IBDP ECONOMICS

CHP 1-  ECONIOMICS NATURE

Economics-It is the branch of social science, which is interlinked with human psychology, political science, mathematics and even geography. Economics mainly deals in production, distribution & consumption of goods and services by an individual, society or an economy.

It will be injustice with economics to tag a single definition. There are various economist who came up with different definitions such as

According to Adam Smith- Economics is the study of wealth

According to Alfred Marshall- Economics is not only the study of wealth but also deals in welfare or well being

According to Lionel Robinson- Economics is the study of Human wants are unlimited with scare resources, which leads to choice.

According to paul Samuelson –  “Economics is the study of how people and society choose, with or without the use of money, to employ scarce productive resources which could have alternative uses, to produce various commodities over time and distribute them for consumption now and in the future among various persons and groups of society.”

Other Definition of Economics- Economics is the study of dealing the central problems or basic economic questions raised in an economy- 1. What to produce?  2. How to produce?  3. For whom to produce? 4. How much to produce?

Branches of Economics- a. Micro economics, b. Macro economics, c. Global economy or International Economics

Micro economics – The term Micro derived from Greek word “MIKROS means small”. It is the study of behaviour of an Individual or Group of consumers, producers and even Government in allocating the resources (land, labour, capital and enterprise) to produce and consume the goods and services at particular cost, price and time.

Examples of Micro economics- Individual demand, Market demand, Individual supply, market supply, Price, Cost, utility, Scarcity, Choice, Opportunity cost¸ taxes, competition, Elasticity, market failure, Externalities etc

Macro Economics - The term Macro derived from Greek word “MACROS means Large”. It is the study of behaviour of all consumers, producers and Government in an economy in allocating the resources (land, labour, capital and enterprise) to produce and consume all the goods and services in an economy.

Examples of macro economics- Aggregate demand, Aggregate supply, Inflation, Deflation, Monetary policy, Fiscal policy, Budget, Gross domestic product. (Balance of payment, Export & Import, Exchange rate, Economic growth & Economic development, Unemployment rate)

Unlimited want- Human wants are always unlimited, whether a consumer, a producer of a Government, all faces unlimited want.

Scarcity of resources- As discussed above, human wants are unlimited (consumer, producer & Govt) however resources to fulfill the unlimited wants are always scarce. Resource for consumer is money which is scarce, Resource for producer is LLC(land Labour & Capital) which is scarce & Resource for Govt. is taxable income which is also scarce.

Choice- A situation which arises due to unlimited want & scarce resources. A consumer, producer or a Govt has to make choice.

Opportunity cost- A situation where, The next best alternative forgone or in a simple meaning To have something, we have to sacrifice something, the thing which we sacrifice is knows as opportunity cost.

Example of Unlimited want, limited resources, scarcity, choice & opportunity cost-

With Consumer- A consumer named Tanirika, visited a shopping mall & likes two jeans, black and blue colour and wanted to buy both, the price of each jeans is $500 and she has just $600 in her pocket. Here unlimited want is two jeans and scarcity is money. Since she cannot buy both the jeans, she has to make a choice between two, she made her choice and bought black colour jeans and sacrificed the blue colour jeans, The blue colour jeans which she has sacrificed is opportunity cost. 

With Producer- A producer who is producing two goods such as Pen & pencil with limited land labour & capital (LLC). The daily capacity to produce pen or pencil is 10000 units each however producer’s unlimited want will be to produce more than 10,000 units which is not possible with scarce LLC since he has to make choice.  If he is producing 10,000 pen then he has to sacrifice all the pencil’s production and vice versa or to produce 5000 of pencil still he has to sacrifice 5000 units of pen. The units which has been sacrificed in both scenario is opportunity cost.

With Government-  The main resource for the Government is taxable income which is scarce however the planned and non planned expenditure is much more (unlimited want), Here Government has to make choices in planned and unplanned expenditure and There are many projects which can never come into picture as Government has to undertake few projects & sacrifice few projects, the projects which has been sacrificed will be termed as opportunity cost.

Economic Problem-Economic problem is universal truth of each and every economy, It is the problem arises due to unlimited human wants and scarcity of resources. Above we have explained how a consumer, producer and Government faces economic problem.

Basic economic problem or Four basic economic questions – Economic There are four basic economic questions arises by firms or Government in each and every economy.

1. What to produce
2. How to produce
3. For whom to produce
4. How much to produce  

1. What to produce- In an economy, Firms or Government will always face a question known as what to produce ? Either goods or services. Say an economy decided to produce goods. The problem of what to produce solved.
2. How to produce- After solving the problem of what to produce, the economy will face its second problem, How to produce the  goods. Either hiring more labour less capital or vice versa. Once an economy decided that production can be done by hiring more labour and less capital. The second problem how to produce solved.
3. For whom to produce- The third basic economic question arises in an economy is for whom to produce the goods or services? In the above explanation we have decided to produce goods. Say for example the economy is targeting to produce shoes but who will be the target consumers ? There are many varieties of shoes for different ages such as Sports shoes or formal shoes. Say an economy is targeting to produce sports shoes then the problem of for whom to produce has been solved.
4. How much to produce- This problem is based on demand and supply of goods or services.  

Factors of production – There are many resources which are known as factors of production. These resources are essential to produce goods or services in an economy. The factors of production LLCE

1. Land – It is one of the factor of production. Land is a natural resource which is essential to produce goods or services. Example of land can be- Mountain, Desert, Agricultural land, Ocean, Sea, River, Industrial land etc. These are considered as land because we often get either resources or it is used to produce further goods or services.

Reward for land- Rent

Mobility of land- Geographically its immobile however occupationally its mobile the same land can be used for different purpose

Question- Can we consider residential land as Land YES or NO ? Discuss this with our experts today or watch our YouTube videos https://www.youtube.com/channel/UCoqI7C9rI2UbFPITF2bPgnQ

2. Labour – Labour is considered as human resource, which is used to produce either goods or services or both. Labour can be categorized as Skilled or Unskilled labour- Skilled labour such as  Engineer, Doctor, Teacher, Professor, Designer, an Actor etc these are skilled labour because proper education & training is required to do skilled job, whereas Unskilled job such as construction workers, here proper education that is 12 to 16 years of education  and training is not required to lift bricks. There are various interesting examples available to understand Labour.

Reward for labour- Wages

Mobility of labour- Labour is mobile, however there are many factors which are behind the immobility of labour such as Children education, Social, family, language & culture, Legal restrictions etc

3. Capital – Capital in economics can be considered as machines. It is machines which is used to produce goods or services. There are many circumstances Capital as consider as stock or money but in economics we only consider machines. It is also a matter of discussion and debate. Few other capitals such as Financial capital, natural capital, Physical capital etc

Reward for capital- Interest

Mobility of capital- Its mobile, however giant machines such as railway tracks inside the mining is not mobile. It is difficult to take it our or may be cost of taking it out will be very expensive.

Question – Why in economics capital is knows as only machines but not money or stock or all ?  

Question- How Interest can be consider as reward for capital ?

For more details watch our videos or get in touch with our experts https://www.youtube.com/channel/UCoqI7C9rI2UbFPITF2bPgnQ

4. Enterprise – The term enterprise means name of a business. For example JIO Telecom in India. It is the enterprise who take risk to produce goods and services.

Entrepreneur- The one who run the business. For example – Mr Mukesh Ambani helped his son cum entrepreneur to start JIO telecom. Here Mr. Mukesh Ambani and his son can be considered as entrepreneur

Entrepreneurship- The idea invested in the business or using the proper skills to run the business. Example- The way JIO telecom entered into Indian market is the best example of entrepreneurial skills. Free sim, Free calls, Free SMS, Free internet in early 8 to 10 months.

Reward for enterprise- Profit

Mobility of enterprise- It is the most mobile among all the factors of production

Free Good VS Economic good–  Free good are those goods which a consumer should not pay for using the same. It is the gift of nature or GOD and nature or GOD is not charging for the same. For example air, rain water, sun light.

Question- In which case fresh air, rain water, greenery & proper sunlight can be consider as economic good or economic services? For better understanding visit our YouTube channel https://www.youtube.com/channel/UCoqI7C9rI2UbFPITF2bPgnQ or connect with our experts.

Economic good are those goods for which a consumer has to pay for. It is economic good because production cost has been involved. For example we have to pay for buying any good or service like electricity bill, a mobile phone, vegetables, TV, car etc

Production possibility schedule- It is the tabular representation of two different goods or services which are being produced at maximum level within an economy with given scarce resources (LLCE).

Schedule 1

Production possibility schedule- Production possibility curve– It is the curve, which shows two different goods or services can be produced at maximum level by using the scarce resources (LLCE) land, labour, capital & resources.   In the above schedule Opportunity cost is increasing hence due to increasing opportunity cost the shape of PPC would be Concave to the origin as shown in diagram 1.

Diagram 1

In the above diagram resources has been used to produce good Y and good X. Point a,b,c are the different combinations where production of both the goods are possible in an efficient way, However point e achieved inefficiency as few resources has been utilized to produce both the goods however point d is unattainable as resources are not available to produce at point d.

Question- In the above diagram, Is there any possibility that production will be possible at point d?

For better understanding visit our YouTube channel https://www.youtube.com/channel/UCoqI7C9rI2UbFPITF2bPgnQ or connect with our experts.

Note- However if Opportunity cost decreases then the shape of PPC would be Convex to the Origin

Diagram 2

Shift in PPC –There are two causes behind shift in PPC. PPC may shift outward or right and inward or left. When there will be increase in resources (LLCE) PPC will shift to the right or outward shift whereas when there will be decrease in resources (LLCE) PPC will shift to the left or inward shift.

LLCE= land, Labour, Capital, Enterprise

Diagram 2

In the above diagram, AA’ is initial PPC, due to increase in all or any one of resources (LLCE), PPC shifted outward from AA’ to BB’ and due to decrease in the resources (LLCE) PPC shifted inward from AA’ to CC’.

Movement along PPC- There might be movement on same PPC from one point to another, In case if the producer or an economy has seen an increase in the demand for Good X, hence resources can be moved from one point to other point to meet the demand by producing more unit of good X and Vice Versa.

In the above diagram we can see, Initial production of good X is 10 units and Good Y is 10 units, When an economy has realized there is an increase in the demand of good X, the resources has been moved from point a to c to produce more of good X and Vice versa for good Y.

Rotation in PPC-PPC rotates along X axis because of improvement in technology or different techniques in the production of good X.

Diagram 3

 In the above diagram PPC rotates from AA’ to AB due to improvement in technology .

PPC rotates along Y axis because of improvement in technology or different techniques in the production of good Y.

Diagram 4

In the above diagram PPC rotates from AA to AB due to improvement in technology.

Shape of PPC or Why PPC concave –  A PPC can be concave to the origin because of increasing opportunity cost. Increasing opportunity cost has been calculated in schedule 1. A concave PPC has been drawn in diagram 5.

Diagram 5

Shape of PPC or why PPC straight line- A PPC can be straight because of constant opportunity cost. constant opportunity cost has been calculated in schedule 2. A straight PPC has been drawn in diagram 6.

Diagram 6

History of economic thought- Economist through out the ages have contributed a lot in the definition, theories and practices of economics. Few economist are categorized as follows

18^th century Economist- Adam Smith the father of economics & Jean Jacques Rousseau etc .

 Adam Smith (1723-1790) a Scottish social, political & economist. Adam smith came into picture for his economic work an inquiry into the nature & causes of wealth of nations. He proposed invisible hand as economic theory, according to this theory market forces decides which good or services will be consumed or produced. He suggested laissez faire means no Government intervention.

Jean Jacques Rousseau (1712-1778) a philosopher who came into picture with his work A Discourse on the sciences & arts. He suggested advancement of the science and arts has caused corruption of morality and virtue.

19^th century economist- David Ricardo, John Stuart Mill, Jeremy Bentham, Alfred Marshall, Jean Baptiste Say,  karl Marx, Thomas Malthus, John Bright, Henry George, David Hume etc

David Ricardo (1772-1823) is one of the classical 19^th century economist, who is famous for his theory on wage rate and profit, theory of rent & theory of comparative advantages.

John Stuart Mill (1806-1873) a classical 19^th century economist suggested the theories of economies of scale, opportunity cost and comparative advantages in international trade.

Jeremy Bentham (1748-1832) a 19^th century economist belong to classical era, he is known for his theory of utilitarianism means social action should be evaluated by axiom. He said interest rates should be free from government control.

Alfred Marshall (1842-1924) a classical economist developed demand and supply curve which later used to understand market equilibrium. He further introduced the concept of price elasticity of demand. He further added demand, supply, price elasticity and cost of production related to each other or depend on each other.

Jean Baptiste Say (1767-1832) is also known as JB Say or Say’s law. He suggested supply creates its own demand. His famous book a treatise on political economy was published in 1803. His theory supply creates its own demand can be seen in 2016 in India when a firm called JIO telecom introduced into the Indian market.

karl Marx (1818-1883) a classical 19^th century economist, He motivated by economist David Ricardo and Adam Smith. His economic analysis can be found in his three books The Grundrisse, The surplus value & Capital. He argued that capitalism proven as disaster. He has contributed in labour theory, according to him the value of a good can be measured by average product of labour (APL) that is number of hour a labour need to produce a good.

Thomas Malthus (1766-1834) A classical economist known for his theory of population that is Malthus theory of population, population grows at geometric rate (2, 6, 18, 54) whereas food grows at arithmetic rate (1,2,3,4)

John Bright (1811-1889), Henry George (1839-1897) and David Hume (1711-1776) are few economist belongs to 19^th century economist.

20^th century economist- JM Keynes, AC Pigou, Gary Becker, Irving Fisher, Milton Friedman, John Richard Hicks, Simon Kuznets, William Arthur Lewis, Harry Markowitz, Gunnar Myrdal, Bertil Ohlin, Edward Prescott, Paul Samuelson, Amartya Sen etc  

JM Keynes (1883-1946) 20^th century economist can be categorized as father of macro economics, He is known for his work the general theory of employment & interest and money. He put emphasis on role of the Government intervention in the production of goods and services in an economy. He further said how to come out from recession by autonomous investment (it is the government who do autonomous investment). He suggested demand is the driving force of an economy.

Arthur Cecil Pigou (AC Pigou) 1877-1959- A British economist, He is known for welfare economics. His famous book the economics of welfare depict Alfred Marshall concept of externalities, cost & benefits. He was against Keynesian economic theory, He stated the relationship among employment, output, wealth and consumption specially during deflation (AD decreases drastically)  

Irving Fisher (1867-1947) A 20^th century economist, contributed in the theory of money, theory of interest, and theory of capital. He stated that income and capital are different from each other and we should not have any kind of confusion in it. He was the one who has developed indifference curve with normal and inferior good. He also mentioned that rate of interest depends on preference of present goods, productivity, risk and uncertainty. Few of famous books are The Nature of capital & income, The rate of interest, The purchasing power of money, The theory of interest, Boom & Depression etc

Milton Friedman (1912-2006) A 20th century economist & statistician. He strongly believes in free market capitalism. His contribution is to make people understand about depression. One of his famous book is Capitalism & Freedom.  

Simon Kuznets (1901-1985)- A 20^th century economist contributed in various economic theories such as savings, consumption, investment, distribution of income and economic growth. His theory Kuznets Curve is most popular. Kuznets curves is hypothetical curve that explains economic inequality over per capita income during economic development. It is inverted U shaped curve.

Paul Samuelson (1915-2009)- His major contribution in economics are as follows- The theory of preference, Business cycle, Social welfare function, Utility possibility etc

Amartya Sen (1933- 2021)- A great Nobel Prize Indian Economist contributed his time and his work in the field of economics. He has contributed in various economic theories such as Poverty & Famines, Poverty & Inequality, Concept of capability, Entitlement, Choice of technique, Time series criterion etc

John Richard Hicks (1904-1989), William Arthur Lewis (1915-1991), Harry Markowitz (1927- 2008), Gunnar Myrdal (1898-1987), are famous economist during 20^th century

Circular Flow of Income- Closed Economy & Open Economy

In a closed economy, there are only two main sectors: households and firms. There is no foreign trade, government, savings, or investment—everything earned is spent. Households provide resources like land, labour, capital, and entrepreneurship (LLCE) to firms through the resource market. Firms use these to produce goods and services, which are sold back to households. This creates a circular flow: in the real (clockwise) flow, resources move from households to firms, and goods and services move back; in the money (anti-clockwise) flow, households receive income as rent, wages, interest, and profit, which they spend on goods and services, generating revenue for firms. This revenue becomes the cost of production again, completing the cycle.

In an open economy, the circular flow includes leakages and injections. Leakages are money that leaves the flow—like savings (money not spent), taxes (money collected by the government), and imports (spending on foreign goods). Injections are money that enters the flow—like investment (money borrowed and spent by firms), government spending (on infrastructure, salaries, etc.), and exports (foreigners buying domestic goods). Even though money leaks out, it re-enters through these injections, keeping the economy active. This makes the open economy more complex but more realistic, as it includes the full picture of financial systems, government, and global trade.

Injection- Investment, Government Investment, Export

Leakage- Saving, Taxes, Import

POSITIVE AND NORMATIVE ECONOMICS

 1. Meaning

Types of Positive Economics Facts

 2. Examples

Positive Economics Examples (Factual & Testable):

1. "A rise in income taxes will reduce consumer spending." (Future-based)
2. "India’s inflation rate was 5.4% in 2024." (Past-based)
3. "Higher petrol prices lead to lower car usage." (General present/past correlation)

Normative Economics Examples (Opinion-based):

1. "The government should reduce income taxes to help the poor."
2. "India must invest more in rural education."
3. "It is unfair that CEOs earn more than average workers."

These reflect opinions or value judgments, and cannot be proven true or false through data.

3. Key Words to Differentiate

 Quick Trick to Remember

Positive = Proof → Factual, Past–Present–Future
Normative = Opinion → What should happen

Ceteris paribus

“All other things being equal” or “Keeping other factors constant.”

Origin:

•  Language: Latin
•  Meaning: “Ceteris” = other things, “Paribus” = equal
• Common in economic theories to isolate the effect of one variable while assuming others stay unchanged.

Who Introduced Ceteris paribus in Economics?

• Alfred Marshall, a famous British economist, widely used "Ceteris Paribus" in his 1890 book “Principles of Economics.”
• He used it to explain how one economic factor affects another, assuming all other factors stay the same.

Simple Meaning:

When economists say “Ceteris Paribus,” they mean:
 "We are changing just one factor, and everything else remains unchanged."

Examples of Ceteris Paribus

 Microeconomics (Individual/Firm Level):

1. If the price of ice cream rises, ceteris paribus, the quantity demanded will fall.
   (Assuming income, weather, and preferences stay the same.)
2. If a firm increases wages, ceteris paribus, its cost of production will increase.
   (Assuming rent, electricity, and raw material prices are constant.)

 Macroeconomics (Whole Economy):

1. If interest rates fall, ceteris paribus, consumer spending will increase.
   (Assuming taxes and income stay unchanged.)
2. If government spending increases, ceteris paribus, national income (GDP) will rise.
   (Assuming other components of AD like exports and private investment stay the same.)

 International Economics (Trade & Finance):

1. If the Indian Rupee depreciates, ceteris paribus, Indian exports will increase.
   (Assuming foreign demand and trade policies are unchanged.)
2. If the US imposes tariffs on Chinese products, ceteris paribus, US imports from China will decrease.
   (Assuming product quality and alternatives remain constant.)

 Why Its Important in Economics

It helps economists:

• Simplify complex situations
• Focus on one variable
• Create clear, testable economic theories

For example: In the Law of Demand, we say "As price increases, demand falls – ceteris paribus." (i.e., if income, tastes, and prices of other goods stay the same.)

Key terms & Concepts

 1. Hypothesis – Meaning

A hypothesis in economics is a testable statement or assumption about the relationship between two or more variables.

It is usually based on observation or theory and is tested using data.

Types of Hypotheses with Simple Examples

2. Law – Meaning

An economic law is a well-tested theory or principle that consistently holds true under specific conditions.

Based on repeated observations and empirical data.

Examples of Economic Laws:

1. Law of Demand:
   "As the price of a good increases, ceteris paribus, its quantity demanded decreases."
2. Law of Diminishing Marginal Utility:
   "As more units of a good are consumed, the additional satisfaction from each extra unit decreases." 

3. Model – Meaning

An economic model is a simplified representation of the real world, used to explain, predict, or analyse economic behaviour.

It often includes diagrams, graphs, equations, or assumptions.

Examples of Economic Models:

1. Circular Flow of Income Model:
   Explains how money, goods, and services flow between households and firms in an economy.
2. AD-AS Model (Aggregate Demand – Aggregate Supply):
   Shows how output and price levels are determined in an economy.

 4. Refutation – Meaning

Refutation occurs when a hypothesis or theory is proven false using real-world data or counter-evidence.

 It shows that a theory doesn’t always hold true or needs modification.

Examples of Refutation in Economics:

1. Phillips Curve Refutation:
   The original idea said low unemployment leads to high inflation, but in the 1970s stagflation (high inflation + high unemployment) disproved this.
2. Rational Expectations Theory vs. Keynesian Models:
   When Keynesian policies failed in the 1970s, new classical economists refuted them with rational expectations models.

 Summary Table:

Equality and Equity

Image Credit- Angus Maguire

 1. Simple Meaning

Visual Analogy:

• Equality = Everyone gets the same size box to stand on — some can’t see over the fence.
• Equity = Everyone gets a box based on their height — now everyone can see over the fence.

2. Economic Meaning

 3. Examples in Economics

Equality in Economics (Same for All):

1. Flat Tax Rate:
   A country charges everyone 10% tax, regardless of income level.
   Equal, but may be unfair to the poor.
2. Equal Healthcare Vouchers:
   Government gives each person 1,000 for healthcare, regardless of their health needs.
   Equal help, but not necessarily useful for sicker people.

Equity in Economics (Fair for All):

1. Progressive Tax System:
   Higher income earners pay a higher percentage in taxes (e.g., 30%), while low earners pay less (e.g., 5%).
   ? Fairer based on ability to pay.
2. Targeted Subsidies:
   Government gives free food/rations to poor families but not to the rich.
   Based on need, not equality.

Summary Table