IB HL Microeconomics

Adverse selection

When a buyer and seller do not have the same information and causes a transaction to take place on uneven terms

Allocative efficiency

The socially optimum level of output where MC=AR

Allocative inefficiency

When MSC is not equal to MSB, or MC (any external cost) is not equal to price charged to consumers

Asymmetric information

When one party in an economic transaction has access to more or better information than the other party

Capital

Factor of production that comes from physical (manufactured resources), and human (value of workforce) capital

Central bank

The government’s bank and responsible for an economy’s monetary policy

Collusive oligopoly

Where a few firms act together to avoid competition by resorting to agreements to fix prices or output in an oligopoly

Common access resources

Resources that are non-excludable but rivalrous

Complementary goods

Goods used in combination with each other (eg. toothpaste and toothbrush)

Consumer nudge theory

Positive reinforcement and indirect suggestions used to influence the behaviour and decision making of consumers

Consumer surplus

The positive difference of what the consumer is willing/able to pay and what they actually pay

Consumption (C)

Spending by households on consumer goods and services over a period of time

Demand

The willingness and ability of consumers to buy a good or service at any given price over a period of time

Demerit goods

Goods/services that are considered harmful to people and are overconsumed

Economies of scale

As output increases, average costs decrease

Elasticity of demand

Measure of responsiveness of the change in quantity demanded when there is a change in price

Engel curve

Curve showing the relationship between income and quantity demanded

Entrepreneurship

Factor of production involving organising and risk=taking

Excess demand

Where QD>QS

Excess supply

Where QS>QD

Externalities

External costs or benefits to a third party when a G/S is produced or consumed

Free market economy

Economy where means of production are privately held by individuals and firms

Free rider problem

When people who don’t pay benefit from consuming a good and results in overconsumption

Income effect

When the price of G/S decreases and there is relative increase in real income, allowing them to purchase more of the G/S

Income elasticity of demand (YED)

Measure of responsiveness of the demand for a good or service to a change in income

Indirect tax

Taxes on expenditure that are paid through a firm to the government by the consumer

Inferior good

Goods where demand decrease as income increase

Joint supply

Goods which are produced together

Labour

Factor of production of physical and mental contribution of the existing work force to production

Land

Factor of production which are the physical natural resources

Law of demand

As price decrease, QD increase
As price increase, QD decrease

Law of supply

As price increase, QS increase

As price decrease, QS decrease

Marginal cost

Additional costs of producing one more unit of output

Market equilibrium

Where QD=QS, creating a market clearing price and quantity where there is no excess demand/supply

Market failure

Misallocation of resources where there is failure to produce where social surplus is maximised

Monopolistic competition

Market structure where there are many buyer and sellers, producing differentiated products, with no barriers to entry or exit

Monopoly

Market structure where there is one firm in the industry with high barriers to entry, a unique product, and have market power

Moral hazard

When a party provides misleading information and changes behaviour after a transaction has taken place

Necessity good

Demand for good increases as income increases
Increase in demand is less than proportional to the rise in income

Negative externalities of consumption

Negative effects on third parties when a G/S is consumed

Negative externalties of production

Negative effects on third parties when a G/S is produced

Non-collusive oligopoly

Firms in an oligopoly do not resort to agreements to fix prices/output, competition tends to be non-priced and have stable pricing

Non-excludable

A consumption of a good/service does not diminish the utility from another individual

Normal goods

Demand increase as income increase

Oligopoly

Market structure where there are few large firms dominating the market

Opportunity cost

The next best alternative forgone

Perfect competition

Where there are a large number of small firms, producing identical products and are price takers. No barriers to entry and have perfect information

Perfect information

When all stakeholders in an economic transaction have access to the same knowledge

Pigouvian taxes

Indirect tax that is imposed to eliminate external costs of negative externalities

Planned economy

Economy where means of production are collectively owned (except labour) by the government

Positive externalities of consumption

Positive impacts on third parties when a G/S is consumed

Positive externalities of production

Positive impacts on third parties when a G/S is produced

Price ceiling

Price imposed by an authority set below the equilibrium price, prices cannot be above this price.

Price controls

Prices imposed by an authority

Elastic demand

Where change in price of G/S leads to proportionally larger change in QD
PED>1

Elastic supply

Where change in price of G/S leads to proportionally larger change in QS
PES>1

Inelastic demand

Where change in price of G/S leads to proportionally smaller change in QD
PED<1

Inelastic supply

Where change in price of G/S leads to proportionally smaller change in QS
PES<1

PED

Measure of responsiveness of QD of a G/S when there is a change in price

PES

Measure of responsiveness of QS of a G/S when there is a change in supply

Price floor

Price imposed by authority set above the market price. Prices can’t fall below this price

Primary sector

Extraction of natural resources for raw material

Privatisation

Supply-side policy where government sells public assets to the private sector

Producer surplus

Additional benefit received by producers by receiving price that is higher than price they were willing to receive

Profit maximisation

Level of output where profits are greatest
MR=MC

Proportional tax

Tax increases as income increases

Public goods

Goods or services provided by public sector, non-rivalrous and non-excludable.

Rivalrous

When consumption of a G/S prevents another from consuming the good

Satisficing

When entrepreneurs don’t push themselves further to earn higher profits, profits are sufficient (satisfy + suffice)

Rationing

Artificial control on the distribution of scarce resources

Screening

Use of screening process to gain more information regarding transaction to reduce asymmetric information, so reduce adverse selection

Signalling

Sending signal revealing relevant information to participant in transaction to reduce asymmetric information, so reduce adverse selection

Signalling effect

Prices giving signal to producer and consumer. Increase price signals to producers to increase QS, and signals to consumers to decrease QD.

Social surplus

Combination of consumer surplus and producer surplus

Socially optimum output

Where MSC=MSB or P=MC

Subsidies

Financial support from government to firms

Substitute good

Goods that can be used in place of another

Substitution effect

When price of a good falls, in relativity to other products, there is incentive to purchase more of the good

Supply

Willingness and ability of producers to produce quantity of a good for a given price in a given period of time

Tradable permits

Permits issued by governing body that sets a legal amount of pollution allowable which can be traded for money

Tragedy of commons

When individual users act independently according to own self-interest and goes against common good of all users by depleting the resource through collection actions

Unitary elastic demand

Change in price of G/S leads to equal and opposite proportional change in QD
PED=1

Unitary elastic supply

Change in price of G/S leads to equal and opposite proportional change in QS
PED=1

Utility

Measure of satisfaction derived from purchasing a good/service

Wealth

Total value of all assets owned by a person

Welfare loss

Loss of economic efficiency when equilibrium for G/S is not allocatively efficient.

Determinants of demand

Substitute goods
Advertisement
Demographic changes
Fashion and tastes
Income
Complementary goods
Seasonal

Determinants of supply

Change in FOP
Productivity
Government intervention
Firms expectations
Price of related goods

Determinants of PED

Habits
Income
Necessity of not
Time
Substitutes

Formula of PED

% change in QD / % change in P

Determinants of PES

Mobility of FOP
Unused capacity
Storage of stocks
Time period
Rate at which costs increase

Formula of PES

% change in QS / % change in P

Formula of YED

% change in QD / % change in Y

Why do markets not operate at socially optimum equilibrium?

1. Government hasn’t intervened yet to move the market

2. Addiction and myopic behaviour mean consumers will make the wrong decision

3. Information failure creates poor decision making

Why is there market failure for positive consumption?

Markets underproduce goods with positive externalities because individual consumers and producers do not take into account the external benefits - creates inefficiency in the market

What are ways the government can intervene for common resources

Indirect tax, education, carbon tax, tradable pollution permits

Pros and cons of indirect tax

Pros: revenue made for government to use for other policies
Cons: punishes all producers of good even if clean production, if PED is inelastic, tax has limited impact on QD

Pros and cons of education

Pros: consumers become more aware, reduces information failure, MPB shifts in and solves overconsumption/value
Cons: difficult and costly for an effective campaign that targets all consumption, no viable substitutes for the problem, it may not be information failure

Pros and cons of carbon tax

Pros: taxes only the polluting products, incentivises firms to find cleaner production methods
Cons: hard for small firms to adapt to cleaner methods, difficult to police and measure emissions

Pros and cons of tradable pollution permits

Pros: limits carbon emissions to predetermined level, incentivises firms to switch to cleaner technology, consumers and producers pay for external costs, flexibility for firms who may switch to cleaner technology
Cons: increased production costs, firms can relocate to other countries, difficult to determine socially optimum level of pollutants, costly and difficult to police