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IB Economics, while it relies on you understanding the foundational micro-economic concepts and macro-economic concepts, also requires an understanding to integrate between the topics.
We're going to provide microeconomics topical revision in this article just below. Click on the Economics topics you are the weakest within, and you'll see a concise breakdown for your revision needs.
Micro-Economics Topical Revision:
Demand
Shifts in the Demand Curve
Calculating the Demand Curve (HL)
Supply
Shifts in the Supply Curve
Calculating the Supply Curve (HL)
Market Equilibrium
Basic Definitions
Economics:
The study of how groups allocate scare resources to satisfy unlimited wants and needs
Opportunity Cost:
The value of the next-best alternative forgone
Factors of Production:
All inputs used to produce goods and services
C- Capital (equipment)
E- Entrepreneurship (management)
L- Land (natural resources)
L- Labor (workforce)
Normative Statement:
A statement that is a matter of opinion
Positive Statement:
A statement that can be proven or disproven
PPF (Production Possibilities Frontier):
Represents all combinations of the maximum amounts that two goods can be produced in an economy when there is a full employment of resources and efficiency. The PPF model demonstrates concepts such as scarcity and opportunity cost.
Point A = the economy is operating less than full efficiency
Point B = the economy is operating at full efficiency however the opportunity cost to produce more guns is a lot of bread
Point C = the economy is operating at full efficiency however the opportunity cost to product more bread is a lot of guns
Point X = the economy can not operate at this efficiency as they do not have the factors of production to do so
Economic Growth:
The measure of a change in countries GDP, or real national income such that an increase in national income is classified as economic growth
Economic Development:
The measure of welfare and well-being, instead of being measured in monetary indicators, it is measured in terms of indicators such as education, health and social indicators
Demand
Demand and the Law of Demand
Demand is the quantity of a good that consumers are willing and able to purchase at a given price in a given time period.
The law of demand states that as the price of a product falls, the quantity demanded increases. Ceteris paribus
Shifts in the Demand Curve
Income
Normal Goods: as a consumer’s income rises, the demand for the product will also rise, shifting the demand curve to the right
Inferior Goods: as a consumer’s income rises, the demand for the product will fall, shifting the demand curve to the left
Substitutes
If products are substitutes, then a change in the price of one of the products will lead to a change in the demand for the other product. For example, if there is a fall in the price for Good A (movement along the demand curve), then the demand for Good B will decrease (demand shifts left).
Complements
If products are complements to each other, then a change in the price of one good will lead to a change in the demand for the other product. For example, if there is a fall in the price for Good A (movement along the demand curve), then the demand for Good B will increase (demand shifts right).
Calculating the Demand Curve (HL)
Equation: Qs = c +dP
A = where the graph meets the x-axis and where demand would be if the price was zero. If A changes, there will be a parallel shift in the demand curve.
B = sets the slope for the demand curve (rise/run). If B changes, there will be a change in the steepness of the curve therefore a change in the elasticity.
Supply
Supply and the Law of Supply
Supply is the willingness and ability of products to produce a quantity of a good or serve at a given price in a given time period.
The law of supply states that as the price of a product rises, the quantity supplied of the product will increase. Ceteris Paribus.
Shifts in the Supply Curve
Cost of Factors of Production
If there is an increase in the costs of the factors of production, such as a wage increase, ths will increase the firm’s costs meaning that they can supply less (shift to the left)
Price of Other Products
Producer’s often have a choice of what they would like to produce such that if there is a raise in the price of Good A, they may produce less of Good B (shift to the left) to maximize revenue
Technology
Improves in the state of teachnology in a firm should lead to an increase in supply thus a shift of the supply curve to the right
Calculating the Supply Curve (HL)
C = the quanitity that would be supplied if the price was zero. If C changes, there will be a parallel shift in the supply curve
D = sets the slope of the curve. If D changes, there will be a change in the slope therefore the elasticity.
Market Equilibrium
Equilibrium
The point in which the demand and supply curve intersect and the economy is in a state of rest such that there is no “outside disturbance”
Changes in Equilibrium
If there is a change in one of the determinants of demand or supply there will be a shift in one of the curves resulting in a new equilibrium.
Surpluses and Shortages
If the price is raised above the equilibrium, suppliers will have more incentive to produce however demand will decrease resulting in a surplus (excess supply)
If the price is lowered, demand will increase while supply will decrease resulting in a shortage (excess demand)
Consumer and Producer Surplus
Consumer surplus: the highest price consumers are willing to pay minus the price they actually pay. Consumers who are willing to pay for a product at a higher price, but only have to pay at equilibrium price are experiencing a gain.
Producer surplus: the price received by firms for selling their goods minus the lowest price they are willing to accept. Producers who are willing to supply a product at a lower price, but instead can supply at equilibrium are experiencing a gain.
Economic Efficiency
When allocative and productive efficiency are achieved and marginal cost = marginal benefit (MC=MB) in every market
Allocative Efficiency
When an economy produces the combination of goods most desired by society where the consumer surplus is equal to producer surplus thus community surplus is achieved and where marginal cost is equal to marginal benefit
Calculating Market Equilibrium
Set Qs and Qd equal to one another and solve for P to get the equilibrium price
Substitute P into either of the equations to get the equilibrium quantity
Elasticity’s
Elastic vs. Inelastic
Elastic: responds substantially to price (e.g. luxuries, goods with close substitutes), such that if the price goes down the change in Qd/Qs is greater
Inelastic: does not respond to price (e.g. necessities, addictiveness), such that if the price goes down the change in Qd/Qs is smaller/
Price Elasticity of Demand (PED)
Price Elasticity of Demand
The measure of how much the demand for a good changes when there is a change in the price of the product
*Percentage change is calculated by taking (New – Old)/Old
Values of PED
PED<1 --> inelastic
PED>1 --> elastic
PED=1 ---> unit elastic
PED=0 --> perfectly inelastic
PED=P ---> perfectly elastic
Inelastic Demand
If a product has inelastic demand, then a change in the price of a product leads to a proportionally smaller change in the quantity demanded of it. Therefore raising the price of an inelastic product leads to a larger total revenue.
Elastic Demand
If a product has elastic demand, then a change in the price leads to a greater than proportionate change in the quantity demanded of it.
Determinants of PED
The number of substitutes: If a product has more substitutes then likely the demand will be elastic
The necessity of the product: If a product is a necessity, then likely it will have inelastic demand
Cross Elasticity of Demand (XED)
Cross Elasticity of Demand
The measure of how much the demand for a product changes when there is a change in the price of another product.
Values of XED
XED>0 substitutes
XED<0 complements
Large number > close substitutes/complements
Small number > remote substitutes/complements
Income Elasticity of Demand (YED)
Income Elasticity of Demand
The measure of how much the demand for a product changes when there is a change in the consumer’s income
Values of YED
YED>0 = normal good
YED<0 = inferior good
0<YED<1 = income inelastic (necessity)
YED>1 = income elastic (superior good)
Price Elasticity of Supply (PES)
Price Elasticity of Supply
The measure of how much the supply of a product changes when there is a change in the price
Values of PES
PES=0 à perfectly inelastic
PES=P à perfectly elastic
0<PES<1 à inelastic supply
PES >1 à elastic supply
PES=1 à unit elastic supply
Determinants of PES
Mobility of factors of production: the ability for the factors of production to be switched, if it is easily switched then PES is elastic but if they cannot be easily switched then PES is inelastic
Time Period: the time in which elapses for suppliers to change their supply, in the short run PES is inelastic while in the long run PES is elastic
Spare Capacity Available: the higher the spare capacity the more elastic PES is
Taxation
Indirect Tax
A tax imposed upon expenditure. It is placed upon the selling price of a product so it raises the firm’s costs and shifts the supply curve for the product vertically upwards by the amount of the tax.
Specific Tax
This is a fixed amount of tax that is imposed upon a product like $1, thus shifting the supply curve vertically upwards by the amount of the tax.
Ad Valorem Tax
This is a percentage tax on the selling price so the supply curve will shift such that as prices increase, the tax curve will become increasingly larger.
Effect of Taxation
Revenue Before Tax:
Q x $5.00
Revenue After Tax:
Q1 x $4.50
Government Revenue:
Consumer burden + producer burden
Deadweight Loss:
The triangle formed by the loss in producer and consumer surplus
Incidence of Taxation
Refers to the group that shares the greatest burden of the tax, since the elastic group is more affected by the tax, the more inelastic party has the greatest burden
When the government taxes an inelastic product, they generate large revenue whereas when they tax elastic products, they generate much smaller revenue
Subsidization
Subsidies
An amount of money paid by the government to a firm per unit of output thus shifting the supply curve vertically downwards. The government may do this for two reasons:
The lower the price of essential goods to consumers
To guarantee the supply of products that the government thinks are necessary for the economy
Effect of a Subsidy
Consumers:
P decreases (P1)
Quantity increases (Q1)
Producers:
Price increases (P0)
Quantity increases (Q1)
TR increases
Tax Payers:
Pay more taxes to cover subsidies
Price Control and Government Intervention
Price Controls
Price controls are imposed when policymakers believe the market price is unfair to either producers or consumers
Price Ceiling
A price ceiling is the legal maximum at which a good can be sold. If it is above the equilibrium, it is not binding because the equilibrium can be obtained. However if it is below the equilibrium, then it is binding because the equilibrium cannot be obtained
Consequences of a price ceiling
Smaller quantity supplies and sold
Quality decreases
Failure to meet allocative efficiency (shortage)
Price Floor
A price floor is the legal minimum at which a good can be sold. If it is below the equilibrium is it not binding because equilibrium can be reached however if is it above equilibrium, then it is binding because equilibrium cannot be obtained.
Consequences of a price floor
Failure to reach allocative efficiency (surplus)
Smaller quantity demanded and purchased
Illegal sales below the price floor
Market Failure
Market Failure
A situation in which the free market leads to a misallocation of societies resources leading to either an overproduction or underproduction of a good
Private (MPC) vs. Social (MSC) Cost
Private Cost: internal monetary costs such as wages, raw materials and heating/lighting
Social Cost: real cost to society such that it reflects the private costs plus the negative externality
Private (MPB) vs. Social (MSB) Benefit
Private Benefit: the monetary value of the benefit such as sales revenue
Social Benefit: the benefit to society such that is reflects the private benefit plus the positive externality
Positive Externality
A benefit not reflected in the free market price that the generator of the externality imposes benefits on others who are not responsible for initiating it.
Positive Externality of Consumption
Occurs when marginal social benefit exceeds marginal private benefit in relation to marginal social cost.
Positive Externality of Production
Occurs when marginal private cost is greater than marginal social cost in relation to marginal social benefit. There is potential welfare gain because quantity could be increased to Qs.
Negative Externality
A cost not reflected in the free market price such that the generator of the externality imposes the cost not those who are not responsible for it.
Negative Externality of Production
Occurs when marginal social cost is larger than marginal private cost in relation to marginal private benefit. There is welfare loss because there is an overproduction.
Negative Externality of Consumption
Occurs when marginal private benefit is larger than marginal social benefit in relation to marginal social cost.
Merit vs. Demerit Goods
Merit Goods: goods that are deemed socially desirable but are likely to be under produced and under consumed (e.g. education, health care and public parks). Merit goods are often associated with positive externalities.
Demerit Goods: goods that are deemed socially undesirable and are likely to be over produced and over consumers (e.g. alcohol, cigarettes and illegal drugs). Demerit goods are often associated with negative externalities.
Remedies for Externalities
Taxation: the government could tax a negative externality of production, which would result in MPC shifting upwards towards MSC. If they tax a negative externality of consumption, the MSC will shift upwards therefore decreasing quantity because of an increase in price.
Cap and Trade: the government could issue tradable emission permits to give firms the license to create pollution up to a set level, this would solve negative externalities of production.
Subsidization: the government could subsidize firms who generate positive externalities, which would decrease the marginal social cost curve
Advertising: the government could advertise the consequences of negative externalities of consumption to reduce consumption, or could increase the advertising of the benefits of positive externalities of consumption
Tragedy of the Commons
Tragedy of the Commons
The overconsumption of resources in the interest of self-worth and are able to do so because the goods are common or unknown
Public Goods
Public goods have two qualities that make them a part of the tragedy of the commons.
Non rivalry: one persons consumption of the public good does not deprive another’s ability to consumer that goods
Non-excludability: once the good is provided for one person it is not possible to prevent others from consuming it
Public Goods and Market Failure
Public goods are likely to be under produced or not produced at all because their properties make them incapable of providing private profitability.
The free rider problem arises because those who enjoy the benefits of a public good do not have to pay.
Costs, Revenues and Profits
Short Run vs. Long Run
Short run: the period of time in which at least one factor of production is fixed.
Long run: the period of time in which all factors of production are variable
Fixed vs. Variable Costs
Fixed Costs: costs that do not change as production is increased or decreased
Variable Costs: costs that vary in direct proportion to output
Total Product (TP)
The total output that a firm produces using its fixed and variable factors in a given time period
Average Product (AP)
Average product is the output that is produced, on average, by each unit of the variable factor.
Marginal Product (MP)
The change in output resulting from one additional unit of the variable input
Law of Diminishing Returns
As more units of variable input are added to fixed inputs, the marginal product at first increases but then decreases
Economics Costs
A combination of explicit and implicit costs
Explicit costs: firms use resources they do not own and makes payments of money to the resource suppliers
Implicit Costs: the cost is the opportunity cost of the sacrifice of income that would have been earned if the resource had been employed in its best alternative use
Economics of Scale
Advantages that a firm gains due to an increase in size.
Constant Returns to Scale: change in input is equal to change in output
Increasing Returns to Scale: as input changes, output increasingly changes
Decreasing Returns to Scale: as input changes, output decreasingly changes
Cost Curves
Average Fixed Cost (AFC): The fixed cost per unit of output. Calculated by dividing total fixed cost by quantity. Since total fixed cost is constant, AFC falls as output increases.
Average Variable Costs (AVC): The variable cost pet unit of output. Calculated by dividing total variable cost by quantity. AVC tends to fall as output increases but then increases again.
Average Total Cost (ATC): The total cost per unit of output. Calculated by dividing total cost by quantity. ATC tends to fall as output increases and then rise again as the output continues to increase.
Marginal Cost (MC): The increase in total cost of producing and extra unit of output. Calculated by dividing the change in total cost by the change in quantity. MC tends to fall as output increases and then start to rise because as more variable factors are added to fixed factors, the cost per unit of output eventually begins to rise
Graphical Representation of Cost Curves
Perfect Competition
Perfect Competition
Type of Product: identical
Market Power: price takers
Number of sellers: many
Role of advertising: negligible
Barriers to entry: low
Cost Curves
The price of the industry determines the price that firms must sell at. The shaded region represents normal profit such that it shows both the cost and the revenue of the firm.
Short Run vs. Long Run
Supernormal profits can be earned in the short run if the demand in the industry shifts right, therefore increasing price. However in the long run, the entry of new firms will result in supply in the industry shifting right and therefore price decreasing back to its original.
Allocative and Productive Efficiency
Allocative: when P = MC, in this market P = MR
Productive: when P = min AC, in this market P = min AC
Monopoly
Monopoly
Type of Product: the same
Market Power: price market
Number of sellers: one or two firms
Role of Advertising: possibly high
Barriers to entry: very high
Cost Curves
The light grey box represents the firm’s costs, while the dark grey box represents supernormal profits.
Short Run vs. Long Run
In the short run and the long run, the monopolist experiences supernormal profits as there are high barriers to entry and exit.
Allocative and Productive Efficiency
Allocative: when P= MC, in this market P>MC because there is an under allocation of resources
Productive: when P= min ac, in this market P> min AC because the monopolist is producing at higher than minimum average cost
Monopolistic Competition
Monopolistic Competition
Type of Product: different but serve the same purpose
Market Power: non-price determinants
Number of sellers: many
Role of Advertising: high
Barriers to entry: moderate
Monopolistic Competitive firms aim to achieve the benefits that monopolies enjoy, therefore by using product differentiation and advertising, they can experience similar characteristics
Cost Curves
The light grey box represents the firm’s costs, while the dark grey box represents supernormal profits.
Short Run vs. Long Run
In the short run, monopolistic competitive firms can experience supernormal profits however in the long run, more firms are attracted by the supernormal profits and therefore average revenue shifts downwards, erasing supernormal profits.
Allocative and Productive Efficiency
Allocative: when P=MC, in this market P>MC indicating there is an under allocation of resources
Productive: when P= min AC, in this market P>min AC therefore average cost is higher than what is optimal, if excess capacity is lowered than it can become productively efficient
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