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IB ECONOMICS HL - Microeconomics
IB ECONOMICS HL - Microeconomics
FOUNDATIONS
scarcity: any good or service that has a price, and is thus being rationed, is known as an
economic good
opportunity cost: the next best alternative foregone when an economic decision is made
FACTORS OF PRODUCTION:
- Land
- Labour
- Capital (physical capital: stock of manufactured resources / human capital: value of the
work force)
PPD
z: most productive
total utility: total satisfaction gained from consuming a certain quantity of a product
marginal utility: extra utility the consumer gains from consuming one more unit of the
product
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PLANNED ECONOMIES
planned economies: decisions on what to produce, how to produce, and who to produce
for are made by the government
Government bodies arrange: production, set wages, and set prices through central planning
free market economies: capitalism, where prices are used to ration goods and services
- demand and supply are left free to set wages and prices in the economy
Demerit goods will be over provided , driven by Total production, investment, trade and
high prices (high pro t motive) consumption are too complicated to plan
e ciently // misallocation of resources of
resources, shortages, surpluses
Merit goods are under provided, only produced No price system leads to lack of e ciency
for those who can a ord them
Resources may be used up too quickly - Incentives will be distorted (motivation is
environmental damage (pollution) di cult) - output and quality will su er
Some members of society will not be able to dominance of the government may lead to a
take care of themselves (orphans, unemployed) loss of personal liberty and freedom of choice
Large rms may grow and dominate industries, governments do not share the same aims as the
leading to high prices, loss of e ciency and majority of the population (corruption)
excessive power
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ECONOMIC GROWTH
Measured by HDI: adds up real national income per head, adults literacy rate, average
years of schooling and life expectancy (value from zero to one)
sustainable development: development that meets and the needs of the present without
composing the ability of future generations to meet their own needs
market: buyers and seller come together to carry out an economic transaction
demand: quantity of a good or service that consumers are willing and able to purchase at a
given price in a given time period
law of demand: as the price of a product falls, the quantity demanded will increase, ceteris
paribus
ceteris paribus: an assumption that means ‘all other things being equal’ // when there is a
change in one factor, all other factors remain constant
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NON PRICE TYPE EFFECT GRAPH
DETERMINANTS
OF DEMAND
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movements along the demand curve: a change in price
Veblen goods:
law of supply: as the price of a product rises, the quantity supplied of the product will
usually increase, ceteris paribus
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LINEAR DEMAND FUNCTION:
QD = a - bP
QS = c - dP
c and d: will be a ected by non price determinants of supply (eg. costs of production)
MARKET EQUILIBRIUM
to nd equilibrium price: QS = QD
consumer surplus: the extra satisfaction (utility) gained by consumers from paying a price
that is lower than that which they are prepared to pay a price that is lower than that which
they are prepared to pay
producer surplus: the excess of actual earning that a producer makes from a given
quantity of output, over the amount the producer would be prepared to accept for that
output
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community surplus (total bene t to society)= consumer surplus + producer surplus
ELASTICITIES
elasticity of demand: measure of how much the demand for a product changes when
there is a change in one of the factors that determine demand
elasticity of demand: measure of how much the demand for a product changes when
there is a change in one of the factors that determine demand
Perfectly inelastic
PED = 0
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Perfectly elastic
PED = ∞
Inelastic demand
example: oil
Elastic demand
example: butter
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Unit elastic demand
PED =1
DETERMINANTS OF PED
DETERMINANTS WHY
Number and closeness of substitutes More substitutes: more elastic
cross elasticity of demand: measure of how much the demand for a product changes
when there is a change in the price of another product
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positive substitutes
types of margarine
close substitutes: high value
negative complements
shampoo and conditioner
close complements: lower
value
zero unrelated houses and match sticks
- Firms need to be aware of XED for the products they produce in regard to a ‘rivals’
product.
income elasticity of demand: measure of how much the demand for a product changes
when there is a change in the consumers income
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Engel curve
ELASTICITY OF SUPPLY
price elasticity of supply: measure of how much the supply for a product changes when
there is a change in price of a product
Perfectly inelastic
PES = 0
example:
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Perfectly elastic
PES = ∞
example:
Inelastic supply
example:
Elastic supply
example:
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Unit elastic supply
PES = 1
example:
DETERMINANTS OF PES
DETERMINANTS HOW
how much costs as output increases prevent rise in cost
PRIMARY COMMODITIES
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INDIRECT TAXES, SUBSIDIES AND PRICE CONTROLS
indirect tax: a tax imposed on expenditure that is placed on the selling price of a product
Raises the rms cost and shifts the supply curve upwards by the amount of the tax.
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This is why governments impose indirect tax on products with relatively inelastic demand
(cigarettes/alcohol)
SUBSIDIES
subsidies: amount of money paid by the government to a rm, per unit of output
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Why do governments give subsidies?
1) lower prices of essential goods: increase the consumption due to the ‘lower price’
2) e ciency: whether the subsidy will ine cient since they don't have to compete with
overseas rms
3) taxpayers: the subsidy is funded by taxpayers who may not necessarily bene t
4) damage to foreign products: the rms overseas who are not receiving subsidies from
their government
PRICE CONTROLS
- protect consumers
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Lead to shortages:
Reduce shortages:
Leads to surplus:
- producers have a surplus (excess supply) so they may sell their goods for a lower price
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Reduce surplus:
shifting the demand curve to the right
Issues:
- advertising
FIRM THEORY
Short run: period of time in which at least one factor of production is xed. All production
takes place in the short run
Long run: period of time in which all factors of production are variable, but the state of
technology is xed. All planning takes place in the long run
Fixed factor of production can be: element of capital, land, type of high skilled labour
Total product: total output that rm produces, using its xed and variable factors in a given
time period
Output in the SR can only be increased by applying more units of the variable factors to the
feed factors
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Average product: the output that is produced, on average, by each unit of the variable
factor
Marginal product: the extra output that is produced by using an extra unit of the variable
factor
The hypothesis of eventually diminishing average returns: As more variable factor are
added to a xed factor, the output per unit of the variable factor will eventually falls, so the
cost per unit of output eventually rises
* The economic cost of producing a good is the opportunity cost of the rm’s production
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Calculating the economic cost of production:
- The economic cost of producing a good is the opportunity cost of the rm’s production
- opportunity cost of the factors of production (resources) that have been used in
producing the good or service
1) Factors that are purchased from others and not already owned by the rm - explicit
costs
explicit costs: any costs to a rm that involve the direct payment of money
implicit costs: the earnings that a rm could have had if it had employed its factors in
another use or if it had hired out or sold them to another rm
SHORT-RUN COSTS
Total xed cost (TFC): total costs of the xed assets that a rm uses in a given time period
(a constant amount)
Total variable cost (TVC): total costs of the variables assets that a rm uses in a given time
period
Total cost (TC): total costs of all the xed and variable factors used to produce a certain
output
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Average costs: costs per unit of output
AVC falls as output increases, then starts to rise again as the output continues to increase
(hypothesis of eventually diminishing average returns)
Marginal cost (MC): increase in total cost of producing an extra unit of output
The MC cuts the AVC and the ATC curves at their lowest
points
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THE LONG RUN
Costs when all the factors of production are increased in order to increase output
Increasing returns to scale: long-run average costs are falling as output increases
Constant returns to scale: long-run average costs are constant as output increases
Decreasing returns to scale: long-run average costs are rising as output increases
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CHANGE IN LONG RUN
ECONOMIES OF SCALE
economies of scale: any decreases in long-run average costs that come when a rm alters
all its factors of production in order to increase its scale of output
LARGE MACHINES Some machines are too large to be owned by small rms
PROMOTIONAL ECONOMIES the cost of promotion tend not to increase by the same
proportion as output
Diseconomies of scale: any increases in long-run average costs that come when a rm
alters all its factors of production in order to increase its scale of output
ALIENATION AND LOSS OF Workers may lose a sense of belonging and loyalty
- less productive
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SHAPE OF THE CURVES
Long run cost curve U-shape: existence of economies and diseconomies of scale
REVENUE THEORY
Total revenue: total amount of money that a rm receives from selling a certain amount of a
good or service in a given time period
Marginal revenue: extra revenue that a rm gains when it sells one more unit of a product
in a given time period
If a rm does not have to lower price as output increases and it wishes two sell more of its
product - perfectly elastic demand curve
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2) Revenue when price falls as output increase
TR drops: extra revenue gained from dropping price and selling more units is out < loss in
revenue from the units that were being sold at a higher price and now have to be sold at a
higher price
A rm knowing whether their price is elastic or inelastic : know what pricing policy to adopt
to increase revenue
To increase revenue:
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PROFIT THEORY
Total pro t = total revenue - economic costs (explicit and implicit costs)
shut down price: level of price that enables a rm to recover its variable cost in the short
run
break even price: price at which a rm is able to make normal pro t in the long-run
- If a rm does not cover ATC in the long-run, it will shut down for good
- price = ATC
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PROFIT MAXIMISING LEVEL OF OUTPUT
The rm has made a loss on ever unit produced up to this level of output
maximise pro t:
MC cuts MR from below
Other aims:
- Revenue maximisation: measure success by the amount of revenue that they make /
maximise their sales revenue by producing where the marginal revenue is zero
- Growth maximisation: achieve growth in the short run, rather than pro ts, in order to
gain a large market share and then dominate the market in the long run.
Growth through: quantity of sales, sales revenue, employment or the percentage of market
share
- Satis cing: perform satisfactorily rather than to a maximum level, in order to persue
other goals: pursuit of leisure, encourage development in the local community through
educational projects, reducing environmental e ects
Done to gain a good reputation in order to take people’s attention away from their product
(cigarettes and alcohol)
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PERFECT COMPETITION
ASSUMPTIONS
- each rm is small relative to the size of the industry (a rm cannot a ect the
output of the industry as a whole)
* if they sell at a lower price, the consumers will use buy it from another rm
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Pro t maximisation
pro t is maximised: MC = MR
P = D = AR = MR
- the quantity of output from the rm is very small relative to the industry, so one rm will
not a ect the output of the industry
Short-run abnormal pro ts: more than covering their total costs, including opportunity
costs
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Short-run losses: not covering their total costs
- loss minimising
other rms begin to react and the situation starts to change until an equilibrium point is
reached in the long-run
- a rm making abnormal pro ts in the short-run will not continue making abnormal pro ts
in the long-run
- cover
opportunity costs
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Short-run losses to long-run normal pro ts:
Short-run abnormal pro ts / losses: rms will leave the industry until normal pro ts are
made
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productive e ciency: it produces its products at the lowest possible unit cost
MC = AC
allocative e ciency: suppliers are producing the optimal mix of goods and services by
consumers
marginal cost: cost to society of all the resources used in producing tan extra unit of a good
price > marginal cost: consumers would value the good more than the cost to make it
impossible to make one person better o , without making someone else worse o
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EFFICIENCY IN THE SHORT-RUN
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EFFICIENCY IN THE LONG-RUN
MC = AC
MONOPOLY
ASSUMPTIONS
- barrier to entry exists (stops new rms from entering the industry and maintains the
monopoly)
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SOURCES OF MONOPOLY POWER
a monopoly will continue to be the only producer in the industry if it is able to stop other
rms from entering the industry in someway.
Barriers of to entry:
1) economies of scale: rms gain cost advantages as their size increases / small rms
wanting to start will not bene t from these economies of scale will not have equal
economics of scale so its will not be able to compete and the infant industry would
make losses
3) Legal barrier: Firm may be given a legal right to be the only producer / patents is a rm
which is given the right to be the only producer only after (usually) 20 years of ivention.
After patents expire, other producers are allowed to produce the goods
5) Anti competitive behaviour: adopt restrictive practices, which should be legal or illegal /
eg. starting price wars / lowering their price when a new rm enters the industry
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DEMAND CURVE AND PROFIT MAXIMISING LEVEL OF OUTPUT IN MONOPOLY
Pro t maximising: MC = MR
When monopolist produce something with little demand, it will not earn abnormal pro ts
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REVENUE MAXIMISATION IN MONOPOLY
Revenue maximisation: MR = 0
EFFICENCY IN MONOPOLY
- produce at higher output and lower price than - Higher prices and lower output exist in
perfect competition Monopoly
- make abnormal pro ts which can be used to - act against the public interest
fund research
- governments have laws and policies to limit
- this would bene t consumers monopoly power
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Economies of scale in Monopolies
MONOPOLISTIC COMPETITION
ASSUMPTIONS
- brand name
- colour
- appearance
- packaging
- design
- quality of service
- skill levels
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Lead to brand loyalty: producers have some element of independence when deciding on
price
maximising pro t: MC = MR
MC = MR
as
MC = MR
as
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LONG-RUN EQUILIBRIUM IN MONOPOLISTIC COMPETITION
- maximising pro ts at MC = MR
cost (including opportunity costs) = price
Short-run abnormal pro ts: attracted to the industry / demand curve shifts the to left
Short-run losses: rms will leave the industry / remaining rms will experience demand
curve shifting to the right as they pick up consumers from leaving rms
SHORT RUN
productive e ciency: level of output where rm produces at the lowest possible cost per
unit
MC = AC
MC = AR
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LONG RUN
ADVANTAGES DISADVANTGES
ine ciency is due to the consumers desire for pay slightly more
variety
consumers have the opportunity to make
choices
OLIGOPOLOY
ASSUMPTIONS
- price rigidity
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CRx: ‘x’ represents the number of the largest rms / percentage of market hare by
the largest rms in the industry
higher the percentage: more concentrated the market power of the ‘x’ number rms
collusive: rms in an oligopolistic market collude to charge the same prices fro their
product
Formal collusion (cartel): rms openly agree on the price that they will charge / could be
on market share or on marketing expenditure
- Usually banned by governments (if they are discovered they may get penalised,
ned, etc.)
Tacit collusion: charge the same prices without formal collusion (through adverts, charging
the same price as a dominant rm)
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In both collisions, the process is the same
1) Behave as monopolist
Non-collusive: rms in an oligopoly do not collude / must be aware of other rms when
making decisions and must be aware of their reactions
GAME THEORY
Assuming:
- it is a duopoly
- identical products
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Non-collusive - Kinked demand curve
Assume:
- possess an MR curve that has a vertical section because MR curve will be 2x as steep as
the 2 parts of the demand curve
1) Firms are afraid to raise prices above the current market price, because other rms
will not / they will lose trade, sales and pro t
2) Firms are afraid to lower their prices below the current price, because other rms will
follow (undercutting them) - creating a price war that may harm all the rms involved
3) Shape of MR = if MC were to rise, then it would be possible for MC = MR, so the rms
being pro t maximisers would not change their prices or outputs
NON-PRICE COMPETITION
Firms in oligopolies tend to not compete in terms of price
1) brand names
2) packaging
3) special features
4) advertising
5) sales promotion
6) personal selling
7) publicity
8) sponsorship deals
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They try to develop brand loyalty and make their demand fro their product less elastic
PRICE DISCRIMINATIO
price discrimination: a producer sells the exact same product to di erent consumers at
di erent prices
CONDITIONS
2) consumer must have di erent price elasticities of demand for the product (if not
the consumer will not be prepared to pay di erent prices
- inelastic demand: pay higher price
LEVELS OF DISCRIMINATION
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pasar-malams work like this
The consumers are identi ed in di erent market segments and separate price is
charged in each market segment that recognises the di erent price elasticities
cinemas: students having a more elastic demand than inelastic demand with adults
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ADVANTAGES to the rm DISADVANTAGES to the rm
not allowed to sell below cost of production in forge in markets - dumping / only allowed to sell at
prices below the domestic market price
Allow some consumers to purchase a product Any consumer surplus that existed before price
that they would otherwise have to pay a higher discrimination will be lost
price for
- ‘subsidising’ the poorer consumers
Increases total output in a market so the some consumers will have to pay more than
product is available to more consumers the price they would have been charged in a
single, non discriminated market
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MARKET FAILURE
market failure: a market fails to allocate resources e ciently, or provide the quantity and
combination of goods and services mostly wanted by society
public goods: goods that are non-rivalrous and non-excludable so rms don’t have the
incentive to produce it
GOVERNMENT INTERVENTION
- provide the public good themselves through the money of the tax payers / fund
provision to spread the cost over a large number of people
Merit goods: goods that are held desirable for the consumer, but which are under provided
by the market.
positive externalities / consumers with low incomes cannot a ord it / consumer ignorance
doesn’t know about the bene ts
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GOVERNMENT INTERVENTION
government will attempt to increase the supply and consumption of the good depending on
how important the government thinks the good is
- Government will subside them until they are available at no direct cost to the consumer
(cost shared amongst tax payers)
Demerit goods: goods that are undesirable for consumers and are over provided by the
market
GOVERNMENT INTERVENTION
- government could make laws / making them illegal / ban them completely
may lead to a black market - attracted by the chance to make pro ts by ful lling existing
demand
Marginal social cost: MPC plus minus any external external costs or bene t of production
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If no externalities exist: MSC = MPB
GOVERNMENT INTERVENTION
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Pass laws:
Issues:
- Once they are issued: rms can trade, sell, and buy the permits on the market
Issues:
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GOVERNMENT INTERVENTION
Issue:
- di cult for the government to estimate the level of subsidy deserved by every rm
- setting up centres
Issue:
example: cigarettes
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GOVERNMENT INTERVENTION
Indirect tax
- Shift MSC curve upwards to MSC + tax / reducing consumption to socially e cient level
Provide education
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GOVERNMENT INTERVENTION
Subsides
Issue:
Positive advertising
Issue:
Pass laws:
common access resources: resources that are not owned by anyone, do not have a price
and are available for anyone to use without payment. Their depletion leads to environmental
unsustainability.
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Nature of resource: inability to charge for them may encourage overuse or over
consumption
marginal utility: extra satisfaction that a person gets by consuming one more unit of a
good or service
- It’s in the interest to each individual to take as many sh as they want, because each sh
adds marginal utility
Bene ts to the individual > external costs:incentive for individual to keep using the resource
sustainability: consumption needs of the present generation are met without reducing the
ability to meet the needs of future generations
developing countries: weak regulations result in massive negative externalities and a treat
to sustainability / rely on common access resources to sustain themselves - due to over-
consumption less income
- loss of forests: too many resources will be allocated to the production of these wood
products (seen through negative externalities)
GOVERNMENT INTERVENTION
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IMPERFECT COMPETITIO
IMPERFECT INFORMATION
- producer has more information than the consumer / charges a high price than is socially
e cient / too many resources have been allocated to the good
- consumer has more information / pays a lower price than the socially e cient price / too
few resources are allocated to the good
example: insurance
Adverse selection: buyers of insurance have more information about the themselves than
the seller / buyers of insurance know more about the state of their health than sellers of
insurance
Moral hazard : where one party takes risks, yet doesn’t face the full costs of these risks /
set limits to the issues that can go wrong
GOVERNMENT INTERVENTION
- improve ow of information
- set regulations to producers of taking advantage of lack information / expensive and not
possible for all sectors of the economy
IMPERFECT COMPETITION
monopolists: restrict the output in order to push up prices and maximise pro ts
-Pro t maximisation: MC = MR
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- Loss of producer surplus
GOVERNMENT INTERVENTION
- paw laws: do not permit mergers or take overs that give a rm / more than a certain
personage of the market
- set up regulatory bodies: investigate markets where monopoly power is felt / against the
interest of the public
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