IB HL Economics - Microeconomics

Scarcity

Limited resources → insufficient to satisfy unlimited needs & wants

Choice

Because of scarcity, choices must be made to allocate scarce resources (e.g., what to produce, what to forego)

Efficiency

Useful output ÷ Total input. Aim: maximize efficiency using minimum resources to produce maximum useful output

Equity

Being fair/just. Normative concept since different people have different views of fairness

Economic well-being

Prosperity / economic satisfaction / standard of living (includes job security, health, education, quality of life, social connections)

Sustainability

Ability of present generations to use resources without limiting future generations' ability to satisfy their needs

Change

Economics is in continuous change; equilibrium = state of rest with no tendency to change

Interdependence

Economic decision-makers depend on each other. Globalisation increases interdependence, but creates risks of unintended consequences

Intervention

Governments intervene because free markets often fail to achieve goals (equity, efficiency, sustainability). Debate exists over degree of intervention

Factors of Production Definition

the fundamental resources required to produce goods and services

Opportunity Cost

Value of the next best alternative sacrificed to obtain something else

Free Good

Not scarce → zero opportunity cost

Economic Good

Scarce → incurs opportunity cost of consumption/production

PPC shows

Scarcity, Choice, Opportunity cost

Straight-line PPC

Constant opportunity cost

Curved PPC

Increasing opportunity cost

Movement towards PPC

Actual growth: ↑efficiency, ↓unemployment

Outward shift of PPC

Potential growth: ↑FOPs, ↑technology

Positive economics

Deals with "what is, was, or will be" (can be proven true/false)

Normative economics

Deals with "what should be" (value judgments, cannot be proven true/false)

Demand

Willingness + ability of consumers to buy a good/service at different prices over a time period

Supply

Willingness + ability of producers to provide a good/service at different prices over a time period

Determinants of demand

Income, direct tax, price of substitutes, price of complements, tastes/preferences, expectations, population

Determinants of supply

Costs of production, taxes/subsidies, technology, price of related goods, producer expectations, unexpected events, number of firms

Law of Demand

Price↑ → income effect + substitution effect → Qd↓

Law of Supply

Price↑ → more profitable to produce → incentive to supply more → Qs↑

Demand curve links

D curve = MB curve → Law of diminishing marginal utility

Supply curve links

S curve = MC curve → Law of diminishing returns

Equilibrium

Qd = Qs; shortage → P↑, surplus → P↓; price mechanism restores equilibrium

Functions of price

Signal + Incentive

Rational consumer choice assumptions

Rationality, perfect information, utility maximisation

Limitations of rational consumer choice

Biases, bounded rationality, bounded self-control, bounded selfishness, imperfect information

Biases examples

Rules of thumb, anchoring, framing, availability bias

Bounded rationality

Rational only within limits (lack of info, cost of info, limited processing) → satisficing not maximising

Bounded self-control

People often lack self-control (overeat, overspend, undersave)

Bounded selfishness

People are not always selfish (selfless behaviour, public good contributions)

Imperfect information

Consumers lack full info → cannot maximise utility

Nudge theory

Influences decisions without financial incentives/limiting choice (e.g., placing healthier food visibly)

Choice architecture

Decisions influenced by how options are presented

Default choice

Chosen automatically if no action taken (e.g., subscriptions)

Restricted choice

Options limited by authority (e.g., speed limits)

Mandated choice

Compulsory to choose between options (e.g., organ donation opt-in at licence renewal)

Rational producer behaviour

Firms maximise profit

Alternative firm goals

Market share, growth, revenue maximisation, satisficing, CSR

Elasticity

Responsiveness of Qd or Qs to change in price/income/related goods

Formula for PED/PES

% change in Q ÷ % change in P

PED along curve

Left: elastic → Right: inelastic

Special cases

Perfectly elastic, perfectly inelastic, unitary elastic

Determinants of PED

Necessity, substitutes, proportion of income, time

Determinants of PES

Time, unused capacity, stocks, mobility of FOP, cost increases

PED < 1

Inelastic → P↑ leads to TR↑

PED > 1

Elastic → P↑ leads to TR↓

TR max when PED

= 1

Primary commodities PED

Inelastic (necessity, few substitutes) → price volatility

Manufactured goods PED

Elastic (many substitutes, less necessity)

Primary commodities PES

Inelastic (long time to produce, perishables)

Manufactured goods PES

Elastic (quick to produce, can store)

Indirect taxes & PED

Lower PED → more govt revenue

Tax incidence rule

PED < PES → consumers bear more burden; PES < PED → producers bear more

YED < 0

Inferior goods

0 < YED < 1

Normal goods (necessities)

YED > 1

Normal goods (luxuries)

Implication of YED

High-YED industries grow fastest in growing economies

Sector YED

Primary: lowest YED; Services: highest YED

Reasons for government intervention

Govt revenue, support firms, support households, influence production, influence consumption, correct market failure, promote equity

Indirect tax benefits

Govt gains revenue; corrects negative externalities; discourages harmful consumption; redistributes income; reduces imports

Indirect tax drawbacks

Consumers pay higher prices; producers earn less; workers lose jobs; welfare loss; regressive impact

Subsidy benefits

Consumers gain lower prices; producers gain revenue; workers gain jobs; encourages desirable goods; supports industries; corrects positive externalities

Subsidy drawbacks

Govt loses revenue (opp. cost); inefficiency (high-cost producers supported); misallocation (overproduction); welfare loss

Price ceiling benefits

Some consumers access necessities at lower prices; govt may gain political support

Price ceiling drawbacks

Shortages; black markets; welfare loss; producers earn less; workers may lose jobs

Price floor benefits

Supports producers (farmers, workers); protects low-skilled workers; ensures minimum income/consumption standard

Price floor drawbacks

Surpluses; govt must buy/store/dispose at opp. cost; inefficient firms survive; welfare loss; higher consumer prices; harms foreign producers if exported

Minimum wage benefits

Protects workers; increases incomes; may increase motivation and productivity

Minimum wage drawbacks

Unemployment; misallocation of resources; higher production costs; higher consumer prices; black markets for illegal workers

Market failure

Occurs when MSB ≠ MSC (no allocative efficiency)

Negative externality of production

MSC > MPC → overproduction → welfare loss

Negative externality of consumption

MPB > MSB → overconsumption → welfare loss

Positive externality of production

MSC < MPC → underproduction → underallocation

Positive externality of consumption

MPB < MSB → underconsumption → underallocation

Merit goods

Positive externalities, desirable, underprovided and underconsumed without govt intervention

Demerit goods

Negative externalities, undesirable, overprovided and overconsumed without govt intervention

Legislation/Regulation benefits

Simple to implement; firms forced to comply; effective at least partially; may be most appropriate

Legislation/Regulation drawbacks

Monitoring/enforcement costs; one-size-fits-all inefficiency; no incentive to innovate; incomplete knowledge on extent of damage

Collective self-governance benefits

Sustainable use of resources by local users; effective with good communication; low cost

Collective self-governance drawbacks

Only feasible in small/local settings; hard to enforce universally; depends on trust and cooperation

Negative advertising/education benefits

Shifts consumer preferences; firms respond to consumer opinion; can raise awareness effectively

Negative advertising/education drawbacks

Limited real effect; short-lived changes; opportunity costs for campaigns

Indirect tax benefits

Internalises externality; discourages harmful activity; govt revenue; efficiency via price mechanism

Indirect tax drawbacks

Hard to measure exact external cost; regressive; compliance/enforcement difficult; inelastic goods not much affected

Carbon tax benefits

Incentive to switch to clean tech; higher emissions → higher tax; predictable energy prices; govt revenue

Carbon tax drawbacks

Hard to set correct tax; regressive impact; requires monitoring; political pressure to set too low

Tradable permits benefits

Sets pollution cap; incentive to innovate; efficient (low-cost reducers cut more); govt can auction permits for revenue

Tradable permits drawbacks

Hard to set cap; distribution may be politicised; volatile permit prices; enforcement required

Positive advertising/education benefits

Raises awareness of benefits; may encourage consumption of merit goods; relatively easy to implement

Positive advertising/education drawbacks

Partial effect only; opportunity cost of funds; unlikely to fully close welfare gap; may raise prices if demand shifts

Direct government provision benefits

Free/affordable access; ensures equity; very effective at increasing Q

Direct government provision drawbacks

High government spending; opportunity costs; inefficiency risk; political influence in provision choices

Subsidy for positive externalities benefits

Lowers price; encourages production and consumption; corrects underallocation; affordable for consumers

Subsidy for positive externalities drawbacks

Difficult to measure external benefit; govt expenditure (opp. cost); inefficiency risk; political bias in subsidy allocation