IB Economics I

Microeconomics

What is Economics?

Is a social science that studies how societies use their scarce resources, which are needed to produce goods and services, to fulfill the unlimited needs and wants of the population, and distribute these goods and services among different groups.

Efficiency

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

Scarcity

It refers to the limited availability of economic resources relative to society’s unlimited demand for goods and services.

Choice

The ability to make decisions between different opportunities.

Interdependence

The connection between different economies.

Equity

It refers to the concept or idea of fairness.

Sustainability

It refers to the ability of the present generation to meet its needs without compromising the ability of future generations to meet their own needs.

Economic Well-Being

It is a multidimensional concept relating to the level of
prosperity and quality of living standards enjoyed by members of an economy.

Intervention

It refers to government involvement in the
workings of markets.

Change

The constant changes in all aspects of the economy and what influences it.

Microeconomics

Studies the behavior of individual economic agents such as consumers, households, firms, industries, and the government, and how they make economic decisions.

Macroeconomics

Studies the economy as a whole, focusing on countries fundamental economic goals.

Trade-Off

All the alternatives that are given up when a choice is made.

Opportunity Cost

The next best-alternative that is given up when a choice is made.

Factors of Production (FoP)

Capital, entrepreneurship, land, labor.

Physical Capital

Any human-made resource used to create other goods or services.

Human Capital

Skills or knowledge gained through education or experience.

Entrepreneurship

Leaders who bring together other factors of production to create goods and services. Their primary motivation is profit.

Land

Any natural resource used to produce goods or services basically anything that comes naturally from the Earth.

Labour

A person who devotes effort to a task and who is usually paid.

Marginal Analysis

Means making decisions based on increments. Marginal analysis is a means of examining the costs and benefits making a change in the production of goods and service.

The 3 Basic Economic Questions

What to produce?
How to produce?
For whom to produce?

Centrally Planned Economic System

- The government makes all economic decisions.
- They owns all FoP.
- They decide what to produce.
- They decide how the resources are used.
-They how to distribute the goods in society.

Free Market Economic System

- The consumers make all economic decisions.
- Individuals and firms own all FoP.
- Entrepreneurs and profit decide what is produced.
- Firms employ individuals and seek the most efficient use of resources for higher profit.
- Price determines who is able to pay for and purchase goods.
- Theoretically, no government intervention.

Mixed Market Economic System

They incorporate some government intervention and some free-market principles. (Most economies in the world)

Production Possibilities Curve (PPC)

A model designed to show the alternative combinations a firm or country can produce using their maximum resources.

Assumptions of the PPC

- Only 2 goods can be produced.
- Full employmennt.
- Fixed resources.
- Fixed technology.

PPC Point A

Any point inside the curve is inefficient as all resources are not being used to the fullest efficiency and can be improved to point B, C or D.

PPC Point B, C and D

Any point on the curve is efficient as all the resouces are used to their maximal potential.

PPC Point E

Any point outside the curve is impossible or unattainable given the current resources.

PPC Movement from Point B to Point D

This represents an increase in the production of Good B. The opportunity cost would be some quantity of Good A.

PPC Increasing Opportunity Cost

As you produce more of one good, the opportunity cost increases because not all resources are equally suited for he production of both goods. The result of this leads to a 'bowed out' curve.

PPC Contant Opportunity Cost

Resources can be easily interchanged to produce either good leading to a constant opportunity cost. A constant opportunity cost results in a straight line PPC.

PPC Actual Growth

When growth/efficiency is achieved by making better use of resources.

PPC Potential Growth

An increase in the maximum amount that can be produced is potential growth.

Shifter of the PPC (Potential Growth)

- Change in quality or quantity of FoP.
- Improvement in technology.

Closed Circular Flow

It is how money moves through an economy in a constant loop from producers to consumers and back again.

Open Circular Flow

It is when there are:
- Leakeges: money that flows out of an economy (savings, taxes, imports).
- Injections, money that flows into an economy (investments, government spending, exports).

Capitalism

- Ownership: by private firms or individuals.
- Equality & Prices: income & prices are determined by the markets.
- Problems: inequality, market failure, monopoly.

Communism

- Ownership: by government or state.
- Equality & Prices: redistribution of income and price controls.
- Problems: inefficiency of state industry, poverty and less incentives.

Demand

It is a principle of economics that captures the consumer's desire to buy the product or service.

Law of demand

As the price of a good or service increases, the quantity demanded decreases, and vice versa for a decrease in price.

1:1 demand curve

A 1:1 ratio demand curve is represented by a perfectly diagonal line in which if the price drops by one metric demand increases by one metric.

Elastic demand curve

An elastic demand curve reflects a change in demand for a given product with any change in price.

Inelastic demand curve

An inelastic curve reflects a stable product that consumer demand doesn’t change for even when it fluctuates to various prices.

Is Price a Determinant of Demand?

Price is not a determinant of demand because demand by definition is the quantity of goods and services that consumers are willing and able to purchase - at a given price.

What are the Determinants of Demand?

- The price and availability of substitute products.
- The price of complementary products.
- Tastes and preferences.
- Real income levels.

What are substitute products?

Exchangeble products for example Coke and Pepsi

What are complementary products?

They are products that are a relation between one another for example cars and petrol.

Utility Theory

The satisfaction and individual receives from consuming a good or service. More satisfaction equals more demand, this satisfaction is measured in utils.

Total Utility

Total satisfaction from consuming successive units of a good.

Marginal Utility

The satisfaction an individual receives from the last unit of the good they consume. If there is less marginal utility so consumers are willing price to pay. Marginal utility is measured in utils.

The Law of Diminishing Marginal Utility

States that for each extra unit of a good consumed by an individual, the marginal utility they receive from consuming the good falls.

Relationship between Total Utility and Marginal Utility

As the units consumed increase the total utility also increases on a curve. But the marginal utility first increases but then starts declining.

Supply

How business owners adapt to meet changes in price.

Why do people start businesses?

Profit.

Profit

The difference between the cost to produce a good or service and the amount it is sold for.

Law of supply

As price increases the supply increases or as the price decreases the supply decreases too.

Supply schedule

A supply schedule is a chart that lists how much of a good a supplier will offer at different prices.

Supply curve

A supply curve is a graph of the quantity supplied of a good at different prices.

Shifters of Supply (Non-Price Determinants)

- Price od resources (FoP).
- Number of producers.
-Technology.
- Taxes and subsidies.
- Expectations.

Movements of the supply curve

Occurs only when the price of the product changes causing a change in the quantity supplied.

Competitive Supply

Prices of related goods affect the supply curve.

Joint supply

An increase in the production of one product automatically increases the supply of at least another.

How do markets exist?

Markets exist when buyers and sellers interact. This interaction determines market prices and allocation of scarce goods and services.

How are market prices determined?

Market prices are determined through the buying and selling decisions made by buyers and sellers.

Equilibrium price

The market clearing or equilibrium price for a good or service is the one price at which quantity supplied equals quantity demanded.

What happens when the price is above the equilibrium?

If a price is above the equilibrium price, it will fall, causing sellers to produce less and buyers to purchase more.

What happens when the price is below the equilibrium?

If it is below the equilibrium price, it will rise, causing sellers to produce more and buyers to buy less.

What do prices do?

Prices send signals and provide incentives to buyers and sellers. When supply or demand changes, market prices adjust, affecting incentives.

What happens when there are higher prices?

- Consumers: The higher prices provide incentives for buyers to purchase less as well as to look for substites.
- Producers: they make or sell more and are able to cover high cost per unit and earn profits.

What happens when there are higher or lower prices?

Lower prices provide incentives for buyers to purchase more and for producers to make or sell less of it.

Market equilibrium

Is when the quantity supplied is equal to the quantity demanded. It works at the equilibrium price and there is no excess demand or supply.

Surplus

Excess supply. It is a market disequilibrium.

Shortage

Excess demand. It is a market disequilibrium.

Price ceilings

A maximum price allowed by the government. And this price is below or above the equlibrium price.

Why are price ceilings imposed?

They are implemented to make commodities affordable to the general public.

Effects of price ceilings

- Shortages.
- Reductions in product quality.
- Wasteful production lines.
- Misallocation of resources.
- Loss in gains from trade.

Elasticity of Supply

The degree to which a change in price will change supply and this depends on how easy it is to change production.

PES Formula

PES = Percentage change in quantity supplied
Percentage change in price

Elastic Supply

Items that have supplies that are increased easily are elastic, the supply will go up/down a lot with a change in price. Ex. Pizza.

Reasons of Elastic Supply

- Spare capacity in the factory.
- Stocks available.
- In the long run, capital can be varied.
- If it is easy to employ more FoP.
- E-commerce because of competition that increases options for supply.

Inelastic Supply

Items that have supplies that are increased with great difficulty are inelatic, the supply will go up/down very little with a change in price.

Reasons of Inelastic Supply

- Producers producing on full capacity.
- Producers with low levels of stocks.
- Capital is fixed in the short run.
- It is not easy to have more FoP (highly skilled labour).
- Agricultural products because it takes several months to grow new crops.

Why the Government Intevenes?

Markets can fail to be allocatively efficient, which means they do not allocate resources in a way that maximizes the interests of all participants or third parties.

Reasons of Government Intervention

- To support firms.
- To promote equity.
- Earn government revenue.
- Influence consumption levels.
- Influence production levels.
- Support low income households.
- Correct market failure.

Types of Government Intervention

Indirect taxes, subsidies and price controls.

Indirect taxes

Taxes imposed on spending to buy goods and services. They are paid by consumers, but firms collect the money to transfer it to the government.

Direct taxes

Direct taxes involve the payment of the tax by the taxpayers directly to the government.

Types of indirect taxes

-Excise taxes: imposed on particular goods and
services. Ex. Gasoline, cigarettes and
alcohol.

- Taxes on spending: on all (or most) goods
and services. Ex. IVA.

Price controls

Setting of minimum or maximum prices by the government. This makes prices unable to adjust to their equilibrium level determined by demand and supply.

Consquences of Price Controls

Price controls result in market disequilibrium, and therefore in shortages (excess demand) or surpluses (excess supply).

Price Ceiling

When the government sets the maximum price below the equilibrium price so that producers can't sell above it.

Reasons for Price Ceilings

To protect consumers usually on neccesity and/or merit goods. This can also be to increase consumption, reduce the price and prevent exploitation.

Price Ceiling Consequences

- Shortages.
- Rationing problems.
- Parallel or black makets.
- Eliminates allocative efficiency.
- Generates welfare loss (cost to society's well- being).

Allocative efficiency

It's a property of an efficient market. All goods and services are optimally distributed among buyers in an economy taking into account consumer’s preferences.

Pareto optimality

It's a situation where no individual or preference criterion can be made better off without making at least one individual or preference criterion worse off.

Pareto efficiency

Individuals maximize their utility.

Requirements for Allocative Efficiency

Market efficiency which is made up of informational and operational efficiency.

Market Efficency

All pertinent data regarding the market and its activities is available to all market participants and is always reflected in market prices.