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Summary Economics For IB International Business
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Economics - IBHow can we think like an economist? - Chapter 1
This chapter9s learning goals are:
1. Explaining the concepts of scarcity and choice, the cost-benefit principle, and the
importance of incentives.
2. Evaluating and identifying costs and benefits.
3. Understanding the concept of economic rationality.
4. Understanding why what happens <in the margins= is important.
5. Distinguishing between positive and normative statements in economics.
How does an economist reason? We look at this by focusing on the following statement:
smaller classes are better for the child9s education.
An economist will first wonder whether there is any evidence for the hypothesis before
accepting it. What would indicate that making classes smaller would result in better
education for a child?
Second, an economist will look for motives, because people will often act on their self-
interest (incentives matter). A teacher, for example, benefits from smaller classes, because
that would result in less work. Perhaps that is the reason why this person would argue for
smaller classes. There are exceptions, here, of course4individual altruism does exist (for
instance, environmentalists).
Third, the economist will make a cost-benefit analysis: do the potential advantages (benefits)
of creating smaller classes outweigh the potential disadvantages (costs) (cost-benefit
analysis)?
Finally, the economist will likely emphasize that there is a point where reducing class size will
no longer lead to a positive result.
^
How do we study choice under conditions of scarcity?
Economics is the study of how people make choices under conditions of scarcity, and how
these choices affect society.
The scarcity principle (also known as the no-free-lunch-principle) means that, despite people
having infinite wants, resources available to us are limited, which means that having more of
one thing often means having less of another thing. That is where the cliché comes
from, there ain9t no such thing as a free lunch, or TANSTAAFL.
Inherent in the fact that a person must make choices is the cost-benefit principle, which
entails that an individual (or a firm, or a society) should only take action when the additional
benefits of that actions are at least as great as its additional costs.
Consider also that concepts such as time and energy are scarce: both can run out. This is why
rich people make different choices from poor people: they often value time over money.
,^
How do we apply the cost-benefit principle in practice?
In the study of choice we constitute, first, that people are rational, which means that they
have specific goals that they wish to fulfill as well as possible. One of the biggest issues with
the cost-benefit analysis is that certain goals do not have a specific monetary value, so
priorities are difficult to establish.
Example: you have two choices: buying a computer game for 25 euros nearby your house, or
buying one for 15 euros in the city center, which is a 30-minute walk away. A cost-benefit
analysis makes clear that a person will only save her 10 euros when she thinks it9s worth a
30-minute walk.
An economic surplus is the benefits minus the costs of an action taken. Say the costs of the
30-minute walk in the example above are 9 euros, that leaves an economic surplus of 1 euro.
Now say that you could have invested the time you would in studying for a test, instead. In
that case we say that the opportunity costs, the value of what you have sacrificed (that is,
time to study), are high. This way, you will be less likely to sacrifice that time.
^
What is the role of economic models?
Economists know that people do not constantly reason like this. However, it is important to
realize that rational choice is, either implicitly or explicitly, based on weighing the costs and
benefits. The cost-benefit principle is an abstract model, which means that it offers a
simplified description of certain essential elements in a given situation, so that we can
analyze the situation logically.
^
What are four important pitfalls?
The first pitfall is measuring the costs and benefits in proportions of absolute amounts.
Example: it is more valuable to save 100 euros on a 2000 euro plane ticket than to save 90
euros on a 200 euro plane ticket (even though in the first case you save only 5% and in the
second you save 45%).
The second pitfall is ignoring opportunity costs. Example: the question is not <Should I walk
to the pub=, but rather, <should I walk to the pub, or watch a movie at home?= It is
essential to appreciate the value that you sacrifice for a certain action.
The third pitfall is taking sunk costs into account. Sunk costs are costs that you have already
made at the moment you make a decision. Example: you bought a ticket for a movie one
week ago. Tonight is the screening, but you don9t feel like going. You have already spent
the 10 euros, so that should not be taken into consideration in deciding whether you will go
or not.
The fourth pitfall is to fail to understand the difference between average and
marginal. Marginal costs are costs that result from executing an additional unit of an
,activity. Marginal benefits are benefits that result from the execution of an additional unit of
activity. Example: when a government tries to decide whether they will spend extra money
on a certain subsidy, it doesn9t matter whether they increase it from 2 to 3 billion, or from 5
to 6 billion. The marginal costs, so the cost of every extra, individually spent euro should be
lower than the marginal benefits to justify the extra expenses.
The average costs and benefits, on the other hand, are the total costs (or benefits) of
executing n number of units of an action, divided by n.
^
What are the differences between microeconomics and macroeconomics?
Microeconomics is the study of individual choice under conditions of scarcity and the
implications of this for the behavior of prices and amounts in individual
markets. Macroeconomics is the study of how national economies function and how
governments use policies in attempt to improve such functioning. The scarcity principle and
the fact that resources are limited are very important in both disciplines.
^
What are two important lessons?
First, it is important to try to become an economic naturalist4someone who applies
economic insights to everyday events.
Second, it is important to know the difference between positive and normative statements.
Example: a climatologist can establish the effects of different greenhouse gasses on the
climate in the coming decades. Such conclusions would be positive (descriptive). However,
say the climatologist would say: we ought to avoid this scenario by banning the use of
private automobiles, then that statement would be normative (prescriptive).
^
How do we make calculations in economics?
It is also important to make calculations in economics.
An equation is the mathematical expression which describes the relationship between two
or more variables. A variable is a quantity that is free to take different values. We have
the dependent variable, which is a variable in an equation whose value is determined by the
value taken by another variable in the equation, and the independent variable, which is a
variable in an equation whose value determines the value taken by another variable in the
equation. Aside from this, there is the constant (or parameter), which is a quantity that is
fixed in value.
In other words, in the equation B = 5 + 0.10T, B is the dependent variable and T the
independent variable.
In making graphs there is the vertical intercept: in a straight line this is the value taken by the
dependent variable when the independent variable equals zero (the value on the x-axis).
Then there is the slope: in a straight line this is the ratio of the vertical distance the straight
, lien travesl between any two points to the corresponding horizontal distance. In the example
above, the vertical intercept equals 5 and the slope equals 0.10.
^
How do you calculate the slope of a curve in a graph?
There is an important problem: how do you calculate the slope? In a straight line this is
simple: you take two random points on the line and you calculate how much the line has
risen on the y-axis per distance traveled on the x-axis. However, when calculating the slope
of a curve, this is more difficult. For this, you have to differentiate (. Differentiating means
calculating the slop or the change in a function by using algebra rather than geometry.
In the expression Y = a + bX + cX² + dX³ you differentiate (dY/dX) like this:
dY/dX = b + 2cX + 3dX²
In economics, price is P and quantity is Q.
So, when the expression is Q = 2000 - 350P + 5P²
Then we can find the slop, dQ/dP, by differentiating and solving:
dQ/dP = -350 + 10P
So we can see that at different prices (value in P) there are different quantities (value in Q).
How do markets, specialization, and economic efficiency
work? - Chapter 2
This chapter9s learning goals are:
1. Explaining the difference between absolute and comparative advantage.
2. Understanding how comparative advantage enables gains from specialization
and exchange, even when there is absolute disadvantage in international trade.
3. Understanding what increasing opportunity costs are.
4. Using the concept of production possibility curve.
5. Understanding how comparative advantage can change and be changed.
6. Explaining what the difference is between technical and economic efficiency.
^
What is the principle of comparative advantage?
One of the most important insights in the modern economy is that when two people (or
countries) have different opportunity costs in executing different tasks, they can always
increase their total combined value by trading available goods and services with each other.
See the following table:
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