ksusha <3#8872

Chapter 3 – Demand

Market
- Buyers and sellers carry out economic transaction
o Product market
o Factor market
o Stock market
o International finance market
Demand
- Quantity of a good or service that consumers are willing
and able to purchase at different prices in a given time
period = if they are able to buy what they want it is known
as effective demand
Law of Demand
- As price of a product falls, quantity demanded of the
product increases (ceteris paribus)
- Demand curve slopes downwards
Non-price determinants of demand
- Demand shifts
- Income:
o Normal goods – increase in income, increases demand –
depends on the product, e.g., salt – small increase,
cinema tickets – large increase
o Inferior goods – demand falls, as income rises, higher
priced substitutes are bought, e.g., cheap wine
- The price of related goods
o Substitutes – change in price of one changes price of the other, e.g., fall of
price in chicken, increases its demand and decreases demand of beef – leads to
movement along for chicken and shift to the left for beef
o Complements – purchased together – if one’s price changes, the other’s does
too; e.g., decrease in game prices, increase in sales of games and game
consoles
o Unrelated goods – change in price of one has no effect on the other. E.g.,
increase in toilet paper price has no effect on pencils
- Tastes and preferences
o Tastes and preferences influence quantity demanded – decrease in quantity if a
product is less popular
Can be affected by marketing, media, peer pressure
E.g., = skateboarding advertised and televised then demand could
increase
- Future price expectations
o If consumers think that price will increase in the future, demand will increase
now
e.g., taxes on cigarettes announcement; decrease in demand could
happen during Black Friday
- Number of consumers
o If there is an increase in #of consumers, demand increase – strategies would
be based on the age of the populations
E.g., senior citizens number increases – ads are targeted at them
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Difference between movement and shift

Movements along – price determinant factors
Shifts – non-price determinant factors

Individual consumer demand and market demand

- Method of horizontal summing – take the consumers demand and add it up to
determine market demanded quantity for each price

Law of demand (HL)

Law of demand functions the way it is for 2 reasons:
1. Income effect – when price of product falls, people have an increase in the real
income, being able to buy more
a. Buying 14 lattes for $2.95 you spend $41.30, price falls to $2.45 you spend
$34.3, saving $7 (increase in real income)
2. Substitution effect – people receive utility (satisfaction), when they consume their
product, and gain additional benefit when the price falls, becoming more attractive,
substituting it for products that have a poorer satisfaction to price
Assumptions (HL)
- Assumption that humans are rational, seek to maximize utility, have perfect
information = make decisions that give most utility
- Behavioral economics say the opposite – humans are biased, limited, have incomplete
information, have bounded rationality, change tastes, have self-control issues
o Different agents = different information, lack of ability and time to process
information, inability to control themselves and give in to temptation
o Humans do not act in their own self-interest – charity and others
o Automatic and Reflective system – assumption that we only use reflective is
incorrect – automatic is often used and results in poor decision-making
Cognitive biases (HL)
- Availability bias – information influences decision making – young people smoke
seeing that adults are healthy
- Anchoring bias – having a certain value as a reference and buying more of a product
when there are discounts – producers use that to set high prices initially and then
lowering them
- Framing bias – positive/negative advertisement of products, leads to consumers
thinking more positively/negatively
o E.g., 90% fat free sounds better than 10% fat
- Social Conformity/Herd behavior – because we want to fit in with others we buy what
the majority thinks is good (clothes companies normally do this)
- Status Quo/Inertia bias – many options might lead to doing nothing instead, as it takes
too much time to research and choose = mobile phone contracts
- Loss aversion bias – losing has a bigger psychological effect on consumers than
gaining something – producers take advantage of that and would say “Buy now before
stock runs out!”
- Hyperbolic discounting – humans prefer short-term rewards over long-term rewards –
putting off work and enjoying a night out, instead of benefiting from completing your
work
Choice Architecture (HL)
- Presenting the choices in such a way that would encourage a consumer to buy
products
o Stands next to cashier – snacks that are appealing
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- Default choice – pre-set option that is effectively selected (Google search engine)
OR/AND choice that is followed unless a decision is made to change it (always
getting caffe latte)
o Example with opt in opt out organ donation, where opt in option means that
people do nothing and organs will not be dontated
- Mandated choice – required by law to know in advance (organ donations)
- Nudge theory – choice architecture can nudge, encourage people to voluntarily
choose a better option for them
o Maintain their right to choose but make better choices
Placing healthy food more accessibly – encourages its consumption
Pension schemes – saving money using private schemes
• Problems of saving result from hyperbolic discounting and loss
aversion
o E.g., Save More Tomorrow program for young working
people to save money
- Key Element: When using nudge theory sovereignty must be present! People should
have the right to choose
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Chapter 4 – Elasticities of Demand

Elasticity
- Measure how something changes when there is a change in one of determinants and it
is a measure of responsiveness
- Elasticity of demand – how much demand for a product changes when there is a
change in one of the determinants
o PED (Price elasticity of demand)
o YED (Income elasticity of demand)
PED
- Quantity demanded of a product changes when there is a change in price

o 1. Calculate price change

o 2. Calculate quantity changed
o 3. Divide percentages of quantity by price
o 4. If the value is negative it indicates a reverse relationship, however
the negative is usually ignored
- Ranges from 0 to infinity (PED will be in between the values)
- If 0 = no effect in price change on demand, demand is perfectly inelastic
- If infinity – perfectly elastic (if prices are raised above P1 demand will fall
to zero)
- Inelastic demand: PED < 1 and >0 - if price changes, then the change in
quantity demanded is small and will not fall/increase, thus increasing firm
revenue (can be explained with drawn boxes on graphs)
o If product inelastic, in order to increase revenue, price should be
increased
- Elastic demand: PED > 1 and < infinity – change in price leads to a greater
than proportional change in quantity demanded; if price increased, q.d. falls
more, thus decreasing revenue
o If product is elastic, to increase revenue, firm should not raise the price
- Unit elastic demand: PED = 1 – change in price leads to a proportionate opposite
change in q.d.; if price increase by a percentage the demand will fall by the same
percentage
o Revenue does not change, because the revenue rectangles’ area is the same

- Note: The elasticity is not the same in a slope – it can be elastic and inelastic when
moving downwards – low-priced products would be more inelastic than high-priced,
due to a smaller concern
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Determinants of PED
- Closeness and number of substitutes
o The more substitutes and the closer they are – the more elastic demand
o Elastic: household products, meat, fruit. Inelastic: oil
- Necessity
o Food is a necessity and should be inelastic, however if products are defined
more narrowly, i.e., other types of meat, then it becomes more elastic
o Important to note that necessity is different for different people (addictives)
- Proportion of income spent
o If a product is low-price – inelastic and vice versa
o E.g., $1.50 for coffee and 10% increase leading to $1.65 is not going to affect
a consumer who has a good salary
- Time period considered
o PED inelastic short-term and elastic long-term because it takes time to change
buying habits
o Austria heating oil prices – demand dropped slightly, however over the years
people started using gas, coal, wood, making PED elastic
Importance:
- Firms – makes revenues
- Governments – taxes on products and elasticity will impact on their revenue; if
demand falls, less workers are needed. Governments thus will put taxes on inelastic
goods
Primary commodities vs. manufactured products (HL)
- Primary commodities – raw materials (cotton, coffee) – inelastic necessities with
no/few substitutes = consumers are firms for production
o E.g., Coffee beans companies – price increases, demand falls slightly, price
increases, demand increases slightly (you make a set amount of coffee and
don’t need more)
- Manufactured goods – processed elastic goods with more substitutes
o E.g., Vacuum cleaner brands
Income elasticity of demand (YED)
- How much demand changes when there is a change in consumer’s income

- Steps are the same as for PED, but using income (see page 1)
- Values: sign of the equation is important to tell us whether it is a normal (rises as
income rises) or an inferior (falls as income rises) good
- Normal goods: YED – positive; if q.d% increase is less than %increase in income,
YED between 0 and 1 is income inelastic, if %q.d. increase is greater than % increase
in income, YED >1 and is income-elastic
o Bread – necessity good and is income-inelastic
o Holidays – superior goods and is income-elastic
- Inferior goods: YED – negative
o Inexpensive jeans demand falls as people buy brand jeans
Importance (HL)
- Decision making by firms
o See YED in order to increase their revenues to grow
E.g., If more people get more revenue, then demand for smartphones
will increase and producers will expand in rapidly growing economies
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Producers want to change production according to incomes, for

example during recession producers would want to increase inferior
goods production in that country
- Explaining sectoral changes in economy
o Primary – agriculture and fishing, extraction – primary products
o Secondary – primary products are made into manufactured products
o Tertiary – services and intangible products
With increase income, demand for secondary products increase, with
more increase in income, tertiary products demand increases,
increasing living standards and growth of the economy
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Chapter 5 – Supply
- Quantity of a good/service that producers are able and willing to supply at different
prices in a given time period
- Effective supply – being able to supply a product
Law of supply
- As price of a product rises, quantity supplied with usually increase (ceteris paribus)
- Assumption that producers are rational maximizers of profits – thus taking advantage
of higher prices
Non-price determinants
- Cost of factors of production
o Increase in costs leads to decrease in supply, shifting it to
the left, and vice versa
- Price of related goods (competitive & joint supply)
o Competitive supply – producing more than one type of a
product
E.g., producing skateboards and roller skates,
when demand of one increases you supply more of one and less of the
other (shift for roller skates) (movement along for skateboards as more
are produced)
o Joint supply – production of goods at the same time
E.g., oil and diesel, if supply of one increases the supply of other also
increases
- Government intervention (taxes + subsidies)
o Indirect taxes – added on to the price of products, where producers pay, thus
shifting supply outwards
o Subsidies – payments to the business to reduce costs of production, shifting
supply downwards
- Expectations of prices
o If demand increases in the future, then producers can hold the product and
offer it at higher prices, thus increasing production for that period and vice
versa
- Technology
o Improvements in technology can increase supply; these are unlikely to shift
backwards
- Weather/Natural disasters
o Good weather – leads to bumper crops, poor weather, droughts – cuts in
supply
Movement along is price related; shifts are non-price related
Individual producer supply and market supply
- Supply of the market can be calculated by using method of horizontal summing,
adding individual producers together
Law of supply in-depth (HL)
- Short run
o Period in which at least one production factor is fixed; long run – all factors of
production are variable; production is short-run, planning is long-run
o Firms cannot rapidly increase production because factors are fixed, therefore
variable factors are applied to plan ahead
o Short-run – determined by how long it takes to increase quantity of fixed
factors – varies from industry to industry
Lawn mower – week delivery time; Electricity plant – two years
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- Law of diminishing returns

o Output will fall as more and more variable factors are
added to the fixed factors
o Total Product (TP) – total output a firm produced using
fixed and variable factors
o Average Product (AP) – average output production by
each variable factor unit – TP/V (# units of variable
factors)
o Marginal Product (MP) – Extra product produced by
using an extra unit of variable factor - ΔTP/ΔV
o Hypothesis of eventually diminishing marginal returns –
output of MP of variable factor will diminish as more
variable factors are added
o Hypothesis of eventually diminishing average returns –
AP of variable factors diminishes as variable factors are
added to a fixed factor
E.g., Adding more workers to a shop increases output, however at a
certain point a newly added worker will produce less marginal product,
because of lack of space and resources
- Increasing marginal costs
o Marginal cost (MC) – increase in total cost of producing an extra output =
ΔTC/ Δq
o Also related to diminishing marginal returns – output falls but the cost
remains, so MC increases
o Firms can only supply more if the prices they receive are going up as output
increases – in order to cover those costs
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Chapter 6 – Price elasticity of supply

Price elasticity of supply (PES)
- How much the supply of a product changes when there is a change in the price of the
product

- Values from zero to infinity and extreme values can be seen in an

economy
- If PES = 0, change in price has no effect on quantity supplied –
perfectly inelastic
- This can be seen in the short-run as firms cannot increase supply
straight away
o Stadium seats tickets – fixed amount
- PES = infinity – perfectly elastic
o International trade – supply is infinite – consumers can
have all they want if they are prepared to pay current
world market price
- Normal products have PES values between 0 and infinity and is
also split in three categories
o Inelastic supply – PES <1 and >0 change in price, less
proportionate change in quantity supplied
o Elastic supply – PES >1 and <infinity , change in price,
greater than proportionate change in quantity supplied
o Unit elastic supply – PES – 1, change in price,
proportionate change in quantity supplied
Determinants of PES
- Rise of costs as output is increased
o If cost rises significantly then supply will not be raised –
inelastic product and vice versa.
o Factors that prevent a significant rise in cost include
Unused capacity
• Resources that are not fully used – high PES if there are many
and low PES if you need to buy more
Factors of production mobility
• PES elastic if products are easily moved
o E.g., production of different volume of water – easy to
switch sizes in the market demands it to be so
- Time period considered
o The longer the time period, the more elastic, immediate time period – inelastic
o Some firms may increase some factors, such as materials and labour in short
run, but not all
- Ability to store stock
o If a firm can hold a lot of stock, then they would be able to react to changes in
price easier, making PES elastic
Difference in PES for primary commodities and manufactures products (HL)
- Commodities – inelastic supply – change in price does not lead to a proportionally
large increase in supply
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o E.g., cocoa – time to harvest and plant takes time, therefore resources need to
be re-allocated; same with lower prices – you cannot lower output since you
harvested it
- Manufactured – elastic – easier to increase/decrease quantity demanded –
determinants of PES make them elastic
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Chapter 7 – Market equilibrium and market efficiency

Equilibrium
- State of rest in absence of any outside disturbance – when the amount of product that
people wish to buy is equal to the price suppliers wish to sell at. P(e) is known as
market-cleaning price as everything will be sold

- Excess supply occurs when producers raise the price, whereas excess demand occurs
at lower prices, where supply falls.
- To eliminate surplus and shortages the producers need to lower/increase the prices to
stabilize the equilibrium
- Equilibrium is self-righting – without outside disturbance will return to the original
position
Effect on equilibrium when there are changes in demand and supply
- Equilibrium is moved when there are changes to determinants of demand or supply.
After that shift the producers will need to readjust their prices to create a new
equilibrium
- Market, if left alone, will adjust to a new equilibrium
Price mechanism
- Forces of supply and demand that can be used to signal for an allocation of scarce
resource
- 3 Functions in a market:
o Signal information
Prices change and are set by actions of consumers and producers so
they signal when one should act
o Ration scarce resource
Help allocate resource, if demand is greater than supply, supply will be
rationed to consumers who are prepared to pay high price
o Incentives to consumers and producer
Lower prices – buy more of a good for more utility; higher price –
disincentive
Higher prices – incentive to produce more for profit
- Key takeaway: price mechanism is a signal to producers to create an incentive to
produce/consumer more/less
- Invisible hand moving factors of production to produce goods and
service that are wanted by buyers
Market efficiency
- Consumer surplus – satisfaction gained by consumers from paying a
lower price than what they were expected to pay
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- Producer surplus – actual earnings that producer makes from a given

quantity of output, above the amount that the producer would be prepared
to accept for that output
o E.g., producing 3 thingies at $3, but the market equilibrium is at
10$
Social surplus and allocative efficiency
- Allocative efficiency – market is in equilibrium with no external
influences
- Allocative efficiency – resources are allocated in the most efficient way from
society’s point of view (productive efficiency)
- Sum of consumer and producer surplus = community (social) surplus, which
is maximized at the equilibrium
- Marginal social cost curve (MSC) = when costs of the industry are equal to
costs of society
- Marginal social benefit (MSB) – when benefits in the market = benefits to society
Calculate consumer and producer surplus (HL)
1. Identify equilibrium price
2. Calculate consumer surplus (1/2 base x height)
3. Calculate producer surplus area (1/2 base x height)
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Chapter 8 - Government intervention

- Governments may intervene to support households, support firms, influence

consumption/production, protect consumers from monopoly, promote well-being,
equity, earn revenue

Indirect taxes
- Indirect tax is imposed upon expenditure – goods and services (GST) and value added
tax (VAT), sales, excise
- Why: provide government revenues, discourage consumption – extra
tax on undesirable goods
o E.g., Chile – 54.1% indirect taxes as a total revenue, USA – 17%
- Indirect tax is placed upon the selling pruce of a product – raises firm
costs and shift supply by amount of tax
- Two types:
o Specific tax: fixed amount of tax
o Percentage tax (ad valorem tax): tax is a percentage of the
selling price, tax will shift as a percentage
Effect on stakeholders:
- Producers raise price
- Consumers pay more
- Government earn more revenue
- Less workers
- Society is better off (less demerit goods)

Who pays:
- Different amount for consumer and producer depending on elasticities
o If supply is inelastic and demand is elastic most of the burden will fall onto the
producer because a large increase in price will significantly lower demand
o If supply is elastic and demand is inelastic most of the burned will fall onto the
consumer because consumers will not react to changes in price
o When value of PED = PES, burden will be shared
o PED > PES, burden will be placed on producers
o PED < PES, burden will be placed on consumers
How to calculate amount of tax (HL)
- To calculate the amount, subtract the difference between supply curves
- Government revenue – number of drinks * tax
- Consumers pay – increase in price * number of drinks
- Producers – amount of tax per unit – what is paid by consumer * supply quantity
- Consumer expenditure: Amount spent after tax – amount before tax
- Producer revenue: producer revenue before tax – revenue after tax
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Subsidy
- Amount of money paid by government to a firm.
- Given for:
o Lower price of essential goods to consumers, to increase consumption
o Supply of necessary products for economy – basic food or power source
o Enabling competition with overseas trade
- Supply shifts downwards, as it reduced costs of production, and will be passed to
consumers in form of lower prices
- Specific subsidy – specific amount of money

- Effect on stakeholders:
o Producers – increase revenues
o More workers employed
o More expenditure
o Less government revenue
- Things to be considered:
o Opportunity cost of spending money on other projects
o See if producers need to compete with foreign producers
o Who is paying the taxes when funding the subsidy
o What damage is done to foreign producers – some subsidies may lead to
overproduction and will harm sustainability. It will also be hard for
developing countries to grow, because they cannot compete with countries that
sell products at lower prices
Why and how do governments impose price controls?
Price ceilings
- Are put below the equilibrium, setting a maximum price –
producers cannot price their products above
- Are set to help consumers and are normally placed when
the product is a necessity or a merit good (underprovided
beneficial good)
o E.g., agriculture during food shortages or helps
with rented accommodation
- Problems of excess demand:
o Black markets – where products are sold at a higher
price
o Queues, where producers may decide who would be able to receive products
- How to reduce excess demand:
o Shift demand to the left – however that limits consumption which is not what
the government wanted
o Shifting supply to the right:
Subsidies to encourage production
Direct provision – government produces the product
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Release stocks of the product into the market

(not possible with perishables)
o This ensures that the government has an opportunity
cost
Calculating effects on stakeholders (HL)
- Potential question of identifying equilibrium price, as well
as changes in expenditure may be asked
Price floors
- Setting minimum prices above the equilibrium price
- Are set for one of two reasons:
o Raise income for producers that are important –
agriculture – this is because the prices always
fluctuate and they might need support
o Support workers by setting minimum wage – ensure
that they get enough to support themselves
- Excess supply may cause the producers to want to lower
prices, causing the government to intervene:
o Buying the surplus products at minimum price – shifts demand to the right
o Store surplus (expensive), destroy surplus (wasteful), sell it as foreign aid
(could be seen as dumping)
o = opportunity costs
- Minimum prices can be maintained by:
Quotas – restricting supply
Increase demand by advertising/restricting foreign product imports
- Government imposes price floors to also minimize consumption of demerit goods –
alcohol and cigarettes
Reasons for government intervention:
1. Help consumers make better choices
a. Indirect taxes – reduce quantity sold – reduces consumption of demerit goods
b. Minimum prices increases prices of harmful goods, discouraging consumption
c. Subsidies makes necessities more affordable
2. Promotes sustainability
a. Indirect taxes can be placed on sustainability threatening products
b. Subsidies may be given to firms with sustainable production methods
3. Promotes equity and economic well being
a. Minimum wages – workers have a fair payment
b. Minimum prices – producers earn a fair payment
c. Maximum prices – make things affordable for low-income families
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Chapter 9 – Market failure

Externalities and market failure
- Externality - when production if a good/service has an effect upon a third party
o Negative if harmful – extra costs to producer/consumer and society
o Positive if beneficial – benefit to producers/consumers and society
- MSC = MPC plus or minus external costs/benefits of production; no externalities –
MSC =MPC
- MSB = MPB plus or minus external cost/benefit of consumption
- No externalities – social efficiency and max. community surplus; if externalities exist
a market failure is created
Positive externalities of consumption
- Goods/services which when consumed produce benefits
to society and individuals
o Health care – by consuming health care people
are less susceptible to diseases and do not pass
them onto others
o MSB > MPB
o Welfare gain, because MSB > MSC – market
fails because too little is produced and there is
an under allocation of resources
o Welfare gain can be represented by welfare loss – what would be achieved if
the market was operation at full level)
Merit goods
- Beneficial to consumers and are under consumed – underestimated or are ignored –
lack of perfect information
- Governments want to increase quantity of merit goods
o E.g., education, vaccines, sport facilities
o Improvement in factors of production will shift out a PPC increasing
production possibilities and having benefits to the economy
How to achieve potential welfare
- Subsidies/Direct provision – government could subsidize provision of a good – shifts
MSC curve downward
o Problem:
Opportunity cost and limited resources
Political policies – different priorities
- Awareness campaigns – sharing information about benefits of consumption, shifting
MPB to the right towards MSB
o Problem:
High ads. Cost and will only take effect in long-run
- Legislation – laws insisting vaccination/health check – only works if free of charge
Positive externalities of production
- Production of a good/service creates favourable benefits to
third party
o E.g., training for employees – perhaps the company
might spend money, other companies wouldn’t, if the
employees were hired there. Thus, MPC>MSC
o Welfare loss is still created as the market is not
operating at a socially efficient level – firms do not
always want to engage in training
Government actions to achieve welfare gain
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- Subsidies – subsidies to firms that offer training – shifts MPC downwards

o Problems include:
Difficulty of estimating levels of subsidies
Subsidies are an opportunity cost
- Direct provision – provide state training (training centres)
o Problems include:
High costs
Lack of expertise
Dissuade firms to offer training
- Overall improvements in labour force will lead to an outer shift of
the PPC, allowing for an economy to grow
Negative externalities of consumption
- Negative effects on third parties, examples include smoking,
petrol, pollution – results in MSB<MPB
- People use those goods because it causes utility and overconsume
it, thus showing that MSC > MSB – welfare loss
- Negative externalities of consumption may also lead to
sustainability threats – greenhouse gases emissions
Demerit goods:
- Harmful to consumers but are still consumed – unawareness or ignoring the risks
- Not all negative externalities are demerit – petrol
- Government reduce quantity of demerit goods consumption
o E.g., cigarettes, alcohol, unhealthy food
Elimination of welfare loss
- Market based: Indirect taxes
o Pigouvian tax on negative externalities – shifts MSC upwards – reduces
consumption and increases government revenue
o Problem:
Inelastic demand does not change quantity demanded
If taxes are high the products are seeked elsewhere – other
countries/places
Are regressive – have a larger effect on lower income people than
higher (takes a larger proportion of income)
- Legislation/regulation – laws to alter behaviors
o Age restriction, bans, advertising
o Problem:
Takes away rights of consumers to decide
Lobbying from large companies who do not
want those regulations
Difficult to enforce – stakeholders must
comply and mechanisms to punish must be
installed
- Education/awareness – spread information about harm of
demerit goods – shift MPB to the left
o Problem:
Teen carelessness of rules and negative effects
- Consumer nudges (HL) – consumers may be peer pressured, enjoy utility short term
and have limited well power
o Nudges include innovative designs to negatively impact on choices – people
have freedom of choice but are nudged to choose differently
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Producers argue that it takes away their right to

pursue profits
Negative externalities of production
- Damaging costs to third parties as a result of production – absence of
government intervention, profit set producers that are unconcerned
about the future
o Paint factory that produces fumes – MSC > MPS because
fumes can cause health problems
- Welfare loss because too much is produced at a low price
Common pool resources – natural resources which people cannot be excluded from using,
and if one person uses it, it reduced the value of that resource to others – rivalrous
o Tragedy of the commons: cattle land – maximizing land would cause soil
degradation if left to no control
o Free rider problem: some would reduce production to limit the harm, however
those who do not continue to benefit from the resource
- Overuse of those resources by firms leads to degradation of environment and creates
scarcity in the long-run or making unequitable conditions
Reduction of negative externalities
International cooperation
- Using agreements to reduce emissions and increase ability to fight climate change
o E.g., 2015 Paris Agreement to reduce carbon emissions, increase carbon sinks
and fight climate change
Strategies:
Market-based responses:
Trade permits:
- Government sets a maximum amount of resources that could be used
- Can be exchanged in the market if you did not reach the maximum
o E.g., Emissions Trading scheme – countries have a maximum amount of
carbon emissions which can be traded if they release less
- Depends on: inclusiveness, if they are able to change environment, allocation of
allowances, whether companies absorb costs, monitoring emissions, strength of
punishments and manipulation of the system by stakeholders
Carbon taxes
- Imposed when fossil fuels are burned and gives polluters
a freedom of choice – burn less or pay more
- Pigouvian tax which is set to eliminate welfare loss and
shifting MPC outwards
- Benefits:
o Cleaner technology
o Reduction of consumption to other efficient
appliances
o Seeking renewable sources
o Government revenue that could be used to
subsidize renewable energies
Command-and control:
Legislation and regulations
- Setting up rules and agencies to prevent production of the product completely
o E.g., plastic bags could be banned or charged a fee (market-based)
o E.g., emissions, protection of species, recycling, waste, pollutants in different
areas
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- Incentive to have producers implement different ways of production

- Concerns:
o Access to information required
o Need to account for different circumstances in different areas
o Increases price of products, making producers less competitive against foreign
o Monitoring is needed
o Discouragement of technology development
o Slow-pace of governments may need time to adapt
o Influence by stakeholders = some areas are more protected than others
Subsidies
- Renewable energy is needed to reduce emissions – governments could subsidize
providers of such energy to make it affordable
- Now there are improvements in technologies subsidies might not be necessary any
longer
Self-governance
- Government could manage resources and regulations of privatize land to be controlled
by the owner
- New suggestion: allow individuals and communities to set rules for themselves, as it
is in their own interest to have a sustainable future – they should be the ones
monitoring and setting up the rules
International cooperation
- Paris agreement and Sustainable Development Goals - ensure that emissions are
reduced globally
- Many countries might start backing out because it is not in their economic interest
- Developing countries are not supported and developed countries stop monitoring their
emissions properly
Lack of public goods – market failure
- Public goods – not provided in free market but are beneficial to society
o E.g., streetlights, national defense
- Are non-excludable and non-rivalrous, - you cannot stop others from consuming it
when it has been provided and it does not prevent others from consuming it
- They are not provided because there is no profit to be made – small MPB
- Quasi-public goods – some characteristics of public goods
o E.g., public pool – everyone can enjoy but it can be limited space wise, roads
– everyone rides them but too many can cause traffic
How can a government increase supply of public goods
- Direct provision – roads, lighting – using taxes
- Public-private partnership – paying firms to create the good

Asymmetric information (HL)

- Type of imperfect information – one party in the transaction has more/better
information than the other
Adverse selection – occurs before transaction is made
- One has more info than the other
o E.g., health insurance – buyers have more info about their health than the
company – where the company does not know if the buyer is a higher risk
person
As a result prices increase and others cannot afford to buy one
Young people might not need one because they think they don’t need it
- Market failure because the price is influenced by imperfect information
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Solution:
- Screening: getting relevant information from the other party
o E.g., health insurance asking information about the buyer and offering
different insurance plans with different prices
- Signaling: party with more information provides information
o E.g., information about quality of the used cars and explanation why it costs
more as well as guarantees and promises to fix problems or show documents
Moral hazard – after transaction was made
- People have an incentive to alter behaviour and take risk even when negative
consequences are borne by others
o E.g., driver with a car insurance drives riskier because insurance will pay –
insurance companies might implement deductibles – driver pays an amount
o E.g., workers with fixed salaries do minimum work, knowing that they are
paid – bonuses and limited-term contracts are awarded to incentivize workers
o E.g., banks giving out more loans in 2008 than they could afford and were
bailed out by governments – could take higher risks knowing that
Solution:
- Regulations – which are not liked by businesses
- Bailed and fines for risky behaviour
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Chapter 10 – Rational producer behaviour (HL)

Profits – when the revenues of the businesses are higher than the cost
Classification of costs
- Economic costs – opportunity cost (best alternative foregone when an economic
decision is made)
- Explicit costs: Opportunity cost of factors of production not owned by the form is the
price paid for them and other things that could have been bought (involve direct
payment of money)
o E.g., $1000 hiring the employee, $1000 could have been spent on wages or
other things
- Implicit costs: Owning factors of production and opportunity cost refers to the
earnings that a firm could have if it employed those factors differently
o E.g., using other building for good production – opportunity cost is not renting
it to other firms and gaining revenue from that
Costs in short run
- Total costs – complete costs of producing output
o Total fixed costs (TFC) – total costs of fixed assets over
time (is constant) – doesn’t matter how much you produce
o Total variable cost (TVC) – total cost of variable assets
over period – increases with more of factors used
#of factors * cost –
• $200 per worker – $1200 for 6
o Total cost (TC): total cost of fixed and variable factors – TFC+TVC
- Average costs: cost per unit of output
o Average fixed cost (AFC) – fixed output/per unit (TFC/q) –
always decreases because TFC is constant
o Average variable cost (AVC) – variable cost/per unit (TVC/q)
– initially decreases and then increases again as per law of
diminishing average returns (more variable factor applied,
output per variable factor falls)
o Average total cost (ATC) – total cost per output – AFC+AVC
(TC/q) – falls and then rises
- Marginal cost (MC) – Total cost of producing an extra cost of an
output – ΔTC/ Δq
o Falls as output increases and rises again – diminishing
marginal returns – as variable factors are applied extra output
falls and extra cost begins to rise
Measuring revenue
Revenue – income that is received from sales
- Total revenue (TR) – total amount a firm receives for selling – TR =
p*q
- Average revenue (AR) – revenue/per unit – AR = TR/q (which is just price)
- Marginal revenue (MR) – extra revenue after selling one more unit of a
product – MR = ΔTR/Δq
Revenue and output
1. If price does not change as output increases, then we can assume that the
demand is perfectly elastic, and demand, average revenue and marginal
revenue are all the same. Total revenue increases infinitely (upward
curve)
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2. If price falls as output increases, then total revenue will

increase until a certain point and then decrease, because of
loss in revenue of goods that were sold at higher prices –
marginal revenue will keep on decreasing – TR will fall.
MR=0 is when TR is maximized
- Three main rules:
o PED elastic – to increase revenue price should be
lowered
o PED inelastic – to increase revenue price should be
raised
o PED unity – to increase revenue price should be
unchanged – revenue already maximized
Measuring profit
- Total profit: Total revenue-economic cost (explicit + implicit costs)
- Total cost – includes explicit and implicit costs
- TR = TC (AR=AC) – the firm is making NORMAL PROFIT (or zero economic
profit)
- TR>TC firm is making ABNORMAL PROFIT (economic
profit)
- TR<TC firm is making LOSSES (negative economic profit)
Maximization of profits
- Price would increase production when MR>MC in a perfectly
elastic demand
- A producer should produce between q2 and q1 points and the
firm would have abnormal profits as MR>MC
o Important to note that q1 is a point of loss minimization
o That point is normally not drawn – profit maximization
occurs when MC cuts MR from below
- In a normal demand curve profit maximization is where
MC=MR
- Profit depends on AC position – AC – abnormal profits, AC1 – zero profit, AC2 –
loss

Other objectives
Corporate social responsibility
CSR – including public interest in decision making – accepting responsibility for the impact
of activities on other areas
- Education projects
- Reducing negative impacts on environment
- Provision of aid
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- Advantages:
o Better workforce
o Better reputation
o Brand loyalty
o If are active in reducing issues that it reduces the need for government
intervention
- Concerns:
o Companies adopt CSR to gain a good reputation to take away attention from
their main product
Satisficing
Satisficing – economic agent aims to perform satisfactory rather than to a maximum level in
order to pursue other goals
- Many work hard enough to make a reasonable living and will follow other goals to
pursue leisure
o E.g., firm owned by shareholders, where managers do not necessarily gain
anything from max profits – managers will do enough to satisfy
Growth maximization
- Set target to achieve growth in short-term to get more market share and dominate in
long run
o Measured in quantity of sales, sales revenue, employment or % of market
share
Revenue maximization
- Amount of revenue made – maximize sales revenue by producing when MR = 0 –
produce above profit maximizing level of output
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Chapter 11 – Perfect competition and monopolistic competition (HL)

Market power
- Ability of a firms to raise market price of a good/service above marginal cost – able to
influence market outcomes to increase price
- Perfect competition – no market power – if prices are raised demand falls – they are
PRICE TAKERS
- Imperfect competition – can raise prices without losing customers – they are PRICE
MAKERS – can alter price or quantity supplied *not both*
o Altering quantity supplied creates market failure – moves the market away
from MSC=MSB – governments would implement legislation
Market forms
- Used to predict and understand operation of the markets
- Perfect competition, monopolistic competition oligopoly and monopoly
Perfect competition
Assumptions
- Made up of very large number of firms
- Small firm compared to size of industry – incapable of altering own output and be
noticeable and thus cannot affect the supply of industry or the price of the product –
PRICE TAKERS
- Identical, homogenous, products – no marketing and brands
- Free to enter/leave – NO BARRIERS TO ENTRY
- Producers/consumers – perfect knowledge of prices and costs, working, quality and
availability (does not happen in reality)
o Example: (close to perfect competition): EU wheat markets – small farms do
not have an impact on the industry and have to sell at given prices
Market power in perfect competition
- Firm has no market power and sells at point P (also is the equilibrium price) – cannot
increase prices, as it will lose customers but it can increase output because it does not
alter the industry
Maximizing profits in short run
- Profit maximization is at MC=MR – at the level of
output q (which is very small in relation to the whole
industry)
- Short-run – 2 main situations regarding profit/loss
o Short-run abnormal profits – covering total costs +
opportunity costs
o Short-run losses – not covering total costs – loss
minimizing because they are still producing at profit-
maximizing point

Short-run profits/losses in long-run

- Other firms begin to react to changes and try to reach the equilibrium point
- Short-run abnormal profits – long-run normal profits
o Perfect knowledge and no barriers to entry attracts other firms, thus shifting
the supply curve to the right
o Price falls – demand curves shift downwards = abnormal profits will be
competed away
o Industry will supply at new price and will now have normal profits – covering
their opportunity costs – no more firms are attracted afterwards because there
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is nothing more to be gained

- Short-run losses to long-run normal profits

o Some firms will leave the industry, and the industry supply curve will start
shifting to the left
o Industry price rises, demand shifts upwards – losses are smaller
o Producers are satisfied, as demand is shifted and they sell at a higher price,
and pay their opportunity costs – no one enters or leaves the market as there is
no abnormal profit

Long-run equilibrium
- Firms are making normal profits, where production is at profit maximizing point –
MC=MR
- No incentive for firms to enter and leave so. It will most likely stay the same unless
there are changes to demand curves or costs
Efficiency
1. Productive efficiency
o When firm produces at the lowest possible unit cost (AC)
o Productive efficient level is at MC=AC
o Important because: resources are combined efficiently as
possible and resources are not wasted by inefficient use
2. Allocative efficiency
o Socially optimum level of output, where suppliers are
producing the optimal mix of goods/services required by
consumers
o P > MC – good is valued more than its cost; MC > P –
society is using more resources to produce the good than its
value
o Allocative efficiency = MC = AR
o Important because = impossible to make someone better off
without making someone else worse off
o In perfect competition in abnormal profits then the firm is producing at profit
maximizing and allocatively efficient points however not at the most efficient
level of output – the same is seen with the loss
Market failure to be rectified in perfect competition?
- Profit-maximizing firms in long-run produce at lowest point of AC and all firms sell
at the same price and minimize their AC by producing at MC=AC, also produce at
allocatively efficient level at MC=PR
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- This means that there is no market failure because it produces everything allocatively
efficient – no need for government intervention
- No market power and are price takers
Imperfect competition
- Imperfect if MSC is not equal to MSB – in normal demand
curves – monopolistic and other firms because they restrict
outputs to maximize profits and increase price
- Because production occurs at MC=MR there is less
supplied, meaning a consumer and producer surplus losses
occur and welfare loss occurs (blue triangle and light blue
triangle combinations)
- More imperfect, the greater the market power and the grater
the market failure
Assumptions of monopolistic competition
- They are: competing firms where each has a bit of market power – sometimes set their
own prices
- Assumptions:
o Industry is made up of a large # of firms
o Firms are small – its actions are unlikely to affect others (are independent)
o Differentiated products
o No barriers to entry/exit
- Main difference is production differentiation – packaging, colour,
appearance, design
o Those include: nail salons, plumbers, jewelers
- Different structure: mainly affected by brand loyalty where the
consumer will stay with that producer even if prices are raised
o Consumers stay with the same plumbers because they believe
their skills are better than the competitions’
- Demand is elastic; however, firms are to an extent PRICE
MAKERS, with maximizing profit point at MC=MR
Market power in monopolistic competition
- Price-makers – can raise prices but can expect a fall in quantity
demanded
- Firm has little market power because firms are small – cannot
increase overall prices by producing less
Maximizing profits in short-run
- Can have abnormal profits and losses by producing at MC=MR and
having AC less than or above the selling price of P
Short-run profits/losses in the long-run
- Similarly, because of no barriers to entry firms will
enter/leave when other firms are producing abnormal
profits/losses
o Sushi shop has many customers – new restaurants will
open up and offer product differentiation to differ from one
another = non-price competition
- End up having normal profits in the long-run
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Efficiency
- Allocative and productive efficiencies are not reached because the firm is producing
at the point of MC=MR – the same happens in the long-run as well

Market failure to be rectified?

- There is a small market failure, but it is a result not because of the firm’s ability to
increase price and restrict prices, but because of consumer desire to have
differentiated products
- Gives consumer choices – are prepared to pay higher prices
- Governments do not intervene - can intervene to correct other market failures
o Government try to correct imperfect info – setting standards for trades giving
authorization to people who reach those standards – gives information to
consumers to see approved firms
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Chapter 12 – Market Power: Monopoly and Oligopoly

What is monopoly
Assumptions of monopoly
- One firm produces the product
- Barriers to entry exist
- Monopolies make abnormal profits in the long run
o Depends in definition of industry – Microsoft may be the only main producer
of a kind of software but does not own all software
Question of how much market power, setting price ability a firm has and this market power
depends on substitutes
o Underground railway has a monopoly underground but competes against other
transportation means
What gives a monopoly its ability to have position and market power
Mainly – its ability to have barriers to entry, which include:
- Economies of scale
o Decreases in average costs as more output is produced (in the long run) –
appear when form alters its factors of production
o Economies of scale include:
Specialization: Managers and workers specialize in different areas and
are thus more efficient
Division of labour: Breaking down production methods into small
activities to increase efficiency flow/line/mass production (TV sets)
Bulk buying: Discounts negotiation with suppliers which reduces costs
Financial economies: Raise money cheaper than small firms and have
lower interest rates because large firms are less likely to fail repayment
Transport economies: Large firms with bulk orders would be charged
less and if a firm has its own fleet then it will cost even less
Large machines: When a firm is large it is able to use large machinery
small farmers can’t use a combine harvester on their own but large
firms can
Promotional economies: Promotion of products is not likely to increase
if output increases thus costs of promotion per unit of output fall
o Small new firms wishing to enter the monopoly industry is not going to
survive because it does not enjoy the economies of scale and are thus unable
to compete
- Natural monopoly
o Only enough economies of scale for one firm – diagram
shows that if another firm enters the market demand will
shift and both businesses will work at a loss because
LRAC>AR
E.g., water, electricity, gas = natural monopolists
- Legal barriers
o Legal right to be the only producer – patents/intellectual
property rights – to encourage R&D and new investments
Patents are valid for ±20 years
E.g., pharmaceutical industry
o Rights to produce a product to a certain form – nationalized industry that bans
other firms from production/rights to be a sole supplier
E.g., postal services, network providers
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- Brand loyalty
o Products that are known for their brand name discourage competition if they
are not able to produce a different product
E.g., Hoover vacuum cleaner
- Anti-competitive behaviour
o Legal/illegal practices – e.g., setting up low prices to
sustain losses and drive out the new business
Market power
- Have the power to control price/quantity – not both – monopoly
is the industry and the level of market power is significant
Profit situations
- If a firmis making abnormal profits in the short run that will
continue in the long run as well – are maximizing profits
- Monopolists can earn losses if there is little demand they will
need to plan their production in the long run to earn
normal/abnormal profits otherwise they will shut down

Efficiency
- Produce at a level that is not productively or allocatively efficient – production
occurs at profit-maximizing level
Market failure to be rectified in monopoly
- Advantages of monopoly that could outweigh market failure:
o Economies of scale – in which MC curve would be pushed downwards and
more output at lower price could be made – relative price/output idea is
debatable
o Higher levels of R&D – investment of profits into research and development
that will benefit consumers and provide better products
- Disadvantages of monopoly against perfect competition
o If there aren’t economies of scale then output could be restricted and higher
prices could be placed
o High profits are seen as unfair and the firm can use its power to abuse the
market
Main problems: inefficiency, high price and low output and anti-competitive behaviour
Oligopoly
Assumptions of oligopoly
- Few firms dominate an industry – are determined by a concentration ratio of CRx
where x is a number of firms
o E.g., US malt beverages of 160 firms with CR4 of 90% indicated that the 4
firms are the largest producers, and thus are an oligopoly
- Can be differentiated or same products with different names
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- Distinct barriers to entry – depending on the industry

- Interdependence – where small number of large firms can collude to act as a
monopoly or compete vigorously to gain market share
- Price rigidity – do not change often because of competitors
Difference between collusive and non-collusive
- Firms collude to charge the same prices for their product, acting as a monopoly. There
are two types:
o Formal collusion – when firms decide on the price they will charge (or
market share/marketing expenditure) – known as cartel
Against the law and is penalized
E.g., of governmental collusion (legal) – OPEC – setting oil prices
o Tacit collusion – charge same prices without formalities – just by looking at
competition
- Firms act as a monopoly and get monopoly profits
- Price rigidity is maintained – because of long run profits, however there is an
incentive to cheat and get more revenue and profit
o E.g., duopoly where one firm break the agreement and lowers prices, thus
getting more revenue price wars to gain the market share back
- Non-collusive oligopolies have to be strategic and take their rival into an account of
their decision and this can be explained by game theory (but only for duopolies):
o Firms can be optimistic/pessimistic – using a maximum strategy – adopting
least worst outcome (minimax) or maximax strategy to gain maximum profit

Firms competition
- Non-price competition – brand names, packaging, features, ads, promotion, sponsors,
publicity
- Marketing is aimed to increase brand loyalty and make demand less elastic
o E.g., Pepsi and Coke, Adidas and Nike
o Interesting to note that many brands are bought by MNCs – e.g., Unilever and
Procter & Gamble
Market failure to be rectified in oligopoly
- Because oligopolies act as monopolies, they will also be
inefficient and maximizing profits, the same will happen in
non-collusive oligopolies but with a lower market power
When does the government intervene
1. Restriction of output – if the prices are increased and there
is less output then there will be a loss of consumer surplus
2. Lower consumer choice – The less firms there are the less
choice there is
3. Productive inefficiency – causes a waste of resources
4. Allocative inefficiency – underallocation because value of output > its cost
5. Abnormal profits and inequity – high prices exploit low incomers and high profits of
firms lead to unequal distribution of income
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Government intervention in response to abuse of market power

Governments intervene when there is significant market power and have agencies to promote
competition and prevent abuse of such power
- Laws that restrict mergers – two companies combine to become one; and takeovers –
company gets the other one – those laws include the restriction of gaining more than a
certain % of market share and may restrict the total percentage of the market occupied
my oligopoly – CR4 could be restricted to 60% (e.g.,)
- Laws against price fixing – collusion would be illegal
- Legislation to stop firms influencing retailer decisions
Government will undertake investigations where market power is abused
Governments could also implement bodies to promote competition – e.g., Office of gas and
electricity markets (UK). Those could have different powers:
- Set price controls (price capping)
- Fines for anti-competitive behaviour
- Insist average price levels (fair rate of return) – based on profit levels
- Unbundling products (e.g., Microsoft selling Word, Excel and others)
- Break monopolies into separate businesses – is an extreme
- Set standards for quality of service
Note: if there is an extreme situation the government could make the industry publicly
owned – producing goods in a nationalized industry