use specific analytical lenses—the nine Key Concepts—to understand, categorize, and solve real-world problems. These concepts run throughout all four units of the IB course.

We already covered Scarcity and Choice. Here are the other seven:

1. Efficiency

Efficiency refers to making the best possible use of scarce resources to avoid waste. In production, this means achieving the maximum possible output from the inputs available.

• Example: If a factory can produce 1,000 cars using 100 workers, but by reorganizing its production line (becoming more efficient) it can produce 1,200 cars with the same 100 workers, it has improved its efficiency.

2. Equity

Equity refers to the idea of fairness or justness in the distribution of an economy's income and wealth.

• Crucial Distinction: Equity is NOT the same as Equality. Equality means everyone receives the exact same amount. Equity means everyone receives a fair distribution based on need or contribution.
• Example: Taxation policies often aim to improve equity by having the wealthy pay a higher percentage of their income in taxes (progressive taxation).

3. Economic Well-being

This is a broad concept covering the overall health and quality of life for the population. It includes factors beyond just income, such as access to healthcare, education, environmental quality, and job security.

• Did You Know? Economists are increasingly looking at metrics like the Human Development Index (HDI) rather than just GDP to measure true economic well-being.

4. Sustainability

Sustainability means the ability of the current generation to satisfy its needs and wants without causing detrimental effects that compromise the ability of future generations to satisfy their needs and wants.

• Focus: Environmental resources, non-renewable energy, and responsible resource management.

5. Change

Economics is a dynamic field. The concept of Change recognizes that economic conditions, technology, consumer preferences, and government policies are constantly evolving, requiring continuous analysis.

• Example: The shift from physical retail stores to e-commerce is a major technological change influencing market structures.

6. Interdependence

Interdependence describes how economic agents (consumers, firms, governments, and countries) rely on each other for survival and prosperity.

• Real-World Connection: Globalization has made countries highly interdependent. If a war halts oil production in one nation, oil prices rise globally, affecting transport costs everywhere.

7. Intervention

Intervention refers to the actions taken by governments or other organized institutions (like central banks) to influence the economy, typically to correct problems or achieve specific economic goals.

• Example: Implementing a tax on sugary drinks (to discourage consumption) or setting interest rates (to control inflation) are forms of intervention.

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The Tools of Economic Thinking

To analyze complex scenarios and relationships, economists rely on specific methodologies and assumptions.

1. Ceteris Paribus: Isolating Variables

Ceteris Paribus is a Latin phrase meaning “all else being equal.” It is a foundational assumption in model building.

• Why we use it: In the real world, hundreds of things change at once. To establish a cause-and-effect relationship (e.g., “If price goes up, demand goes down”), we must assume that factors like income, taste, and prices of related goods remain unchanged.

Memory Trick: Think of "Ceteris Paribus" as pressing the pause button on the entire economy, except for the two variables you are studying.

2. Rational Economic Behaviour

A core assumption in economics is that economic agents act rationally—meaning they make choices to maximize their own objective:

• Consumers aim to maximize their utility (satisfaction).
• Firms aim to maximize their profit.
• Governments aim to maximize the economic well-being of society.

(We will later critique this assumption, but it forms the starting point for most economic models.)

3. Positive vs. Normative Economics

When economists discuss policy, they must clearly separate facts from opinions:

Positive Economics

Positive economics deals with statements that are objective and factual. They describe “what is” and can be tested, confirmed, or refuted using data and evidence.

• Example: “A 10% increase in the income tax rate will lead to a 2% fall in consumer spending.” (This is testable.)

Normative Economics

Normative economics deals with statements that are subjective and based on value judgments. They describe “what ought to be” and cannot be proven true or false.

• Example: “The government should subsidize public transport to reduce carbon emissions.” (This is a policy recommendation based on values.)

4. The Two Branches of Study

The entire IB Economics curriculum is split into two major branches:

Microeconomics (Unit 2)

Microeconomics studies the behavior of individual economic agents (consumers, firms) and the functioning of specific markets (e.g., the market for coffee, the market for labour). It is about the smaller parts that make up the whole economy.

Macroeconomics (Unit 3)

Macroeconomics studies the performance and structure of the economy as a whole (aggregate levels). It focuses on big national issues like inflation, unemployment, national income, and economic growth.

Key Takeaway: Economists rely on clear assumptions (rationality, ceteris paribus) and differentiate between objective facts (positive) and subjective values (normative) when analyzing the world.