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Micro economics cheat sheet Cheat Sheet by

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
ASSUMP­TIONS
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.

Demand curve

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
Income
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
ASSUMP­TIONS
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.

Supply curve

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
Indirect taxes
Subsidies
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

Surpluses

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

Allocative efficiency

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
ASSUMP­TIONS
Consumer ration­ality
Utility maximi­zation
Perfect inform­ation
LIMITA­TIONS
Biases (rule of thumb, anchoring, framing and availa­bility)
Bounded ration­ality
Bounded self control
Bounded selfis­hness
Imperfect inform­ation

Behavi­oural economics

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.

Business objectives

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 SIGNS
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 firms
Support households on low incomes
Influence the level of production
Influence the level of consum­ption
To correct market failure
Promote equity

Main forms of government interv­ention

PRICE CONTROLS
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
INDIRECT TAXES
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.
SUBSIDIES
a sum of money granted to help keep the price of a commodity or service low.
DIRECT PROVISION
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

Extern­alities

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

Public goods

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

Asymmetric inform­ation

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

GOVERNMENT RESPONSES
legisl­ation
Provision of inform­ation
PRIVATE RESPONSES
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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