Year 1

Microeconomics
Knowledge organisers

NAME:

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 Introduction
Purpose of economic activity Production possibility
THE PRODUCTION OF GOODS AND SERVICES TO SATISFY WANTS diagrams

to Economics
AND NEEDS AKA PPF (PRODUCTION POSSIBILITY FRONTIER) OR
The key economic decisions are: PPC (PRODUCTION POSSIBILITY CURVE)
PPFs show the maximum combinations of goods that can be produced

1 2 3
What to How to For whom to given current resources and technology
economic Methodology
produce produce it produce it
STRAIGHT PPF CURVED PPF
Factors equally Factors not equally
How these 3 questions are answered determines the type of economy ECONOMICS IS A SOCIAL SCIENCE
successful at making successful at making both
Answered by Answered by both goods goods
market forces government
Constant opportunity Increasing opportunity cost
H um
cost
Free Market o f unp a ns a
Mixed Command (Planned) e d re d r
Economy U s r o l l e n ts ic ta e
Economy Economy n t e b le Economic growth Resource depletion is
c o e r im Use of data
comes from an where quantity of
p
ex Theories increase in quantity
economic resources
d resources falls
Controlle or productivity of Resource depreciation
Hypotheses m e n ts
FACTORS OF PRODUCTION ARE INPUTS INTO THE PRODUCTION PROCESS experi factors of is where resources are
very
Ha ‘Laws’ ing production worn down
FACTOR ( e . rd la w challeng
DEFINITION EXAMPLE gl s Use of models
PAYMENT g ra a w o The opportunity cost of gaining 40 units of A is
v it f
y) Soft laws giving up 20 units of B
Natural physical inputs f
Wood (e.g law o
LAND which are used up in Rent
Gold d e m a nd ) 1 = productively inefficient
production 2 and 3 = productively efficient
4 = impossible to sustain with
The exertion (physical Bakers current resources
LABOUR
and mental) of workers Teachers
Wages POSITIVE STATEMENTS NORMATIVE STATEMENTS
Objective Subjective
VS
Can be proved right Value judgement
Productive efficiency is where resources are
Used to make other or wrong Can’t be proven
Laptops produced at the lowest possible cost
CAPITAL goods which are not Interest
Machinery
used up in production
Allocative efficiency is where the resources
Organiser factors of Both are needed for decision making produced optimise economic welfare
Sara Blakely
ENTERPRISE production Profit
Alan Sugar
Taker of risks Economists use models: simplified frameworks
based on a set of assumptions. All points on the PPF are productively efficient but only one is
allocatively efficient
The Economic ProbleM Ceteris Paribus means ‘all else equal’.
SCARCITY OCCURS BECAUSE WE HAVE FINITE RESOURCES AND INFINITE WANTS It is an assumption which helps us to Specialisation
isolate the effect of a change.
Because of scarcity, we have to make choices about how we use our FOCUSSING ON ONE TASK OR PRODUCT
resources. We assume economic actors are rational and make choices to POTENTIAL PROS: POTENTIAL CONS:
maximise: Higher productivity Boring for workers
utility (consumers) profits (firms) society’s welfare (government) Microeconomics Macroeconomics Higher pay Difficult to monitor productivity
More profit for investment Workers have less pride in
In making these choices, they have to consider the opportunity cost: Looks at prices Looks at general Lower prices their work
and quantities of price levels and Better use of scarce resources Less flexible
The value of the next best alternative foregone individual goods total output of all Less occupational mobility
and services goods and services Productivity = Less synergy
The net benefit – (e.g GDP) output per unit of input
2nd choice only! Given up
it’s subjective!
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 Market Demand
THE TOTAL QUANTITY OF A GOOD OR SERVICE THAT
CONSUMERS ARE WILLING AND ABLE TO CONSUME
Markets Market Supply
THE TOTAL QUANTITY OF A GOOD OR SERVICE THAT FIRMS ARE
WILLING AND ABLE TO PRODUCE
The law of demand:
Price Mechanism The law of supply:
As price increases, quantity demanded decreases HELPS US TO ALLOCATE SCARCE RESOURCES As price increases, quantity supplied

As we consume Reasons for law of demand
more units, the
additional utility from
each unit decreases
1.
Signalling - Rising or falling prices in response to shortages or
Reasons for law of supply
surpluses signal that level of production and consumption need to
1. Law of diminishing change 1. Law of diminishing
marginal utility Rationing - When there is a shortage, prices rise to ration the
2.
As we add additional marginal returns
scarce resource by allocating it to those with the highest inputs, the additional
2. Income effect 2. Profit motive
willingness and ability to pay output from they

3.
3. Substitution effect produce decreases 3. New entrants
Incentive - Rising prices following a shortage gives an incentive
for firms to increase production or to enter the market
Causes of demand curve shifts
If price is too high If price is too low
Population changes – more or fewer people to sell to there is a surplus there is a surplus Costs of Ease of

I ncome – the disposable income consumers have

production production

R elated goods – price of complements and substitutes

Market
forces bring Causes of

Advertising – how aware consumers are of the good us back to supply curve
shifts
T astes – how fashionable the good is
equilibrium
Profits in
Expectations – what people think will happen to the price
Productivity
other

S easons – changes due to the time of year

markets

Consumer Surplus

+
Consumer Surplus: Allocative efficiency Producer Surplus:
:The difference between the is achieved when we :The difference between the
price a consumer is willing to Producer Surplus price a firm is willing to sell at
maximise Economic
=
pay and what they actually pay Welfare and what they actually sell at
Economic Welfare

Interrelated markets a.k.a

Shifts and slides
extension Quantity

Outwards shift
Demand
demanded VS

Expansion
increases
increases
Joint Demand Competitive Demand Derived Demand Composite Demand Joint Supply
Quantity
Demand for Demand for substitutes, Supply of by-products ie Supply
Demand for one good Demand for two goods supplied VS
complements, ie two ie two goods which can the production of one increases
because it is an input for which share the same increases
goods which are be purchased instead of good also produces
another input(s)
consumed together one another another
Quantity
Demand
demanded VS

Inwards shift
Contraction
Demand for Good A↑ Demand for Good A↑ Price of Good A↑ Supply for Good A↑ Supply of Good A↑ decreases
decreases
Demand for Good B↑ Demand for Good B↓ Supply of Good B↓ Supply of Good B↓ Supply of Good B↑
Quantity
e.g. Butter and Cheese e.g wool and lamb Supply
e.g. Dogs and Dog Food e.g. Tea and Coffee e.g. Wheat and Bread supplied VS
(from milk) (from sheep) decreases
decreases
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 Elasticity
Price elasticity of demand Price elasticity of Supply
THE SENSITIVITY OF DEMAND TO CHANGES IN PRICE THE SENSITIVITY OF SUPPLY TO CHANGES IN PRICE
(AKA PED) When we increase (AKA PES) When we
price by 1%, what % change in quantity supplied increase price by
% change in quantity demanded
PED =
% change in price
happens to
demand? AKA SENSITIVITY PES =
% change in price
1%, what happens
to supply?

ELASTIC VS INELASTIC
Demand becomes less price elastic as we
Relatively Sensitive Relatively Insensitive
move down the curve Perfectly price
elastic
PES = ∞
Perfectly REVENUE AND PED
price
inelastic Price elastic Price inelastic
PED = 0 demand demand Unit elastic
PRICE ELASTIC
PES =1 PRICE INELASTIC
SUPPL Y
PRICE ELASTIC When price SUPPLY
PRICE INELASTIC rises…
Revenue falls Revenue rises
DEM AN D
Unit DEMAND
elastic When price Perfectly
Revenue rises Revenue falls price
PED =-1 falls…
inelastic
PES = 0
Price change with Price change with
Perfectly
more price elastic more price inelastic
price
demand demand PERFECTL Y PRICE PERFECTL Y PRICE
elastic PERFECTL Y PRICE PERFECTL Y PRICE ELASTIC SUPPLY INELASTIC SUPPL Y
PED = -∞ ELASTIC DEMAND INELASTIC DEMAND

DETERMINANTS OF PED DETERMINANTS OF PES

S P L A T
Number of Proportion Degree of How addictive Time period
substitues of income Luxury the good is Capacity Substitutability Storability Time period
of inputs

Income elasticity of demand Cross price elasticity of demand

THE SENSITIVITY OF DEMAND TO THE SENSITIVITY OF DEMAND OF GOOD A TO
CHANGES IN INCOME (AKA YED) CHANGES IN THE PRICE OF GOOD B When we increase the
price of good B by
When we increase income (AKA XED) 1%, what happens to
% change in quantity demanded by 1%, what happens to demand?
YED = demand? % change in quantity demanded of good A
% change in income XED =
% change in price of good B

Normal goods: Inferior goods:

Demand increases when income Demand decreases when income
Substitutes: Complements:
increases increases
Two goods which can be Two goods which are
Luxury goods: Necessity goods: purchased instead of one consumed together,
Demand increases by a smaller % another, e.g tea and coffee e.g dogs and dog food
Demand increases by a bigger
% than income than income
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*According to the laws of supply and demand
 Market
Price Mechanism Externalities
HELPS US TO ALLOCATE SCARCE RESOURCES THIRD PARTY EFFECTS OUTSIDE THE MARKET

Failure
TRANSACTION

+ =
Signalling - Rising or falling prices in response to
1. shortages or surpluses signal that level of production Private Costs External Costs Social Costs

+ =
and consumption need to change

Rationing - When there is a shortage, prices rise to

WHERE MARKETS LEAD TO A Private Benefits External Benefits Social Benefits
2. ration the scarce resource by allocating it to those MISALLOCATION OF RESOURCES Costs and benefits may occur outside of the market
with the highest willingness and ability to pay
transaction because of an absence of property rights –
Incentive - Rising prices following a shortage gives an
3. incentive for firms to increase production or to enter
Complete Partial Market Failure since no-one owns the air or the water, those affected
Market Failure Where market exists but by changes to them are out of the market transaction.
the market Leads to a result in a suboptimal
missing market quantity of production or External
Welfare Loss
consumption Cost/Benefit

NON- NEGATIVE PRODUCTION POSITIVE PRODUCTION

EXCLUDABLE EXCLUDABLE MSC > MPC MPC > MSC
Merit and Demerit
You can stop
P P
someone else You can’t stop MSC MPC
QUASI-
Goods
consuming it someone else MPC
RIVAL Public consuming it MSC

One person’s Goods NON-RIVAL Merit Goods are goods Demerit goods are goods
which are beneficial for which are harmful for
consumption One person’s MSB=MPB
society yet are often society and are often MSB=MPB
affects consumption underconsumed in the free overconsumed in the free Q
another’s doesn’t affect market. There may be Q
market. There may be
another’s Overproduction Underproduction
positive externalities or negative externalities or
imperfect information. imperfect information.
NEGATIVE CONSUMPTION POSITIVE CONSUMPTION
Public goods result in missing markets because of the HOWEVER… MSB > MPB
free-rider problem: since people cannot be excluded MPB > MSB P
Not all goods with positive externalities are merit P
from consuming without paying, there is no incentive MSC=MPC MSC=MPC
goods and not all goods with negative externalities are
for firms to provide the good.
demerit goods. Determining which goods are merit or
demerit goods requires value judgements.
The Tragedy of the Commons is the tendency for MPB MSB
common access resources (goods which are non
excludable but rival) to be overconsumed, degraded Other Market MSB MPB

IMPERfections
and depleted
Q Q
Overconsumption Underconsumption

IMPERFECT INFORMATION INFORMATION ASYMMETRY INEQUALITY MONOPOLY POWER

When consumers and/or
FACTOR IMMOBILITY
One party in a transaction If people cannot afford basic When there are only a few firms in Market failure can occur if inputs can’t be utilized where they
producers do not have needs, those goods won’t be
knowing more than another a market, they each have power need to be. This can be geographic immobility (where factors
enough information to efficiently allocated
can result in market failure to raise prices and restrict quantity can’t move between geographic locations) or occupational
make optimal decisions
below optimum immobility (where factors can’t move between jobs)

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 Government
Reasons for government Direct State Provision
intervention COMMONLY APPLIED TO MERIT GOODS. TO ENCOURAGE CONSUMPTION

Intervention
• Correct market failure
AND IMPROVE ACCESS
These goods or services are typically free at the point of
• Improve equity
consumption and then paid for via taxes. This may involve:
• Improve productive capacity
Regulation
• Nationalising the industry
• Achieve macroeconomic objectives
• Provision via local government
• Raise revenue APPLYING RULES TO PRODUCTION OR CONSUMPTION • Contracting out to private firms
• Change patterns of production and consumption
This might involve: Alternatively, governments might provide information
Indirect taxes • Banning Regulations
Subsidies
• Quality or specification control work best
COMMONLY APPLIED TO DEMERIT GOODS TO DISCOURAGE CONSUMPTION • Compulsory consumption when they are COMMONLY APPLIED TO MERIT GOODS TO ENCOURAGE CONSUMPTION
AND PRODUCTION. • Rules on labelling well designed AND PRODUCTION
Indirect taxes: compulsory charges on goods and services, levied by • Licensing and well
Subsidy: payment from government to producer (or consumer) to
government • Age restrictions enforced
reduce the cost of a good
PROS: CONS: PROS: CONS: PROS: CONS:
Raises revenue for Consumption won’t fall Provides governments Lose the benefits of the Raises consumption Consumption won’t rise
government to correct much if demand is inelastic with some certainty market mechanism More affordable so improve much if demand is inelastic
market failure Difficult to judge level of Relatively low cost for Less freedom for consumers equity Difficult to judge ideal level
Reduces consumption taxation government and firms Uses the market mechanism of subsidy
Uses the market Can affect international Can be expensive for
tradeable permits
thus still providing incentives
mechanism thus still competitiveness and choices government
providing incentives and Can be regressive Improves international Could be seen as
choices
USED TO CREATE MARKETS FOR THE RIGHT TO POLLUTE protectionism
competitiveness
The regulator decides Permits allow firms
how many permits to to pollute a certain
If demand is more
distribute . amount. If demand is more
price elastic than
supply, producer tax price elastic than
incidence is greater. If a firm has more
supply, producers
If a firm has fewer
permits than it benefit more.
permits than it
If supply is more price needs, it sells them needs, it buys them
elastic than demand, If supply is more
consumer tax PROS: CONS: price elastic than
incidence is greater. Provides Difficult to monitor demand, consumer
governments with Unpredictable benefit is greater.
some certainty costs for firms
Efficient Distributing initial

Price controls
Dynamic permits ‘fairly’ is

MAXIMUM PRICES
difficult Government failure
MINIMUM PRICES
WHERE GOVERNMENT INTERVENTION REDUCES ECONOMIC WELFARE
• Legal price ceilings • Legal price floor
• Typically set below the • Typically set above the Admin and
Lack of
equilibrium price P Min equilibrium price enforcement
information
• Used to make goods more • Used to make goods less costs
affordable affordable or to support
Causes of
• Leads to shortages producers
government
• Reduces production • Leads to a surplus
Market failure. Regulatory
• May lead to poor quality, • Reduces consumption
distortions capture
low investment and black • Governments may need to
markets step in to buy excess

Unintended Consequences
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Rational decision making
TRADITIONAL ECONOMICS ASSUMES RATIONAL DECISION MAKING, BASED
ON MARGINAL CHANGES.
Marginal decision making
looks at the cost and
benefit of an additional
unit (ie instead of deciding
whether to eat donuts or
not, a person decides
whether or not to eat an
extra donut)
TOTAL UTILITY - the total satisfaction gained from all units
MARGINAL UTILITY - additional satisfaction gained from
Quantity
Total Marginal
of
Utility Utility
doughnuts
1 9
2 15
3 17
4 17
5 16
Consumer
Applications of
behavioural economics
behaviour
BUSINESSES AND GOVERNMENTS CAN USE THESE INSIGHTS TO
A rational decisio n is one that is
CHANGE OUTCOMES
made based on logical and They may encourage certain behaviours using:
clear reasoning, aiming to
Choice architecture
maximise utility (consumers) or
Behavioural economics
The way in which choices are
profits (firms). Economic
presented (e.g the order, arrangement,
agents are incentivised to pick
presence or absence of choices)
the option which provides most While Traditional Economics assumes that economic
utility. actors always make rational decisions, Behavioural
Economics questions this assumption Framing
How a question/information is presented
This is because… to influence the perceptions of the
We lack full information and even if we do, it is costly
decision.
consuming one more unit
i and time consuming to obtain and process.
Default choice
A pre-set option is chosen unless an
We have limited cognitive capacity so we rely on
The second donut active decision in made
doesn’t give us quite heuristics (rules of thumb) and habits.
the same level of E.g. we might assume the largest package of a certain
satisfaction as the
9 9 product is the best value for money Restricted choice
first.
Limiting the options to choose from to
6 9 6
We have biases. prevent decision fatigue
By the 5 th
2 9 6 2 donut, we e.g. Anchoring Bias – where we rely to heavily on the
start to feel first piece of information we receive
0 9 6 2 0 sick… Availability bias – tendency for people to base their Mandated choice
judgements on only readily available information Requiring a decision to be made
-1 9 6 2 0 -1
We have habits: we make the same choices even if
we get more information or if the situation changes.
Nudges
THE LAW OF DIMINISHING This is called inertia. Nudges are small changes to the environment of a
MARGINAL UTILITY: decision that encourage someone to act a certain way
As more of a good or service We are affected by others: whilst still preserving freedom of choice. These changes
is consumed, the additional • Social norms (unwritten rules of behaviour in society) would not influence the behaviour of completely rational
satisfaction derived from can require us to do things that are not of any benefit humans.
each additional unit (e.g covering our mouths when we yawn)
Altruism and perceptions of fairness means we may
They are an alternative to other forms of government
decreases. •
act in a way beneficial for others even if it does not intervention.
This implies that consumers are benefit us
willing to pay less for each • Herd mentality means we may follow the crowd PROS: CONS:
additional unit of the good or instead of making our own decisions Relatively cheap Could be considered
service they consume. Rarely unpopular manipulative
Preserves choice Context dependent, so
There is therefore an inverse We lack willpower, so even if we can identify the Fast-acting don’t always
relationship between price and rational choice, we might still take a different one Limited scope
quantity demanded.
Possible uses for Governments include reducing
This is one of the reasons why the smoking and speeding or encouraging tax compliance
demand curve is downward sloping This means our rationality may be ‘bounded’ – we may
or organ donation.
(more units, lower demand). satisfice rather than optimise
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