IB1 economics sem 2

Market failure

Resources are not allocated efficiently and to what is optimum for society

Negative externality of production

Production of good/service has a negative effect on a third party. MSC>MPC, MSB=MSC. Chicken farming

Negative externality of consumption

An individual's consumption of a good generates a negative effect on third parties not factored into decision to consume the good. MPB>MSB, MSC=MPB. Smoking

Positive externality of production

Resources are underallocated to the production of that good/service, production has a positive effect on third parties. MPC>MSC, MSB=MPB. Beekeeping

Positive externality of consumption

Underconsumption of a good, if external benefits were considered then demand would increase. MSB>MPB, MPC=MSC. Vaccinations

Public good

Provides benefits to society that are non rivalrous and non excludable. No free market for the good eg public parks

Merit good

Goods that are beneficial to individuals or society as a whole but are underconsumed, should be subsidised eg healthcare

Demerit good

Consumption occurs at a rate higher than what is considered socially optimal eg smoking cigarettes

Common access resources

Resources accessible to everyone but can't be used by everyone at the same time and not owned by anybody eg fishing lake

Carbon tax

Tax per unit output of pollutants emitted eg Sweden carbon tax gradually increasing over time

Collective self governance

Stakeholders in a community working together to combat negative externalities of production usually associated with common pool resources eg ecotourism in Borneo rain forests

Tradable permits

Government sets admitted level of pollution, splits it into permits and allocates them to firms- exist on a free market eg used in USA for sulphur dioxide emissions to mitigate acid rain

Pigouvian tax

Indirect tax to increase private costs and correct negative externalities eg UK alcohol tax

Adverse selection

One party in a transaction has more information than the other eg in insurance market highlighting risks of your lifestyle

Economies of scale

Decreases in average costs of production over the long run as firms increase all factors of production (downward sloping portion of LRAS curve). Specialisation of labour, bulk buying of FOPs, lower interest rates, spreading of costs like marketing

Diseconomies of scale

Company is so big that average costs increase. Coordination and monitoring difficulties eg time zones, multiple levels of management creating slow communication, poor worker motivation (upward sloping of LRAS curve)

Total revenue formula

Price x quantity

Marginal revenue formula

Change of total revenue / change in quantity

Average revenue formula

Total revenue / quantity

Profit formula

Total revenue - total costs

Total costs

(fixed + variable costs) x quantity

Marginal cost

Change in total costs / change in quantity

TR/TC approach to profit maximisation

Output where difference between TR and TC is highest is where profit maximisation occurs

MR/MC approach to profit maximisation

Where MR=MC is the point that profit maximisation occurs at

Market power

Ability of a firm to set price and their relative share of the market

Characteristics of perfectly competitive firms

Many firms, homogenous goods, price takers, only earn normal profit in long run, low barriers to entry/exit (theoretical)

Characteristics of monopolistic competition

Large number of sellers, price takers, similar but not identical goods that are differentiated by advertising eg clothing

Characteristics of oligopolies

Small number of firms, high competition, price makers, high barriers to entry/exit eg supermarkets

Characteristics of monopolies

One firm with all market power, high barriers to entry, no competition eg water companies

Collusive agreement

Non competitive, secret agreement between rival firms to disrupt market equilibrium and gain an unfair market advantage

What does game theory tell us about the characteristics of oligopolies?

Firms are highly interdependent, display strategic behaviour, become worse off as a result of price competition, strong interest in avoiding price wars

Cartel

Formal agreement between firms to take actions to limit competition eg fixing quantity produced by each firm, dividing the market geographically, setting higher prices eg OPEC

Concentration ratio

Percentage output of the market of the largest firms in an industry. If 4 firms produce 45% of the market's output, the 4-firm concentration ratio is 45%

Natural monopoly

A market that runs most efficiently when one large firm supplies all of the output

Business cycle

Charts changes in real GDP that occur in an economy over time

Leakages (circular flow)

Taxes, spending money on imports, money saved in banks- all income not spent on goods and services so don't contribute to total output

Injections (circular flow)

Government spending, investment, exports

Expenditure approach for GDP

Sum of 4 components of GDP (household consumption, investment, government spending, net exports)

Income approach for GDP

Sum of costs of production (wages, interest, rent, profits) earned by a nation's household in a year

Output approach for GDP

Sum of outputs of primary, secondary, and tertiary sectors (finished goods to avoid double counting)

GDP

Total value of a nation's output in a particular period of time

GNI

GDP + (income from abroad - income sent abroad)

Happy Planet index

Gives HPI score measured by (wellbeing x life expectancy) / ecological footprint to rank countires by sustainability and happiness

OECD Better Life index

Measures 11 variables such as housing, income, and safety

Aggregate demand

Total demand for final goods and services in an economy at a given time

Aggregate suppy

Total amount of goods and services in the economy available at all possible price levels

Household consumption effect on AD

Consumer confidence, interest rates, income tax, household debt, future price expectations, wealth

Capital investment effect on AD

Interest rates, business confidence, technology (efficiency), level of corporate indebtedness, excess capacity available

Government spending effect on AD

Political and economic priorities

Net exports effect on AD

Foreign and domestic incomes, exchange rate, protectionism

Recessionary/deflationary gap

Real GDP is less than potential GDP created by a fall in aggregate demand. Recession part of business cycle

Inflationary gap

Real GDP is greater than potential GDP created by a rise in aggregate demand. Expansion part of business cycle

Natural rate of unemployment

The unemployment rate that exists when an economy is producing at full employment levels- includes frictional, seasonal, and structural but NOT cyclical

Frictional unemployment

Unemployment that results because it takes time for workers to search for the jobs that best suit their tastes and skills

Seasonal unemployment

Unemployment caused by seasonal changes in the demand for certain kinds of labor

Structural unemployment

Unemployment that occurs when workers' skills do not match the jobs that are available

Cyclical unemployment

Unemployment caused by a business cycle recession

Short term growth

Increase in actual output from reductions in unemployment and inefficiency- increases In AD/SRAS

Long term growth

Increase in resource quantity or quality creating an increase in production possibilities- an increase in potential output

Budget defecit

When the government spends more than it takes in

Debt servicing

Payment of interest and principal of debt (of a country or individual).