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Unit 2 Microeconomics

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  1. 2.1 Demand

    1. 2.1.1Law of demand

      • Demand shows the relationship between price and quantity demanded • Quantity demanded usually falls as price rises, ceteris paribus

    2. 2.1.2(HL)—Assumptions behind demand

      • Income and substitution effects help explain the law of demand • The law of diminishing marginal utility helps explain why consumers demand less at higher prices

    3. 2.1.3Demand curve

      • Demand can be represented by a downward-sloping demand curve • Diagram: downward-sloping demand curve

    4. 2.1.4Individual and market demand

      • Market demand is derived from individual consumers' demand • Demand analysis distinguishes individual behaviour from total market behaviour

    5. 2.1.5Non-price determinants of demand

      • Demand shifts with income, tastes and preferences, future price expectations, and number of consumers • Demand also shifts with prices of related goods, including substitutes and complements

    6. 2.1.6Movements and shifts in demand

      • A price change causes movement along a demand curve • Non-price determinants shift the demand curve • Diagram: movements along and shifts of the demand curve

  2. 2.2 Supply

    1. 2.2.1Law of supply

      • Supply shows the relationship between price and quantity supplied • Quantity supplied usually rises as price rises, ceteris paribus

    2. 2.2.2(HL)—Assumptions behind supply

      • The law of diminishing marginal returns helps explain rising production costs • Increasing marginal costs help explain the upward-sloping supply curve

    3. 2.2.3Supply curve

      • Supply can be represented by an upward-sloping supply curve • Diagram: upward-sloping supply curve

    4. 2.2.4Individual and market supply

      • Market supply is derived from individual producers' supply • Supply analysis distinguishes firm behaviour from total market behaviour

    5. 2.2.5Non-price determinants of supply

      • Supply shifts with factor costs, related goods prices, indirect taxes, subsidies, future price expectations, technology, and number of firms • Related goods include joint and competitive supply cases

    6. 2.2.6Movements and shifts in supply

      • A price change causes movement along a supply curve • Non-price determinants shift the supply curve • Diagram: movements along and shifts of the supply curve

  3. 2.3 Competitive market equilibrium

    1. 2.3.1Market equilibrium

      • Demand and supply curves form market equilibrium • Equilibrium price and quantity coordinate buyers and sellers • Diagram: market equilibrium

    2. 2.3.2Changes in equilibrium

      • Shifts in demand or supply create new market equilibrium • Excess demand causes shortages; excess supply causes surpluses • Diagram: changes in equilibrium and the role of the price mechanism

    3. 2.3.3Price mechanism

      • The price mechanism allocates resources through signalling and incentives • Rationing is another function of the price mechanism for scarce goods and services

    4. 2.3.4Consumer and producer surplus

      • Consumer surplus and producer surplus measure welfare gains in a market • Social or community surplus combines consumer and producer surplus • Diagram: consumer surplus and producer surplus as social or community surplus

    5. 2.3.5Allocative efficiency

      • Allocative efficiency occurs at competitive market equilibrium when social surplus is maximized • Marginal benefit equals marginal cost at the allocatively efficient output • Diagram: social or community surplus maximized at competitive market equilibrium

    6. 2.3.6(HL)—Surplus calculations

      • Calculate consumer surplus and producer surplus from a diagram

  4. 2.4 Critique of the maximizing behaviour of consumers and producers

    1. 2.4.1(HL)—Rational consumer choice

      • Rational consumer choice assumes consumer rationality, utility maximization, and perfect information • Behavioural economics critiques these assumptions • Limitations include rule of thumb, anchoring, framing, availability bias, bounded rationality, bounded self-control, bounded selfishness, and imperfect information

    2. 2.4.2(HL)—Behavioural economics in action

      • Choice architecture includes default, restricted, and mandated choices • Nudge theory uses behavioural insights to influence decisions

    3. 2.4.3(HL)—Business objectives

      • Firms may pursue profit maximization • Alternative objectives include corporate social responsibility, market share, satisficing, and growth

  5. 2.5 Elasticities of demand

    1. 2.5.1Concept of elasticity

      • Elasticity measures responsiveness between economic variables • Diagram: relatively elastic and relatively inelastic demand

    2. 2.5.2Price elasticity of demand

      • PED equals percentage change in quantity demanded divided by percentage change in price • PED has a theoretical range of values and indicates responsiveness of demand to price • Calculation: PED, change in price, quantity demanded, or total revenue from data

    3. 2.5.3PED diagrams and revenue

      • PED can be perfectly elastic, perfectly inelastic, unitary, elastic, or inelastic • PED affects total revenue when price changes • Diagram: constant PED cases and unitary PED along a demand curve • Diagram: revenue changes when demand is price elastic or price inelastic

    4. 2.5.4(HL)—PED along a straight-line demand curve

      • PED changes along a straight-line downward-sloping demand curve • Diagram [HL]: PED along a straight-line demand curve

    5. 2.5.5Determinants and importance of PED

      • PED depends on number and closeness of substitutes, necessity, income proportion, and time • PED matters for firm pricing and government decision-making

    6. 2.5.6(HL)—PED for primary commodities

      • Primary commodities generally have lower PED than manufactured products • Lower substitutability and necessity can reduce responsiveness

    7. 2.5.7Income elasticity of demand

      • YED equals percentage change in quantity demanded divided by percentage change in income • Positive YED identifies normal goods; negative YED identifies inferior goods • YED below one is typical of necessities; YED above one is typical of services and luxury goods • Diagram: income elastic, income inelastic, and inferior goods on an Engel curve • Calculation: YED, change in income, or quantity demanded from data

    8. 2.5.8(HL)—Importance of YED

      • YED helps firms predict demand changes after income changes • YED helps explain changes in the sectoral structure of an economy

  6. 2.6 Elasticity of supply

    1. 2.6.1Price elasticity of supply

      • PES equals percentage change in quantity supplied divided by percentage change in price • PES has a theoretical range of values and indicates responsiveness of supply to price • Calculation: PES, change in price, or quantity supplied from data

    2. 2.6.2PES determinants and diagrams

      • PES depends on time, factor mobility, unused capacity, ability to store, and rate of cost increases • Diagram: relatively elastic and relatively inelastic supply • Diagram: perfectly elastic, perfectly inelastic, and unitary PES along a supply curve

    3. 2.6.3(HL)—PES for primary commodities

      • Primary commodities generally have lower PES than manufactured products • Biological, seasonal, capacity, and storage constraints can limit responsiveness

  7. 2.7 Role of government in microeconomics

    1. 2.7.1Reasons for government intervention

      • Governments intervene to raise revenue, support firms, support low-income households, and influence production or consumption • Intervention can aim to correct market failure and promote equity

    2. 2.7.2Main forms of intervention

      • Main tools include price ceilings, price floors, indirect taxes, subsidies, direct provision, command and control regulation, and legislation • Diagram: price ceiling, price floor, indirect tax, and subsidy with effects on markets and stakeholders

    3. 2.7.3Consequences of intervention

      • Government intervention affects market outcomes and stakeholders • Consequences should be analysed and evaluated using efficiency, equity, and welfare criteria

    4. 2.7.4(HL)—Consumer nudges

      • Consumer nudges are a form of government intervention in markets • Nudges influence behaviour without banning choices or changing prices directly

    5. 2.7.5(HL)—Intervention calculations

      • Calculate effects of price ceilings and price floors on markets and stakeholders • Calculate effects of indirect taxes and subsidies on markets and stakeholders

  8. 2.8 Market failure - externalities and common pool or common access resources

    1. 2.8.1Socially optimum output

      • Social optimum occurs where marginal social benefit equals marginal social cost • Allocative efficiency maximizes social or community surplus • Diagram: allocative efficiency

    2. 2.8.2Externalities and welfare loss

      • Positive externalities of production or consumption create under-allocation without intervention • Negative externalities of production or consumption create over-allocation without intervention • Merit goods and demerit goods are linked to positive and negative externality cases • Diagram: market failure from negative production, negative consumption, positive production, and positive consumption externalities

    3. 2.8.3(HL)—Welfare loss calculation

      • Calculate welfare loss from an externality diagram

    4. 2.8.4Common pool resources

      • Common pool resources are rivalrous but non-excludable • The tragedy of the commons can cause unsustainable production and negative externalities

    5. 2.8.5Responses to externalities and common pool resource problems

      • Responses include Pigouvian taxes, carbon taxes, regulation, education, tradable permits, international agreements, collective self-governance, subsidies, and government provision • Diagram: government responses to externalities using Pigouvian taxes, carbon taxes, subsidies, legislation, regulation, and education • Diagram: carbon tax effects on a particular polluting industry

    6. 2.8.6Evaluating policy responses

      • Evaluation considers measurement challenges, policy effectiveness, and stakeholder consequences • International cooperation matters because sustainability issues are global • Monitoring and enforcement are major challenges in international cooperation

  9. 2.9 Market failure - public goods

    1. 2.9.1Public goods

      • Public goods are non-rivalrous and non-excludable • Free rider problems can prevent efficient market provision

    2. 2.9.2Government responses to public goods

      • Governments may directly provide public goods • Governments may contract provision out to the private sector

  10. 2.10 Market failure - asymmetric information

    1. 2.10.1(HL)—Asymmetric information

      • Asymmetric information occurs when one side of a transaction has more or better information • Adverse selection and moral hazard are key cases

    2. 2.10.2(HL)—Responses to asymmetric information

      • Government responses include legislation, regulation, and provision of information • Private responses include signalling and screening

  11. 2.11 Market failure - market power

    1. 2.11.1(HL)—Market structures

      • Perfect competition has many firms, free entry, and homogeneous products • Monopoly has a single or dominant firm, high barriers to entry, and no close substitutes • Oligopoly has a few large firms, high barriers to entry, and interdependence • Monopolistic competition has many firms, free entry, and product differentiation

    2. 2.11.2(HL)—Rational producer behaviour

      • Profit maximization occurs where marginal cost equals marginal revenue • Profit equals total revenue minus total costs • Abnormal profit occurs when average revenue exceeds average cost; normal profit when they are equal; losses when average revenue is below average cost • Calculation [HL]: profit, MC, MR, AC, and AR from data

    3. 2.11.3(HL)—Degrees of market power

      • Market power is the ability of a firm to influence price • Perfectly competitive firms have no market power and are price takers • Imperfectly competitive firms have varying degrees of market power and are price makers • Diagram: perfectly competitive firm as price taker where P = D = AR = MR • Diagram: perfectly competitive firm showing abnormal profit, normal profit, and losses • Diagram: perfectly competitive market equilibrium and allocative efficiency where P = MC or MB = MC

    4. 2.11.4(HL)—Monopoly

      • Monopoly profit maximization can create allocative inefficiency and welfare loss • Monopoly may restrict output and raise price compared with perfect competition • Natural monopoly is a special monopoly case linked to economies of scale • Diagram: market power where AR exceeds MC • Diagram: monopolist showing abnormal profit, normal profit, and losses • Diagram: monopoly versus perfect competition with welfare loss • Diagram: natural monopoly

    5. 2.11.5(HL)—Oligopoly

      • Oligopoly can be collusive or non-collusive • Interdependence creates risk of price war, incentive to collude, and incentive to cheat • Oligopoly may create allocative inefficiency • Firms may use price and non-price competition • Market concentration can be measured using concentration ratios • Diagram: collusive oligopoly acting as a monopoly • Diagram: simple game theory payoff matrix

    6. 2.11.6(HL)—Monopolistic competition

      • Monopolistically competitive firms maximize profit in the short run and long run • Many substitutes make demand more elastic than monopoly demand • Monopolistic competition is allocatively inefficient but offers more product variety and less inefficiency than monopoly • Diagram: monopolistically competitive firm showing abnormal profit, normal profit, and losses • Diagram: monopolistic competition with more elastic demand than monopoly

    7. 2.11.7(HL)—Advantages and risks of market power

      • Large firms may gain economies of scale, including natural monopoly efficiencies • Abnormal profit may fund research, development, and innovation • Market power risks include lower output, higher prices, and reduced consumer choice

    8. 2.11.8(HL)—Government responses to market power

      • Governments may use legislation, regulation, government ownership, and fines • Responses target abuse of significant market power

  12. 2.12 The market's inability to achieve equity

    1. 2.12.1

      • Free market outcomes may create unequal distribution of income and wealth • Diagram: circular flow model illustrating why free markets may create inequalities