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CONTENTS ABOUT THIS BOOK – Please read! ....................................3 SECTION 1: MICROECONOMICS......................................4 Scarcity ..................................................................................... 4 Markets...................................................................................... 7 Demand .................................................................................. 7 Supply .................................................................................. 10 Equilibrium: the Interaction of Demand and Supply ............. 11 Market Efficiency .................................................................. 13 Elasticities of Demand and Supply....................................... 14 Price Elasticity of Demand ................................................... 14 Cross Price Elasticity of Demand ......................................... 18 Income Elasticity of Demand ................................................ 18 Price Elasticity of Supply ...................................................... 19 Government Intervention....................................................... 21 Maximum and Minimum Prices ............................................ 21 Indirect Taxation ................................................................... 23 Subsidies .............................................................................. 25 Market Structures................................................................... 26 Aims and Objectives of Firms............................................... 26 Production and Costs ........................................................... 26 Revenue ............................................................................... 29 Profit ..................................................................................... 31 Perfect Competition .............................................................. 32 Monopoly .............................................................................. 34 Monopolistic Competition ..................................................... 38 Oligopoly .............................................................................. 40 Price Discrimination.............................................................. 42 Market Failure and Government Response ......................... 43 Externalities .......................................................................... 43 Negative Externalities........................................................... 43 Positive Externalities ............................................................ 47 Public Goods ........................................................................ 48 Merit and Demerit Goods ..................................................... 49 Monopoly Power................................................................... 49 Common Access Resources and Sustainability ................... 50 Asymmetric Information........................................................ 51 Microeconomics Sample Questions..................................... 52 SECTION 2: MACROECONOMICS ...................................53 Measuring National Income................................................... 53 Circular Flow of Income........................................................ 54 Business Cycle Model .......................................................... 54 Macroeconomic Models......................................................... 56 Aggregate Demand and Supply Analysis ............................. 56 The Keynesian/Monetarist Debate ....................................... 64 The Multiplier ........................................................................ 65 Demand-side Policies........................................................... 65 Supply-side Policies ............................................................. 69 Unemployment and Inflation ................................................. 70 IB HL Economics Page 1 3rd Edition Unemployment ..................................................................... 70 Inflation ................................................................................. 74 ECONOMIC GROWTH ............................................................ 82 DISTRIBUTION OF INCOME .................................................. 85 Macroeconomics Sample Questions.................................... 88 SECTION 3: INTERNATIONAL ECONOMICS.................. 89 Reasons for Trade .................................................................. 89 Terms of Trade ....................................................................... 91 Free Trade/Protectionism ...................................................... 92 Economic Integration............................................................. 95 Exchange Rates...................................................................... 97 Balance of Payments ........................................................... 101 Correcting a Current Account Deficit ................................. 102 International Trade and Exchange Rate Sample Questions ............................................................................................... 104 SECTION 4: DEVELOPMENT ECONOMICS................... 105 Introduction to Development .............................................. 105 Measuring Development ...................................................... 108 Domestic Factors ................................................................. 110 International Trade ............................................................... 111 Foreign Direct Investment ................................................... 113 Aid and Multilateral Assistence .......................................... 114 International Debt ................................................................. 117 Markets vs. Intervention ...................................................... 118 Development Economics Sample Questions .................... 119 REVISION ADVICE........................................................... 120 Assessment Objectives (AOs) ....................................... 121 Higher Level Assessment............................................... 122 Essay Technique ............................................................. 124 Model Markschemes ............................................................ 125 Data Response Technique ............................................. 133 Model Markschemes ............................................................ 134 IB HL Economics Page 2 3rd Edition SECTION 1: MICROECONOMICS SCARCITY The basic economic problem is scarcity. But, to be more accurate, the problem is finite resources (land, labour, capital and enterprise) in relation to infinite wants. Because these resources are finite, individual consumers, firms and governments constantly have to make choices between having one thing, and not having another. These choices can be focused down into three questions. What to produce? How to produce? For whom to produce? All economies, whether tending to command or to free market, exist as an attempted solution to these three questions. All economies, including developed and less economically developed, face the same problem, and therefore the same questions. For example, developed economies might face the choice between more nuclear weapons or more healthcare, whereas a less economically developed country (ELDC) might face a choice between clean water and basic vaccination programmes. Factors of Production are the scarce resources that an economy has at its disposal to produce goods and services. It is important that you understand that the act of investment involves the buying of capital goods and has nothing to do with money. Land represents natural resources Labour is the human resource Capital is goods that are used to produce other goods, and requires an economy to forgo current consumption Enterprise, also a human resource, organises the three other factors to produce goods and services. The reward for this risky activity is profit Allocation of these resources can be organised through several different Economic Systems. In the end, all economies are mixed, although some will tend towards free market (eg. UK, USA), and others will tend towards centrally-planned or command (North Korea, Cuba). Traditional systems still exist in many of the poorest LDCs, and involve actions such as barter, gift and communal activities. Opportunity Cost is the cost of the next best thing forgone. As long as economic resources are used in the production of a good or service, a cost is involved, even if a price is not. A Production Possibility Curve (also referred to as boundary, or frontier) shows the combinations of two goods/services that can be produced efficiently with a given set of resources: IB HL Economics Page 4 3rd Edition You will normally see a curved PPC, because as more consumer goods are produced, more capital goods have to be given up in order to produce each marginal unit of consumer goods. As we shall see later on, this is due to the law of diminishing returns. Any combination of goods produced within the PPC (A) means that there are unemployed resources. Points on the PPC (B) represent different bundles of goods, but with fully employed resources. Points beyond the PPC (C) are currently unattainable. In order to attain these points, an economy would have to increase the number of resources, increase the productivity (efficiency) of its current resources, or improve technology. For example, Brazil discovers offshore oil, a developed economy invests in its human capital, and car factories become robotised. IB HL Economics Page 5 3rd Edition