U1 + U2 (without Theory of the Firm) concepts & definitions

This a mixture of all the concepts and vocabulary in the syllabus for U1 + U2 (WITHOUT THEORY OF THE FIRM) Not necessarily the most in depth, please refer to notes for more detail. Meant for quick review.

Factors of production

The four resources that allow an economy to produce its output: land, labour,

capital and entrepreneurship (management).

Economics

“Economics is the science that studies human behaviour as a relationship

between ends and scarce resources which have alternative uses”. Lionel

Robbins (1932)

Macroeconomics

The study of aggregate economic activity. It investigates how the economy as a

whole works.

Microeconomics

The study of the behaviour of individual consumers, firms, and industries and

the determination of market prices and quantities of good, services, and factors

of production.

Scarcity

This is the limited availability of economic resources relative to society’s

unlimited demand for goods and services.

Land

The physical factor of production. It consists of natural resources, some of

which are renewable (for example, wheat) and some of which are non-

renewable (for example, iron ore).

Capital

The factor of production that comes from investment in physical capital and

human capital. Physical capital is the stock of manufactured resources (e.g.

factories, roads, tools) and human capital is the value of the workforce

(improved through education or better health care).

Labour

The human factor of production. It is the physical and mental contribution of

the existing work force to production.

Entrepreneurship

The factor of production involving organising and risk-taking.

*combining other three FOP

Opportunity cost

The next best alternative foregone when an economic decision is made.

Economic good

Goods produced with scarce resources and have an opportunity cost

*non IB definition

Free good

The few things, such as air and salt water, that are not limited in supply

(relatively scarce) and so do not have an opportunity cost.

*goods not produced with scarce resources

Fundamental economic questions (3)

What to produce? How to produce? Whom to produce for?

Economic systems

Ways that societies allocate scarce resources and distribute goods and services

*non IB definition

Planned economy

An economy where the means of production are collectively owned (except

labour). The state determines what/how much to produce, how to produce,

and for whom to produce.

Free market economy

An economy where the means of production are privately held by individuals

and firms. Demand and supply (market forces) determine what/how much to

produce, how to produce, and for whom to produce.

Mixed economy

An economy that has elements of planning and elements of the free market. In

reality, all economies are mixed. What is different is the degree of the mix from

country to country.

Production Possibility Curve (PPC)

A curve showing the maximum combinations of goods or services that can be

produced by an economy in a given time period, if all the resources in the

economy are being used fully and efficiently and the state of technology is

fixed.

Positive economics

Positive economics deals with areas of the subject that are capable of being

proven to be correct or not.

Normative economics

This deals with areas of the subject that are open to personal opinion and

belief.

Invisible Hand

Tendency of free markets to regulate themselves by means of competition in search for self interest

*non IB definition

Say’s law of markets

Production of goods creates its own demand

*non IB definition

Utility

A measure of the satisfaction derived from purchasing a good or service.

Marginal utility

The extra utility derived from consuming one more unit of a good or service.

Law of diminishing marginal utility

As a person consumes more of a good or service, the additional satisfaction (or utility) they derive from each additional unit decreases.

*non IB definition

Law of increasing opportunity cost

As you continue to increase production of one good, the opportunity cost of producing that next unit increases. This comes about as you reallocate resources to produce one good that was better suited to produce the original good.

*non IB definition

Circular economy

An economic system that looks beyond the linear take-make-dispose model

and aims to redefine growth, focusing on society-wide benefits. It is based on

three principles: design out waste, keep products and materials in use, and

regenerate natural systems.

Markets

A market is where buyers and sellers come together to carry out an economic

transaction.

*Any place where people are willing and able to purchase a good, service or resource carry out an exchange with those who are willing and able to provide it.

Consumers

People or organisations that buy goods and services in a market

*non IB definition

Demand

Quantity of a good or service that consumers are willing and able to purchase at any price during a specific time period.

Law of demand

As the price of a good falls, the quantity demanded will normally increase, ceteris paribus.

Income effect

When a decrease in the price of a good or service that is being consumed

means that consumers experience an increase in real income, usually allowing

them to purchase more of the product. The income effect may be negative.

Substitution effect

When the price of a product falls, relative to other products, there is an

incentive to purchase more of the product, since the marginal utility/price ratio

has improved.

Complements

Goods are used in combination with each other. For example, digital cameras

and memory cards.

Producers

People, companies or countries that make, grow or supply goods, services or resources in a market

*non IB definition

Supply

Quantity of a good or service that producers are willing and able to offer at any price during a specific time period

Law of supply

As the price of a good rises, the quantity supplied will normally rise, ceteris paribus.

Ceteris paribus

A Latin expression meaning “other things being equal”.

Law of diminishing marginal returns

Adding one more unit of a factor while at least one other factor is constant will yield lower marginal returns at some point.

*non IB definition

Marginal returns

Additional output gained from adding an additional unit of input to a production process

*non IB definition

Law of increasing marginal costs

As output increases, marginal cost increases.

*non IB definition

Marginal costs

Marginal costs are the additional costs of producing one more unit of output.

Non-price determinants of demand (6)

Changes in income, Preferences and tastes, Changes in price of substitutes, Changes in prices of complements, Population/demographic changes (number of consumers), Future price/quantity expectations

Non-price determinants of supply (8)

Price of related goods, Costs of FOP, Technological change, Taxes, Subsidies, Number of firms, Weather, Future price expectations

Related goods

Goods that share the same resources, materials, or production processes during manufacturing.

*non IB definition

Joint supply

Goods which are produced together, or where the production of one good

involves the production of another product (for example, as a by-product of

production).

*Supply is positively linked.

Competitive supply

This exists where products are produced by the same factors of production,

and so compete for these resources for their production.

*Supply is negatively linked.

Indirect taxes

These are taxes on expenditure. They are added to the selling price of a good or

service.

Subsidies

Subsidies are financial support paid by governments to firms.

Regulations

Rule made by government that requires certain behavior of individuals, firms, or other groups which usually increase costs for firms.

*non IB definition

Market equilibrium

The point where the quantity of a product demanded is equal to the quantity

of a product supplied. This creates the market clearing price and quantity

where there is no excess demand or excess supply.

Excess demand (Shortage)

This occurs where the price of a good is lower than the equilibrium price, such

that the quantity demanded is greater than the quantity supplied.

Excess supply (Surplus)

This occurs where the price of a good is higher than the equilibrium price, such

that the quantity supplied is greater than the quantity demanded.

Price mechanism (Market mechanism)

This is the system in which the forces of demand and supply determine the

prices of products. Also known as the price mechanism.

Market demand

The horizontal sum of the individual demand curves for a product of all the

consumers in a market.

Market supply

The horizontal sum of the individual supply curves for a product of all the

producers in a market.

Laissez faire

The view that markets should be left alone, with minimal intervention by

government.

Keynesian revolution

An economic school of thought based upon the works of John Maynard

Keynes, challenging the classical (laissez faire) viewpoint and advocating the

role of government in managing the level of aggregate demand.

Price mechanism functions (3)

Signalling function, Rationing function, Incentive function

Signalling function

Prices give signal to both producers and consumers. A rising price gives a signal

to producers that they should increase their quantity supplied, and signals to

consumers that they should decrease the quantity demanded and vice versa.

Incentive function

Prices give producers the incentive to either increase or decrease the quantity

that they supply. A rising price gives producers the incentive to increase the

quantity supplied, as the higher price may allow them to earn higher revenues.

Rationing function

Rising prices "ration out" limited supplies to consumers. Whenever there is a shortage (when more people want a product than there is available), the price goes up. This higher price ensures that only buyers who are willing and able to pay receive the item.

*non IB definition

Efficiency

Efficiency is a quantifiable concept, determined by the ratio of useful output to

total input.

*making the best use of resources

Allocative efficiency

The level of output where marginal cost is equal to average revenue. The firm

sells the last unit it produces at the amount that it cost to make it. The socially

optimum level of output.

*producing the optimal combination of goods from society’s point of view

Productive efficiency

Producing goods using the fewest possible resources (and lowest cost).

*non IB definition

Consumer surplus

The additional benefit/utility received by consumers by paying a price that is

lower than they are willing to pay.

*difference between highest price consumers are willing and able to pay and the actual price paid 

Producer surplus

The additional benefit received by producers by receiving a price that is higher

than the price they were willing to receive.

*difference between the lowest price producers are willing and able to offer the good at and the actual price they received

Pareto optimality

The economic state where resources are allocated in the most efficient manner possible. At this point, it is impossible to make one person better off without making at least one other person worse off.

*non IB definition

Welfare loss

A loss of economic efficiency that can occur when equilibrium for a good or

service is not allocatively efficient.

Social surplus

The combination of consumer surplus and producer surplus.

Rational consumer choice

The economic theory that individuals make logical, self-interested decisions by comparing costs and benefits to get the most personal satisfaction (utility) from their limited money.

*non IB definition

Assumptions of rational consumer choice (4)

• Consumers have clear preferences that are stable over time and transitive 

• Consumers have highly developed analytical skills to compare choices for costs and satisfaction (consumer rationality)

• Consumers have perfect information (perfect information)

• Consumers want to maximise personal satisfaction at all times (utility maximisation)

Behavioral economics

This is a branch of economic research that adds elements of psychology to

traditional models in an attempt to better understand decision-making by

economic actors. It challenges the assumption that actors will always make

rational choices with the aim of maximising utility.

Cognitive biases

Systematic errors in thinking that influence how we process information when making decisions and these influence the process of rational decision making.

Rule of thumb

Mental shortcuts (heuristics) for decision-making to help people make a quick, satisfactory, but often not perfect, decision to a complex choice.

Anchoring bias

Anchors are mental reference points, relating to ideas or values, which are used

to make decisions. Value is often set by anchors or imprints in our minds that

we then use as mental reference points when making decisions. When an idea

or a value is firmly anchored in a person’s mind, it can lead to automatic

decisions and behaviours.

Framing

This is the way that choices are described and presented. Changing the framing

of a choice may affect tastes and preferences.

Perfect information

This exists where all stakeholders in an economic transaction have access to the

same knowledge.

Availability bias

Occurs when people rely on immediate examples or information that comes to mind easily when making judgments or decisions. It leads individuals to overestimate the likelihood or importance of events or situations based on how readily available they are in their memory
Availability bias is influenced by personal experiences, vividness of the information, media exposure, and emotional impact.

*non IB definition

Bounded rationality

This suggests that most consumers and businesses do not have enough

information to make fully-informed choices and so opt to satisfice, rather than

maximise their utility.

Bounded selfishness

Concern for the well-being of others.

*Humans are conditional cooperators

Bounded self-control

In reality, consumers are often not rational in their self-control and do not stop

consuming, even when it is sensible to stop. They consume even though the

price of the good or service is greater than the marginal utility they gain from

consumption.

Hyperbolic discounting

Choosing smaller sooner rewards over later bigger rewards.

Choice architecture

Choice architecture suggests that the decisions that we make are affected by

the layout, language used, sequencing, and range of choices that are available.

Default choice

This is when consumers are automatically enrolled in a system, so that the

consumer will “make” this choice if he/she takes no action.

Mandated choice

Mandated choices are when consumers are required to state whether or not

they wish to take part in an action.

Restricted choice

This is when the choice of a consumer is restricted, but still exists.

Consumer nudges

Positive reinforcement and indirect suggestions used to influence the

behaviour and decision making of consumers.

Nudge theory

This is generally used to describe situations where nudges (prompts, hints) are

used to improve the life and wellbeing of people and society.

*any arrangement of the choice architecture that alters people’s choices without limiting choices or significantly changing incentives

Firm objectives (4)

Profit maximisation, corporate social responsibility, growth & market share, satisficing

Profit maximisation

Profit maximisation is producing at the level of output where profits are

greatest: where marginal revenue equals marginal cost.

Corporate social responsibility

An approach taken by firms where they attempt to produce responsibly/

ethically towards the community and environment, demonstrating a positive

impact on society.

Growth & market share (Firm objectives)

Focus on increasing market share, potentially sacrificing profits in the short term. In the long term, may earn higher profits.

(Profit) satisficing

This occurs when entrepreneurs endeavour to cover their opportunity costs,

but do not push themselves significantly further, even though they might be

able to earn higher profits. It is essentially a mix of the words “satisfy” and

“suffice”.

Price elasticity of demand

A measure of the responsiveness of the quantity demanded of a good or

service when there is a change in its price.

Determinants of PED (6)

Number+closeness of substitutes, degree of necessity, how widely product is defined, time period considered, proportion of income

Primary commodities

Raw materials that are produced in the primary sector.

PED of primary commodities

Generally price inelastic

Income elasticity of demand (YED)

A measure of the responsiveness of the demand for a good or service to a

change in income.

Normal good

A good where the demand for it increases as income increases.