IB HL Economy Year 1 Hannah Phillips Diagram and Definition
Economy Economics is the study of how scarce resources are or should be used.
Section 1 Introduction
Microeconomics Microeconomics is the study of the behaviour of individual markets Macroeconomics
Microeconomics is the study of how the economy as a whole works.
Positive Economics Positive economics examines matters of economics that can be proven to be right or wrong by looking at the facts. Normative economics examines matters of economics that are based upon opinion and so are incapable of being proven to be right or wrong. Normative Economics
Scarcity Scarcity exists because of the limited availability of economic resources relative to society’s unlimited demand for goods and services.
Factors of Production
Land is the physical factor of production. It consists of natural resources, some of which are renewable and some of which are non-renewable.
Capital is the factor of production that is made by humans and is used to produce goods and services. It occurs as a result of investment.
Labor is the human factor of production. It is the physical and mental contribution of the existing workforce to production.
Entrepreneurship is the factor of production involving the organization of the other factors of production and also involves risk-taking.
Opportunity Cost Opportunity cost is the next best alternative foregone when an economic decision is made. X Increasing Opportunity Cost Y Good A Good B
Free Goods Free goods are goods which are unlimited in supply and have no opportunity cost. A free good has an unlimited supply at market price zero. Aneconomic good is a good or service that is relatively scarce and so has a price. An opportunity cost is involved when it is consumed. EconomicGood
Utility Utility is the satisfaction or pleasure that an individual derives from the consumption of a good or service.
Production Possibilities Curve (PPC) A production possibilities curve (PPC) shows the maximum combination of goods or services that can be produced by an economy in a give time period, if all the resources in the economy are being used fully and effectively. All resources being used efficiently. Good A Good B
Actual Output Actual output is the production of goods and services in an economy achieved in a given time period. Potential output is the possible production that would be achieved in an economy if all available factors were employed. Potential Output
Actual Growth Actual growth occurs when previously unemployed factors of production are brought into use. Potential Growth
Potential growth occurs when the quantity and/or quality of factors of production within an economy is increased.
Economic growth is the growth of real output in an economy over time
Economic Development Economic development is a broad concept involving improvement in standards of living, reduction in poverty, improved health and improved education. Increased freedom and economic choice may also be included. Sustainable development is economic development that meets the needs of the present without compromising the ability of future generations to meet their needs. Sustainable Development
Free Market Economy A free market economy is an economy where the means of production are privately held by individuals and firms. Demand and supply determine what to produce, how to produce it and for whom to produce. CommandEconomy
A planned (command) economy is an economy where the means of production are owned by the state. The state determines what to produce, how to produce it and for whom to produce.
A transition economy is an economy in the process of moving from a centrally planned economic system towards a more market-oriented economic system.
Section 2.1 Markets
Market A market is where buyers (consumers) and sellers (producers) come together to establish an equilibrium price and quantity for a good or service. It does not need to be an actual place.
Ceteris Paribus Ceteris paribus is an assumption that all other variables are being held equal, when a single variable is being altered in an economic model.
Demand Demand is the willingness and ability to purchase a quantity of a good or service at a certain price over a given time period. Law of Demand
This states that as the price of a good or service rises, the quantity demanded decreases .
As the price of a good or service decreases, the quantity demanded increases.
Demand Curve Demand curve is a graphical representation of the law demand. It is usually a downward-sloping line illustrating the inverse relationship between price and quantity demanded. Price Quantity
Determinants of Demand Tastes and preferences Other related goods Expectation of future income Income Size of market Special circumstances TOEISS
Movement (Change in Quantity Demanded) As price decreases, Quantity Demanded increases. Price P1 P2 Q1 Q2 Quantity
Price D2 D1 D3 Quantity Shift (Change in Demand) A rightward shift shown by Curve D2 shows an increase in Demand. A leftward shift shown by Curve D3 shows an decrease in demand. P Q1 Q2 Q3
Supply Supply is the willingness and ability of a producer to produce a quantity of a good or service at a certain price over a given time period. Law of Supply
This states that as the price of a good rises, the quantity supplied increases.
As the price of a good decreases, the quantity supplied decreases.
Supply Curve Supply curve is a graphical representation of the law of supply. It is an upward-sloping line illustrating the direct relationship between price and quantity supplied. Price Quantity
Determinants of Supply Subsidies and taxes Technology Other related goods Resources Expectations Special events or circumstances STORES
Movement (Change in Quantity Supplied) As price increases quantity supplied increases. P2 Price P1 Q1 Q2 Quantity
Shift (Change in Supply) A rightward shift shown by Curve D2 shows an increase in supply. A leftward shift shown by Curve D3 shows an decrease in supply. D3 D1 D2 Price P Q1 Q2 Q3 Quantity
Equilibrium Price Equilibrium price is the market clearing price. It occurs where demand is equal to supply. Price P Q Quantity
Price Ceiling (Maximum Price) The maximum price is also known as price ceiling. It is a price set by the government, above which the market price is not allowed to rise. It may be set to protect consumers from high prices, and it may be used in markets for essential goods, such as rice, or house rentals. Price P Quantity
Price Floor( Minimum Price) The minimum price is also known as the floor price. It is a price set by the government, below which the market price is not allowed to fall. It may be set to protect producers producing essential products from facing prices that are felt to be too low, such as many agricultural products in the European union. P Price Quantity
Buffer Stock Scheme A buffer stock scheme sets a maximum and a minimum price in a market to stabilize prices.
Section 2.2 Elasticities
Price Elasticity of Demand (PED) Price elasticity of demand (PED) is a measure of the responsiveness of the quantity demanded of a good or service to a change in its price. How sensitive is a buyer to a change in price?
Elastic Demand Elastic demand means that a change in the price of a good or service will cause a proportionately larger change in quantity demanded. PED>1 P2 Price P1 Q1 Q2 Quantity
Inelastic Demand Inelastic demand means that a change in the price of a good or service will cause a proportionately smaller change in quantity demanded. PED<1 P2 Price P1 Q1 Q2 Quantity
Cross Elasticity of Demand (XED) Cross elasticity of demand (XED) is a measure of the responsiveness of the demand for a good or service to a change in the price of a related good. How sensitive is a buyer when another product changes price? XED = Percentage Change in Quantity Demanded for X Percentage Change in Price of Y
Substitute Goods Substitute goods are goods that can be used instead of each other. For example, Pepsi and Coca-Cola. XED is a positive value. Price for Pepsi P2 P1 Q2 Q1 Demand for Coca-Cola
Complement Goods Complement goods are goods which are used together, such as Oreos biscuits and milk. XED is a negative value. Price of Milk P1 P2 Q1 Q2 Demanded for Oreos
Income Elasticity of Demand (YED) Income elasticity of demand (YED) is a measure of the responsiveness of demand for a good to a change in income. How sensitive is a buyer to changes in their own income? YED = Percentage Change in Quantity Demanded Percentage Change in Income
Normal Good A normal good has a positive income elasticity of demand. As income rises, demand increases. Income P2 P1 Q2 Q1 Quantity
Inferior Good Inferior goods have a negative income elasticity of demand. As income rises, demand decreases. Income P2 P1 Q2 Q1 Quantity
Price Elasticity of Supply (PES) Price elasticity of supply (PES) is a measure of he responsiveness of the quantity supplied of a good or service to a change in its price. How sensitive is a supplier to a change in price? PES = Percentage Change in Quantity Supplied Percentage Change in Price
Indirect Tax An indirect tax is an expenditure tax on a good or service. An indirect tax is shown on a supply and demand diagram as an upward shift in the supply curve, where the vertical distance between the two supply curves represents the amount of the tax. A specific tax is shown as a parallel shift. An ad valorem tax is shown as a divergent shift. Ad Valorem Tax Specific Tax Supply + Tax Supply + Tax Price Price Fixed percentage of tax Quantity Quantity
Incidence (Burden) of Tax The incidence (or burden) of tax refers to the amount of tax paid by the producer or the consumer. If the demand for a good is inelastic the greater incidence of the tax falls on the consumer. If the demand for a good is elastic, the greater incidence of the tax falls on the producer.
Section 2.3 Theory of the Firm
Fixed Costs Fixed costs are costs of production that do not change with the level of output. They will be the same for one or any other number of units. Variable Costs
Variable costs are costs of production that vary with the level of output.
Total Costs Total costs are the total costs of producing a certain level of output. (Fixed cost+ Variable cost) Average Costs
Average costs is the average cost of production per unit. Calculated by dividing the total cost by the quantity produced.
Marginal cost is the additional cost of producing an additional unit of output.
TP Price AP MP Quantity
The Law of Diminishing Returns This law states that as extra units of a variable factor are applied to a fixed factor, the output per unit of the variable factor will eventually diminish.
Total Revenue Total revenue is the aggregated revenue gained by a firm from the sale of a particular quantity of output. Marginal Revenue
Marginal revenue is the extra revenue gained from selling an additional unit of a good or service.
Average revenue is total revenue received divided by the number of units sold.
Price = AR
Normal Profits Normal profits are the amount of revenue needed to cover the total costs of production, including the opportunity cost. MC AC Normal Profit AR=D MR
Abnormal Profits Abnormal profits are any level of profit that is greater than that required to ensure that a firm will continue to supply its existing good or service. (Amount or revenue greater than the total costs of production, including opportunity costs) MC AC Abnormal Profits AR=D MR
Profit-maximizing Level of Output Theprofit-maximizing level of output is the level of output where marginal revenue is equal to marginal cost.
Shut-down Price The shut-down price is the price where average revenue is equal to average variable cost. Below this price, the firm will shut down in the short run. The break-even price is the price where average revenue is equal to average total cost. Below this price, the firm will shut down in the long run. Break-even Price