Economics HL Study Notes: Foundations and Microeconomics

IB Economics Assessment Structure

• Paper 1: Extended response (1 hour 15 min). Part A (10 marks) covers theory; Part B (15 marks) requires a real-life example and evaluation throughout.
• Paper 2: Data response (1 hour 45 min). Includes definitions, math, explain diagrams, and a 15-mark evaluation question using provided text/data.
• Paper 3: Policy paper (1 hour 45 min). Students must recommend and evaluate policies based on provided information and economic knowledge.

Foundations of Economics

• Scarcity: The fundamental economic problem of infinite wants vs. finite resources.
• 9 Key Concepts: Scarcity, Choice, Efficiency, Equity, Economic well-being, Sustainability, Change, Interdependence, and Intervention.
• Factors of Production and Income:
  • Land: Rent
  • Labour: Wage
  • Capital: Interest
  • Entrepreneurship: Profit
• Opportunity Cost: The value of the next best alternative foregone when a choice is made.
• Production Possibilities Curve (PPC): Illustrates combinations of two goods an economy can produce efficiently. Points on the curve are efficient and attainable; points inside are inefficient; points outside are unattainable.

The Circular Flow of Income

• Closed Economy: No government or trade. Income = Expenditures = Output.
• Open Economy Factors:
  • Injections ($J$): Investment ($I$), Government spending ($G$), and Exports ($X$).
  • Withdrawals ($W$): Savings ($S$), Taxes ($T$), and Imports ($M$).
• Economic Activity Change: Measured by $J - W$.

Demand, Supply, and Market Efficiency

• Law of Demand: A negative relationship between price and quantity demanded ($QD = a - bP$). Driven by income and substitution effects and the Law of Diminishing Marginal Utility.
• Law of Supply: A positive relationship between price and quantity supplied ($QS = c + dP$). Driven by the Law of Diminishing Marginal Returns and Increasing Marginal Costs.
• Market Equilibrium: Occurs at the intersection of supply and demand curve ($QS = QD$).
• Consumer Surplus: Difference between what consumers are willing to pay and the market price.
• Producer Surplus: Difference between the actual earnings of a producer and the price they were willing to accept.

Elasticities

• Price Elasticity of Demand (PED): $\frac{\% \text{ change in } QD}{\% \text{ change in } P}$. Influenced by substitutes, necessity, time, and proportion of income.
• Price Elasticity of Supply (PES): $\frac{\% \text{ change in } QS}{\% \text{ change in } P}$. Influenced by factor mobility, unused capacity, and ability to store stocks.
• Income Elasticity of Demand (YED): $\frac{\% \text{ change in } QD}{\% \text{ change in } \text{income}}$.
  • Positive YED indicates a normal good; negative YED indicates an inferior good.
  • $YED > 1$ indicates a luxury good; $YED < 1$ indicates a necessity.

Behavioral Economics

• Challenges the assumption of the "Rational Consumer" (Econs) versus actual human behavior (Humans).
• Dual System Model (Daniel Kahneman and Amos Tversky): System 1 (fast, intuitive) and System 2 (slow, logical).
• Limits to Human Behavior: Bounded rationality, bounded self-control, and bounded selfishness.
• Choice Architecture and Nudge Theory: Designing how choices are presented to encourage (nudge) better voluntary decisions.
• Cognitive Biases: Includes Anchoring, Framing, Availability, Social conformity, and Loss aversion.

Market Failure and Intervention

• Externalities: Costs or benefits to a third party not involved in the transaction.
  • Negative Production: Marginal Social Cost ($MSC$) > Marginal Private Cost ($MPC$).
  • Positive Consumption: Marginal Social Benefit ($MSB$) > Marginal Private Benefit ($MPB$).
• Public Goods: Non-rivalrous and non-excludable goods (e.g., dams), leading to the free rider problem.
• Asymmetric Information: Occurs when one party has more knowledge than the other (Adverse selection, Moral hazard).
• Common Access Resources: Non-excludable but rivalrous resources (e.g., fishing grounds), leading to overuse and threats to sustainability.
• Intervention Tools: Indirect taxes (Specific/Ad valorem), subsidies, price ceilings (maximum prices causing shortages), and price floors (minimum prices causing surpluses).

Theory of the Firm and Market Structures

• Law of Diminishing Returns: In the short run, adding variable factors to a fixed factor eventually results in decreasing marginal output.
• Costs: Total Cost ($TC$), Average Total Cost ($ATC$), and Marginal Cost ($MC$).
• Profit Maximization: Achieved when $MC = MR$.
• Revenue Maximization: Achieved when $MR = 0$.
• Market Structures:
  • Perfect Competition: Many price-taking firms, homogeneous products, no barriers to entry. Long-run profit is normal.
  • Monopoly: Single dominant price-maker, high barriers to entry, no close substitutes. Can make abnormal profits in the long run.
  • Monopolistic Competition: Many firms, differentiated products, no barriers.
  • Oligopoly: Few dominant firms, high interdependence. May involve Collusion (Cartels) to act as a monopoly.