A full summary of the Microeconomics section within the IB diploma. Closely linked to the textbook and curated by many students, all of which have received a 7 in the course. It has been updated to the new syllabus and guarantess a 7.
Unit 2: Microeconomics ..................................................................................................................... 2
Chapter 2: Competitive markets: Demand and supply ................................................................. 2
2.1 Introduction to competitive markets .................................................................................. 2
2.2 Demand ................................................................................................................................ 2
2.3 Supply ................................................................................................................................... 4
2.4 Competitive market equilibrium: demand and supply ....................................................... 6
2.5 The role of the price mechanism and market efficiency .................................................... 8
2.6 critique of the maximising behaviour of consumers and producers ................................ 10
Chapter 3: Elasticities ................................................................................................................... 15
3.1 - Price elasticity of demand (PED)...................................................................................... 15
3.2 - Income Elasticity of Demand (YED) ................................................................................. 17
Chapter 4: Government intervention in microeconomics .......................................................... 19
4.1 Government intervention in markets................................................................................ 19
4.2 Price controls ...................................................................................................................... 21
4.3 indirect taxes ...................................................................................................................... 24
4.4 Subsidies ............................................................................................................................. 25
Chapter 5: Market failure and socially undesirable outcomes 1 ................................................ 27
4.1 The meaning of common pool resources .......................................................................... 27
5.2 Market failure and externalities: diverging private and social benefits and costs .......... 27
5.3 Negative production externalities ..................................................................................... 28
5.4 Negative consumption externalities.................................................................................. 31
Chapter 6: Market failure and socially undesirable outcomes 2 ................................................ 32
6.1 positive production externalities....................................................................................... 32
6.2 Positive consumption externalities ................................................................................... 33
6.3 Market failure and public goods ........................................................................................ 34
6.4 Assymetric information...................................................................................................... 35
6.5 Equity in the distribution of income and wealth .............................................................. 37
Chapter 7: Market failure and socially undesirable outcomes 3 (market power) ..................... 37
7.1 introduction to firms, industries, and market structures ................................................. 37
7.2 Profit maximisation by the rational producer................................................................... 38
7.3 Perfect competition............................................................................................................ 41
7.4 Monopoly ........................................................................................................................... 42
7.5 Monopolistic competition.................................................................................................. 45
7.6 Oligopoly............................................................................................................................. 46
7.7 Government intervention in response to abuse of market power .................................. 47
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Unit 2: Microeconomics
Chapter 2: Competitive markets: Demand and supply
2.1 Introduction to competitive markets
Markets
o The nature of markets
A market originally was a place where people gathered to buy and sell goods
The term market has since evolved to include any kind of arrangement
where buyers and sellers of goods, services or resources are linked together
to carry out an exchange.
Goods and services are sold in product markets, while resources (factors of
production) are sold in resource markets (factor markets)
o The meaning of a competitive market
Competition – understood as a process in which rivals compete in order to
achieve some objective.
For example, firms may compete over who will sell the most output
Consumers may compete over who will buy a scarce product
Workers compete over who will get the best jobs with the highest
salaries
Countries compete over while will capture the biggest export
markets
Competitive markets – composed of sellers and buyers acting
independently, so that no individual seller or small group of sellers has the
ability to control the price of the product sold.
2.2 Demand
Understanding the law of demand and the demand curve
o Demand – is concerned with the behaviour of the buyers.
o Individual demand
The demand of an individual consumer indicates the various quantities of a
good the consumer is willing and able to buy at different possible prices
during a particular time period, ceteris paribus.
Consumer demand is affected not only by price, but also by income, tastes,
and prices of related goods.
The demand curve only tells us the ammoutn of a good the consumer would
be prepared to buy, depending on the price
o The law of demand
Illustrates a crucial relationship: as the price of a good falls, the quanitity of
the good, demanded increases.
According to the law of demand, there is a negative relationship between
the price of a good and its quantity demand over a particular time period,
ceteris paribus
As the price of the good increases, quantity demanded falls
As the price falls, quanity demand increases, ceteris paribus
o From individual demand to market demand
Market demand – is the sum of all individual demands for a good. The
market demand curve illustrates the law of demand, shown by the negative
relationship between price and quantity demanded.
Non-price determinants of demand and shifts of the curve
o Non-price determinants
, 3
Non-price determinants – are the variables other than price that can
influence demand.
Changes in non-price determinants of demand cause shifts in the demand
curve (right or left)
A rightward shift of the demand curve indicates that more is
demanded for a given price
A leftward shift of the demand curve indicates that less is demanded
for a given price.
The non-price determinants of market demand include:
Income in the case of normal goods – when demand for it increases
in response to an increase in consumer income (most goods are
normal). An increase in income leads to a rightward shift in the
demand curve.
Income in the case of inferior goods – for inferior goods the
demand falls as consumer income increases (EX second-hand
clothing)
Preferences and taste – if preferences change in favour of a good
then the demand will increase
Prices of substitute goods – Two goods are substitutes if they satisfy
similar needs. A fall in the price of one, results in the fall in demand
for another
Prices of complementary goods – two goods are complementary if
they tend to be used together. A fall in price of one lead to an
increase demand for the other (rightwards shift).
The number of consumers – If there is an increase in the number of
consumers (demanders), demand increases (rightward shift)
o Movement along the demand curve
Any change in price produces a change in the quanitity demanded, shown as
a movement on the demand curve. Any change in a non-price determinant
of demand leads to a change in demand, represented by a shift of the entire
demand curve.
Assumptions underlying the law of demand
o The law of diminishing marginal utility
Based on a simple theory of consumer behaviour that explains the negative
relationship between price and quanitity demanded
Utility is the Satisfaction the consumers gain from consuming something.
Utility cannot be measured, but for the purpose of developing the theory we
assume that utility is quantifiable (using the unit Utils)
Total utility – the total satisfaction the consumers get from
consuming something
Marginal utility – the extra satisfaction that consumers receive from
consuming one more unit of a good.
According to the law of diminishing marginal utility, as consumption of a
good increases, marginal utility, or extra utility consumers receive,
decreases with each additional unit consumes. This underlies the law of
demand, as it shows that a consumer will be willing to buy an additional unit
of a good only if its price falls.
o The income and substitution effects
Are an alternative explanation for the law of demand
, 4
The substitution effect: If the price of a good falls, the consumer
substitutes (buys more) of the now less expensive good. Hence,
quantity demanded increases. There is always a negative
relationship between price and quantity demanded as a result of the
substitution effect.
The income effect: Consider again a fall in price. This means that the
consumer’s real income (or purchasing power) has increased. As
price falls and real income increases, quantity demanded of the
good increases. Once again there is a negative relationship between
price and quantity demanded.
o The income effect becomes important only if the good
purchased takes up a large fraction of income.
The substitution and income effect reinforce eachother: a fall in price leads
to an increase in quantity demanded.
(Note that the above analysis refers to normal goods)
2.3 Supply
Understanding the law of supply and the supply curve
o Supply is concerned with the behaviour of sellers, which include firms in the product
market and households in the resource market
o Individual supply
The supply of an individual firm indicates the various quantities of a good (or
service) a firm is willing and able to produce and supply to the market for
sale at different possible prices, during a particular time period, ceteris
paribus
The supply information tells us only how much of a good the firm would be
prepared to produce and sell at a certain price
o The law of supply
According to the law of supply, there is a positive relationship between the
quantity of a good supplied over a particular time period and its price,
ceteris paribus
As the price of the increases, the quantity of the good supplied also
increases
As the price falls, the quantity supplied falls, ceteris paribus
o From individual to market supply
Market supply is the sum of all individual firms’ supplies for a good. The
market supply curve illustrates the law of supply, shown by a positive
relationship between price and quantity supplied.
o The vertical supply curve
Under certain special circumstance the supply curve is vertical at some point
particular fixed quantity.
A vertical supply curve tells us that even as price increases, the quantity
supplied cannot increase. The quantity supplied is independent of price.
There are two reason why this may occur:
There is a fixed quantity supplied because there is no time to
produce more of it. (Tickets to a theatre)
There is a fixed quantity of the good because there is no possibility
of ever producing more. (An original painting of an artist)
Non-price determinants of supply and shifts of the supply curve
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