IB Economics Higher Level Revision Notes
Graphs to Microeconomics
1. Microeconomics
- Market = an institution, which permits interaction between buyers & sellers.
- Demand Law = inverse relationship between P & QD, all other factors assumed constant. A change in price causes a movement along the curve. A change in income, price related goods, consumer preference and demographic changes causes a shift of the curve. QD = a-bP (a=shift, b=slope)
- Supply Law = positive casual relationship between P & QD, ceteris paribus. A Change in price causes a movement along the curve. A change in Factors of Production (FoP = land, labour, capital, entrepreneurship), in technology, tax, subsidies causes a shift of the curve.
- Market Equilibrium = no excess supply or demand. – Price has a signaling and incentive function. Full efficiency achieved.
- Market Efficiency
- Consumer Surplus = The difference between how much a consumer is willing and able to pay and what the real price, which they pay is.
- Producer Surplus – the difference between what firms earn from selling goods and services and what they would have earned at P=minimum.
- Elasticity
- Price Elasticity of Demand = responsiveness of QD to change in P
- %changeQD/%changeP
- >1 elastic, <1 inelastic
- Used for prediction, comparison, price discrimination, tax.
- Low for primary goods
- High for manufactured goods
- Cross Elasticity of Demand = responsiveness of D for good X to a change in P of good Y
- %changeQDofX/%changePofY
- >0 substitute (X), <0 complimentary (X)
- Used to describe markets, determine types of goods
- Income Elasticity of Demand = responsiveness of D to a change in Income
- %changeQD/%changeY
- >0 normal goods, <0 inferior goods
-
Used for income determination, market understanding
- Price Elasticity of Supply = responsiveness of QS to change in P
- %changeQS/%changeP
- >1 elastic, <1 inelastic
- Determinants = time, FoPs, capacity, stocks
- Low for primary goods
- High for manufactured goods (many substitutes)
- Taxation
- Indirect Taxes = taxes on goods & services fixed or percentage value (specific or Ad Valorem)
- To Collect Revenue, pay for public goods, decrease consumption.
- Price Increases
- Equilibrium Q decreases
- Tax incidence = who pays what proportion of tax = PES/PED
- To Collect Revenue, pay for public goods, decrease consumption.
- Direct Taxes = taxes on income
- Subsidies
- Payment to firms by the government to lower price, increase production, consumption and revenue.
- Market Price decreases
- Equilibrium Q increases
- Producer revenue increases
- Government expenditure increase
- Price Controls
- Maximum prices = set if market prices is too high to protect buyers
- Outcomes – shortage, inefficient resource allocation, welfare impact, underground market, rationing.
- Effects – lower prices, more demand, less supply.
- Minimum prices = set if market price is too low to protect producers ( farmers)
- Outcomes – surplus, government buying surplus, taxpayers burdened, welfare impact, inefficient
- Effects – higher prices, less demand, more supply
- Market Failure – Due to failure to achieve efficiency resulting in under/over allocation of resources. Failure to achieve social optimum of MSB=MSC.
- Marginal Private Benefits (MPB) = the benefits individuals enjoy from extra consumption.
- Marginal Private Costs (MPC) = costs of extra production (wages, FoP, etc.)
- Marginal Social Costs (MSC) = costs of extra production borne by society.
- Marginal Social Benefits (MSB) = benefits society enjoys from extra consumption.
- Externalities
- Negative of Production – MSC lies above MPC so there is an external costs, welfare loss, and overproduction. Demerit goods and their consumption create external costs (alcohol). Possible responses = taxation, government regulation.
- Negative of Consumption – MSB lies below MPB so there is an external loss, welfare loss, over consumption.
- Positive of Production – MSC lies below MPC so there is a external gain. Underproduction. Merit goods and their consumption create external benefits
- Positive of Consumption – MSB lies above MPB so there is an external benefit, under consumption. Possible responses are subsidies, legislation, education, advertisement, direct provision of goods & services.
- Public Goods
- Non-excludable & Non-rival consumption
- Common access resources & sustainability threat – fishing, pastures, forest, fossil fuels, etc.
- Difficult to exclude individuals
- Rivalry
- Sustainability
- Lack of pricing for CAR – goods are overruled, depleted.
- Government responses – legislation, taxation, trade schemes, funding.
- Asymmetric information – market failure may occur when either the buyer/seller possesses more info. Than the other party. Government response – legislation, regulation, provision of information
- Abuse of monopoly power – able to restrict output, charge higher prices leading to a welfare loss. Government response – legislation, regulation, nationalization, trade liberalization.
- Theory of Firms and Market structures
- Short run – time period during which at least one FoP is constant.
- Long run – no constant factor of production, all adjustments are possible.
- Total Product = Total output of a firm = Q
- Average Product = Q/L
- Marginal Product = changeQ/changeL
- The Law of Diminishing Returns – As more units of a variable factor (labour) are added to a fixed factor (capital) there is a point beyond which the total product will continue to rise, but at a diminishing rater, or the marginal product will decline.
- Economic Costs = the value of all resources that are sacrificed during the production process.
- Explicit = production costs (wages, resources)
- Implicit = minimum payment to secure entrepreneurship.
- Fixed = costs, which do no vary when the level of production varies (rent, insurance)
- Variable = vary with the level of output.
- Marginal = the additional cost of producing an extra unit of output.
- MC=changeTC/changeQ = changeVC/change Q
- Average Variable = variable costs over the level of output
- Average Total = total costs over the level of output
- ATC = AFC+AVC
- Average Fixed = Fixed costs over the level of output.
- Long run production costs
- Increasing returns to scale - %change increase in output > than %increase in all inputs
- Constant returns to scale - %increase in all inputs
- Decreasing returns to scale - %increase in output < than % increase in all inputs.
- Revenue
- Total Revenue = TR = P x Q
- Marginal Revenue = MR = changeTR/change
- Average Revenue = AR = P
- Economic Profits
- Abnormal = TR > economic costs
- Normal = TR=Economic Costs or when TR is just sufficient enough to keep the firm in business. Π = TR – TC
- Goals of Firm
- Profit Maximization = MR = MC
- Revenue maximization, growth maximization, satisficing & social responsibility.
- Perfect Competition – Large number of firms, homogeneous product, freedom of exit/entry, perfect information, and perfect resource mobility.
- Monopoly = a single dominant firm in the market, no close substitutes, barriers to entry – economies of scale, branding, copyright and legislation.
- Can set price.
- AR = D
- Profit Maximization – more units at a lower price
- Desirable monopolies
- Ability to finance research and development
- Need to innovate to maintain profit
- Possible economies of scale
- Monopolistic Competition – large number of firms, differentiated product, absence of barriers.
- Product differentiation – small degree of monopoly power
- Neither allocative or productive efficiency achieved.
- Oligopoly – dominance of industry by a small number of firms, important interdependence, differentiated or homogeneous products, high barriers to entry. – Joint profits.
- Perfect Competition – very many small firms, homogenous product, no barriers
Price discrimination – charging different prices to different consumer groups for the same producer, when the price difference is not justified by difference in cost.
- Price Elasticity of Supply = responsiveness of QS to change in P
Graphs to Macroeconomics
2. Macroeconomics
- Goals
- Satisfactory & Sustainable growth
- Low level of unemployment
- Price stability
- Long –run equilibrium
- Distribution of income
- Gross Domestic Product = GDP = C + I + G + (X-M)
- C = consumption
- I = investment
- G = government spending
- (X-M) = net exports
- Gross National Income (GNI)
- Business Cycle
- Recession
- Trough
- Recovery
- Boom
- Peak
- Line of Best-fit = Long-time average annual growth
- Aggregate Demand = AD = GDP
- Shifts due to individual components of GDP
- Aggregate Supply = AS = LRAS or SRAS
- LRAS = long run aggregate supply = new classical
- LRAS = long run aggregate supply = Keynesian
- SRAS = short run aggregate supply – wages assumed fixed
- Shifts due to change in FoPs, resource prices, taxes, subsidies, technology, unemployment reduction, institutional changes.
- Keynesian multiplier - effect on GDP of change in investment, gov. spending and exports. (Shifts)
- 1/(1-MPC)
- Macroeconomic Objectives
- Unemployment = actively searching for a job but cannot find one.
- Rate = number of unemployed/labour force x 100
- Consequences = loss of GDP, loss of Tax revenue, increased costs, loss of income, less equality, increased crime.
- Types
- Seasonal – predictable variation in D & S of labour
- Frictional – people in between jobs
- Structural – unemployment due to recovery, boom.
- Cyclical – due to business cycle
- Policies = training, subsidies, increase of AD
- Low & Stable inflation
- Inflation = sustained increase of the average price level.
- Deflation = sustained decrease in the average price level.
- Disinflation = a decrease in the rate of inflation.
- Inflation = %changeCPI
- Consequences = uncertainty, less savings, damage to exports, increase in cyclical unemployment, bankruptcies
- Stagflation = recession with rising inflation
- Economic Growth = Growth of (real) GDP over time
- Increase in Output
- Outward shift of PPC (Production Possibility Curve)
- Increase in potential output
- Income Distribution & low poverty
- Lorenz Curve/Gini coefficient
- Poverty & Taxation
- Marginal Tax Rate = extra tax on extra income
- Average Tax Rate = tax over income
- Progressive = more income, more tax
- Proportional = % of income
- Regressive = more income, less tax
- Fiscal Policy = Government Spending and Taxation
- Expansionary
- May close deflationary gap
- Increase AD & Growth
- Increase of Gov. Spending
- Decrease in Gov. Revenue
- Possible increase in inflation
- Contractionary
- May close inflationary gap
- Decreases AD & inflation & growth
- Government Spending Increases
- Government Revenue Decreases
- Unemployment increases
- Monetary Policy = Interest Rates / Exchange Rates = Central Banks
- Expansionary
- Increase in AD
- Close deflationary gap
- Lower interest rates
- Increase S of Money
- C, I, (X-M) increase
- Contractionary
- Decreases AD
- Close inflationary gap
- Increase S of Money
- C, I, (X-M) decrease
- High interest rates
- Supply-Side Policies
- Increased Production by: improving institutions, capacity,
- Market based or interventionist
- Interventionist = Investment in
- Human Capital - Training
- New Technology – Research and Development
- Infrastructure - Improvement
- Industry – Tax Cuts
- Market based
- Encourages competition – deregulation
- Reforms – less union power
- Policies – tax cuts, investment
- Effectiveness
- Time Lags
- Creates unemployment
- Greater choice
- Requires resources
- Efficient
- Source of foreign exchange
- Increased competition
- Producer benefits
- Interventionist = Investment in
Pictures to International Economics
3. International Economics
- Free Trade – lower prices for consumers, producer benefits, resources, competition, foreign exchange
- Absolute Advantage
- Comparative Advantage
- WTO – World Trade Organization
- 1995
- 153 countries
- Trade liberalization
- Arbitrator
- Biased for US & EU
- Economics only no human viewpoint
- Restrictions = Protectionism
- Tariffs
- Quotas
- Subsidies
- Administrative Barriers
- + Domestic jobs, national security, industries, health, environmental standards, anti-dumping measures, source of government revenue
- - Inefficient use of resources, retaliation, trade wars, political tensions, corruption, costs, less imports, less export competition.
- Exchange Rates
- Floating = free, no market, government or bank intervention
- Fixed = set and maintained by government or bank
- Managed = allowed to float within a certain range
- Change in D & S
- D for exports, D for imports, interest rates, inflation, oversea investment, speculation, and tourism.
- Effects of D & S
- Change in inflation rate, employment, growth, and balance of payments.
- Appreciation = increase of price in a floating rate.
- Depreciation = decrease of price in a floating rate.
- Revaluation = official price increase in a fixed rate.
- Devaluation = official price decrease in a fixed rate.
- Balance of Payments = a record of all transactions of a country with the rest of the world over a period of time.
- Current Account
- Goods & services = exports and imports
- Primary income = profits, interest, rent
- Secondary income = aid
- Capital Account
- Debt forgiveness
- Non-financial assets
- Financial Account
- Foreign Direct Investment
- Sale of bonds and stocks
- Reserve assets
- Current Account Balance = Capital + Financial
- Account Deficit – May results in downward pressure on the exchange rate
- Implication:
- Foreign ownership of domestic firms
- Exchange & interest rates
- Indebtedness
- International credit ratings
- Expenditure Switching - low imports, high domestic production, devaluation, depreciation of exchange rate
- Expenditure reducing – low AD, low spending on imports, contractionary fiscal and monetary policies.
- Increased competition – growth of domestic market.
- Marshal-Lerner condition = For devaluation/depreciation of a currency to improve a current account deficit the sum of the PED for imports and the PED for exports must be greater than 1. (J-Curve Effect)
- Economics Integration & Trade Liberalization
- Trade Agreement – bilateral/multilateral – reduction tariffs, etc.
- Trading Blocs
- Free Trade Area – no barrier of trade to members
- Customs Union – common external tariff
- Common Market – free flow of Factors of Production
- Economic Union – same macroeconomic policies
- Monetary Union – same macroeconomic policies & free flow of FoPs & a common currency with a common central bank. (Euro Zone)
- + Lower costs, greater transparency, no exchange rate, less uncertainty greater political and economic power.
- - no independent monetary policies, no exchange rate policy, limited fiscal policy, loss of economic and political sovereignty.
- Terms of Trade = Avr. P of exports as index/Avr. P of imports as index x 100
- Improvement = Increase in imports
- Deterioration = Decrease in Imports
- Short Term Changes = D for exports, imports, change in global supply of key inputs, changes in inflation rates and exchange rates.
- Long Term Changes = world income level change, change in productivity and technological development and a Global redistribution of income.
Pictures to Dev. Economics
4. Development Economics
- Economic Growth = increase in (real) GDP over time.
- Economic Development = A multidimensional concept including the following:
- Reducing poverty
- Raising living standards
- Reducing income inequalities
- Increasing employment opportunities.
- Economic Development needs growth with few exceptions and growth does not lead to development without additional action!
- Common Characteristics of LEDCs
- Low GDP per Capita
- High Poverty
- Large agricultural sector
- Large urban informal sector
- High birth rate
- Diversity among LEDCs
- Variety of factors
- Resources
- Climate
- History
- Stability of the political system
- Poverty Trap/Cycle
- No investment in human capital due to low savings
- Transmission of poverty from generation to generation
- Intervention needed to break
- Aid often useless
- Millennium Development Goals until 2015
- Eradicate Poverty/Hunger
- Achieve universal primary educaton
- Promote gender equality
- Reduce child mortality
- Improve maternal health
- Combat HIV/Malaria
- Ensure Environmental stability
- Global partnership for development
- Measuring Development
- GDP & GNI per Capita
- No income distribution
- No environmental degradation
- No living standards
- Human Development Index
- Life Expectancy
- Literacy Rate
- GDP
- No human freedom measure
- No Gender equality
- No environmental measure
- No political measure
- National average only.
- Domestic Factors & Economic Development
- Education & Health
- Higher labour productivity
- Faster long-term growth
- Improved living standards
- Larger workforce
- Credit & Microcredits
- More investment
- More business
- More employment
- More human capital
- Break of poverty cycle
- Appropriate Technology
- Capital – physical capital, jobless growth
- Labour – use of labour, less unemployment
- Empowerment of Women
- More employment
- More family security
- Lower mortality rate
- Increaser health
- Political involvement.
- Distribution of Income - Leads to all factors
- Poverty reduction
- Less corruption
- Increased trust
- Increased health and education
- Lower civil unrest
- More investment
- More demand
- Cyclical nature of increase
- International Trade & Economic Development
- Barriers to Development
- Over-specialization – inelastic demand
- Price volatility
- No access to markets - protectionism
- Long-Term changes
- Trade Strategies for Economic Growth & Development
- Import substitution
- Export promotion
- Trade agreements
- Trade liberalization
- Diversification
- WTO
- Foreign Direct investment FDI = long-term investment where a firm based in one nation establishes pressure in another country.
- Multinational cooperation = a firm within more that one nations.
- In LEDCs – new resources, markets, lower costs, less rules.
- Stable environment
- Public policy
- Weak regulation
- Secure legal framework
- High human capital
- Large market
- Free trade areas
- For:
- Investment
- Gov. revenue
- Less unemployment
- Training
- Management
- Technology
- Against:
- Hurts domestic firms
- Inappropriate technology
- Unskilled labour
- Inequality of income
- Political & economic power
- Profits may go abroad
- Foreign Aid (Official Development Aid & Non-governmental Orgs.)
- Humanitarian Aid = Food, medical supplies, relief aid
- Development Aid = loans, project aid, programme aid
- NGOs – small scale aid to achieve development objectives
- Bilateral, Multilateral, Tied Aid
- IMF, UN, UNDP, World Bank.
- Effective or Ineffective
- Foreign Debt = owed to non-residents of a nation. Money owed to foreign entities.
- High levels lead to:
- Foreign exchange earning depleted
- No gov. funds
- Political tensions
- Investment decreases
- Opportunity costs
- Balance of payments problems
- Development to be achieved by:
- Good governance
- A balance of Market-based and interventionist politics
Governmental cooperation