IB Microeconomics

Law of Diminishing Returns

As more inputs are added, the marginal product increases, then decreases. This is usually due to overcrowding and physical limitation.

Economic Cost =

Accounting costs + Opportunity Costs

Average Total Costs =

Average Variable Costs + Average Fixed Costs

Returns to Scale

Increasing returns to scale

• Total production grows proportionally more than the change in inputs.

Constant Returns to scale

• Total production change proportionally to changes in inputs

Decreasing returns to scale

• Total production change is proportionally less than change in inputs.

Normal Profit

When AR = AC

Profit Max

Marginal Revenue = Marginal Costs

Revenue Max

When MR = 0

Other Goals of Firms

1. Sales Volume Maximization (Predatory Pricing)

2. Corporate Responsibilities (Environment)

3. Revenue Maximization (When MR=0)

4. Satisficing (Achieving a minimum income)

Satisficing

When a firm operates at the minimum output and price to pay all of its costs, or reach a certain goal.

Conditions of Perfect Competition

1. All knowledge is shared.

2. All firms possess the same technology.

3. Infinite number of firms.

4. All products are the same.

5. Firms have no influence on price.

6. No barriers to entry/exit.

Profit in SR (Perfect Comp)

A firm can earn a profit in the SR if they lower their AC below AR. This will not earn profit in the LR because firms will just copy them.

Shut Down Price

A firm should shut down when it is operating at AVC = 0

Break Even Price

A firm should continue to operate at the minimum of AC

Allocative Efficiency

Occurs when a firm operates at AR=MC. No resource is wasted, and producer and consumer surplus is maximized.

Productive Efficiency

Occurs when a firm operates at the minimum of AC. When a firm produces at the lowest possible cost.

Conditions of Monopoly

1. One dominant firm

2. High barriers to entry/exit

3. One firm price sets

4. Profit maximization

5. Homogeneous products

How does a Monopolistic Firm control Price?

A monopolistic firm controls price by changing quantities.

Natural Monopolies

Natural Monopolies occur when the nature of the market is such that a single producer has an overwhelming cost advantage over other firms. Usually due to very high fixed costs.

Advantages of Monopolies

- Economies of scale

Lower costs of firms, which may result in lower costs for consumers

- Research Development

High profits encourage firms to invest into research and development allowing better products for consumers

Issues of Monopolies

- Excessive Profits

- Misallocation of resources

Solutions to Monopolies

1. Taxation

2. Nationalizing industries (Government buys firm)

3. Price Ceiling

4. Monopoly Breakups

Perfect Competition vs. Monopoly

Advantages of PC

1. Lower Prices

2. Allocatively efficient in LR

Disadvantages of PC

1. Normal Profit in LR

2. No differentiation of products

3. Little or no R&D for producers

Advantages of Mon

1. Higher Profit for Firms, meaning more R&D (Better for consumers)

2. Average cost is lower because of economies of scale

Disadvantages of Mon

1. Not allocatively or productively efficient

2. High prices and lower production

3. predatory pricing

4. ability to produce high barriers to entry

Conditions of Monopolistic Competition

1. High number of firms

2. Differentiated products

3. Low barriers to entry/exit

4. Profit maximising

Monopolistic Competition

As firms differentiate products they have more market power and can influence price in the market. Good example are restaurants.

Monopolistic Competition vs Perfect Competition

Prices are higher in monopolistic competition

Quantity higher in monopolistic competition

Perfect competition are both productively and allocatively efficient in the LR and SR, Monopolistic is not.

More producers in PC but no differentiation in products.

Higher profits in Monopolistic competition, more R&D

Conditions of an Oligopoly

1. Market dominated by a group of firms

2. High barriers to entry

3. Can be differentiated or similar products

4. Imperfect information

5. Profit maximisers

Oligopoly profits

Revenue is maximized when an oligopoly operates at the kink.

Informal Collusion

Collusion without formal agreement, often characterized by a leading firm.

Non-Collusive Collusion

When firms take into account what other firms are doing to influence their strategy.

Competition in Ologopolies

Due to the risk of price wars, and inelastic section of the kinked AR curve, there is unlikely to be price competition in the market, so there is no incentive to change price.

Price Discrimination

Price discrimination occurs when a firm charges different people different prices, depending on their willingness to pay.

Common access resources

Resources that are not owned by anyone, do not have a price, and are available for anyone to use without payment (for example, lakes, rivers, fish in the open seas, open grazing land, the ozone layer and many more); their depletion or degradation leads to environmental unsustainability.

Contracting

Is the process of spelling out all the terms and conditions of a transaction.

Demerit goods

Goods that are considered to be undeniable for consumers and are over provided by the market. Reason for overproduction may be that the goods have negative externalities, or consumer ignorance about the harmful effects.

Excludable

A characteristic of good accordion to which it is possible to exclude people from using the good by charging a price for it; if someone is unwilling or unable to pay the price they will be excluded from using it. Most goods are excludable. It is one of the two characteristics of 'private goods'. See also rivalrous.

Externality

Occurs when the actions of consumers or producers give rise to positive or negative side-effects on other people who are not part of these actions, and whose interests are not taken into consideration. Positive externalities give rise to positive side-effects; negative externalities to negative side-effects.

Market failure

Occurs when the market fails to allocate resources efficiently, or to provide the quantity and combination of goods and services mostly wanted by society. Market failure results in allocative inefficiency, where too much or too little of goods or services are produced and consumed from the point of view of what is socially more desirable.

Merit goods

Goods that are held to be desirable for consumers, but which are underprovided by the market. Reasons for underprovision may be that the good has positive externalities, or consumers with low incomes cannot afford it (and so do not demand it), or consumer ignorance about the benefits of the good.

Nationalization

A transfer in ownership of a firm away from the private sector and toward government ownership; a nationalized firm is a government-owned firm.

Negative externality

A type of externality where the side effects on third parties are negative or harmful, also known as 'spillover costs'. To be contrasted with positive externality; see also externality.

Negative externality of consumption

A negative externality caused by consumption actives, leading to a situation where marginal social benefits are less than marginal private benefits (MSB

Negative externality of production

A negative externality caused by production activities, leading to a situation where marginal social costs are greater than marginal private costs (MSC>MPC); see also externality and negative externality.

Non-excludable

A characteristic of some goods where it is not possible to exclude someone from using a good, because it is not possible to charge a price; it is one of the two characteristics of public goods (to be contrasted with excludable). See also non-rivalrous.

Non-rivalrous

A characteristic of some goods where the consumption of the good by one person does not reduce consumption by someone else; it is one of the two characteristics of public goods (to be contrasted with rivalrous). See also non-excludable.

Overallocation of resources

Occurs when too many resources are allocated to the production of a good relative to what is socially most desirable, resulting in its overproduction.

Positive externality

A type of externality where the side-effects on third parties are positive o beneficial, also known as 'spillover benefits'; to be contrasted with negative externality, see also externality.

Positive externality of consumption

A positive externality caused by consumption activities, leading to a situation where marginal social benefits are greater than marginal private benefits (MSB>MPB); see also externality and positive externality.

Positive externality of production

A positive externality caused by production actives, leading to a situation where marginal social costs are less than marginal private costs (MSC

Private good

A good that is both rivalrous and excludable. To be contrasted with public good.

Public good

A good that is non-rivalrous (its consumption by one person does not reduce consumption by someone else) and non-excludable (it is not possible to exclude someone from using the good). Since it is not possible to exclude someone from using the good even though they do not pay for it, firms do not have an incentive to produce it. Public goods are therefore provided by the government. This is a type of market failure.

Rivalrous

A characteristic of a good according to which its consumption by one person reduces its availability for someone else; most goods are rivalrous. It is one of the two characteristics of 'private goods'. See also excludable.

Ad valorem taxes

Taxes calculated as a fixed percentage of the price of the good or serve; the amount of tax increases as the price of the good or service increases.

Allocative efficiency

An allocation of resources that results in producing the combination and quantity of goods and searches mostly preferred by consumers. It is achieved when the economy allocates its resources so that no one can become better off in terms of increasing their benefit from consumption without someone else becoming worse off.

Excise taxes

Taxes imposed on spending on particular goods or services (for example, gasoline/petrol); are a type of indirect tax. See indirect taxes.

Government intervention

The practice of government to intervene (interfere) in markets, preventing the free functioning of the market, usually for the purpose of achieving particular economic and social objectives (such as provision of subsidies, provision of public goods, etc.).

Indirect taxes

Taxes levied on spending to buy goods and services, called indirect because, whereas payment of some or all of the tax by the consumer is involved, they are paid to the government authorities by the suppliers (firms), that is, indirectly.

Interventionist policy

Any policy based on government intervention in the market; to be contrasted with market -orientated policy. See also government intervention.

Maximum price

A legal price set by the government, which is below the market equilibrium price; this does not allow the price to rise to its equilibrium level determined by a free market; also known as a price ceiling.

Minimum price

A legal price set by the government which is above the market equilibrium price; this does not allow the price to fall to its equilibrium level determined by a free market; also known as a price floor.

Minimum wage

A minimum price of labor (the 'wage') set by governments in the labor market, in order to ensure the low-skilled workers can earn a wage high enough to secure them with access to basic goods and services. It is a type of price floor.

Non-price rationing

The apportioning or distributing of goods among interested users/buyers through means other than price, often necessary when there are price ceilings (maximum prices); may include waiting in line (queues) and underground markets; to be contrasted with 'price rationing', which involves distributing goods among users by means of market determined prices.

Price ceiling

A maximum price set by the government for a particular good, meaning that the price that can be legally charged by the sellers of the good cannot be higher than the legal maximum price. Results in a shortage of the product.

Price control

Setting of minimum of maximum prices by the government (or private organizations) o that prices are unable to adjust to their equilibrium level determined by demand and supply. Price controls result in shortages or surpluses.

Price floors

A minimum price set by the government for a particular good, meaning that the price that can be legally charged by the sellers of the good cannot be lower than the legal minimum price. Results in a surplus of the product.

Price support

Minimum prices (or price floors) set by the government for agricultural products; see minimum price.

Subsidy

An amount of money paid by the government o firms for a variety of reasons to prevent an industry from failing, to support producers' incomes, or as a form of protection against imports (due to the lower costs and lower prices that arise from the subsidy. A subsidy given to a firm results in a higher level of output and lower price for consumers. May also be paid to consumers as financial assistance or for income redistribution.

Sustainability

Refers to maintaining the ability of the environment and the economy to continue to produce and satisfy needs and wants into the future.

Tax incidence

Refers to the burden of a tax, or those who are the ultimate payers of the tax.

Welfare loss

Refers to loss of a portion of social surplus that arises when marginal social benefits are not equal to marginal social costs (MSB≠MSC), due to market failure.

Cross-price elasticity of demand (XED)

A measure of the responsiveness of the demand for one good to a change in the price of another good; measured by the percentage change in the quantity of one good demanded divided by the percentage change in the price of another good. If XED>0 the two goods are substitutes; if XED<0, the two goods are complements.

Elasticity

In general, this is a measure of the responsiveness or sensitivity of a variable to changes in any of the variable's determinants. See specific elasticities: price elasticity of demand, cross-price elasticity of demand, income elasticity of demand, price elasticity of supply.

Income elastic-demand

Relatively high responsiveness of demand o changes in income; YED (income elasticity of demand) >1. See income elasticity of demand.

Income elasticity of demand (YED)

A measure of the responsiveness of demand to changes in income; measured by the percentage change in quantity demanded divided by the percentage change in income.

Income inelastic demand

Relatively low responsiveness of demand to changes in income; YED (income elasticity of demand) <1. See income elasticity of demand.

Inferior good

A good the demand for which varies negatively (or indirectly) with the income; this means that as income increases, the demand for the good decreases.

Luxuries

Goods that are not necessary or essential; they have a price elastic demand (PED >1) and income elastic demand (YED >1). To be contrasted with necessities.

Necessities

Goods that are necessary or essential: They have a price inelastic demand (PED<1) and income inelastic demand (YED <1). TO be contrasted with luxuries.

Normal good

A good the demand for which varies positively (or directly) with income this means that as income increases, demand of rate good increases.

Perfectly elastic demand

Refers to a price elasticity of demand value of infinity, and arises in the case of a horizontal demand curve, see price elasticity of demand.

Perfectly elastic supply

Refers to a price elasticity of supply value of infinity, and arises in the case of a horizontal supply curve, see price elasticity of supply.

Perfectly inelastic demand

Refers to a price elasticity value of zero, and arises in the case of a vertical demand curve, see price elasticity of demand.

Perfectly inelastic supply

Refers to a price elasticity of supply value of zero, and arises in the case of a vertical supply curve see price elasticity of supply.

Price elastic demand

Relatively high responsiveness of demand to changes in price; PED (price elasticity of demand) >1. See price elasticity of demand.

Price elastic supply

Relatively high responsiveness of supply to changes in price; PES (Price elasticity of supply) >1. See price elasticity of supply.

Price elasticity of demand (PED)

A measure of the responsiveness of the quantity of a good demanded to changes in its price, given by the percentage change in quantity demanded divided by the percent change in price. In general, if there is a large responsiveness of quantity demanded (PED >1), demand is referred to as being elastic; if there is a small responsiveness (PED <1), demand is inelastic.

Price elasticity of supply (PES)

A measure of the responsiveness of the quantity of a good supplied to changes in its price, given by the percentage change in quantity supplied divided by the percentage change in price. In general, if there is a large responsiveness of quantity supplied (PES >1), supply is referred to as being elastic; if there is a small responsiveness (PES <1), supply is inelastic.

Price inelastic demand

Relatively low responsiveness of demand to changes in price; PED (price elasticity of demand) <1. See price elasticity of demand.

Price inelastic supply

Relatively low responsiveness of supply to changes in price; PES (price elasticity of supply) <1. See price elasticity of supply.

Substitute good

Two or more goods that satisfy a similar need, so that one good can be used in place of another. I two goods are substitutes, an increase in the price of one leads to an increase in the demand for the other.

Unit elastic demand

Refers to a price elasticity of demand value of one; see price elasticity of demand.

Unit elastic supply

Refers to a price elasticity of supply value of one; see price elasticity of supply.

Competitive market

A market composed of many buyers and sellers acting independently, none of whom has any ability to influence the price of the product. (i.e. no market power)

Competitive supply

In the case of two goods, refers to production of on for the other by a firm; in other words the two goods compete with each other for the same resources (for example, if a farmer can produce wheat or corn, producing more of one means producing less of the other).

Competition

Occurs when there are many buyers and sellers acting independently, so that no one has the ability to influence the price at which the product is sold in the market

Complements (complementary goods)

Two or more goods that tend to be sold together. If two goods are complements, an increase in the price of one will lead to a decrease in the demand of the other.

Consumer surplus

Refers to the difference between the highest prices consumers are willing to pay for a good and the price actually paid. In a diagram, it is shown by the area under the demand curve and above the price paid by consumers.

Demand curve

A curve showing the relationship between the quantities of a good consumers (or a consumer) are willing and able to buy during a particular time period, and their respective prices, ceteris paribus (all other things being equal).

Equilibrium

A state of balance such that there is no tendency to change.

Equilibrium price

The price determined in a market when quantity demanded is equal to quantity supplied, and there is no tendency for the price to change; it is like the price that prevails when there is market equilibrium.

Equilibrium quantity

The quantity that is bought and sold when a market is in equilibrium, i.e. when quantity demanded is equal to quantity supplied.