microeconomics is a branch of economics that studies how the individual parts of the economy, the household and the firms, make decisions to allocate limited resources. It examines how the decisions that these distinct parts make affect the supply and demand for goods and services.
A market is anywhere goods and/or services are being traded. Markets have both a supply curve and a demand curve. A market could be a store, a website, or even someone's garage. In a market buyers and sellers agree to an, or there is already a set, equilibrium price and quantity that they then trade, so everybody gets what they want at an equal price. This point can be shown as the intersection of the demand curve (relates price and quantity demanded by consumers/buyers) and the supply curve (relates price and quantity supplied by producers/sellers) and is known as the market equilibrium point.
Consumer and producer surpluses are maximized by market equilibrium. Surplus in this context has the same meaning as "added benefit". At equilibrium, there is part of the demand curve that is above the equilibrium price, and part of the supply curve that is below the equilibrium price both of these are to the left of the equilibrium quantity. The consumers generate a benefit from not having to pay as high of a price for the good or the service they are buying. This is the area bounded between the equilibrium quantity and the y-axis as well as the equilibrium price and the y-intercept of the demand curve. The producers generate a "benefit" from being able to raise their price and get more revenue. This effect forms a triangle directly below the consumer surplus.
Wages are sticky within the markets in the shortrun, so markets don't reflect their true affect. In order to get out of a surplus and shortage is by having competitions. If there is a surplus, then producer competes but if there is a shortage, then consumers competes. Markets can also fail, which happens when true equilibrium doesn't occur.
Markets not recorded in the economy are informal markets called black or gray markets. Black and gray markets are not beneficial because without official records they cannot invest and develop. Even though thye wish to make more money by investing in their business. Without any records of their sales, they cannot receive an official loan from banks. They may get unofficial loans at higher interest rates but they may not make enough money by making this investment and taking out this loan. They also don't send taxes which is bad for the economy. Because they do not send their records of sales, the economy is less efficient.
A market economy is based on the power of division of labor and is set by supply and demand.
Markets are benificial to an economy as long as nothing bad inturrpts it and make markets fail.
- Main Article: Elasticity
- In economics, elasticity is the ratio of the percent change in one variable to the percent change in another variable. It is a tool for measuring the responsiveness of a function to changes in parameters in a unit-less way. Frequently used elasticities include price elasticity of demand, price elasticity of supply, income elasticity of demand, elasticity of substitution between factors of production and elasticity of intertemporal substitution. It is always about how much changes in quantity change the demand for a good or supply of it. Basically, the more elastic the good, the more easily it will be influenced in price with a direct relationship to demand.
- The economy is working to full potential when it is unit elastic. Unit elastic is when elasticity is equal to one. If the elasticity is greater or less than one the economy will not be functioning well and this will cause further problems in the long run.
- The equation for price elasticity of demand is:
- PED= %change in quantity demanded/ %change in price
- The equation for income elasticity of demand is is:
- YED= %change in quantity demanded/ %change in real income
- The equation for price elasticity of supply is:
- PES= %change in quantity supplied/ %change in price
Theory of the Firm
- Main Article: Theory of the Firm
- The theory of the firm is a set of economic theories that attempt to explain the nature of a firm, or a company, and the firm's relationship to the marketplace. Theory of the firm is a higher level extension topic in the IB syllabus for microeconomics.
Market failure is defined as any situation in which a market fails to provide the ideal or optimal amount of a particular good. What is considered allocative efficiency depends on many factors due to externalities. Externalities are costs that third party individuals, not the producer or the seller of the good or the consumer/buyer of the good, have to endure because of either the production or the consumption of the good. For instance, pollution is the classic example of a negative externality because it damages the health of people living near it and the environment. An example of a positive externality could be flowers planted in someone's front yard because they beautify the planter's yard.
Market failure will occur when a good produces either a positive or negative externality, is sold in a non-competitive market, or is a public good. A non-competitive market is defined exactly the way it sounds: the firms in the market do not compete with one another and therefore are not being efficient in production. A public good is a good that is non-rivalrous (meaning its use does not decrease the benefit of another user) and non-excludable (meaning its use does not prevent others from using it) in consumption. Examples are the pleasure associated with watching the sun set, a "cool breeze" on a "hot day", national defense, etc. Whenever the market for a good falls into one of the previously listed scenarios, there is market failure.
Positive externalities are said to be "produced at a lower quantity and a higher price than they should", while negative externalities are said to be "produced at a higher quantity and a lower price than they should". These two statements are derived from market demand and supply curves of the good being bought and sold. If producers of goods with positive externalities were given subsidies as a reward for producing the good, the supply of the good would increase, creating a new equilibrium with a lower price and higher quantity. If producers of goods with negative externalities were forced to pay taxes as a penalty for producing the good, the supply would decrease, creating a new equilibrium with a higher price and a lower quantity. These new quantities and prices will be closer to the socially optimal equilibrium with the taxes and subsidies.
Non-competitive market producers tend to set the equilibrium at the price and quantity where it benefits them because they have no comptetion. they want because they don't care. Public goods, since they are non-rivalrous and non-excludable tend to be provided by the government because it is impossible to put a price on how much the individual should have to pay for things like national defense.
Market failures can also be caused by unsustainability of a good (large fluctuation in price and/or quantity). For example, currently coal is a cheap resource for energy. However, in the future, it is possible that the market of coal will fail because as the finite resourse is used up small quantities of coal will be sold for a significantly higher price, so the market fails, or significantly shrinks. It can occur when prices of goods are set by buyers, but instead the government or sellers. Like monopolies, where the prices are not set by the people and so the price is off equilibrium. "Market failures are the biggest drawback to markets. This is not to over-look the fact that markets are usually the best way to maximize consumer and producer surpluses."