Section 2 definition and diagrams

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IB Economics

SECTION 2 – DEFINITIONS & DIAGRAMS

SERINA YAMADA

+Demand & Law of Demand

Demand is the willingness and ability to purchase a quantity of a good or service at a certain price over a given time of period.

The Law of demand states that as the price of a good or service rises, the quantity demanded decreases.

+The Demand Curve & Change in Quantity Demanded

The demand curve is a graphical representation of the law of demand. It is (usually) a downward – sloping curve (or line) illustrating the inverse relationship between price and quantity demanded.

+Change in Demand

+Supply & Law of Supply

Supply is the willingness and ability of a producer to produce a quantity of a good or service at a certain price over a given period of time.

The law of supply states that as the price of a good rises, the quantity supplied increases.

+Supply Curve & Change in quantity supplied

A schedule (curve) showing how much of a product producers will supply at each of a series of prices over a specific period of time.

+Change in Supply

+Equilibrium Price

Equilibrium price is the market clearing price. It occurs where demand is equal to supply.

+Maximum Price / Ceiling Price

Maximum Price is also known as a ceiling price. It is a price set by the government, above which the market price is not allowed to rise. It may be set to protect consumers from high prices, and it may be used in markets for essential goods, such as rice or house rentals.

+Minimum Price / Floor Price

A minimum price is also known as a floor price. It is a price set by the government, below which the market price is not allowed to fall. It may be set to protect producers producing essential products from facing prices that are felt to be too low, such as many agricultural products in the European Union.

+Price Ceiling & Price Floor

+Buffer Stock Scheme

A buffer stock scheme sets a maximum and a minimum price in a market to stabilize prices.

+Price Elasticity of Demand (PED)

PED is a measure of the responsiveness of the quantity demanded of a good or service to a change in its price. Elastic Demand means that a change in the price of a good

or service will cause a proportionately larger change in quantity demanded.

Inelastic demand means that a change in the price of a good or service will cause a proportionately smaller change in quantity demanded.

+Price Elastic Demand

+Price inelastic Demand

+Cross Elasticity of Demand (XED)

XED is a measure of the responsiveness of the demand for a good or service to a change in the price of a related good. Substitute goods are goods that can be used instead of

each other, such as butter and margarine. Substitute goods have positive cross elasticity of demand.

Complement goods are goods which are used together, such as DVD players and DVD disks. Complement goods have negative cross elasticity of demand.

+Income Elasticity of demand (YED)

YED is a measure of the responsiveness of demand for a good to a change in income. A normal good has a positive income elasticity of demand.

As income rises, demand increases. Inferior goods have a negative income elasticity of demand.

As income rises, demand decreases.

+Price Elasticity on Supply (PES)

PES is a measure of the responsiveness of the quantity supplied of a good or service to a change in its price. An indirect tax is an expenditure tax on a good or service.

An indirect tax is shown on a supply and demand diagram as an upward shift in the supply curve, where the vertical distance between the two supply curves represents the amount of the tax. A specific tax is shown as a parallel shift. An ad valorem tax is shown as a divergent shift.

The incidence (or burden) of tax refers to the amount of tax paid by the producer or the consumer. If the demand for a good is inelastic the greater incidence of the tax falls on the consumer. If the demand for a good is elastic, the grater incidence of the tax falls on the producer.

+Costs

Fixed Costs are costs of production that do not change with the level of output. They will be the same for the one or any other numbers of units.

Variable costs are the total costs of producing a certain level of output- fixed costs plus variable costs.

Total costs are the total costs of producing a certain level of output – fixed costs plus variable costs.

Average cost is the average (total) cost of production per unit. It is calculated by dividing the total cost by the quantity produced.

Marginal cost is the additional cost of producing an additional unit of output.

+TFC, TVC, and TC

+Cost Curves

+Short Run

The short run is the period of time in which at least one factor of production is fixed – the production stage. The law of diminishing average returns states that as extra

units of a variable factor are applied to a fixed factor, the output per unit of the variable factor will eventually diminish.

The law of diminishing marginal returns states that as extra units of a variable factor are applied to a fixed factor, the output from each additional unit of the variable factor will eventually diminish.

+Long Run

The long run is the period of time in which all factors of production are variable. Economies of scale are any fall in long-run unit (average)

costs that come about as a result of a firm increasing its scale of production (output).

Diseconomies of scale are any increase in long-run unit (average) costs that come about as a result of a firm increasing its scale of production (output).

+Long Run & Short Run Curves

+Economies & Diseconomies of Scale

+Revenues

Total revenue is the aggregate revenue gained by a firm from the scale of a particular quantity of output (equal to price times quantity sold).

Average revenue is total revenue received divided by the number of units sold. Usually, price is equal to average revenue.

Marginal revenue is the extra revenue gained from selling an additional unit of a good or service.

+Revenue Curves: Perfectly Elastic Demand

+Normal and Abnormal Profits

Normal profits are the amount of revenue needed to cover the total costs of production, including the opportunity costs.

Abnormal profits are any level of profit that is greater than the required to ensure that a firm will continue to supply its existing good or service. (It is an amount of revenue greater than the total costs of production, including opportunity costs.)

+Profit- maximizing level of output

The profit maximizing level of output is the level of output where marginal revenue is equal to marginal cost.

+Shut down price & Break even price

The shut down price is the price where average revenue is equal to average variable cost. Below this price, the firm will shut down in the short run.

The break even price is the price where average revenue is equal to average total cost. Below this price, the firm will shut down in the long run.