The quantity consumers are willing and able to buy at each price over a period of time.
Law of demand
As price rises, quantity demanded falls, ceteris paribus.
Normal good
Demand rises as income rises.
Inferior good
Demand falls as income rises, e.g. budget own-brand foods.
Substitutes / complements
Used instead of each other / used together.
A change in the good's own price causes a movement along the demand curve (a change in quantity demanded).
The full notes, worked example, interactive diagram and check questions for this subtopic are in the app.
Exam tip: Price changes cause movements along the curve; only non-price factors shift it. Mixing these up is one of the most common lost marks.
2.2Supply
Key terms
Supply
The quantity firms are willing and able to sell at each price over a period of time.
Law of supply
As price rises, quantity supplied rises, ceteris paribus.
Joint supply
Producing one good also produces another, e.g. beef and leather.
Competitive supply
Producing more of one good means producing less of another, e.g. wheat and barley on the same land.
Diminishing marginal returns
In the short run, adding more of a variable factor to a fixed factor eventually adds less and less output.
Supply slopes up because higher prices raise profit and cover the rising marginal cost of extra output.
The full notes, worked example, interactive diagram and check questions for this subtopic are in the app.
2.3Competitive market equilibrium
Key terms
Equilibrium
The price where quantity demanded equals quantity supplied.
Excess demand / supply
Shortage when Qd > Qs (price rises); surplus when Qs > Qd (price falls).
Consumer surplus
Area below demand and above price.
Producer surplus
Area above supply and below price.
Social (community) surplus
Consumer surplus + producer surplus.
Allocative efficiency
Output where MB = MC, so social surplus is maximised.
The price mechanism allocates resources through signalling (prices show scarcity), incentives (higher prices encourage production) and rationing (higher prices limit who buys).
The full notes, worked example, interactive diagram and check questions for this subtopic are in the app.
2.4Critique of the maximising behaviour of consumers and producers HL
Key terms
Rational consumer choice
Assumes consistent preferences, perfect information and utility maximisation.
Bounded rationality
Choices are rational within limits of information, time and thinking ability.
Bounded self-control
People struggle to act in their long-term interest.
Bounded selfishness
People also care about others, e.g. donating to charity.
Nudge
A change in how choices are presented that steers behaviour without banning options.
Satisficing
Aiming for satisfactory rather than maximum results.
Biases: rules of thumb (habits, heuristics), anchoring (relying on a first number), framing (how a choice is described), availability (judging by examples that come to mind easily). Imperfect information also leads to poor choices.
The full notes, worked example and check questions for this subtopic are in the app.
Exam tip: Pair every bias with a short real-world example. Evaluate nudges: cheap and freedom-preserving, but effects can be small and some see them as manipulative.
2.5Elasticities of demand
Key terms
PED
% change in quantity demanded ÷ % change in price.
Elastic / inelastic
|PED| > 1 / |PED| < 1.
YED
% change in quantity demanded ÷ % change in income.
Shows how quantity demanded changes as income changes.
Degrees of PED: perfectly inelastic (0), inelastic, unit elastic (1), elastic, perfectly elastic (∞).
The full notes, worked example, interactive diagram and check questions for this subtopic are in the app.
2.6Elasticity of supply
Key terms
PES
% change in quantity supplied ÷ % change in price.
Perfectly inelastic supply
PES = 0: quantity can't change, e.g. stadium seats on match day.
Perfectly elastic supply
PES = ∞: firms supply any quantity at one price.
Unit elastic supply
PES = 1: any straight-line supply curve through the origin.
A straight-line supply curve starting on the price axis is elastic; starting on the quantity axis is inelastic; through the origin, PES = 1.
The full notes, worked example, interactive diagram and check questions for this subtopic are in the app.
2.7Role of government in microeconomics
Key terms
Maximum price (ceiling)
A legal price set below equilibrium to help consumers.
Minimum price (floor)
A legal price set above equilibrium to help producers or workers.
Specific / ad valorem tax
A fixed amount per unit / a percentage of the price.
Subsidy
A government payment per unit to producers, lowering costs.
Tax incidence
How the tax burden is shared between consumers and producers.
Reasons to intervene: earn revenue, support firms, support low-income households, influence production and consumption, correct market failure, promote equity.
The full notes, worked example, interactive diagram and check questions for this subtopic are in the app.
2.8Market failure: externalities and common pool resources
Key terms
Market failure
The market fails to allocate resources efficiently: MSB ≠ MSC at the market output.
Externality
A cost or benefit to third parties not involved in the transaction.
Good that is under-consumed and benefits society (education) / over-consumed and harmful (cigarettes).
Common pool resource
Rivalrous but non-excludable, e.g. fish stocks, groundwater.
The socially optimal output is where MSB = MSC.
The full notes, worked example, interactive diagram and check questions for this subtopic are in the app.
Exam tip: Label MSC/MPC for production externalities and MSB/MPB for consumption externalities, and shade the welfare loss pointing towards the market quantity.
2.9Market failure: public goods
Key terms
Public good
Non-rivalrous and non-excludable, e.g. street lighting, national defence.
Non-rivalrous
One person's use doesn't reduce what's available to others.
Non-excludable
Non-payers can't be stopped from using it.
Free-rider problem
People benefit without paying, so private firms won't supply.
Contracting out
Government pays private firms to provide a service.
Because of free riders, markets under-provide public goods or don't provide them at all (a missing market).
The full notes, worked example and check questions for this subtopic are in the app.
2.10Market failure: asymmetric information HL
Key terms
Asymmetric information
One party has more or better information than the other.
Adverse selection
Hidden information before a deal, e.g. only high-risk people buy insurance.
Moral hazard
Hidden behaviour after a deal, e.g. taking more risks once insured.
Signalling
The informed party reveals quality, e.g. warranties, qualifications.
Screening
The uninformed party gathers information, e.g. medical checks.
Classic example: second-hand cars, where sellers know quality and buyers don't, so good cars leave the market.
The full notes, worked example and check questions for this subtopic are in the app.
2.11Market failure: market power HL
Key terms
Market power
A firm's ability to raise price above marginal cost.
Normal profit
Revenue just covers all costs, including opportunity cost (TR = TC).
Abnormal (economic) profit
TR > TC.
Barriers to entry
Economies of scale, legal barriers, brand loyalty, control of resources, aggressive tactics.
Natural monopoly
One firm can supply the whole market more cheaply than several, because of huge economies of scale.
Concentration ratio
Market share of the largest n firms, e.g. CR4.
All firms maximise profit where MR = MC. Abnormal profit if AR > AC, normal profit if AR = AC, loss if AR < AC.
The full notes, worked example, interactive diagram and check questions for this subtopic are in the app.
2.12The market's inability to achieve equity HL
Key terms
Equity
Fairness in the distribution of income, wealth and opportunities.
Equality
Everyone receives the same.
Market-based allocation
Goods go to those willing and able to pay.
Free markets reward people according to the factors of production they own (skills, capital, land). Those who own few factors earn little, so incomes and wealth become very unequal.
The full notes, worked example and check questions for this subtopic are in the app.