Microeconomics IB cheatsheet
Law of demand
Demand: the quantity of a good or service that consumers are willing and able to purchase at a given price in a particular time period
Law of demand: quantity demanded increases when prices decrease and vise versa
Income effect: lower price = higher income = higher demand
Substitution effect: consumers replace higher priced products with lower priced ones.
Diminishing marginal utility: as consumption increases, the satisfaction gained from consuming one additional unit of a product decreases.
The demand curve illustrates an inverse relationship which explores how an increase in price leads to a decrease in the quantity demanded
Non price determinants of demand
Future price expectations
Tastes and preferences
Price of related goods (substitutes)
Price of related goods (complementary)
Number of consumers
Law of supply
Supply: quantity of goods and services that firms are willing and able to sell at any given price
Law of supply: As price increases, supply increases
Diminishing marginal returns: after some optimal level of capacity is reached, adding an additional factor of production will actually result in smaller increases in output
Increasing marginal costs: firms are willing and able to increase production only if they receive a higher price for the additional units of output.
An increase in the price of tuna fish provides an incentive on producers to spend more time and effort to catch or farm tuna fish.
Non price determinants of supply
Costs of factors of production
Price of related goods
Future price expectations
Changes in technology
Competitive market equilibrium
Market equilibrium: When the quantity demanded for a product is equal to the quantity supplied of the product
Equilibrium price: the point where the demand for the product matches the supply of the product
Market disequilibrium: when the quantity demanded for a product is either higher or lower than the quantity supplied for the product
Excess supply: e price of a product is set above equilibrium price, creating a surplus in the market represented by the higher quantity supplied than demanded
Excess demand: price for a product is set below equilibrium price, resulting in a higher demand and a lower supply
Functions of the price mechanism
The price mechanism: the interactions between buyers and sellers in order to allocate resources, therefore determining production and consumption choices
Signalling function: aspect of the price mechanism that signifies to producers and consumers where resources are required
Incentive function: as price changes, the mechanism provides an incentive for producers and consumers to change their behaviour in order to maximize their benefits
Rationing function: Higher prices, lower the quantity demanded therefore helping to preserve the good or service
Consumer: Benefit to buyers who can purchase the product at a lower price than they were willing and able to pay
Producer: Benefit to firms who receive a price that is higher than the price at which they were willing to supply at
Social: Sum of consumer and producer surplus at a given market price and output, thereby maximizing economic welfare
Socially optimum situation that occurs when resources are distributed in a way that allows consumers and producers to gain the maximum benefit
Rational consumer choice
decision-making process based on the assumption that people make choices that result in the optimal level of benefits
Biases (rule of thumb, anchoring, framing and availability)
Bounded self control
Choice architecture: the deliberate design of different ways of presenting choices to members of society, and the impact of these methods on decision-making.
Nudge theory: the practice of influencing the choices that people make. Nudges are created by choice architects using small prompts or tweaks to alter social and economic behaviour, but without taking away the power for people to choose.
profit maximization: Sales level where profits are the highest
CSR: commit ethical objectives to benefit stakeholders
Market share: a firm's portion of the total value of sales revenue
Satisfaction: aim for a satisfactory or adequate level or profit
Growth: increasing the size and scale of operations of a firm
Price elasticity of demand
The responsiveness of quantity demanded for a good in relation to a change in the price for the product
Price elastic: if a slight change in the price or income leads to a large change in the demand for the product.
Price inelastic: if a change in price or income has little impact on the demand for a good or service.
Formula: PED = % change in QD / % change in price
DEGREES OF PED VALUES
PED > 1 → price elastic demand
PED < 1 → price inelastic demand
PED = 0 → perfectly price inelastic demand
PED = ∞ → perfectly price elastic demand
PED = 1 → unitary elastic demand
Price elasticity of supply
The degree of responsiveness of quantity supplied of a product due to a change in its price
Formula: PES = % change in quantity supplied / % change in price
DEGREES OF PES VALUES
PES > 1 → price elastic supply
PES < 1 → price inelastic supply
PES = 0 → perfectly price inelastic supply
PES = ∞ → perfectly price elastic supply
PES = 1 → unitary elastic supply
Income elasticity of demand
The degree of responsiveness of demand following a change in income
Formula: YED = % change in QD / % change in income
YED + < 1 → normal goods
YED + > 1 →Luxury goods
YED - → Inferior goods
YED Engel curve
The engel curve is used to demonstrate the relationship between income and the quantity demanded
Reasons for government intervention
Earn government revenue
Support households on low incomes
Influence the level of production
Influence the level of consumption
To correct market failure
Main forms of government intervention
Government regulations establishing a maximum or minimum price to be charged for certain goods and services. They consist of price ceilings and price floors.
price ceilings: limits the maximum price in order to encourage output and consumption.
Price floor: binding minimum price in order to encourage production and supply
A government levy or charge on the sale of goods and services, rather than on incomes or wealth.
specific: charge a fixed amount of tax per unit sold
Ad valorem: impose a percentage tax on the value of a good or service.
a sum of money granted to help keep the price of a commodity or service low.
Government provides certain goods and services deemed to be in the best interest of the public.
Market failure - externalities main terms
Market failure: when the signalling, incentive and rationing functions of the price mechanism fail to operate optimally, which leads to a loss in economic welfare. It is when there is a misallocation of resources
private benefits: advantages or gains of production and consumption enjoyed by an individual firm or person.
Private costs: actual expenses incurred by an individual firm or person
Social benefits: benefits of consumption or production, that is, the sum of private benefits and external benefits
Social costs: costs of consumption or production, that is, the sum of private costs and external costs
MPB: additional value enjoyed by households and firms from the consumption or production of an extra unit of a particular good or service.
MPC additional expense of production for firms or the extra charge paid by customers for the output or consumption of an extra unit of a good or service
MSB: total gains to society from an extra unit of production or consumption of a particular good or service
MSC total expenses to society from an extra unit of production or consumption of a particular product
The external costs or benefits of an economic transaction, causing the market to fail to achieve the socially optimal level of consumption and production
Positive consumption: When consuming a good or service, provides a benefit to an unrelated third party
Positive production: the positive effect an activity imposes on an unrelated third party
Negative consumption: when consuming a good causes a harmful effect to a third party
Negative production: the production process results in a harmful effect on a third party.
INTERVENTION TO CORRECT EXTERNALITIES
Indirect taxes, carbon taxes, education, international agreements, subsidies, direct provision
Collective consumption goods that have two key characteristics of being non rivalrous and non excludable
Non rivalrous: a person’s consumption of a public good does not limit the benefits available to other people.
Non excludable: firms cannot exclude people from the benefits of consumption
FREE RIDER PROBLEM
When people have access to a good or service without having to pay for it. As a result, the good or service will be under provided or not provided at all in the free market
A source of market failure that exists when one economic agent (buyer or seller) has more information than the other in an economic transaction. It occurs owing to incomplete information or inaccessibility to information.
Adverse selection: the undesired decisions or outcomes that occur when buyers and sellers have access to imperfect information.
Moral hazard: situation where a party protected from risk behaves differently than if they were fully exposed to the risk.
Responses to asymmetric information
Provision of information
Signalling: used by parties with access to more information to maximize their own level of satisfaction
Screening: used by parties with access to less information to maximize their own level of satisfaction
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