IB Economics/Introduction to Economics
Introduction to Economics
Basic Definitions
Definition of social science and Economics
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Social Science: The study of society and the way individuals interact
within it.
Economics: the study of how society employs its finite resources in the
attempt to satisfy infinite wants.
Definition of Microeconomics and Macroeconomics


Microeconomics: The study of individual economic units such as
households and firms.
Macroeconomics: The study of the economy as a whole. (e.g. Inflation)
Definition of growth, development, and sustainable development

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Economic Growth: An increase in real GDP or an increase in the quantity
of resources.
Economic Development: A qualitative measure of a country's standard of
living which takes into account numerous factors such as education and
health. The Human Development Index is normally used to measure a
country's economic development.
Sustainable development: The rate at which a country can develop
without compromising the needs of future generations.
'Positive and Normative Concepts


Normative Economics: Based on opinion. Uses words such as "should".
The government should make fixing unemployment its number one
priority.
Positive Economics: Based on testable theories. For example, a hike in
interest rates leads to a fall in aggregate demand can be proven using data.
Know the concept of Ceteris Paribus.

Latin for all things being equal. Since Economics is basically the study of
society, we have to understand that there are thousands of variables
present, and to control each one of these variables is downright
impossible. Thus we make everything else "ceteris paribus" in order to see
the effect of one aspect.
Know the concept of Scarcity

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Scarcity is the observation that no resource is infinite.
Factors of Production
Factors of production are basic components or inputs which are required
in the production of goods and services.

Land: Gifts of nature, this includes everything on the land, under the land,
above the land, or in the sea. Oil is an example.
Labour: The human component hired to assist in producing a good or
service.
Capital: Any man-made aid to production.
Entrepreneurship: Combines the other factors and takes risks
recognizing the possibility of gain from employing these factors in a
specific way.
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Factors of Payment (FoP):
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Land: Rent
Labour: Wages
Capital: Interest
Entrepreneurship: Profit
The concept of Choice

Know the concept of Utility

Utility: The satisfaction gained from the consumption of a good or
service. The demand curve slopes downward because of the law of
diminishing marginal utility. The marginal utility, or extra happiness, we
gain from buying an extra ice cream decreases with every ice cream we
buy at a fixed price.

Know the concept of opportunity cost

Opportunity cost: The cost of the next best alternative forgone. If I have
$5.00 and can either buy a tamogotchi or dinner, and I buy the tamogotchi,
then the opportunity cost is the dinner I could have bought.

Define Free and Economic Goods

Free good: A good with no scarcity, that has unlimited supply and
therefore no price. A good which has no opportunity cost associated with
its consumption.
Economic Good: A good which is scarce and therefore has a possible
opportunity cost.

Production Possibility Curves
Draw Diagrams showing opportunity cost, actual and potential output
Draw diagrams showing Economic growth and actual output
Rationing Systems
What are the basic economic questions?
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What to produce?
How to produce it?
For whom to produce?

Free Market: A market where the forces of supply and demand decide the
economic questions and therefore where to allocate resources.
Command Economy: A market where the government or some central
authority decides where to allocate resources.
Mixed Economies: An economy consisting of both. Some decisions are
made by market forces while some other decisions are made by the
government or some central authority.
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Advantages and Disadvantages of the Free Market
Advantages
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Resources allocated more efficiently by the price mechanism.
The profit motive is a great incentive, and forces producers to reduce costs
and be innovative.
With no imperfections, the free market maximizes community surplus.
Disadvantages:
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Instability
Market Failure- see Chapter II.
Monopolies and corruption - The natural goal of all firms is to attain
monopoly, as this eliminates competition, eliminating the associated costs
and thus maximizing profit. If the market structure does not include
limiting social forces, financial forces will cause firms to externalize costs
such as pollution to gain monopoly. Union Carbide's gas leak in Bhopal is
an example of such an externalized cost.
Advantages and Disadvantages of a Planned Economy
Advantages:

The government can influence the distribution of income.

The government can determine which goods are supplied.
Disadvantages:
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In order to function well, requires an enormous amount of information
which is difficult to obtain.
No real incentive for individuals to be innovative. Goods are of poor
quality since there is a lack of profit motive.
May NOT lead to allocative efficiency or productive efficiency due to lack
of competition and profit motives.
Corruption - the government has the ability to abuse its absolute power.
The economy does not respond as well to supply and demand, firms are
simply told to produce a certain number of goods or services
Other important things to remember
Sectors of an economy:
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Primary sector: Natural resources and raw materials.
Secondary sector: Manufactured goods.
Tertiary sector: The service sector, things like leisure, health, and sport.

Market: Convenient set of arrangements where buyers and sellers agree to
exchange goods.
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IB Economics/Microeconomics
Microeconomics
Markets
Definition of markets with relevant, local, national, and international
examples

A place or situation where buyers and sellers communicate with exchange
in mind.
Brief description of perfect competition, monopoly, and oligopoly as different types
of market structures and monopolistic competition using the characteristic
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Perfect Competition: an industry structure in which there are many firms,
none large enough to influence the industry, producing homogeneous
products. These firms are price takers. There are no barriers to entry or
barriers to exit.
Monopolistic Competition: an industry structure in which there are many
firms, producing slightly differentiated products. There are close
substitutes for the product of any given firm. Competitors have slight
control over price. There are no barriers to entry or exit and success invites
new competitors.
Monopoly: an industry structure where a single firm produces a product
for which there are no close substitutes. Monopolists can set price, but are
constrained by market discipline. Barriers to entry and exit exist and in
order to ensure profits, a monopoly will attempt to maintain them.
Oligopoly: an industry structure in which there are a few firms producing
products that range from slightly differentiated to highly differentiated.
Each firm is large enough to influence this industry. Barriers to entry and
exit are difficult, but exist.
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Importance of price as a signal and as an incentive in terms of
resource allocation

Definition of Demand

Demand is quantity of a commodity that will be bought at a given period
of time at a given price. What consumers are willing and able to buy at a
price affects the demand for that good.
Demand

Law of demand with diagrammatic analysis:

The law of demand states that as a price of good or service rises, the
quantity demanded will fall. Concurrently, if the price of a good or service
falls, the quantity demanded will increase.
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Determinants of Demand
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Function of demand: Qn= f[Pn, Y, (P1....Pn-1), T]
Price of a good: A change in the price of a good causes a movement along
the demand curve.
Price of related goods
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If the price of a substitute rises, demand will increase.
If the price of a compliment falls, demand will increase.

Income: An increase in income will cause an increase in demand for
normal goods and a decrease in demand for inferior goods.
Tastes/Preferences
Other macro factors: Change in the size and composition of a population,
advertising, legislation.
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Fundamental distinction between a movement along the demand
curve and a shift of the demand curve
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A movement along the demand curve is caused by a change in price.
However, a shift of the demand curve means that more is demanded at
each price- this is caused by a change in any of the determinants of
demand (with the exception of price).
The demand curve is downsloping for several reasons, including the law
of diminishing marginal utility. The extra utility gained from the
consumption of a good falls. Therefore, the price must be lower for a
person to purchase extra units of a given good. The income effect states
that as prices fall, real income increases. Consumers can therefore afford
to consume a greater quantity, providing a second reasons for the
downsloping curve. A third reason is the "substitution effect," whereby the
falling price of a good makes that good cheaper in relation to other goods
(substitutes).
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Supply

Definition of Supply

Supply is the willingness and ability for producers to produce a good at a
given price over a given period of time.

Law of supply with diagrammatic analysis: A higher quantity of a good
will be supplied at a higher price. This is because producers can afford to
supply extra units at a higher price because it allows them to produce more
before AC is greater than MC.

Determinants of Supply:

Function of supply: Qn= f(Pn,Pn1....P(n-1),F1...Fm,G,Tech) + Macro
Factors
Price of substitute goods
Costs of the factors of production
Technology
Government Intervention: Taxes/Subsidies
New firms entering a market
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Effect of taxes and subsidies: An indirect tax is a tax placed on each unit
of a good. Therefore the good become more expensive at every price by a
certain value, and the supply curve shifts upwards. A subsidy, or tax
credit, has the opposite effect, namely it shifts the supply curve
downwards because the good is cheaper at every price.

Fundamental distinction between a movement along the supply curve
and a shift of the supply curve: As with a movement along the demand
curve, a movement along the supply curve is a change in quantity supplied
resulting from a change in the good price. All other determinants of supply
will change the supply and so will shift the entire supply curve.
Supply and Demand

Interaction of Supply and Demand: When a good is placed on a market,
it suddenly doesn't begin to sell at its equilibrium price. What follows is a
game of trial and error. Say a new pair of jeans comes out on the market at
$20.00 and it instantly becomes a success selling out everywhere.
Producers decide to produce more and charge it at $30.00. Now they're not
selling enough and have a surplus of stock. They reduce the price to $25
and they sell as much as they make.

Diagrammatic analysis of changes in demand and supply to show
adjustment of a new equilibrium
Price Control

Maximum Price: a maximum price that sellers may charge for a good or
service. This is usually set by the government. For example, concert
tickets may have maximum prices. To be effective, the maximum price (or
price ceiling) must be set below the market clearing price.

Minimum Price a minimum price (or price floor) that sellers may charge
for a good or service. This again is usually set by the government. To be
effective, it must be set above the market clearing price.

Buffer stock scheme: A scheme in which the government tries to relegate
the price level of a good or service by buying the good up when demand is
too low or selling off any surplus when supply is too low. In the free
market, commodities tend to fluctuate in price.

Buffer stock schemes tend to be very expensive. There are storage costs,
the goods in question might be perishable, and there is an opportunity cost
made by the government in implementing them.

Commodity agreements: Agreements between countries to attempt to
stabilise commodity prices. This may be done by a buffer stock scheme or
placing a tariff on foreign goods. OPEC is a good example of such an
agreement.
Why do governments intervene in Agricultural markets
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There has been a downward trend in agricultural markets: Thanks to more
efficient technology, there has been an increase in supply. The result has
been lower prices as demand has increased a bit. Moreover, the income
elasticity of demand for food is inelastic. Someone does not buy more
apples because he has more money.
Agricultural prices are subject to fluctuations because of harvests, time
lags in supply, and the price elasticity of demand is very low. There are
thousands of substitutes which are available. If the price of beef goes up,
individuals will switch to chicken instead.
Governments may wish to subsidize to prevent cheap imports from abroad
in an effort to protect domestic jobs.
Governments may wish to intervene by using buffer stocks, subsidies, or high fixed
prices.
Price Elasticity of Demand
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Formula

%Change in Quanity Demanded of Good A / %change in Price of Good
A

Definition

The responsiveness of the quantity demanded of a good to a change in its
price.

Possible range of values
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PED > 1: Demand is elastic
PED < 1: Demand in inelastic
PED = 1: Demand is unit elastic
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PED = 0: Demand is perfectly inelastic
PED = : Demand is perfectly elastic
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Diagrams illustrating the range of values of elasticity
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Varying elasticity along a straight-line Demand curve
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Determinants of Price Elasticity
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Closeness of substitutes
Luxury or necessity
Percentage of income spent on the good
Time Period
Branding
Cross Elasticity of Demand
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Definition
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The responsiveness of the quantity demanded of one good to a change in
price of another.

Formula'
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%Change in QD of Good A / %Change in the Price of Good B
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Significance of signs with respect to compliments and substitutes
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A positive value signifies that the two goods are substitutes.
If the goods are complements, the value will be negative.
Income Elasticity of Demand

Definition

The responsiveness of the quantity demanded of a good to a change in
income.

Formula
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%Change in QD / %Change Y
Normal goods: When income increases, demand for normal goods
increases as well. Positive YED.

Inferior goods: When income increases, demand for this good falls.
Negative YED.
Price Elasticity of Supply

Definition

The sensitivity of supply to a change in price.

Formula:
%Change QS / %Change in Price.

Possible range of values:
PES > 1: Supply is elastic
PES < 1: Supply is inelastic.
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Diagrams illustrating the range of values of elasticity:
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Determinants of price elasticity of supply
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Number of producers.
Spare capacity
Ease of storage
length of production period
time period of training
Factor mobility
How costs react
Applications of concepts of elasticity

PED and business decisions: the effect of price changes on total
revenue.

PED may be important for businesses attempting to distinguish how to
maximize revenue. For example, if a business finds out its PED is very
inelastic, it may want to raise its prices. If a business finds that its PED is
very elastic, it may wish to lower its prices.
PED may be important for a government to find the impact of a tax or
subsidy.
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PED and taxation
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Governments may wish to know how a tax or subsidy will affect a good.

Cross-elasticity of demand:

Competitors may wish to know what will happen if there is a change in
compliments, or substitutes.

Significance of income elasticity for sectoral change (primary>
secondary > tertiary) as economic growth occurs.

Primary sector is generally income elasticity of demand inelastic. Just
because a person's income changes does not mean he will buy more
tomatoes. However, secondary and tertiary sectors tend to be income
elasticity of demand elastic. A change in income will have a big impact on
quantity demanded of cars, or the demand for personal massages.
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Flat rate and ad valorem taxes
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A flat rate tax is a tax which is the same rate regardless of price or income.
An ad valorem tax is a tax which is a percentage of the price of a good.
The United States has an ad valorem tax of ten percent.

Incidence of indirect taxes and subsidies on the producer and
consumer
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An indirect tax raises the price of a good. Its elasticity determines if the
burden of the tax is on the producer or on the consumer. In the case of a
good with inelastic demand the tax burden can be easily passed on to the
consumer.

Implication of elasticity of supply and demand for the incidence
(burden) of taxation.

If the product is demand inelastic or supply elastic, the consumer would
need to bear the majority of the burden of tax.
If the product is demand elastic or supply inelastic, the producer would
need to bear the majority of the burden of tax.
Taxes

Theory of the Firm (HL)
Types of costs: distinction between short run and long run

Fixed costs: Costs a firm bears in the short run regardless of output. A
firm could produce absolutely nothing and still face fixed costs. These are
things such as rent, etc.

Variable costs: Costs which depend on the level of production.

Total costs: Total cost is variable costs plus fixed costs.

Average costs: Total cost divided by units of output.

Marginal costs: The cost of producing one extra unit of output.

Law of diminishing returns

The Law of diminishing returns states that as additional variable units are
added to fixed units, after a certain point- the marginal product of the
variable unit declines.
Total product: total output produced by factors of production.
Average product: The output per unit of variable factor.
Marginal product : The extra output from employing an additional
variable factor.
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Short-run cost curves: The short run is the period in time in which at
least one factor of production is fixed.

Long-Run cost curves: The long run is the period of time in which all
factors of production are variable.

Economies of Scale : An increase in a firm's scale of production leads to
lower average costs per unit produced.

Diseconomies of scale: An increase in a firm's scale of production leads to
a higher average cost per units produced.
Revenues

Total revenue: The total amount that a firm takes in from the sale of its
product.

Marginal revenue: the additional revenue that a firm takes when it
increases output by one additional unit.

Average revenue: The revenue gained from the sale of a single product.

Distinction between normal (zero) and supernormal (abnormal)
profit.
Profit

Normal profit is where all costs are covered including the expected return
of the entrepreneur, anything gained beyond that is considered
supernormal profit.

Profit maximization in terms of total revenue and total costs and in
terms of marginal revenue and marginal costs.

Profit maximization occurs when the marginal revenue, that is the revenue
gained from producing one extra unit of output, equates the marginal cost
of producing that extra unit.

Profit maximization assumed to be the main goal of firms but other
goals exist (sales volume maximization, revenue maximization,
environmental concerns)

Though a firm may have its primary goal of profit maximization- in the
case of most corporations, other goals may exist. For example, sales
volume maximization, the maximization of revenue, and environmental
concerns. For example, the Body Shop before being incorporated,
proceeded to include many animal friendly measures, which prevented the
firm from maximizing profit.
However, the main goal is indeed profit maximization, rare cases exist
where it is otherwise, and indeed these are valid examples, but they are a
small minority in today's business world.
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Perfect Competition

Assumptions of the model: Perfect competition is an industry structure
which holds numerous assumptions. It is also theoretical.
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There are numerous buyers and sellers of which none are able to influence
the market.
There is perfect information.
Products are homogeneous
There are no barriers to entry and no barriers to exit.

Demand curve facing the industry and the firm in perfect competition

Profit-maximizing level of output and price in the short run and long
run

The profit maximizing level of output is where MC = MR.

The possibility of abnormal profits/losses in the short-run and normal
profits in the long-run.

Short run- yes

Long run- never.

Shut down price, break-even price.

Company has to shut down (in the short-run) if variable costs are not
being covered. In the long-run it's all about covering the average costs.

Definitions of allocative and productive (technical) efficiency

Allocative efficiency occurs when output is at society's optimum level.
P=MC
Productive efficiency is when a firm produces at the lowest possible cost
per unit. AC=MC
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Efficiency in perfect competition

Perfect competition is both allocatively and productively efficient.
However, it is dynamic efficient, in the sense that products can't be
differentiated and no new technology can be produced. In the long run, no
firm will have any profit to spend on research and development.
Monopoly

Assumptions of the model

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One single firm dominates a market for which there are no close
substitutes.
Barriers to entry and exit.

Sources of monopoly power/barriers to entry
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Government legislation.
Patents and copyrights.
Control over supplies
Cost advantage, such as massive economies of scale.
Product differentiation.
Use of force.

Natural monopoly

A monopoly which has gained its status because of massive economies of
scale.

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Demand curve facing the monopolist
Profit-maximizing level of output

A monopoly maximizes profits when MC=MR.

Advantages and disadvantages of monopoly in comparison with
perfect competition.
Monopoly: price - higher,Output- lower, Profit-Abnormal, Produces where Average costs
are higher(inefficient)

However, a monopoly may use economies of scale therefore reducing costs and
increasing output
Perfect Competition: Price- Lower, output- higher,Profit- normal, Produces Where
average costs are lowest(efficient)

Efficiency in monopoly

A monopolist is neither allocatively or productively efficient. It may be
dynamically efficient if it wishes to maintain its monopolistic position.

How to control a monopoly

Dogmatic Approach: This is the approach in the USA. Monopoly is illegal.
o Anti-trust legislation bans monopoly
o If a firm is accused of being a monopoly, they are taken to court and if
found guilty, they are broken up.

Pragmatic Approach: Looking at monopoly with an open mind
o looking at advantages and disadvantages and coming to a conclusion
o the conclusion may be, for example, lowering prices

State control: the government takes over the monopoly because it is assumed that
the government will run the firm for the 'benefit' of the country

A licence: you are given a licence to run a monopoly. If you run it well, it will be
renewed, if not it will be cancelled.
Monopolistic Competition

Assumptions in the model
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Large number of small firms.
(Almost) perfect knowledge.
Differentiated products.
No barriers to entry or exit.

Short-run and long-run equilibrium:
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In the short-run abnormal profits can be earned (at MC=MR)
In the long-run only normal profits can be earned.

Product differentiation:

Efficiency in monopolistic competition:
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Monopolistic competition is an inefficient market structure.
In the short-run/long-run neither allocative nor productive efficiency is
achieved!
Oligopoly
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Assumptions of the model:
Competition between a few firms
many buyers, few sellers
differentiated products
oligopolists will try to block entry
the oligopolist believes that if he puts his price down his competitors will follow
his example
therefore in oligopolistic competition there is non-price competition, for example
supermarkets compete in terms of:
o
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car parks
loyalty cards
trollies
Collusive and non-collusive oligopoly:
Non-collusive Oligopoly: where firms compete against each other in a normal
way
Collusive Oligopoly: where firms try to come to an agreement to reduce the
amount of competition.
o
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It is usually illegal
they will fix the output of the industry and then share the output
between them - this is often called a cartel

Cartels:
o
One example: OPEC

Kinked demand curve as a model to describe interdependent
behavior:
o
The kinked demand curve basically illustrates the downward-stickiness of
prices. The kinked demand curve shows how a change in e.g. raw material
costs does not bring about a change in the price of the final good, due to
the concept of downward-stickiness. The fear of changing prices and then
loosing numerous customers is too big to actually change prices.

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Importance of non-price competition:
Theory of contestable markets:
Price Discrimination

Definition:
price discrimination occurs when different people are charged different prices for exactly
the same good
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Reasons for price discrimination
Necessary conditions for the practice of price discrimination:

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Time
Age
Income
You must be a monopolist- however in the real world every firm has a monopoly
in their own name e.g. Ford
There must be 2 separate markets which must be kept separate
o Geographically
o Lack of knowledge
there must be no leakage between markets e.g. cigarettes in UK are 5 pounds and
in Poland are 1 pound, but markets are kept apart
Price elasticity of demand in each market must be different i.e. demand is more
elastic in one market than in another
The aim of the firm is to maximise profits

Possible advantages to either the producer or consumer
Market Failure
Definition of Market Failure
the inability of an unregulated market( no government intervention) to
use its resources efficiently
Reasons for Market Failure
Perfect markets are socially efficient, they are operating at pareto optimality in which no
one can be made better off with someone being made worse off. Consumer surplus is
maximized. P=MC where MSC=MSB.
In the real world, markets are not perfect. MSC does not equal MSB and market failure
occurs. This is because of externalities, underprovision of merit goods, the overprovision
of demerit goods, a lack of public goods, and imperfect markets. If the free market is left
to its own devices, market failure will occur.

Inefficient Producers: the producers don't produce where the average
costs are at minimum. Therefore they are using more resources than they
need to.

Positive and Negative externalities: An externality is defined as an effect
on a third party which is caused by the consumption and/or production of
a good or service. There are four types of externalities.

Positive externality of production: This occurs when the MSC is greater
than MPC. (bee-keeping)
Negative externality of production: This occurs when MSC is less than
MPC. (Pollution)
Positive externality of consumption: This occurs when MPB is greater
than MSB. (listening to good music)
Negative externality of consumption: This occurs when MPB is less than
MSB (smoking)
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Short-term and long-term environmental concerns, with reference to
sustainable development
Lack of public goods : Public goods are defined as a good which total
cost of production does not increase with the number of consumers. The
classic example is national defence. Other example: street lights. Public
goods will not be provided by the market.

Underprovision of merit goods: If left to its own devices, merit goods( a
private good the society consider underconsumed, often with positive
externailites) will be underprovided. These are goods and services which
have a positive effect on society like education, healthcare and sports
centers.

Overprovision of demerit goods: If left to its own devices, demerit goods
( a private good the society consider overconsumed, often with negative
externalities)will be overprovided. These are such things as prostitution,
alcohol, and cigarettes.
To discourage these demerit goods the government creates: negative advertising,
tax on the good, or ban it.

Abuse of monopoly power: Imperfect markets such as oligopolies and
monopolies restrict output in an attempt to maximize profit. Thus, MSB is
not equal to MSC. MSC is equal to MR.
Possible government responses
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Legislation: Antitrust legislation can be brought in an attempt to break
monopoly power and collusive oligopolies. Legislation to make high
school attendance mandatory. Ban smoking in restaurants.
Direct provision of merit and public goods: Governments can control
the supply of goods that have positive externalities by supplying a high
amount of education, public roads, parks, libraries, etc.
Taxation: Place a "sin tax" on the sale of tobacco products to discourage
consumption. This will internalize some of the external costs (ie smokers
will pay for their second hand smoke through the tax).
Subsidies: Reduce the cost of university education because it has
beneficial externalities. The price will be reduced to reflect the benefit
society attains through the education of individuals.
Tradable permits: Tradable permits are permits allowing a firm to
produce a given amount of pollution. There is limited supply for how
much pollution a firm can produce so if a firm would want to pollute more
it has to purchase tradable permits from other firms. A Carbon Tax (taxing
consumption which causes pollution, such as fossil fuels) achieves the
same result. In both cases, firms and individuals are motivated to reduce
costs by reducing environmental damage.
Extension of property rights:
Advertising to encourage and discourage competition:
International cooperation among governments: In the case of acid rain
for example international cooperation among governments is necessary in
order to reduce its occurrence.
Retrieved from "http://en.wikibooks.org/wiki/IB_Economics/Microeconomics"
Subject: IB Economics
IB Economics/Macroeconomics
National Income (NY)
Measuring National Income
GDP: Gross Domestic product is the total amount of goods and services produced by
means of production which are domestically located in one years time. GNP: Gross
national product is the total amount of goods and services produced by means of
production which are domestically owned in one years time.

circular flow of income
Household provide factor services and consumer spending to firms. Firms provide
income and goods and services.

Methods of measurement- income, expenditure, output. There are three
main ways of measuring a country's GDP:
Income: Income takes into account wages and salaries, rent, interest, selfemployed income and adds up to make total domestic income.
Expenditure: Takes into account all spending in an economy. C+I+G+[X+M]
Output: Takes into account everything which is produced in an economy.
Problems with Measuring National Income
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Transfer payments, payments made to students and pensioners even
though they don't really help produce anything in the economy.
Non-market economy: If you build an extra wall in your house yourself
the NY statistically stays the same but if you had paid a builder it would
have risen, even though the work you have done has contributed to the
total output of final goods and services in the economy.
Price changes
Parallel Economy: Many people work and is unrecorded by the
authorities. This includes both black markets (selling illegal goods) and
informal markets (selling legal goods illegally to circumvent price
restrictions).
Self Sufficiency: In many poor countries food does not enter the market
place. Food is grown for yourself in a subsistence manner thus the national
income is lower than it should be.

Distinction between

Gross and Net: Net domestic product = GDP- depreciation
GNP= GDP + net factor income. Many US Homes and Firms receive factor
income from abroad.
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Domestic and national: See above
Nominal and real: Nominal measures at the current value. Real takes into
account inflation.
Total and per capita: Per capita is divided by a country's population.
Problems with using NY figures for a comparison between countries
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Composition of Output : Does not show what this income is spent on for
example Soviet Russia spent significant amounts on armamaments in the
cold war, however this does not improve the standard of living.
Composition of Expenditure: National income figures do not take into
account what the incomes are spent on. For example heating in cooler
countries adds nothing to standards of living; however, does contribute to
national incomes.
Exchange Rate Distortions: Exchange rate conversions may not create an
accurate representation of a populations relative purchasing power.
Purchasing power parity may take this into account.
Unaccounted for Activity : Parallel markets, such as subsistence living and
black market activity are not taken in GDP.
Distribution of Income: Doesn't take into account how this income is
distributed.
Intangible additions to welfare: Doesn't take into account the ability to
enjoy fresh air and have leisure time.
Externalities and evironmental damage: Damage to the environment and
pollution are not taken into account.
Economic Growth
Introduction to Economic growth

Economic growth: the increase in the real output of a country over a
period of time
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Economic growth is important because:

o
o
o
o
living standards will increase
change in lifestyle
reduction of poverty
life expectancy will increase
Basic factors affecting economic growth (why countries get richer)
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increase in investment (more tools, machines, factories)
Innovation (new tools, new robots, new techniques)
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Improvements of quality of workforce (instead of quantity)
Infrastructure (telephones, roads...)
Social and legal institutions (ownership of land)
Available resources (oil..)
Problems with economic growth
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More inequality
Pollution increases
Breakdown of family values
Social problems (overcrowding, suicide, divorce, traffic...)
Sustainable economic growth: an increase in real output but at the same time not using
up all the available resources . Leaving some or replacing those used up so that future
generations can still grow economically.
Development
Introduction to Development

Definitions of economic growth and economic development

Economic Growth is defined as an increase in output in an economy
measured by an increase in real GDP. An increase in a society's potential
output by a change in a country's quantity and quality of resources.
Economic Development: is defined as a qualitative measure of a country's
standard of living. This takes into account things such as health, education,
and GDP at PPP.
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Differences in the definitions of the two concepts
Gross Domestic Product (GDP) versus Gross National Product (GNP) as
measures of growth: It is quite difficult to measure an increase in
economic growth because of GNP. If Ford's sales increase, then that
doesn't mean that employees in the US benefits, if they have in fact been
outsourced to say China. The government does take in a bit of revenue,
but to say that the rest of the country has benefited is an overstatement.

Limitations of using GDP as a measure to compare welfare between
countries: It is very difficult to use GDP as a measure of welfare for
various reasons.

Allowance for differences in purchasing power when comparing welfare
between countries: A better measure than GDP pc is GDP at PPP or
purchasing power parity. It is a measure which takes into account how
much you can purchase a basket of goods in one country in comparison
with another. For example, it costs in Austria 20 euros for a haircut,
however- with 20 euros one can go to Brazil and purchase 5-6 haircuts.
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Alternative methods of measurement
Problems of measuring development
Macroeconomic models
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Aggregate demand- components: Aggregate demand is composed of five
parts.
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Consumption: How much households demand.
Investment: How much firms demand.
Government: How much Governments demand.
[Exports- Imports]: How many exports are demanded from a country
minus the number of imports said country demands.

This all makes for a very elegant equation: Aggregate demand=
C+I+G+[X-M]

Aggregate supply: Aggregate supply is national output which is equal to
national income.
Short run: In the short run demand and supply are the same.
Long-run (Keynesian versus neo-classical approach): There are two
different examples of long-run supply curves. Keynsians believe that the
long-run supply curve is L shaped. That we are never reaching an
economy's full capacity and working towards it. Neo-classicals believe
that this is not the case, and the supply curve is in fact- inelastic.
Full employment level of national income:
Equilibrium level of national income :
Inflationary gap: the gap between actual output and full employment
output (+) OR the excess of Agg demand at the full employment level of
real GDP
Deflationary gap: the gap between full employment output and actual
output (-) OR the shortfall in Agg demand at the full employment level of
real GDP
Diagram illustrating trade/business cycle:
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A business cycle is composed of four parts.
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Boom
Recession
Slump
Expansion
Factors influencing Aggregate Demand
Fiscal Policy
This is when the government tries to control the economy through
manipulation in government spending,
taxes and transfer payments.
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If the gov. increased spending on roads, aggregate demand would increase
If the gov. decreased income tax, consumer spending would increase and
aggregate demand would also increase
Monetary Policy
This is when the central bank* tries to control the economy by changing
interest rates and the money
supply *(e.g. Federal Reserve, Bank of England. UK split from govt. in
1997)
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The interest rate is the cost of borrowing money
The money supply is how much money/credit there is available for people
to borrow
Changes in the interest rate will either encourage or discourage people to
borrow money hence influencing aggregate demand
Changes in money supply will make it easier or harder for people to
borrow money hence influencing aggregate demand
If interest rate goes down, consumption will go up and investment will go
up (firms will borrow money to invest) and so aggregate demand will go
up.
If money supply goes up, it is easier to borrow money, credit is available
therefore aggregate demand will increase
International Factors
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foreign exchange rate
state of world economy
Expectations
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Expectations of higher income: if you think your salary will rise you will
tend to spend more.
If there is an expectation of higher prices in the future you will tend to buy
more goods in the present, and hence, increase spending.
Expectation of higher profit: you will invest more money into
machines/tools now.

interest rates as a tool of monetary policies
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Shifts in the aggregate supply curve/supply-side policies
Strengths and weaknesses of these policies
Multiplier effect: Keynesian policy that consists of injections of demand
into the circular flow of income stimulate further rounds of spending
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calculation of multiplier
Accelerator
“Crowding out
Unemployment and Inflation

Unemployment

Full employment and Underemployment: A society is almost never fully
employed, but one of the goals is to reach full employment. Full
employment has two conditions: Everyone who wants to work is working,
and the rate of inflation is stable. When the economy is at full
employment, there is no cyclical unemployment but still frictional and
structural unemployment. This is defined as natural unemployment.

You are only classified as unemployed if you go and register with the
government as available for work.
The labor force is defined as those of 16 years of age or older who are
employed plus all those who are unemployed seeking work.
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Unemployment rate : the number of people with no work expressed as %
of the labour force

Cost of unemployment: There are numerous costs of unemployment. For
one thing, demand-side unemployment may be a slippery slope. For
another thing, there are social costs such as high crime rates. There is a
loss in potential output. There is political unrest brought by high levels of
unemployment.
Problems with Unemployment
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the average unemployed person costs the British government 8000 pounds
a year
loss of output
diminished tax base
increased transfer payments
opportunity cost
increased taxes, increased burden
increased difficulty for labor market entrants - employers have more
choices, they favor experienced workers
unemployed workers lose their skills
social costs - social stigma, increased unemployment is said to be
proportional to the increase in domestic violence, crime, use of drugs,
suicide, depression etc. - economically sub-optimal.
Advantages: spare labour-- could be attractive for investors, wages wont be high - they
can pay people less as they know others are available.
Types of unemployment
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Classical Unemployment: your wage is too high, the price of the good
goes up and no one buys it so the firm moves to a cheaper country
Structural: Unemployment caused by the demand for your product falling
e.g. coalmining, we use oil now. Some skills are no longer needed e.g. you
are a trained draughtsman but we use computers now
Frictional: People leaving their jobs looking for another one.
Unemployment associated with frictions in the system that may occur
because of the imperfect job market information that exists.
Seasonal: Unemployment caused by changes in seasons.e.g a Father
Christmas only works a few weeks a year
Cyclical/Demand-deficient: Unemployment resulting from business
recessions that occur when total demand is insufficient to create full
employment.
Regional Unemployment: if there is a coalmining area which closes down
there will be large unemployment in that area
Voluntary Unemployment: you are unemployed by choice, you get money
from the government anyway
real wage
Solutions to unemployment
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boost aggregate demand e.g. increase gov. spending, build statues
(creating jobs), reduce taxes
interest rates reduced: more investment, more money borrowed, more
money spend, more jobs
Supply side economics: train the workers make them more skilful. Also
reduce taxes to increase working incentives
Lower the retirement ages/ raise school leaving age: it reduces
unemployment however these days is unlikely
Conscription: the army counts as employment

Definition of inflation and deflation

Inflation is defined as a sustained rise in the average price level and a fall
in the value of money.
Deflation is defined as a sustained fall in the average price level and a rise
in the value of money.
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Inflation
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Costs of inflation and deflation

Inflation may harm some individuals and benefit others. Individuals with
liquid assets which are not collecting interest may be harmed. Individuals
with fixed assets such as paintings, housing, etc. will benefit.

Causes of Inflation
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cost push: Inflation that occurs when there is an increase in the cost of
production.
demand pull: Inflation that occurs when a sector of the economy increases
the demand for goods and services.
excess monetary growth: The money supply increases, and prices increase.
Distribution of Income
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direct taxation: income tax
Indirect taxation: tax on goods or services
Progressive taxation: the bigger your income, the larger % you pay of tax
Regressive taxation:the bigger your income, the smaller % you pay of tax
Proportional taxation: everyone pays the same tax % e.g. 10%
Taxes
Purpose of taxes
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to raise gov. revenue
to narrow the gap between rich and poor e.g progressive tax
to safe guard health e.g. tax in cigarettes, alcohol
influence consumer spending e.g. lead free petrol
to control the economy (fiscal policy)
to control externalities
to stop/ reduce imports (tariffs)
Different Taxes
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direct taxation: income tax
indirect taxation: tax that is included in expenses, levied on good/service
and not on individual or organization
progressive taxation: tax increases as income increases
proportional taxation: tax remains constant regardless of income
regressive taxation: tax increases as income decreases
Profit Tax: a tax on the firms profits. Usually there are different rates for
smaller and larger firms
Wealth Tax: A tax on your wealth on an annual basis
Inheritance tax/ Death Duties/ Estate Duties: when you die you leave
behind an estate, the gov. taxes these estates
Gift Tax/ Capital Transfer Tax: a tax on large gifts
Capital Gains tax: a tax on the gain you make between buying and selling
something. Usually refers to shares
Transfer payments: payment by government as gift or aid and not for good
or service.
Retrieved from "http://en.wikibooks.org/wiki/IB_Economics/Macroeconomics"
IB Economics/International Economies
International Economies
Reasons for Trade

Differences in factor endowments: Factor endowments is defined as the
total amount of land, labour, capital, and entrepreneurship a country
possess. Countries have different factor endowments. Saudi Arabia may
have a lot of oil, but perhaps not enough lumber. It will thus have to trade
for lumber.

Variety and quality of goods: Japan may have a superior quality of
technological devices (e.g T.V. or camera) but lacks many natural
resources; hence, it may trade with Indonesia for inputs.

Gains from specialization: Countries may gain economies of scale where
long run average costs fall as output increases.
Political: Countries may wish to bring two countries together culturally
and politically and this can be done through trade.
Absolute and comparative advantage (numerical and diagrammatic
representations): Absolute advantage occurs when a country can produce
more of one good than another using the same amounts of resources.
Efficiency: Domestic firms will be forced to be competitive to continue in
the market and thus become more efficient.
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For example: (Costs per unit in manpower)
Wheat---------------England| 10 Portugal|20
It costs 20 units of manpower to produce one unit of wheat in Portugal, while it only
costs 10 for England to produce the same unit of wheat. England is said to have an
absolute advantage in wheat production.
Comparative advantage is where a country has a lower opportunity cost in the production
of a good than another, for example
(costs per unit in man hours)
Wheat-----Wine
England| 15 30 Portugal| 10 15
The opportunity cost of producing 1 more unit of wheat for England is 2 units of Wine.
The cost of producing 1 unit of wheat in Portugal is 1.5 units of Wine. Portugal thus has a
comparative advantage in the production of wheat because it can produce it at a lower
opportunity cost.
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Opportunity cost: The value of the next best alternative foregone.
Limitations of the theory of comparative advantage: There are however
limitations, comparative advantage holds numerous simplistic
assumptions.
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There are no transport costs.
Costs are constant and there are no economies of scale
There are only two economies producing two goods.
Free Trade and Protectionism

Definition of free trade: The unobstructed trade between two goods with
no restrictions on imports and exports.
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Types of protectionism
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tariffs: Tax on imports
Quotas: A restraint on imports
Subsidies: A grant given to producers of a good.
Voluntary Export Restraints (VERS): Political pressure placed on a
country not to export a good.
Administrative obstacles: Bureaucracy.
Health and safety standards: Not accepting goods because of possible
health risks.
Environmental standards

Arguments for protectionism

Infant industry argument: This argument suggests that an industry needs
times to develop. This takes into account that it needs to develop
economies of scale and a learning curve.
Efforts of a developing country to diversify
Protection of employment
Source of government revenue: The consumer has the burden
Strategic arguments
Means to overcome a balance of payments disequilibrium
Anti-dumping: Dumping is known as the selling of goods on the
international market below the normal market price
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Arguments against protectionism
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Inefficiency of resource allocation
Costs of long-run reliance on protectionist methods
Increased prices of goods and services to consumer
The cost effect of protected imports on export competitiveness
Economic Integration

Globalization- political, social, and economic integration.

Trading blocs: a large free trade area formed by tax, tariff, and trade
agreements.
Free trade Areas: (NAFTA) a group of countries that agree to free trade.
Custom unions: A free trade area with a common external tariff (The EU
is an example of a customs union)
Custom markets
Trade creation and trade diversion:
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Trade creation: greater specialisation according to comparative advantage
Trade diversion: Firms may have to pay more for products they would
have paid less for.
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Obstacles of achieving integration:
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Reluctance to surrender political sovereignty
reluctance to surrender economic sovereignty

World Trade Organization
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Aims: attempts to increase international trade by lowering trade barriers.
Success and failure viewed from different perspectives

Balance of Payments: Record of all financial dealings over a period of
time between one country and the rest of the world. (Current account +
capital account)

current account: Composed of the visible and invisible

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balance of trade: Visible exports - visible imports
invisible balance: Invisible exports - invisible imports

capital account: Composed of profits, interest, dividends, and hot money.

Exchange Rates
An exchange rate is the value of one currency expressed in the value of another.
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Fixed exchange rates: fixed exchange rates are exchange rates which the
government sets.
Floating exchange rates: Exchange rates determined by the market forces
of demand and supply.
Managed exchange rates: Exchange rates which are floating exchange
rates but controlled by the government by influence.
Distinction between:
Depreciation and devaluation - When the value of a floating currency
decreases, it means the currency has depreciated. When the value of a
fixed currency is set at a lower value, it means it was devaluated.
Appreciation and revaluation - When the value of a floating currency
increases, it means the currency has appreciated. When the value of a
fixed currency is set at a higher value, it means it was revaluated.
Effects on exchange rates of
Trade flows: If there is a greater demand for a country's imports there is
thus a greater demand for a country's currency and the value of that
currency will rise.
Capital flow/ interest rate change: If interest rates rise, there will be a
greater demand for a country's currency and thus it will appreciate.
Inflation: Inflation may cause a fall in the value of a country's currency.
Speculation: May do either.
Use of foreign currency reserves: A country will use its foreign currency
reserves
relative advantage and disadvantages of fixed and floating exchange rates
A Floating exchange rate has it advantages because it automatically
adjusts so that supply equals demand. There is no need for a central bank
to keep foreign reserves. It prevents inflation. A government can pursue its
own domestic policies.
Causes instability
May lead to inflation
Speculation can lead to major changes in the rate.
A Fixed exchange rate is advantageous because it provides stability, it can
restrain domestic inflation, it can prevent inflation.
A government must have sufficient reserves, a country;s firms may be
uncompetitive. The government must intervene as a priority.
Advantages and disadvantages of single currencies/monetary integration
Purchasing power parity theory (PPP): The theory that floating system
currency adjusts until a unit of currency can buy the exactly the same
amount of goods and services as a unit of another currency.
Balance of Payments Problem
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Consequences of a current account deficit or surplus
Methods of correction
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managed changes in exchange rates
reduction in aggregate demand/expenditure-reducing policies
change in supply-side policies to increase competitiveness
protectionism/expenditure-switching policies
Consequences of a capital account deficit or surplus
Marshall-Lerner condition
J-curve
Terms of Trade
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definition of terms of trade: Index of export prices/ index of import prices
* 100
Consequences of a change in the terms of trade for a country's balance of
payments and domestic economy
The significance of deteriorating terms of trade for developing countries
Measurement of terms of trade
Causes of changes in country's terms of trade in the short-run and long-run
Elasticity of demand for imports and exports
Possible inverse relationship between Terms of Trade and Balance of
Payments - depends on elasticity for imports and exports (Price and
Income elasticities)
Retrieved from "http://en.wikibooks.org/wiki/IB_Economics/International_Economies"
IB Economics/Development Economics
Development Economics
Sources of Economic Growth and/or Development

Natural factors: the quantity and/or quality of land or raw materials
Many LDCs have abundant natural resources. Agriculture is especially important as an
export sector, and is an area for initial mechanisation, productivity gains and growth.
Agricultural land is finite and therefore the law of diminishing returns applies as more
labour is added to the land. Many LDCs have had problems with severe weather, low
agricultural productivity, worsening terms of trade and rising prices for crucial pesticides
and fertilisers.
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Human factors: the quantity and/or quality of human resources
Physical capital and technological factors: the quantity and/or quality of
physical capital
Institutional factors that contribute to development:
-banking system
-education system
-health care
-infrastructure
-political stability
Consequences of Growth
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externalities
Income distribution
Sustainability
Barriers to Economic growth and/or Development
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poverty cycle: low incomes --> low savings --> low investment --> low
income
Institutional and political factors
ineffective taxation structure
lack of property rights
political instability
corruption
unequal distribution of income
formal and informal markets
lack of infrastructure
International trade barriers
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overdependence on primary products
consequences of adverse terms of trade
consequences of a narrow range of exports
protectionism in international trade
International financial barriers
indebtedness
non-convertible currencies
capital flight
Social and cultural factors acting as barriers
religion
culture
tradition
gender issues
Growth and Development Strategies
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Harrod-Domar growth model
Structural change/dual sector model
Types of aid
o bilateral, multilateral
o giant aid, soft loans
o official aid
o tied aid
export-led growth/outward oriented strategies
Import substitution/inward-oriented strategies/protectionism
Commercial loans
Fair trade organizations
Micro-credit schemes
Foreign direct investment
Sustainable development
Evaluation of Growth and Development Strategies
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Evaluation of the following in terms of achieving growth and/or
development
aid and trade
market-led and interventionist strategies
The role of international financial institutions
The IMF: The International Monetary Fund aims to ensure international
financial stability. They provide loans under certain conditions.
The World Bank: Aims to promote development to some extent.
Private sector banks: Provide loans in exchange for interest.
non-governmental organizations (NGOs): Foreign Aid by NGOS
multinational corporations/transnational corporations: Foreign Direct
Investment
commodity agreements: Agreements between developing countries in an
attempt to stabilize prices for certain commodities.
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