IB Economics Teacher Resource eBook - Introduction to Economics & Microeconomics

Foreword – by Brad Cartwright -Hey! Thank you so much for purchasing these teaching resources! In here, you will find Vocabulary Lists, Review Questions, IB Exam Practice Questions, and lesson specific Slides for the entirety of the first two sections of the IB Economics Syllabus - Introduction to Economics and Microeconomics.

The idea is to provide you with the critical pieces of your teaching resources so that you can teach with confidence and calm. With your purchase comes the right to use these resources with your students, whether that by using the Slides to guide class discussions, by sharing the Vocabulary Lists with your students in preparation for a quiz, or by embedding the IB Exam Practice Questions into your assessments.

I’ve come to discover that these resources have been exceptionally useful with my own students here in Santiago, Chile. These resources follow the videos available in both the student and teacher monthly subscriptions.

Good luck and take care of yourselves out there!

1

UNIT 1: what is economics?

Introduction to IB Economics

Foreword by Brad Cartwright ...................................................................1 Introduction to Economics: Key Terms and Concepts ..................2 Lesson 1: Scarcity, Choice, Opportunity Cost and Utility............................. 3-7 Lesson 2: The Basic Economic Problem.........................................................8-9 Lesson 3: The Factors of Production.........................................................10-15 Lesson 4: Production Possibility Curve .....................................................16-19 Lesson 5: The Nine Central Themes of IB Economics ..............................20-30 Lesson 6: Microeconomics and Macroeconomics ...................................31-33 Lesson 7: Positive and Normative Economics ..........................................34-35 Lesson 8: Rational Economic Thinking .....................................................36-37 Lesson 9: Model Building ..........................................................................38-40 Lesson 10: The Circular Flow of Income Model ........................................41-42 Lesson 11: Free Market vs Planned Economics ........................................43-49 Lesson 12: Economic Growth vs Economic Development .......................50-52 Review Questions ....................................................................................53

Introduction to IB Economics UNIT 2: the evolution of economic thinking Lesson 1: Classical Economics – The 18th Century............................................54-58 Lesson 2: Classical Economics – The 19th Century...........................................59-62 Lesson 3: Neoclassical Economics – The 19th Century ....................................63-67 Lesson 4: Karl Marx's Critique on Classical Economics .................................. 68-69 Lesson 5: Keynesian Economics – The 19th Century........................................70-73 Lesson 6: Monetarism (New Classical) Economics – The 20th Century...........74-77 Lesson 7: Behavioral Economics – The 21st Century .......................................78-81 Lesson 8: The Circular & Doughnut Economy – The 21st Century ..................82-86

microeconomics UNIT 1: demand, supply & market equilibrium Demand, supply & market equilibrium: Key terms and Concepts ................87 Lesson 1: The Law of Demand........................................................................................88-92 Lesson 2: Determinants of Demand...........................................................................93-102 Lesson 3: The Law of Supply.....................................................................................103-106 Lesson 4: Determinants of Supply.............................................................................107-116 Lesson 5: The Rule of 11: The Basic Demand &Supply Diagram.............................117-119 Lesson 6: Market Equilibrium...................................................................................120-124 Lesson 7: The Effects of Shifts of Demand and Supply.............................................125-127 Lesson 8: The Role of Price Mechanism...................................................................128-129 Lesson 9: Market and Allocative Efficiency...............................................................130-137 Review Questions ............................................................................................. .......138 ib exam practice questions.................................................................................139

microeconomics UNIT 2: behavioral economics (hl level only) Lesson 1: Assumptions of Neoclassical View of Economics .....................................140-142 Lesson 2: Introduction to Behavioral Economics ....................................................143-146 Lesson 3: Critique of Consumers' Rational Thinking. ..............................................147-148 Lesson 4: The Dual System Model............................................................................149-151 Lesson 5: Cognitive Biases.........................................................................................152-156 Lesson 6: Choice Architecture..................................................................................157-160 Lesson 7: Nudge Theory............................................................................................161-165

microeconomics UNIT 3: elasticities elasticities: Key Terms and Concepts............................................................................166 Lesson 1: Price Elasticity of Demand (PED)...............................................................167-171 Lesson 2: Price Elasticity of Demand: Applications..................................................172-174 Lesson 3: Price Elasticity of Demand: The Diagram.. ..............................................175-178 Lesson 4: Price Elasticity of Demand: Determinants...............................................179-183 Lesson 5: Cross Elasticity of Demand: (XED)............................................................184-186 Lesson 6: Income Elasticity of Demand (YED)..........................................................187-189 Lesson 7: Importance of Income Elasticity of Demand............................................190-191 Lesson 8: Price Elasticity of Supply (PES).................................................................192-196 Lesson 9: Price Elasticity of Supply: Applications.....................................................197-199 Lesson 10: Price Elasticity of Supply: Determinants.................................................200-204 review questions ......................................................................................................205 ib exam practice questions ................................................................................206

microeconomics UNIT 4: government intervention government intervention: Key Terms and Concepts........................................207 Lesson 1: Indirect Taxes .............................................................................................208-212 Lesson 2: Indirect Taxes: Diagram ............................................................................213-217 Lesson 3: Per-Unit Subsidies ....................................................................................218-226 Lesson 4: Per-Unit Subsidy Diagram ........................................................................227-231 Lesson 5: Price Controls: Introduction .....................................................................232-233 Lesson 6: Price Ceiling Diagram ...............................................................................234-238 Lesson 7: Price Floor Diagram ..................................................................................239-243 review questions ......................................................................................................244 ib exam practice questions ................................................................................245

microeconomics

UNIT 5: market failure market failure: Key Terms and Concepts.................................................................246 Lesson 1: Market and Allocative Efficiency ...............................................................247-253 Lesson 2: Market Failure Base Diagram....................................................................254-256 Lesson 3: Negative Externalities of Consumption: The Diagram ............................257-260 Lesson 4: Negative Externalities of Consumption: The Solutions ...........................261-269 Lesson 5: Negative Externalities of Production: The Diagram ................................270-273 Lesson 6: Negative Externalities of Consumption: The Solutions ..........................274-283 Lesson 7: Positive Externalities of Consumption: The Diagram .............................284-287 Lesson 8: Positive Externalities of Consumption: The Solutions ............................288-296 Lesson 9: Negative Externalities of Production: The Diagram ................................297-300 Lesson 10: Negative Externalities of Production: The Solutions .............................301-305 Lesson 11: Common Access Resources .....................................................................306-309 review questions .....................................................................................................310 ib exam practice questions ...............................................................................311 SOURCES ...........................................................................................................................312

- Introduction to Economics – unit 1: what is economics?

The Foundations of Economics Fundamental Vocabulary and Concepts Economics Goods Services Needs Wants Scarcity Choice Opportunity Cost Economic Good Free Good Basic Economic Problem What to produce?

How to produce it?

For whom to produce?

Factors of Production Land Labor Capital Management (Entrepreneurship) Production Possibilities Curve Utility Total Utility Marginal Utility

Microeconomics Macroeconomics Positive Economics (Statement) Normative Economics (Statement) Ceteris Paribus Circular Flow Model Rationing Systems Free Market Economy Planned Economy Rational Economic Thinking Economic Growth Households Firms Real National Income Gross Domestic Product (GDP) Gross National Income (GNI) Economic Development Human Development Index (HDI) Sustainable Development

2

scarcity, choice, opportunity cost, and utility foundations of economics 3

scarcity • scarcity is a simple concept!

• scarcity simply means that there is not enough of something to satisfy everyone who wants it.…and therefore you must pay a price for it • any item that costs something is scarce • once you pay a price for it, that item becomes an economic good, which is defined as any good or service that has a price, and is thus being rationed • if it were not scarce, it would be free or a free good, and you could have as much as you wanted w/o paying for it source: jocelyn blink

4

choice • understanding that people make choices is key to understanding and studying economics • since people do not have infinite incomes, they make choices whenever they purchase goods and services • they have to make decide how to allocate their limited financial resources and so always need to chose between alternatives • this leads to one of the core concepts in economics: opportunity cost source: jocelyn blink

5

opportunity cost • this might sound complicated but it’s not • opportunity cost is simply what you give up in order to have something else – if you buy an empanada instead of a chicken wrap, the opportunity cost of your empanada is the chicken wrap

• other ideas…

– if a good or service has an opportunity cost then it must be relatively scarce, so it will have a price and be classified as an “economic good” – “free goods” do not have an opportunity cost, they’re not scarce, so they have no price, so they are free source: jocelyn blink

6

utility • utility is a measure of usefulness and pleasure a consumer receives when they consume a product • two basic kinds of utility – total utility: total satisfaction gained from consuming a certain quantity of a product – marginal utility: the extra utility gained from consuming one more unit of a product • it is believed that, in the majority of cases, the marginal utility gained from extra units of a product falls as consumption increases source: jocelyn blink

7

the basic economic problem foundations of economics

8

the basic economic problem what?

what should be produced and in what quantities?

how?

how should things be produced?

for whom?

for whom should things be produced?

how and who makes these decisions is the key to economic study. there are two theoretical economics systems—the free market and the planned economy source: jocelyn blink

9

the factors of production foundations of economics

10

factors of production • factors of production are the four resources that allow an economy to produce its output 1.

2.

3.

4.

land labor capital entrepreneurship (management) source: jocelyn blink

11

land • land is defined as all raw and cultivated natural resources – – – –

it includes everything that grows on the land or is found under it it includes everything that is found in or under the sea it includes basic raw materials, such as gold, coal, oil, natural gas, etc. it includes cultivated materials, such as wheat, rice, apples, corn, etc. source: jocelyn blink

12

labor • labor refers to the human resources used in the production of goods and services • labor is the human work, both physical and intellectual, that contributes to the production of goods and services • labor is the human factor of production

source: jason welker and jocelyn blink

13

capital • capital refers to the tools and technologies that are used to produce the goods and services we desire • physical capital is the stock of manufactured resources, like factories, machinery, roads, and tools used to produce goods and services in the economy • human capital is the value of the workforce – investment in education or health care would affect this

• infrastructure (social overhead capital) is the large scale public systems, services, and facilities of a country that are necessary for economic activity, i.e., roads, railways, schools, hospitals, ports, airports, electricity plants, etc source: jason welker and jocelyn blink

14

entrepreneurship • entrepreneurship refers to the innovation and creativity applied in the production of goods and services • also known as management • they organize the other factors of production—land, labor, and capital—to produce goods and services • they also use their personal money and the money of other investors to buy the factors of production, produce the goods and services, and hopefully, make a profit source: jason welker and jocelyn blink

15

production possibilities curve foundations of economics

16

production possibilities curve • a production possibilities curve (PPC) shows the maximum combinations of goods and services that can be produced by an economy in a given time period, if all resources in the economy are being used fully and efficiently and the state of technology is fixed

source: jocelyn blink

17

18

19

the nine central concepts 20

the nine central concepts • • • • • • • • •

scarcity choice efficiency equity economic well-being sustainability change interdependence intervention

source: ib economics subject guide, 2020

21

scarcity • scarcity refers to the limited availability of economic resources relative to society’s unlimited demand for goods and services • economics is the study of how to make the best possible use of scarce or limited resources to satisfy unlimited human needs and wants

source: ib economics subject guide, 2020

22

choice • since resources are scarce, economics is a study of choices • not all needs and wants can be satisfied • this necessitates choice and gives rise to the idea of opportunity cost • economic decision-makers continually make choices between competing alternatives, and economics studies the consequences of these choices, both present and future source: ib economics subject guide, 2020

23

efficiency • efficiency is a quantifiable concept, determined by the ratio of useful output to total input • allocative efficiency refers to making the best possible use of scarce resources to produce the combinations of goods and services that are optimum for society, thus minimizing resource waste

source: ib economics subject guide, 2020

24

equity • in contrast to equality, which describes situations where economic outcomes are similar for different people or different social groups, equity refers to the concept or idea of fairness • fairness is a normative concept, as it means different things to different people • in economics, inequity is often interpreted to refer to inequality, which may apply to the distribution of income, wealth or human opportunity • irrespective of economic system, inequity or inequality remain significant issues both within and between societies • the degree to which markets versus governments should, or are able to, create greater equity or equality in an economy is an area of much debate source: ib economics subject guide, 2020

25

economic well being • economic well-being is a multidimensional concept relating to the level of prosperity and quality of living standards enjoyed by members of an economy • It includes:

– present and future financial security – the ability to meet basic needs – the ability to make economic choices permitting achievement of personal satisfaction – the ability to maintain adequate income levels over the long term.

• there are broad disparities in economic well-being both within and across nations

source: ib economics subject guide, 2020

26

sustainability • sustainability in economics refers to the ability of the present generation to meet its needs without compromising the ability of future generations to meet their own needs • it refers to limiting the degree to which the current generation’s economic activities create harmful environmental outcomes involving resource depletion or degradation that will negatively affect future generations • sustainability is proving increasingly important in all economic analysis as planetary boundaries are pushed to the limit source: ib economics subject guide, 2020

27

change • an understanding of the concept of change is essential in economics • the economic world is in a continual state of flux and economists must be aware of this and adapt their thinking accordingly • the concept of change is important both in economic theory and the empirical world that economics studies • in economic theory, economics focuses not on the level of the variables it investigates, but on their change from one situation to another • empirically, the world that is studied by economists is always subject to continuous and profound change at institutional, structural, technological, economic and social levels source: ib economics subject guide, 2020

28

interdependence • individuals, communities and nations are not self-sufficient • consumers, companies, households, workers, and governments, all economic actors, interact with each other within and, increasingly, across nations in order to achieve economic goals • the greater the level of interaction, the greater will be the degree of interdependence • in a highly interdependent economic world, decisions by certain economic actors are likely to generate many, and often unintended, economic consequences for other actors • a consideration of possible economic consequences of interdependence is essential when conducting economic analysis source: ib economics subject guide, 2020

29

intervention • intervention in economics usually refers to government involvement in the workings of markets • while markets are considered the most efficient mechanism to organize economic activity, it is recognized that they may fail to achieve certain societal goals, such as equity, economic well-being, or sustainability • failure to achieve such goals may be considered sufficient reason for government intervention • in the real world, there is often disagreement among economists and policymakers on the need for, and extent of, government intervention • there is a considerable debate about the merits of intervention versus the free market source: ib economics subject guide, 2020

30

microeconomics vs

macroeconomics foundations of economics

31

microeconomics • microeconomics deals with smaller, discrete economic agents and their reactions to changing events –the study of microeconomics looks at the level of the individual entity: the individual firm, the individual consumer, and the individual worker source: jocelyn blink

32

macroeconomics • macroeconomics takes a wider view and considers such things as measuring all the economic activity in the economy, inflation, unemployment, and the distribution of income in the whole economy – the study of macroeconomics looks at the sum of the behaviors of all consumers (consumer sector), all firms (business sector)

source: jocelyn blink

33

positive economics and normative economics foundations of economics

34

positive and normative economics • a positive economic statement is one that may be proven to be right or wrong by looking at the facts – example: unemployment rates at 4% in China – it’s an analysis of what is

• a normative economic statement is a matter of opinion and cannot be conclusively proven to be right or wrong.

– example: china ought to curb unemployment – it is an analysis of what ought to be source: jocelyn blink

35

rational economic thinking foundations of economics

36

rational economic thinking • rational economic thinking is the assumption that economists make that consumers will seek to maximize their utility and producers will seek to maximize their profits • this also could be stated as follows‌it means that people will make the choices that, at the time and with the information that they have at their disposal, will give them the greatest amount of satisfaction

source: jocelyn blink

37

model building foundations of economics

38

model building • economists tend to build theoretical models in order to test and illustrate their theories • ceteris paribus: Latin for “all other things being equal” – key concept: when economists want to test the effect of one variable on another they need to be able to isolate the effect of the one variable by assuming that there is no change in any of the other variables

• example: the circular flow model

source: jocelyn blink

39

source: jason welker

40

circular flow of income model foundations of economics

41

With Financial Intermediaries (banks)

source: jason welker

42

the free market vs

planned economies foundations of economics

43

rationing systems • rationing system: an system by which an economy decides how to allocate (ration) the goods and services that are produced by them. • free-market economy: an economy where prices are used to ration goods and services. Also called capitalism or private enterprise economy. • planned economy: an economy where decisions as to what to produce, how to produce, and for whom to produce are made by a central body, the government.

Also called a command economy. source: jocelyn link

44

free-market economy • price decides!

– price is main decision maker to allocate resource!

• all production is in private hands and demand and supply are left free to set wages and prices in the economy • the economy should work relatively efficiently and there should be few cases of surpluses and shortages • logic of it…

– individuals are free to make decisions about what products they would like to purchase at given prices and the producers then make decisions about whether they are prepared to provide those products – the consumers are thinking about their utility and the producers are thinking about profit – changes in the pattern of demand will be reflected in the pattern of supply source: jocelyn link

45

free-market economy • the free-market system is self-righting system!

• example of skateboards and roller skates • main idea of Adam Smith…when consumers and products work to their own best interest, the market functions to produce the “best” outcome for both— The Invisible Hand

source: jocelyn link

46

planned economy • government decides!

– the government is the main decision maker to allocate resources

• government bodies arrange all production, set wages, and set prices through central planning • decisions are made by the government on behalf of the people and, in theory, in their best interests • in reality, this has proven very difficult—simply by the shear number of decisions that must be made source: jocelyn link

47

disadvantages of both systems

source: jocelyn link

48

reality: all economies are mixed systems • in reality, all economies are mixed economies • what is different is the degree of the mix from country to country

49

economic growth vs economic development foundations of economics

50

economic growth • economic growth is simply a measurement of the change in the country’s national output, or Gross Domestic Product (GDP). This could also be referred to as Gross National Income (GNI) • economic growth does not say very much about the actual welfare of the people in a country

source: jocelyn blink

51

economic development • unlike economic growth, economic development is a measure of welfare, a measure of the well-being of a country • it is usual to measure economic development not just in monetary terms such as GDP but also in terms of other indicators, such as education indictors, health indicators, and social indicators • Human Development Index (HDI) is one of the most commonly used development measures source: jocelyn blink

52

The Foundations of Economics Review Questions: What you should be able to do!

Explain and illustrate the circular flow of income model.

Define economics as a social science.

Draw the circular flow of income model.

Define, give examples of, and distinguish between, goods and services.

Distinguish between different rationing systems.

Define, give examples of, and distinguish between, needs and wants.

Compare and contrast the advantages and disadvantages of planned and free

Define, give examples of, and distinguish between, economic goods and free

market economies.

goods.

Explain the difference between economic growth and economic development.

Define opportunity cost.

Define scarcity.

Define choice.

Adopted from the IB Economics Subject Guide

Explain the connection between opportunity cost, scarcity and choice, Explain the basic economic question: What to produce? How to produce it? and For whom to produce?

Using proper definitions, describe the factors of production.

Explain, illustrate, and analyze the production possibility curves.

Explain the difference microeconomics and macroeconomics.

Explain the difference positive economics and normative economics.

Define ceteris paribus.

Explain that economists are model builders.

53

- Introduction to Economics – unit 2: the evolution of economic thinking

classical economics the

th 18

century

54

economic thought prior to 1776 • • • •

mercantilism the supremacy of gold and silver goal: maximize exports & minimize imports think: the colonial model

source: jocelyn blink

55

adam smith • the birth of modern economics – or “classical economics” • The Wealth of Nations – written in 1776 – revolutionized economic thought

• Major transformative thought….

– the wealth of a nation is not based on the accumulation of gold and silver but on the value of the goods and services it produces – what we now call gross domestic product or GDP source: jocelyn blink

56

adam smith: transformational thoughts • worker productivity is the key to increasing wealth – division of labor – specialization of labor

• “labor theory of value” – costs of production = the value of the product produced

• the invisible hand – consumers: maximize utility – producers: maximize their profits – therefore, the market is self-regulating source: jocelyn blink

57

adam smith: transformational thoughts • free trade is the key to the prosperity of nations – advocated free trade over protectionism

• “laissez-faire economics” – the economy functions as freely as possible from intervention • consumption, production, trade happen freely

• but…government does have a role to play – defense, education, infrastructure, rule of law, punishment of crime source: jocelyn blink

58

classical economics the

th 19

century

59

the evolution of classical economics • david ricardo • thomas malthus • john stuart mill • jean-baptiste say source: jocelyn blink

60

david ricardo • know for work on international trade • believed: specialization in the production different goods • major contribution to economics –comparative advantage theory –this built on smith’s absolute advantage theory source: jocelyn blink

61

jean-baptiste say • “say’s law of markets” – the production of goods is source of demand • or “supply creates the demand”

– links to circular flow model – production creates purchasing power of consumers – total demand in economy is the result of production – therefore, no such thing as overproduction – a firm believer in free markets source: jocelyn blink

62

neoclassical economics the

th 19

century

63

the birth of neoclassical economics

• william jevons • leon walrus • carl menger • alfred marshall source: jocelyn blink

64

neoclassical economics • broke from classical economist because they shifted focus from supply to demand side of the economy – rather than the value of a good being derived from the costs, the value is derived from the utility of consumers or “demanders” of the product – advent of measuring utility in economics • example: law of diminishing marginal utility

– mathematics began to emerge as important – much of this work done by jovens, walrus, & menger source: jocelyn blink

65

alfred marshall • wrote the “principles of economics” (1890) • advent of the supply and demand diagram and the beginning of models to explain human behavior

source: jocelyn blink

66

neoclassical economics • • • • • •

the beginning of model building based on assumptions about rational economic behavior consumers and producers seen as “optimizers” emergence of self-interest as key to understanding beginning of “rational choice theory” this was a HUGE change in the evolution of economics – the movement towards a “science” with a reliance on mathematics, and away from a pure “philosophical” discipline source: jocelyn blink

67

karl marx the

th 19

century

68

karl marx • a german philosopher who lived from 1818-1883 • wrote famous critiques of capitalism, das kapital and the communist manifesto • saw capitalism as only just a series of methods of production that would eventually break down and communism would be the natural end result • his prediction was based on the idea that production would out pace consumption, thus leading to massive unemployment and economic hardship for the working class • the natural end result would be a communist take over • basis for socialist programs today source: jocelyn blink

69

keynesian economics the

th 20

century

70

early

th 20

century thought

• the neoclassical view of economics was dominant until the beginning of 1930s • free markets were preferred as they were seen to be self-righting and ensuring a proper allocation of resources in society

source: jocelyn blink

71

john maynard keynes • an english economist who lived from 1883 to 1946 • transformed economic thought • changed notion of two aspects of neoclassical model – change of focus from supply to demand – changed notion of “role of the government” • remember that…. keynes = demand and new government role

• in an economic crisis, it is the government that must spend more and lower taxes to ease crisis source: jocelyn blink

72

john maynard keynes • in crisis, governments should spend their way out of it – “they are only ones with cash”

• promoted fiscal policies managing taxing and spending and monetary policies managing interest rates and money supply • became known as “demand-side” theories or “demand management” policies • his theories gained widespread support until the 1970s • until it couldn’t explain phenomenon of “stagflation” – high unemployment and high inflation source: jocelyn blink

73

monetarism (new classical) begins in the 1960s

74

monetarism • emerged to challenge keynesianism in 1960s • made famous by milton friedman • basic belief that main determinant of economic growth is the total money in the economy, so focus was on monetary policy— hence the term monetarist source: jocelyn blink

75

monetarism

• most concerned with level of inflation caused by too much economic growth • key idea: – money supply should be kept constant to rate of output – to avoid “too much money chasing too few goods”

• this is in clear conflict with keynesian belief in demand management policies • clarity:

– economic growth comes from a central bank strictly controlling money supply in economy source: jocelyn blink

76

new classical school • built on neoclassical school and states that the economy will move automatically to an output level where all resources are fully employed • in macroeconomics, we will see where these ideas merge with neoclassicists • this model focuses on the “supply-side” of the economy – creating incentives for business to become more efficient and for workers to work harder via tax breaks and deregulation

source: jocelyn blink

77

behavioral economics the

st 21

century

78

behavioral economics - where economics meets psychology -

• challenges the assumptions that we as humans act in “economically rational” manner when given choices in the market place • branch of economics that “incorporates the insights of psychology and recognizes that the choices consumers make are governed by many factors that are not consistent with the assumptions behind the neoclassical models” • pioneered by richard thaler who won the nobel prize in 2017

source: jocelyn blink

79

behavioral economics - where economics meets psychology -

• richard thaler argued that “rational choice” humans don’t even exist!

• aims to understand decision-making process of actual human beings • consumers can be “nudged” to make decision better for society – examples: labeling of food, etc

• people can be “nudged” to make better choices leading to improved living standards, health, communities, and the environment source: jocelyn blink

80

behavioral economics - where economics meets psychology -

• nudge theory is not not without its critics – taking away of individual rights – redefines role of government – sets up debate between free market economies and those with government intervention

• has shown however, that psychology can show us much about how economic models work and function

source: jocelyn blink

81

the circular economy the

st 21

century

82

the linear economy - take, make, waste approach -

source: jocelyn blink

83

the circular economy

source: jocelyn blink

84

the doughnut economy

source: jocelyn blink

85

source: jocelyn blink

86

- microeconomics unit 1: demand, supply & market equilibrium

Demand, Supply and Market Equilibrium Fundamental Vocabulary and Concepts

Demand Section Law of Demand Market Demand Demand Schedule Demand Curve Effective Demand Quantity Demanded Income Effect Substitution Effect Non-Price Determinants of Demand Income The price of other products Tastes/preferences Normal Goods Inferior Goods Substitutes Complements Unrelated Goods Supply Section Law of Supply Supply Schedule Supply Curve

Supply Section (cont) Effective Supply Market Supply Quantity Supplied Non-Price Determinants of Supply Cost of Factors of Production Price of Other Products that Could be Produced State of Technology Expectations Government Intervention Joint Supply Competitive Supply Market Equilibrium Shortage—Excess Demand Surplus—Excess Supply Equilibrium Price and Quantity Market Clearing Price Consumer Surplus Producer Surplus Incentive Function Signally Function Price Gouging

87

law of demand understanding what it is

88

demand • demand is the quantity of a good or service that consumers are willing and able to purchase at a given price in a given period of time • this is also known as effective demand and is expressed as the demand curve

source: jason welker and jocelyn blink

89

law of demand all else equal, there is an inverse relationship between a good’s price and the quantity demanded by consumers as the price of a product falls, the quantity demanded of the product will usually increase, ceteris paribus (or vice versa) the result is a movement along the demand curve

source: jason welker and jocelyn blink

90

law of demand • reasons for movement along demand curve – simple, a change in price!

– income effect: when the price of a product falls, then people will have an increase in their “real income” or purchasing power, which reflects the amount that their income will buy, thus making it more likely people will buy the product – substitution effect: when the price of a product falls, then the product will be relatively more attractive to people than other products, whose prices have stayed unchanged, thus making it more likely people will buy the product, substituting it for products that were previously purchased

source: jason welker and jocelyn blink

91

92

determinants of demand understanding what they are

93

determinants of demand • • • • • • •

price income price of other products tastes and preferences expectations size of the market special circumstances source: jason welker and jocelyn blink

94

determinants of demand • price – price is the obvious one…it gets to the root of the law of demand – if price goes up, demand will go down – if price goes down, demand will go up – this results in a movement along the demand curve

source: jason welker and jocelyn blink

95

determinants of demand • income – if incomes goes up, demand will go up – if incomes goes down, demand will go down • for normal goods. the opposite for inferior goods

– this results in a shift in the demand curve

source: jason welker and jocelyn blink

96

determinants of demand • price of other products – substitutes: Coke and Pepsi – compliments: Kindles and eBooks – this results in a shift in the demand curve

source: jason welker and jocelyn blink

97

determinants of demand • tastes and preferences – a change in consumer’s tastes and preferences.

– a product becomes “cooler” or “lamer” – this results in a shift in the demand curve

source: jason welker and jocelyn blink

98

determinants of demand • expectations of the future – the expectations among consumers of the future prices of a good or consumer’s future incomes – this results in a shift in the demand curve

source: jason welker and jocelyn blink

99

determinants of demand • size of the market – a change in the number of consumers or population – this results in a shift in the demand curve

source: jason welker and jocelyn blink

100

determinants of demand • special circumstances – changes in factors such as seasons, weather, natural disasters, scientific studies – this results in a shift in the demand curve

source: jason welker and jocelyn blink

101

determinants of demand • • • • • • •

price income price of other products tastes and preferences expectations size of the market special circumstances source: jason welker and jocelyn blink

102

law of supply understanding what it is

103

supply • supply is the willingness and ability of producers to produce a quantity of a good or service at a given price in a given time period • this is also known as effective supply and is expressed as the supply curve

source: jocelyn blink

104

law of supply • simply states that “as the price of a product rises, the quantity supplied of the product ill usually increase, ceteris paribus (and vice versa) • this occurs because at higher prices there will be more potential profits to be made so the producer will increase output

source: jocelyn blink

105

law of supply

source: jocelyn blink

106

determinants of supply understanding what they are

107

determinants of supply • • • • • • •

price cost of factors of production price of related goods state of technology expectations of producers government Intervention (subsidies and taxes) size of the market source: jocelyn blink

108

determinants of supply • price – price is the obvious one…it gets to the root of the law of supply – if price goes up, supply will go up – if price goes down, supply will go down – this results in a movement along the supply curve

source: jocelyn blink

109

determinants of supply • cost of factors of production – If costs of any of the factors of production increase supply decrease – If costs of any of the factors of production decrease supply increases – This results in a shift of the supply curve

source: jocelyn blink

110

determinants of supply • price of related goods – substitutes in production • if another good that a firm could produce rises in price, firms will produce more of it and less of what they used to produce • footballs and volleyballs • skateboards and rollerblades

– this results in a shift of the supply curve

source: jocelyn blink

111

determinants of supply • state of technology – new technologies make production more efficient and increases supply.

– this results in a shift of the supply curve

source: jocelyn blink

112

determinants of supply • expectations of producers – if firms expect the prices of their goods to rise, they will increase production now.

– if they expect prices to fall, the will reduce supply now • example: yellow highlighters at Nido

– this results in a shift of the supply curve

source: jocelyn blink

113

determinants of supply • government intervention (subsidies and taxes) – subsidies • government payments to producers for each unit produced—this will increase supply

– taxes • payments from firms to government—this will decrease supply

– this results in a shift of the supply curve

source: jocelyn blink

114

determinants of supply • size of the market – if the number of firms in the market increases, supply will increase as well – the opposite is also true – this results in a shift of the supply curve

source: jocelyn blink

115

determinants of supply • • • • • • •

price cost of factors of production price of related goods state of technology expectations of producers government Intervention (subsidies and taxes) size of the market source: jocelyn blink

116

supply and demand diagram the core elements of the microeconomic diagram

117

118

119

market equilibrium understanding what it means

120

some key concepts • market-clearing price is the equilibrium price, since everything produced in the market will be sold • excess supply exists when more of a product is being supplied to a market than is demanded at a certain price – also known as a surplus

• excess demand exists when more of a product is demand than what is supplied at a given price – also known as a shortage source: jocelyn blink

121

market equilibrium

when a market is in equilibrium, resources are efficiently allocated—this is the best allocation of resources for society

source: jocelyn blink

122

excess supply (surplus) excess supply

remember, without an “outside disturbance” this situation is “self-righting” 123

excess demand (shortage)

excess demand

remember, without an “outside disturbance” this situation is “self-righting” 124

effect of changes in demand and supply on equilibrium understanding what will happen

125

shift in demand

126

shift in supply

127

the role of price mechanism understanding what it does

128

the role of price mechanism

129

market and allocative efficiency understanding this what it means

130

key terms for allocative efficiency • consumer surplus – the extra satisfaction (or utility) gained by consumers from paying a price that is lower than what they are are prepared to pay

• producer surplus – the excess of actual earnings that a producer makes from a given quantity of output, over and above the amount the producer would be prepared to accept for that output

• community surplus – the total excess utility for society – consumer surplus + producer surplus

• allocative efficiency – when a market is in equilibrium, with no external influences and no external effects, it is said to be socially efficient or in a state of allocative efficiency

source: jocelyn blink

131

market efficiency

source: jocelyn blink

132

market efficiency consumer surplus Community surplus = consumer surplus + producer surplus

producer surplus

source: jocelyn blink

133

allocative efficiency • introduction: marginal social cost & marginal social benefit curves – marginal social cost curve (MSC) (the supply curve) • the supply curve for a market is largely determined by the industry’s costs of production • we assume that the costs of the industry (private costs) are equal to the costs to society (public costs) when the supply curve represents the social cost curve • in efficiency analysis we refer to the supply curve as the marginal social cost (MSC) curve represents this concept

– marginal social benefit curve MSB (the demand curve) • the demand curve is determined by the utility, or benefits, that the consumption of a good or service brings to the consumers • we assume that the private benefits of consumers are equal to the public benefits of society • therefore the demand curve represents social benefits to society • in efficiency analysis, we refer to the demand curve as the marginal social benefit curve or MSB

source: jocelyn blink

134

allocative efficiency a

point of allocative efficiency

consumer surplus d

b

community surplus = consumer surplus + producer surplus

producer surplus

c

source: jocelyn blink

135

allocative efficiency • to conclude – a free market leads to allocative efficiency – community surplus is maximized – the free market is the optimum allocation of resources from society’s point of view – this occurs when demand is equal to supply, or, when marginal social benefit is equal to marginal social cost

source: jocelyn blink

136

allocative efficiency a

point of allocative efficiency

consumer surplus d

b

community surplus = consumer surplus + producer surplus

producer surplus

c

source: jocelyn blink

137

Demand, Supply and Market Equilibrium Review Questions: What you should be able to do!

Define land, labor, capital and entrepreneurship.

Explain how changes in technology can change supply.

Explain how changes prices of related goods can change supply. indirect taxes and subsidies can change supply.

Demand

Explain how changes the number of firms in the market can change supply.

Explain the negative relationship between price and quantity demanded.

De c be he e a

h

be

ee a

d

d a c

e

de a d a d

Distinguish between movements along the supply curve and shifts of the supply a e

curve.

demand.

Explain that a demand curve represents the relationship between the price and the

Market Equilibrium

quantity demanded of a product, ceteris paribus.

Explain how demand and supply interact to produce market equilibrium.

Draw a demand curve.

Draw a diagram showing how demand and supply interact to produce market

Explain how changes in income may change demand.

equilibrium.

Explain how preferences may change demand.

Explain how changes in the determinants of demand and/or supply result in a new

Explain how prices of related goods may change demand.

market equilibrium.

Define substitutes and compliments.

Using a diagram, explain that price has a signaling function and an incentive function.

Define inferior good and normal good

Define the concept of consumer surplus.

Explain the difference between movements along the demand curve and shifts of the

Define the concept of producer surplus.

demand curve.

E a a e he e

ha he be a

ca

f e

ce f

ce

f

e

at competitive market equilibrium.

Supply Explain the positive relationship between price and quantity supplied.

De c be he e a

h

be

ee a

d

d a

d ce

a d

a e

supply.

Explain that a supply curve represents the relationship between the price and the

Adopted from the IB Economics Subject Guide

quantity supplied of a product, ceteris paribus.

Draw a supply curve.

Explain how changes in costs of factors of production market can change supply.

138

Demand, Supply, and Market Equilibrium IB Exam Practice Questions

Paper 1: Essay Questions 1. (a.) Using examples, explain two non-price determinants of demand. (b.) Evaluate the roll of price mechanism in the market place.

2. (a.) Using examples, explain two non-price determinants of supply. (b.) Evaluate the impact of these changes of supply on producers and consumers.

3. (a.) Using the appropriate diagram, explain what will happen to the supply of corn if there were a drought. (b.) Evaluate the impact of the drought on stakeholders.

4. (a.) Using a diagram, explain the law of demand. (b.) Discuss the importance of price mechanism in determining the behavior of producers.

5. (a.) Using an appropriate diagram, explain the concept of market equilibrium. (b.) Evaluate the impact of increase of demand for soccer balls in the last six months before the World Cup.

139

- microeconomics unit 2: Behavioral economics (hl only)

assumptions of neoclassical model 140

remember! economics is a study of assumptions made about human behavior if you change the assumptions, things change dramatically

source: jocelyn blink

141

assumptions of neoclassical model • neoclassical model assumes a rational thinking human – consumers will always maximize utility – producers will always maximize profits

• it is assumed that consumers will always work in their self-interest • it is assumed that consumers have access to all of the relevant information they need – perfect information • the rational economic agent sis known as homo economicus • so...

– “when faced with choices, it is assumed that homo economicus will make intelligent, logical and well-considered decisions that give them the most utility” source: jocelyn blink

142

behavioral economics 143

behavioral economics - where economics meets psychology -

• challenges the assumptions that we as humans act in “economically rational” manner when given choices in the market place • branch of economics that “incorporates the insights of psychology and recognizes that the choices consumers make are governed by many factors that are not consistent with the assumptions behind the neoclassical models” • pioneered by richard thaler who won the nobel price in 2017 source: jocelyn blink

144

behavioral economics - where economics meets psychology -

• richard thaler argued that “rational choice” humans don’t even exist!

– we are homo sapiens, not homo economicus – he reduced it down to “econs” and “humans”

source: jocelyn blink

145

source: jocelyn blink

146

behavioral economics critique of rational consumer model

147

behavioral economics - critiques of rational consumer model -

• imperfect information – challenges the assumption of perfect information

• bounded rationality – challenges the assumption of rational choice

• bounded selfishness – challenges the assumption of self-interest

• bounded self-control – challenges the assumption of rational thinking source: jocelyn blink

148

the dual system model 149

the dual-system model

- how “humans” make decisions differently than “econs” • based on the work of daniel kahneman and amos tversky – two different systems of thinking • system 1: the fast thinking system • system 2: the slow thinking system

• richard thaler, in nudge, renames the systems – system 1: the automatic system – fast, subconscious decisions – system 2: the reflective system – slow, controlled decisions

source: jocelyn blink

150

the dual-system model

- how “humans” make decisions differently than “econs” -

source: jocelyn blink

151

cognitive biases & decision making 152

cognitive biases • • • • • • •

availability bias anchoring bias framing bias social conformity status quo or inertia bias loss aversion bias hyperbolic discounting source: jocelyn blink

153

cognitive biases • availability bias – the availability of information examples overly impacts people’s decision-making processes • examples: health dangers, smoking,

• anchoring bias – the “anchor” is information about the value of one thing, and this serves as our reference point for other choices and decisions • examples: sales in stores, offering an overly high price to start source: jocelyn blink

154

cognitive biases • framing bias – the way in which we learn about something—the way it is framed to us initially—frames our decisions • examples: all over the place in marketing – “90% fat free vs contains 10% fat”

• social conformity (herd behavior) – we want to fit in – there, you get it – even if it’s against our best interest • examples: trends, bandwagon effect, being cool, even if it’s source: jocelyn blink

155

cognitive biases • status quo (inertia bias)

– there are so many choices, we do nothing

• examples: cell phone company, bank choice

• loss aversion bias

– people may make choice based on not loosing something even if the decision is ill-informed • examples: buy now, only 4 seats left at this price

• hyperbolic discounting

– tendency for humans to prefer short-term rewards over larger later rewards source: jocelyn blink

156

choice architecture 157

choice architecture • choice architecture is the “theory that the decisions that we make are heavily influenced by the way someone, referred to as a “choice architect” presents the choices to us” – examples: the supermarket check out line options

• default choice – an example of when choice architecture can be observed • google search • going to starbucks source: jocelyn blink

158

default options • key points – though not always brining the best outcomes, they are popular – status quo bias is alive here – consumers may not have the time, or interest, or cognitive skills to understand the alternatives – they may lack the courage to change and are comfortable with what they already know

• case study: organ donation programs – opt-in vs. opt-out source: jocelyn blink

159

mandated choice • mandated choice – another example of choice architects influencing consumers • these are situations where consumers are required by law to make a choice in advance • organ donation is a good example of this – they must click a box when they get their drivers license – forcing a choice

• these are both examples of “choice architects” making decisions for us source: jocelyn blink

160

nudge theory

161

nudge theory • nudge theory suggests that “the choice architecture offered to people can be carefully designed to gently encourage (nudge) the people to voluntarily choose the option which is better for them • pioneered by richard thaler and cass sunstein’s book, nudge: improving decisions about health, wealth, and happiness

source: jocelyn blink

162

nudge theory • the key to nudge theory!

– consumers keep their consumer sovereignty but are encouraged to make better choices • example: healthy foods at check out lines

– a kin to your parents suggesting something but not mandating a decision – over time you will begin to choose it – you keep the power to choose, but the options are made by choice architects

source: jocelyn blink

163

nudge theory • the key to nudge theory!

– when designing the choices, “architects” must help people override their cognitive biases • change the system 1 choice structure

• examples – private retirement savings • save more tomorrow (SMT)

source: jocelyn blink

164

nudge theory • nudge theory is not not without its critics – taking away of individual rights – redefines role of government – sets up debate between free market economies and those with government intervention

• has shown however, that psychology can show us much about how economic models work and function

source: jocelyn blink

165

- microeconomics unit 3: elasticities

Elasticities Fundamental Vocabulary and Concepts Elasticity Price Elasticity of Demand (PED) Cross Elasticity of Demand (XED) Income Elasticity of Demand (YED) Elastic Demand Inelastic Demand Unit Elastic Demand Perfectly Elastic Demand Perfectly Inelastic Demand Determinants of Price Elasticity of Demand 1. The number and closeness of substitutes 2. The necessity of the product and how widely the product is defined 3. The time period considered

Income-Elastic Demand Income-Inelastic Demand Necessity Goods Superior or Luxury Goods Engel Curve Price Elasticity of Supply (PES) Elastic Supply Inelastic Supply Unit Elastic Supply Perfectly Elastic Supply Perfectly Inelastic Supply Determinants of Price Elasticity of Supply 1. How much costs rise as out is increased 2. The time period considered 3. The ability to store stock Commodities

166

price elasticity of demand range of values and applications of PED

167

168

range of values of PED • elastic:

PED é 1

• inelastic:

PED ê 1

• unit elastic:

PED = 1

• perfectly elastic:

PED = infinity

• perfectly inelastic:

PED = 0

169

perfectly elastic demand curve • when PED = infinity • definition: a product has perfectly elastic demand is completely responsive to any change in price, and therefore even the slightest change in price will result in no quantity demanded of the product

source: jocelyn blink

170

perfectly inelastic demand curve • when PED = 0 • definition: a product that has perfectly inelastic demand is completely unresponsive to price changes, and therefore a change in the price of the product will have no effect on the quantity demanded

source: jocelyn blink

171

applications of price elasticity of demand understanding what they are

172

applications of PED • firms: to maximize revenue – firms benefit from knowing how responsive their consumers are to price changes at any given time • if a seller knows demand is highly elastic, she may wish to lower price an capture new customers • if a seller knows demand is highly inelastic, she may wish to raise her prices as she will not lose many sellers but will enjoy higher revenues source: jason welker

173

applications of PED • government: to maximize tax revenue – the government needs to know how consumers will respond to taxes imposed on particular goods – for example, if the government wishes to raise revenues from taxing goods, it should know that • a tax on a relatively elastic good (restaurant meals) will not raise much revenue because demand will drop as the price rises due to the tax • a tax on a relatively inelastic good (cigarettes) will raise a lot of revenue because most people will continue smoking and thus have to pay the tax source: jason welker

174

price elasticity of demand diagram the diagram!

175

source: jocelyn blink

176

source: jocelyn blink

177

source: ellie tragakes

178

determinants of price elasticity of demand elasticity

179

source: jocelyn blink

180

the determinants of PED • the number of substitutes – the more substitutes a good has the more elastic demand will be, as consumers can replace a good whose price has gone up with one of its now relatively cheaper substitutes

• luxury or necessity?

– if a good is a necessity, changes in price tend no to affect quantity demanded, so demand is inelastic. If it’s a luxury that a consumer could go without, demand becomes more elastic source: jocelyn blink

181

the determinants of PED • time period – the amount of time a consumer has to respond to the price change the more elastic it will become – if prices remain high over a longer period of time, consumers can find substitutes or learn to live without, do demand is more elastic over time

• proportion of income – the proportion of income the purchase of a good represents.

If a good represents a higher proportion of a consumer’s income, his or her demand tends to be more elastic source: jocelyn blink

182

the determinants of PED • addictive product?

– if a product is addictive or habit forming, demand tends to be inelastic • examples: cigarettes, alcohol

source: jocelyn blink

183

cross elasticity of demand understanding XED

184

source: jocelyn blink

185

cross elasticity of demand (XED)

source: jocelyn blink

186

income elasticity of demand the impact of a change in income on the quantity demanded of a product

187

source: jocelyn blink

188

source: jocelyn blink

189

income elasticity of demand: importance

190

income elasticity of demand • for firms

– income means more demand – examples: there are many

• for governments

– for explaining structural changes in the economy • primary sector – the earth • secondary sector – manufacturing • tertiary sector – advising

– globalization makes importing so easy – this makes YED really important to governments source: jocelyn blink

191

price elasticity of supply range of values and applications of PES

192

price elasticity of supply definition:

the measure of how much the supply of a product changes when there is a change in price of the product.

remember: since there is direct relationship between price and quantity supplied PES will always be a positive number

source: jocelyn blink

193

range of values of PES • elastic:

PES é 1

• inelastic:

PES ê 1

• unit Elastic:

PES = 1

• perfectly Elastic:

PES = infinity

• perfectly Inelastic:

PES = 0 source: jocelyn blink

194

perfectly elastic supply curve • when PES = infinity • definition: a product has perfectly elastic supply is completely responsive to any change in price, and therefore even the slightest change in price will result in no quantity supplied of the product

• key point!

– in international trade, it is often assumed that the supply of commodities, such as wheat, available to a country is infinite – thus, the market in the country will have a “world supply” curve that is perfectly elastic at the current world market price source: jocelyn blink

195

perfectly inelastic supply curve • when PES = 0 • definition: a change in the price of a product will have no effect on the quantity supplied at all, or better said, it is completely non-responsive to price changes

• key point!

– in the very short run, sometimes known as the immediate time period, it is impossible for firms to increase their supply straight away, no matter what happens to price, so a perfectly inelastic supply curve is a possibility source: jocelyn blink

196

applications of price elasticity of supply understanding what they are

197

applications of PES • firms: to maximize profits – if a producer expects the price of her product to change in the future, she will want to adjust her output accordingly – being able to adjust output in a timely manner to price changes is key to maximizing a firm’s profits

source: jocelyn blink

198

applications of PES • government – a government must consider PES for a good if it is considering intervening in the market for that good – for example, if a government is considering imposing price controls PES should be considered

sources: jason welker

199

price elasticity of supply the determinants of PES

200

the determinants of PES • how much costs rise as output is increased – the existence of unused capacity – the mobility of the factors of production

• the time period considered • the ability to store stock source: jocelyn blink

201

how much costs rise as output is increased • if the total costs rise significantly as a producer attempts to increase supply, then it is likely that the producer will not raise the supply and so the elasticity of supply for the product will be relatively inelastic • factors that prevent a significant rise in costs – the existence of unused capacity • if there is unused capacity, PES will be elastic • if firm is producing at capacity, PES will be inelastic – the mobility of factors of production • if factors of production are easily moved from one productive use to another then PES will be relatively elastic • if not, PES will be inelastic

source: jocelyn blink

202

the time period considered • more time = more elastic • in general terms, the longer the time period considered the more elastic the supply will be – in the immediate time period, firms are not really able to increase their supply very much, if at all, if price changes • value of PES will be inelastic

– in the short-run firms may be able to increase the quantity of some factors of production that they employ, such as raw materials and labor, but they may not be able to increase all of their factors • value of PES will be more elastic than immediate

– in the long-run firms may be able to increase the quantity of all factors they employ and so the value of PES will be much more elastic • value of PES will be even more elastic than others

source: jocelyn blink

203

the ability to store stock • more “stockable” = more elastic • if a firm is able to store high levels of stock (inventories) of their product, then they will be able to react to price increases with swift supply increases and so PES will be relatively elastic

source: jocelyn blink

204

Elasticities Review Questions: What you should be able to do!

Price Elasticity of Demand

Cross Elasticity of Demand

Using a diagram, explain the concept of elastic supply.

Define cross price elasticity of demand (XED).

Using a diagram, explain the concept of unit elastic supply.

Explain the concept of cross price elasticity of demand.

Using a diagram, explain the concept of perfectly elastic supply.

Calculate XED using the following equation:

Using a diagram, explain the concept of perfectly inelastic supply.

XED = percentage change in quantity demanded for good X

Define price elasticity of demand (PED).

percentage change in price of good Y

Identify and explain the determinants of PES, including time, mobility of factors of production, unused capacity and ability to store stocks.

Using a diagram, explain the concept of price elasticity of demand.

Show that substitute goods have a positive value of XED.

Explain why the PES for primary commodities is relatively low and the PES for

Calculate PED using the following equation:

Show that complements a negative value of XED.

manufactured products is relatively high.

PED =Percentage change in quantity demanded Percentage change in price

Examine the implications of XED for businesses if prices of substitutes or complements change.

Explain why that the is expressed as positive although its mathematical value is usually negative.

Adopted from the IB Economics Subject Guide

Income Elasticity of Demand

Using a diagram, explain the concept of price elastic demand.

Define income elasticity of demand (YED).

Using a diagram, explain the concept of price inelastic demand

Explain the concept of income elasticity of demand.

Using a diagram, explain the concept of unit elastic demand.

Calculate YED using the following equation:

Using a diagram, explain the concept of perfectly elastic demand.

YED = percentage change in quantity demanded

Using a diagram, explain the concept of perfectly inelastic demand.

percentage change in income

Explain the determinants of PED.

Show that normal goods have a positive value of YED.

Examine the role of PED for firms in making decisions regarding price changes and

Show that inferior goods have a negative value of YED.

their effect on total revenue.

Distinguish between necessity goods and luxury goods.

Explain why the PED for many primary commodities is relatively low.

Explain why the PED for manufactured products is relatively high.

Examine the significance of PED for government in relation to indirect taxes.

Price Elasticity of Supply Define price elasticity of supply (PES).

Explain the concept of price elasticity of supply.

Calculate PES using the following equation: PES = percentage change in quantity supplied percentage change in price

205

Elasticities IB Exam Practice Questions

Paper 1: Essay Questions 1. (a.) Using at least three examples, explain price elasticity of demand. (b.) Discuss the importance of price elasticity of demand for a small business in your local community.

2. (a.) Using at least two examples, explain cross elasticity of demand. (b.) Discuss the importance of cross elasticity of demand for a small business in your local community.

3. (a.) Using at least two examples, explain price elasticity of demand. (b.) Discuss the importance of price elasticity of demand for a small business in your local community.

4. (a.) Using examples, explain what is meant by perfectly elastic and perfectly inelastic demand. (b.) Compare the impact of an indirect tax on a very inelastic product to that of a very elastic product.

5. (a.) Using examples, explain the concept of price elasticity of supply. (b.) Discuss the importance of price elasticity of supply to a producer.

206

- microeconomics unit 4: government intervention

Government Intervention Fundamental Vocabulary and Concepts Indirect Tax Direct Tax Excise Tax Specific Tax Ad Valorem Tax Producer Revenue Consumer Expenditure Government Revenue Tax Revenue Subsidies

Price controls Maximum Price Price Ceiling Minimum Price Price Floor Rent Control Food Price Controls Underground or Parallel Markets Minimum Wage Agricultural Price Supports

207

indirect taxes understanding what they are

208

big picture: reasons why governments impose indirect taxes • source of government revenue – simply to collect revenue

• method to discourage consumption of goods that are harmful for the individual.

– cigarettes, alcohol, gambling

• to redistribute income – taxes on luxury goods like cars, boats, furs to reduce the differences incomes in a society

• method to improve the allocation of resources (reduce allocative inefficiencies)

source: jocelyn blink

209

indirect tax • indirect tax – a tax imposed upon expenditure – it is placed upon the selling price of a product, so it raises the firm’s costs and shifts the supply curve for the product inward by the amount of the tax – because of this shift, less product will be supplied at every price level

source: jocelyn blink

210

two types of indirect taxes • specific tax

– this is a specific or fixed amount of tax that is imposed upon a product.

• example: a tax of $1 per unit.

• effect: a specific tax will have the effect of shifting the supply curve inwards by the amount of the tax.

• percentage tax

– this tax is a percentage of the selling price and so the supply curve will shift inwards as well, but the gap between S1 and the S1 + tax will widen and the price increases.

• effect: a percentage tax will have the effect of shifting the supply curve inwards by the amount of the tax, but the gap between supply curves widens because it is a percentage tax source: jocelyn blink

211

impact of indirect taxes • • • •

how will consumers be affected? how will producers be affected? how will the government be affected? also, consider: – what will happen to the price that consumers pay?

– what will happen to the amount received by the producer?

– how much tax will the government receive?

– what will happen to the size of the market, and employment? source: jocelyn blink

212

indirect tax diagram understanding how to draw it

213

214

215

X

producer revenue pre-tax producer revenue post-tax

Y

government tax revenue consumer tax burden producer tax burden

Z

total welfare loss

216

217

per-unit subsidy understanding what it is

218

subsidy • subsidy – an amount of money paid by the government to a firm, per unit of output

• subsidies shift supply curve outwards by the amount of the subsidy—always!

• specific subsidy is a specific amount of money that is given for each unit of the product, for example, a subsidy of $2 per unit • percentage subsidies are sometimes granted, they are rare, so we will concentrate on specific subsidies source: jocelyn blink

219

why give a subsidy?

• to lower the price of essential goods, such as milk, to consumers – in this way, the government hopes that the consumption of the product will be increased, encouraged by the lower price

• to guarantee the supply of products that the government thinks are necessary for the economy – this may be because the goods are essential for economy—a basic food supply or a power source like coal – it may be also be that the industry creates a lot of employment that would be lost, thus causing economic and social problems

• to enable producers to compete with overseas trade, thus protecting the home industry

source: jocelyn blink

220

what happens to the supply curve?

• if a subsidy is granted to a firm on a certain product, then the supply curve for the product will shift vertically downwards by the amount of the subsidy • this reduces the cost of production for the firm • more product will be supplied at every price • as with indirect taxes, the amount of the subsidy that is passed on to the consumers in the form of lower prices, and the amount that is retained by the producers, will depend on the relative elasticities of demand and supply source: jocelyn blink

221

evaluating a subsidy • government opportunity cost – the opportunity cost of government spending on the subsidy in terms of other alternative spending projects.

• does it create inefficiencies?

– the subsidy allows firms to be inefficient if they do not have to compete with foreign producers in a “free market”.

• who is going to pay for it?

– although the subsidy allows consumers to buy products at a lower price, the taxpayers are who are funding the subsidy. so, is it really cheaper?

• is there damage to foreign producers?

– this is complex debate between high-income and low-income countries – example: high-income countries subsidize their farms, thus, leading to overproduction of goods that could have been produced in other countries more cheaply, but because of subsidies it’s not the case. source: jocelyn blink

222

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producer revenue pre-subsidy producer revenue post-subsidy government cost subsidy consumer benefit producer benefit total welfare loss

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W X

Z

Y

producer revenue pre-subsidy producer revenue post-subsidy government cost subsidy consumer benefit producer benefit total welfare loss

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W producer benefit

X X

consumer benefit Z

Y

producer revenue pre-subsidy producer revenue post-subsidy government cost subsidy consumer benefit producer benefit total welfare loss

P1 Q1 P3 Q2 W Y P2 P1 P2 X Y P1 P3 X W XYW

producer revenue pre-subsidy

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per-unit subsidy diagram understanding what it is

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producer revenue pre-subsidy producer revenue post-subsidy government cost subsidy consumer benefit producer benefit total welfare loss

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W X X

Z

Y

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price controls understanding what they are

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price controls • although it may seem to be an optimum situation, the free market does not always lead to the best outcomes for all producers, consumers, or society in general.

• therefore, governments often choose to intervene in the market in order to achieve a different outcome • there are two key situations where this occurs: – price ceilings or maximum prices – price floors or minimum prices

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price ceiling understanding what it is

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price ceiling • a maximum price control, or price ceiling, is when the government sets a maximum price, below the equilibrium price, which then prevents producers from raising the price above it • the price is capped or stopped by the price ceiling…it can’t go higher!

• like a balloon in a room • why do governments set maximum prices?

– maximum prices are usually set to protect consumers and they are normally imposed in markets where the product in question is a necessity and/or a merit good 235

Market for Housing

upply d and s n a m e basic d iagram d

Quantity of Housing (000 units/year)

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S2

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price floor understanding what it is

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price floor • the government sets a minimum price, above the equilibrium price which then prevents producers from reducing the price below it • sometimes known as prices floors, since the price is not able to go below “the floor” • the price can’t go lower • minimum prices are mostly set for two reasons – raise incomes for producers – protect workers by setting a minimum wage

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and and basic dem gram supply dia

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Government Intervention Review Questions: What you should be able to do!

Price Ceiling Define price ceiling.

Draw a diagram to show a price ceiling.

Indirect Taxes

Discuss the consequences of imposing price ceilings on stakeholders—

Define and give examples of an indirect tax.

consumers, producers, the government, and the market.

Explain why governments impose indirect taxes.

Define shortage.

Explain the difference between a specific tax and a percentage tax.

Examine the possible consequences of a price ceiling.

Draw diagrams to show specific taxes.

Explain, distinguish between, illustrate and give examples of price ceilings

Explain the importance of elasticity in understanding the impact of a specific tax

(maximum price controls) and price floors (minimum price controls).

on the demand for, and supply of, a product.

Discuss the consequences of imposing a price ceiling on stakeholders in a

Discuss the consequences of imposing an indirect tax on consumers, producers,

market—consumers, producers, and the government

and the government.

Price Floor Subsidies

Define price floor.

Define subsidy.

Explain why governments impose price floors.

Explain why governments provide subsidies.

Describe examples of price floors, including price support for agricultural

Draw a diagram to show a subsidy.

products and minimum wages.

Discuss the consequences of providing a subsidy on the stakeholders in a market,

Draw a diagram of a price floor.

including consumers, producers, and the government.

Define surplus.

Examine the possible consequences of a price floor.

Price Controls Define price controls.

Discuss the consequences of imposing a price floor on stakeholders in a market—consumers, producers, and the government.

Explain why governments impose price ceilings.

Describe examples of price ceilings, including food price controls and rent

Adopted from the IB Economics Subject Guide

controls.

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Government Intervention Review Questions: What you should be able to do!

Indirect Taxes Define and give examples of an indirect tax.

Explain why governments impose indirect taxes.

Explain the difference between a specific tax and a percentage tax.

Draw diagrams to show specific taxes.

Explain the importance of elasticity in understanding the impact of a specific tax on the demand for, and supply of, a product.

Discuss the consequences of imposing an indirect tax on consumers, producers, and the government.

Subsidies Define subsidy.

Explain why governments provide subsidies.

Draw a diagram to show a subsidy.

Discuss the consequences of providing a subsidy on the stakeholders in a market, including consumers, producers, and the government.

Price Controls Define price controls.

Explain why governments impose price ceilings.

Describe examples of price ceilings, including food price controls and rent controls.

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- microeconomics unit 5: market failure

Market Failure Fundamental Vocabulary and Concepts Market Failure Merit Goods Demerit Goods Public Goods Non-Excludable Good Non-Rivalrous Good Marginal Private Benefits (MPB) Marginal Social Benefits (MSB) Marginal Private Costs (MPC) Marginal Social Costs (MSC) Types of Market Failure 1.

Lack of public goods 2.

Undersupply of merit goods 3.

Oversupply of demerit goods 4.

The existence of externalities

Positive Externalities Negative Externalities Negative Externalities of Production Negative Externalities of Consumption Positive Externalities of Production Positive Externalities of Consumption Internalizing External Costs Tradable Permits Cap and Trade Programs Common Access Resources Sustainability Welfare Loss Socially Efficient Output

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market and allocative efficiency understanding what they are

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key terms for allocative efficiency • consumer surplus – the extra satisfaction (or utility) gained by consumers from paying a price that is lower than what they are are prepared to pay

• producer surplus – the excess of actual earnings that a producer makes from a given quantity of output, over and above the amount the producer would be prepared to accept for that output

• community surplus – the total excess utility for society – consumer surplus + producer surplus

• allocative efficiency – when a market is in equilibrium, with no external influences and no external effects, it is said to be socially efficient or in a state of allocative efficiency

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market efficiency

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market efficiency consumer surplus Community surplus = consumer surplus + producer surplus

producer surplus

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allocative efficiency • introduction: marginal social cost & marginal social benefit curves – marginal social cost curve (MSC) (the supply curve) • the supply curve for a market is largely determined by the industry’s costs of production • we assume that the costs of the industry (private costs) are equal to the costs to society (public costs) when the supply curve represents the social cost curve • in efficiency analysis we refer to the supply curve as the marginal social cost (MSC) curve represents this concept

– marginal social benefit curve MSB (the demand curve) • the demand curve is determined by the utility, or benefits, that the consumption of a good or service brings to the consumers • we assume that the private benefits of consumers are equal to the public benefits of society • therefore the demand curve represents social benefits to society • in efficiency analysis, we refer to the demand curve as the marginal social benefit curve or MSB

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allocative efficiency a

point of allocative efficiency

consumer surplus d

b

community surplus = consumer surplus + producer surplus

producer surplus

c

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allocative efficiency • to conclude – a free market leads to allocative efficiency – community surplus is maximized – the free market is the optimum allocation of resources from society’s point of view – this occurs when demand is equal to supply, or, when marginal social benefit is equal to marginal social cost

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market failure base diagram understanding what it is

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negative externalities of consumption welfare loss

P2

negative externality

MPB

Q2

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negative externality of consumption solutions!

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negative externalities of consumption welfare loss

P2

negative externality

MPB

Q2

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possible government solutions to negative externalities of consumption 1. ban 2. indirect tax 3. negative advertising campaign and education source: jocelyn blink

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1. ban the product • the government could ban smoking—make it illegal • there are some problems with this solution – this isn’t that simple: it would have a huge impact tobacco industry, government would experience decrease in tax revenue for government from cigarettes, might effect voting – a partial ban is possible, a ban inside restaurants perhaps

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2. indirect tax • the government could impose an indirect tax on consumption in order to reduce consumption • this will shift the MSC curve upwards to MSC + tax • this will reduce consumption to the socially efficient level of output but will raise the price • the government will gain significant revenue and this may be used to correct some of the negative externalities caused by smoking • there is a problem with this solution – the inelastic demand of cigarettes will prevent the tax from moving the quantity demanded

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negative externalities of consumption MSC + tax Solution 2: Indirect Tax

P2 b MPB

Q2

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3. negative advertising campaign and education • in order to educate about dangers of smoking and shift the MPB downward • the goal of this would be to shift MPB curve downward • there are some problems with this solution – costs may be too high, although taxes could pay for this – also, there is doubt as to the effectiveness of education and advertising on reducing cigarette consumption

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negative externalities of consumption

P2 a MPB Solution 3: Negative advertising campaign

Q2

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negative externalities of consumption MSC + tax Solution 2: Indirect Tax

P2 a MPB Solution 3: Negative advertising campaign

Q2

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NEP

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negative externalities of production MSC welfare loss

P2

b

MPC

negative externality

Q2

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negative externality of production solutions!

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negative externalities of production MSC welfare loss

P2

a b

MPC

negative externality

Q2

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possible government solutions to negative externalities of production • in a free market, this situation would continue because profit-maximizing firms will only take into account their private costs of production • therefore, it is up to the government to rectify the situation, by cutting out as much of welfare loss as possible

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possible government solutions to negative externalities of production 1. tax firms to increase their private costs 2. legislate by banning polluting firms or restricting output in some way 3. tradable emissions permits

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1. tax firms to increase their private costs • the government could tax the firm in order to increase the firm’s private costs and so shift the MPC curve upwards toward the point of social efficiency • if the tax is equal to the external cost of the production, then we say that the government has “internalized the externality” • if the tax is not equal to the external cost, then it will reduce the loss of welfare, but not eliminate it • there is still a welfare loss, but it is less than under the free market with no government intervention

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negative externalities of production MSC welfare loss

MPC + tax MPC= MPC

P2 P3

Q2 Q3

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1. tax firms to increase their private costs • evaluation: there are some problems with a tax – one, it is difficult to measure accurately the pollution created and to put a value on it, to be regained by the tax – two, it is difficult to identify which firms are polluting and to what extent each is responsible for pollution – three, it is often argued that taxes do not actually stop the pollution from taking place

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2. legislate by banning polluting firms or restricting output in some way •

the government could legislate and ban the polluting firms, or restrict their output in some way

•

it could also pass laws relating to measurable environmental standards in the firm’s production units

•

to meet the standards, the firms would have to spend money, thus increasing their private costs

•

evaluation: there are some problems with this solution – one, the ban or restriction may lead to unemployment and the non-consumption of whatever was being produced, which may have been a valuable product – two, the cost of setting and then policing the ban may be greater than the cost of the pollution

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3. tradable emissions permits • the government could issue tradable emission permits • these are a market-based solution to negative externalities of production • tradable emission permits are issued by the government and give firms the license to pollute up to a set level • once they are issued, firms can buy, sell, and trade the permits on the market • this is also known as a “cap and trade system” • the government decides upon the level of pollution and then splits up the total level of pollution into a number of tradable emission permits, each allowing a certain level of pollution • at this point the market takes over—if you want to pollute you buy a permit from other firms

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3. tradable emissions permits • evaluation: there are some problems with this solution – one, this solution does not lead to the reduction of pollution, once the allowable limit has been set – two, the government faces a difficult decision to allow pollution and to decide at what levels

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PEC

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positive externalities of consumption positive externality

potential welfare gain

P 2

b

MSB

MPB The goal is Q2 consumption!

Q2

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positive externality of consumption solutions!

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positive externalities of consumption positive externality

potential welfare gain

P 2

b

MSB

MPB The goal is Q2 consumption!

Q2

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possible government solutions to positive externalities of consumption 1. subsidy 2. positive advertising campaign 3. pass laws making it mandatory

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1. subsidy • the government could subsidize the supply of healthcare • a subsidy would shift the MSC curve downwards and, in this way, the socially efficient level of consumption • indeed, it may be that the government believes the importance of healthcare to be so great that they will subsidize it to the point where it is free to the consumer, or the state will supply it at no cost to the consumer • there are some problems with this solution – the main problem is cost, and developing countries are less capable of subsidizing

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positive externalities of consumption positive externality

MSC + subsidy b

P 2

Solution 1: Subsidy

P 3

MSB

MPB The goal is Q2 consumption!

Q2

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2. positive advertising campaign • the government could use positive advertising to encourage people to consume more healthcare • this will shift the MSB curve to the right, and thus increase welfare toward socially efficient point • there are some problems with this solution – the problem here is high cost of providing the advertising

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positive externalities of consumption positive externality

potential welfare gain

P 2

b

MSB Solution 2: Positive advertising MPB The goal is Q2 consumption!

Q2

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3. pass laws making it mandatory • the government could pass laws insisting that citizens have vaccinations against certain diseases, or have regular health checks, but this will only be successful if the government provides this free of charge • there are some problems with this solution – people often resent laws of this sort being imposed by the government – they also see it as an infringement on civil liberties

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conclusion: positive externalities of consumption • the extent to which the government will intervene will depend on the amount of external benefits • in the case of merit goods such as healthcare and education, the positive externalities are massive • indeed, economic growth is heavily dependent on the productivity of labor, which is of course dependent on the education and health of the people • therefore, it is generally a government priority to have an effective system for providing healthcare and education

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PEP

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positive externalities of production potential welfare gain

MPC = MPC MSC

b

P2

positive externality

Q2

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positive externality of production understanding the diagram

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positive externalities of production potential welfare gain

MPC = MPC MSC

b

P2

positive externality

Q2

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possible government solutions to positive externalities of production • in a free market, it is up to the government to rectify the situation • they have two possible solutions 1. subsidize firms that offer training 2. provide vocational training itself

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1. subsidize firms that offer training • the government could subsidize the firms that offer the training • if this were to happen, then the MPC curve would be shifted downward by size of the subsidy and, if a full subsidy were given, then the MPC would be the same as MSC and the socially efficient point “a” would be reached • there are some problems with this solution – one, how do you calculate the level of the subsidy deserved by each firm?

– two, the cost of the subsidy would pull government resources from other programs that may be more worthy

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2. provide vocational training itself • the government could provide vocational training by creating training centers for workers in certain industries • there are some problems with this solution – although this is a possibility, the costs would be high, the trainers may lack expertise found in the firms, and it may dissuade firms from offering training on their own – regardless of the cost (or who pays for it) economies benefit enormously through the training and re-training of the labor – the improvement in the quality of labor, a factor of production, can shift out an economy’s PPC source: jocelyn blink

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common access resources understanding what this means

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common access resources • common access resources have many different names, such as common-pool resources and common property resources • definition: common access resources are typically natural resources, such as fishing grounds, forests, and pastures, or human-made systems for managing natural resources, such as irrigation systems • one problem with such resources is that it is very difficult or very expensive to exclude people from using them

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common access resources • key point: the fear is that the nature of the resource and the inability to charge for them may encourage overuse or over-consumption, and eventually lead to the depletion of the resource – the benefits to the individual outweigh the external cost and give the individual the incentive to keep using the resource – so, a market failure will take place because of over-consumption

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connection to sustainability • sustainability – this concept is very much tied with the concept of sustainability – sustainability exists when the consumption needs of the present generation are met without reducing the ability to meet the needs of future generations

• it has been argued that a lack of a price for common access resources means they are almost bound to be over-consumed and so eventually they will run out • alternatively, they may be overused such that the resource is degraded and will not be available as a resource for future generations • solutions depend largely on who uses the resources – if resources are used by a group of people geographically situated in one country, then national solutions may be employed – where the common property resource extends to more than one country at time, for example the world’s oceans, then international negotiations and solutions are required

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Market Failure Review Questions: What you should be able to do!

Using a diagram explain the concept of positive externalities of production.

Explain that merit goods are goods whose consumption creates external benefits.

Define market failure.

Explain and give examples of merit goods.

Explain and give examples of demerit goods.

Explain and give examples of public goods Define positive and negative externalities of production and consumption.

Explain the concept of market failure as a failure of the market to achieve allocative efficiency resulting in an over-allocation of resources or an underallocation of resources Explain the concepts of marginal private benefits (MPB).

Using a diagram, evaluate the use of government policy responses to solve the problem of positive externalities of production and consumption.

Define common access resources.

Define sustainability.

Explain the threat to sustainability posed by the use of fossil fuels in developed countries.

Explain the threat to sustainability posed over-exploitation of agricultural land in developing countries.

Evaluate, using diagrams, possible government responses to threats to sustainability.

Explain the concepts of marginal social benefits (MSB).

Explain the concepts of marginal private costs (MPC).

Explain the concepts of and marginal social costs (MSC).

Adopted from the IB Economics Subject Guide

Describe the meaning of externalities as the failure of the market to achieve a social optimum equilibrium (where MSB = MSC).

Using a diagram explain the concept of negative externalities of production.

Using a diagram explain the concept of negative externalities of consumption.

Explain that demerit goods are goods whose consumption creates external costs.

Using a diagram, evaluate the use of government policy responses to solve the problem of negative externalities of production and consumption.

Using a diagram explain the concept of positive externalities of consumption.

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Market Failure IB Exam Practice Questions

5. (a.) Using the appropriate diagram, discuss how the consumption of gasoline qualifies as a negative externality. (b.) Evaluate the effectiveness of an indirect tax in solving this market

Paper 1: Essay Questions

failure.

1. (a.) Using the appropriate diagram, explain why the consumption of cigarettes is a market failure. (b.) Evaluate the use of government policies to reduce this market failure.

2. (a.) Using the appropriate diagram, explain why the impact of emissions from a paint factory are a market failure. (b.) Discuss the best policy a government may implement to minimize this negative externality of production.

3. (a.) Using the appropriate diagram, explain how the consumption of education provides positive outcomes for society. (b.) Evaluate the possible government policies that can be implemented to correct a positive externality of consumption

4. (a.) Explain how merit goods and public goods qualify as market failures. (b.) Discuss the impact of government policies to promote these goods.

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Sources I am grateful for the work of my fellow IB Economics teachers Jocelyn Blink, Ian Dorton, Ellie Tragekes, and Jason Welker. Though they may not know it, each of them have accompanied me through my teaching of IB Economics over the years.

Thank you!

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