2 Microeconomics

Microeconomics studies the decisions of individual consumers, firms and governments, and how those decisions interact in the markets for particular goods, services and factors of production. It explains how prices are set, why they change, and when the outcome a market produces is efficient, sustainable or fair, and when it is not.

The questions that frame microeconomics

The unit is built around two real-world questions. The first is how consumers and producers make choices in trying to meet their economic objectives: why people buy more of a good when its price falls, why firms supply more when it rises, and how far people really behave in the calculating way the basic model assumes.

The second is when markets fail to meet important economic objectives, and whether government intervention helps. Markets can overproduce goods that damage the environment, underproduce goods that benefit everyone, let firms with market power raise prices, and leave some households unable to afford essentials. Government responses to these failures help some groups and impose costs on others, so each one has to be evaluated.

Behind both questions lies the problem of scarcity. Because resources are limited, every market answers the basic economic questions of what to produce, how to produce it and for whom, and every intervention involves a choice with an opportunity cost.

The subtopics

How the subtopics connect

The unit has two halves. The first half builds the model of a competitive market. Demand and supply together determine the market equilibrium, elasticity measures how strongly each side responds to price, and at the competitive equilibrium marginal benefit equals marginal cost, which is the condition for allocative efficiency.

The second half uses that competitive outcome as a benchmark. Each form of market failure is a way in which real markets depart from it: externalities and common pool resources, public goods, asymmetric information, market power, and an unequal distribution of income. The role of government ties the two halves together, because the same intervention tools (price controls, indirect taxes, subsidies, regulation and provision) are analysed first as changes to a market and then as possible remedies for its failures.

One market through the whole unit: cocoa

The world cocoa market from 2023 to 2026 shows most of the unit’s ideas at work. Côte d’Ivoire and Ghana, which grew more than half of the world’s cocoa in 2022, suffered heavy rain followed by drought in the 2023/24 season, together with black pod disease, the spread of cocoa swollen shoot virus and ageing trees. Global cocoa production fell by 11% in 2023/24, and Ghana’s harvest was expected to fall about 40% short of its target.

The chart shows the result. A fall in supply, meeting demand that changes little when the price rises, more than quadrupled the monthly average price between 2022 and January 2025, which illustrates supply shifts and low price elasticity of demand and supply. Because new cocoa trees take several years to bear fruit, supply could not respond quickly. The price then fell back sharply during 2025 and early 2026, as the theory of the price mechanism predicts: high prices reduce the quantity demanded and give farmers an incentive to produce more.

Governments were involved throughout. In both Côte d’Ivoire and Ghana the state sets the farmgate price paid to cocoa farmers each season, a form of price control intended to give farmers a stable income. Whether farmers gain enough of the high world price raises questions of equity and intervention, while clearing forest for new plantations raises questions of sustainability.

Sources: FAO production data (2022), via Wikipedia; NTU Centre for African Studies, “Cocoa production in Ghana and Côte d’Ivoire collapses” (2024); IMF primary commodity prices, via FRED (2026).

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Key concepts in microeconomics

All nine key concepts appear in the unit, but five carry most of the weight:

• Scarcity and choice. Markets ration scarce goods through prices, and every purchase, production decision and policy has an opportunity cost.

• Efficiency. The competitive equilibrium maximises social surplus where marginal benefit equals marginal cost; market failures are judged against it.

• Equity. Markets distribute output by ability to pay, which can be unfair; price controls, subsidies and redistribution are often justified on grounds of equity.

• Sustainability. Externalities and common pool resources show how markets can use up resources faster than they can be replaced.

• Intervention. Governments intervene to raise revenue, support firms and households, and correct market failure, but intervention can also fail.

Change and interdependence run through the unit too: a shock in one market, such as a poor cocoa harvest, affects farmers, manufacturers and consumers in many countries.

How SL and HL differ

SL and HL students study the same core of the unit: demand, supply, equilibrium, elasticity, the role of government, externalities, common pool resources and public goods. HL students study four additional subtopics in full and several HL-only extensions within the shared subtopics.

HL-only subtopics

• 2.4 Critique of the maximising behaviour of consumers and producers: behavioural economics, choice architecture and nudges, and business objectives other than profit maximisation.

• 2.10 Market failure: asymmetric information: adverse selection, moral hazard, and the responses of governments and private firms.

• 2.11 Market failure: market power: costs and revenues, profit maximisation, the four market structures, game theory, and regulation of market power. This is the largest HL subtopic in the unit and has many diagrams.

• 2.12 The market’s inability to achieve equity: why a free market produces an unequal distribution of income and wealth, shown with the circular flow model.

HL extensions within shared subtopics

Most of the HL extensions are calculations that read prices and quantities off a labelled diagram or a table, such as consumer and producer surplus, tax revenue and welfare loss. These calculations, together with the HL-only subtopics, are examined in HL Paper 3.

Assessment

Microeconomics is examined in every external paper:

• Paper 1 (SL and HL): an extended-response question on microeconomics is normally one of the three choices. HL questions can include HL-only material.

• Paper 2 (SL and HL): data-response questions often include microeconomic parts, such as definitions, elasticity calculations and demand and supply diagrams. Paper 2 does not include HL-only material.

• Paper 3 (HL only): the policy paper can use any microeconomic content, including HL calculations such as consumer and producer surplus, tax incidence, welfare loss and a firm’s costs and revenues.

One of the three commentaries in the internal assessment portfolio must be based on a news article linked to microeconomics.