IB Economics - Definitions: Microeconomics
1.1 & 1.2 *Demand and Supply and Elasticity
Price Mechanism: is the means for allocating resources through supply and demand in a market arriving at an equilibrium price. Prices act as a signal to firms and consumer to adjust their economic behaviour.
Demand: is the relationship between quantity, and the price consumers are willing to and able to offer each quantity at, over a period of time, ceteris paribus.
Supply: is the relationship between quantity, and the price at which producers are willing to offer and produce each quantity at, over a period of time, ceteris paribus.
Parallel Market (black or informal): Is unrecorded activity where no tax is paid and regulations can be avoided
Allocative Efficiency: Refers to the efficiency with which markets are allocating resources. A market will be efficient when it is producing the right goods for the right people at the right time. Another way of looking at it is you cannot make someone better off without making someone else worse off.
Price mechanism: is the process by which prices rise or fall as a result of changes in demand and supply. Signals and incentives are given to producers and consumers to produce more or less or consume more or less.
*1.3 Government Intervention
Subsidy: Financial assistance made by governments to enterprises which will lower the price and increase production, effectively a negative tax
Direct tax: is a tax upon income – it directly taxes wages, rent, interest and profit.
Indirect tax: is an expenditure and sales tax upon goods and services – collected by sellers and passed onto governments. Can be avoided.
*1.4 Market Failure
Externalities: Costs or benefits of economic activity which are met by a third party (that wasn’t involved in the process of decision making).
Positive externalities (also called social benefits): Benefits of economic activity that are not accounted for in production costs or price. i.e. Vaccination for flu will benefit all.
Negative externalities (also called social costs): Costs of economic activity that are not accounted for in production costs or price, i.e pollution from nearby chemical factory is imposed on others outside the economic activity.
Public goods: Goods and services that everyone can consume at the same time, and are non-rivalrous and non-excludable.
Merit good: A good with positive externalities that benefit other people, i.e education – the market will only provide at a private optimum level and hence under produce (provide) the socially optimum level. There’s an under provision of merit goods.
Demerit good: A good with negative externalities that has costs for society. There’s an overprovision of demerit goods.
Asymmetric information: When one party to a transaction has access to relevant information that the other party doesn’t.
Allocatively efficient output: This occurs where marginal social cost equals marginal social benefit (MSC = MSB).
Market mechanism: The process by which prices rise or fall as a result of changes in demand and supply. Signals and incentives are given to producers and consumers to produce more or less or consume more or less.
1.5 *Market Structures
Law of diminishing returns: when one or more factors are fixed, there will come a point beyond which the extra output from additional units of the variable factor will diminish
Marginal cost: the cost of producing one more unit of output
Long-run: the period of time where all factors to be variable
Constant returns to scale: this is where a given percentage increase in inputs will lead to the same increase in output
Increasing returns to scale: this is where a given percentage increase in inputs will lead to a larger percentage increase in output
Decreasing returns to scale: this is where a given increase in inputs will lead to a smaller percentage increase in output
Economies of Scale: when increasing the scale of production leads to a lower cost per unit of output
– so if a firm is getting increasing returns to scale from its factors of production then smaller and smaller amounts of factors per unit are needed – therefore average cost must be reduced.
Diseconomies of Scale: where the costs per unit of output increase as the scale of production increases.
Fixed costs: total costs that do not vary with the amount of output produced
Variable costs: total costs that do vary with the amount of output produced
Total cost: the sum of total fixed costs and total variable costs
TC = TFC + TVC
Price taker: a firm that is too small to influence the market price i.e. it has to accept the price given by the intersection of demand and supply in the whole market
Price maker: a firm that has some power to dictate the price it charges for its product – a situation where there is little competition e.g. an oligopolistic or monopolist market structure
Normal Profit: returns or earnings needed to keep a firm operating
- this profit is needed to cover fixed and variable costs as well as opportunity cost
Productive Efficiency: is achieved when firms produce at the lowest possible average cost curve
Allocative Efficiency: is achieved when resources are allocated in a way which maximizes consumers satisfaction - sometimes called economic efficiency; MC = AC
Perfect competition: A market structure where there are many small firms, there is freedom of entry into the industry, all firms produce an identical product, and all firms are price takers.
Monopolistic competition: a market structure where, like perfect competition there are many firms and freedom of entry, but where each firm produces a differentiated product, and thus they have some control over the price. Examples: restaurants, hairdressers.
Oligopoly: a market structure dominated by only a few firms or where a product is supplied by only a few firms (there may be many firms but it is dominated by only a few) examples: car industry in the USA, mobile phone industry.
Collusive oligopoly: where oligopolies agree (formally or informally) to limit competition between themselves
– they may set output quotas, fixed prices, limit product promotion or development or agree not to poach each others markets – they do this to reduce uncertainty, and to maintain industry profits.
Non-collusive oligopoly: where oligopolies have no agreement between themselves (thus results in a kinked demand curve).
Kinked Demand Curve: A model developed to show price inflexibility of firms that do not compete.
Monopoly: where is there is only one dominant firm in the industry and very high barriers to entry / exit – remember they don’t have to control 100%, example: Microsoft is a monopoly – sometimes hard to define. – extent of monopoly power depends on the closeness of substitutes.
Price Discrimination: where a firm sells the same product at different prices.
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