IB DP Economics: The market and equity (HL) – Revision Notes

These notes condense sub-topic 2.12, the market’s inability to achieve equity, which is HL only. They follow the IB Diploma Programme Economics guide (first assessment 2022, published February 2020), the course examined from the 2022 session onwards. For full explanations, read the study guide. Then test yourself with the practice questions, check progress on the printable checklist, see the wider course on the IB DP Economics hub, or start with a free 10-minute diagnostic.

What is on the syllabus

Item	Depth	Level
The workings of a free market economy may result in an unequal distribution of income and wealth	AO2 (apply and analyse)	HL only
Diagram: circular flow model showing why the free market results in inequalities	Draw and label	HL only

No calculation is listed for this sub-topic. Questions at AO2 depth can use command terms from AO2 or AO1, such as explain, analyse, outline, distinguish, state and list. Evaluation terms are not used for a topic at this depth.

Definitions to recall word for word

Term	Meaning
Income	A flow: what a household earns in a period from selling factors of production
Wealth	A stock: the value of what a household owns at a point in time
Factor incomes	Wages (labour), rent (land), interest (capital), profit (enterprise)
Equality	Equal shares
Equity	Fairness, which is a judgement
Free market economy	Prices and quantities set by buyers and sellers, with no government
Property income	Rent, interest and profit, which go to owners of non-labour factors

The circular flow in four lines

1. Households own the factors of production and sell their services to firms in the factor market.
2. Firms pay factor incomes (wages, rent, interest, profit) back to households.
3. Households spend that income on goods and services in the product market.
4. Firms receive spending as revenue and pay it out again as factor incomes.

The key point: the market creates the inequality in step 2. Income depends on how many units of each factor a household owns and on the price each factor earns.

Checklist for your diagram:

• Two boxes: households and firms.
• Two markets, both named: factor market and product market.
• Arrows for factor services, factor incomes, spending and goods and services, each labelled.
• The four factor incomes written on the factor income arrow.
• A short note beside the factor market saying that inequality arises here.

Causes of unequal outcomes, in order of use

1. Unequal ownership of factors. Some households sell only labour. Others also receive rent, interest and profit.
2. Different factor prices. Demand and supply set each price, so scarce and strongly demanded factors earn more.
3. Unequal access to skills. Scarce skills need costly training, and low-income households find it harder to fund that.
4. Wealth earns income and builds more wealth. Savings and assets produce returns that can be saved again.
5. No rule based on need. The market pays for scarcity and demand, not for need, and starting positions differ.

Method in steps for “explain” questions:

1. Say what the market does (sets factor prices; households sell factors).
2. Link to the diagram (point at the factor market).
3. Give one cause, then the effect on income or wealth.
4. Add a second and third cause, each in its own paragraph.
5. Use a labelled example and say what it shows.

Worked reminder: Tarnovia

Tarnovia is an invented free market economy with no government and six equal-sized households. Total income is 450 tarn.

Household	Wages	Rent	Interest	Profit	Income
T1	20	0	0	0	20
T2	28	0	0	0	28
T3	36	0	0	0	36
T4	50	10	0	0	60
T5	60	0	20	20	100
T6	70	30	40	66	206
All	264	40	60	86	450

Working:

• T6’s share of income: 206 / 450 = 45.8%.
• Share of the poorest three (T1 to T3): (20 + 28 + 36) / 450 = 84 / 450 = 18.7%.
• Property income: 40 + 60 + 86 = 186, which is 186 / 450 = 41.3% of income.
• T6’s share of property income: (30 + 40 + 66) / 186 = 136 / 186 = 73.1%.
• Ratio of richest to poorest: 206 / 20 = 10.3.
• Circular flow check: if every household spends all of its income, spending is 450 and firms’ revenue is 450, which equals the factor incomes paid out.

What the example shows: the poorest three have only labour to sell, while T6 has all four factor incomes, and only 70 of its 206 comes from wages.

Worked reminder: wealth building on itself

Two Tarnovian households each earn a 6% return on wealth. Household R holds wealth of 250 and has 60 of other income. Household P holds wealth of 20 and has 24 of other income. Both save 10% of income.

Step	Household R	Household P
Year 1 interest	0.06 x 250 = 15	0.06 x 20 = 1.2
Year 1 income	60 + 15 = 75	24 + 1.2 = 25.2
Year 1 saving	0.10 x 75 = 7.5	0.10 x 25.2 = 2.52
Wealth, start of year 2	257.5	22.52
Year 2 interest	0.06 x 257.5 = 15.45	0.06 x 22.52 = 1.35
Year 2 income	60 + 15.45 = 75.45	24 + 1.35 = 25.35

The income gap moves from 75 - 25.2 = 49.8 to 75.45 - 25.35 = 50.10. It is a small change in two years, but it moves in one direction and keeps going. This is the link between wealth and income that the guide’s statement covers.

Method for reading a data table on this topic

1. Find the total, then each group’s share of it (group / total).
2. Split income into labour income and property income.
3. Find who holds the property income. A few households holding most of it is the signal of unequal factor ownership.
4. Name the cause in economic terms and point to the factor market on your diagram.
5. State what the data cannot show, such as how fair the outcome is.

Must-know distinctions

Pair	Difference
Income and wealth	Flow over a period, against stock at a date
Wages and property income	Return to labour, against return to owning land, capital or a business
Equality and equity	Equal shares, against fair shares
Cause of inequality in the market and a policy reply	Explain the first; the guide does not list the second for this sub-topic
Product market and factor market	Households buy goods and services, against firms buy factor services

Quick self-test

Answer each in a line or two, then check below. Use Tarnovia’s table where it helps.

1. Distinguish between income and wealth.
2. Name the two markets in the circular flow model.
3. List the four factor incomes.
4. What share of Tarnovia’s income does T6 receive?
5. What share do T1 to T3 receive together?
6. What percentage of Tarnovia’s income is property income?
7. What share of property income goes to T6?
8. How many times larger is T6’s income than T1’s?
9. In an invented labour market, demand is Qd = 300 - 5w and supply is Qs = 5w, where w is the hourly wage. Find the equilibrium wage and quantity.
10. A household holds wealth of 250 earning a return of 6% a year. How much income does it receive from that wealth?
11. Explain why a low-income household may struggle to supply a scarce skill.
12. Which flow in the diagram carries the four factor incomes?

Answers

1. Income is a flow earned over a period. Wealth is a stock, the value of assets held on one date.
2. The factor market and the product market.
3. Wages, rent, interest and profit.
4. 206 / 450 = 45.8%.
5. 84 / 450 = 18.7%.
6. 186 / 450 = 41.3%.
7. 136 / 186 = 73.1%.
8. 206 / 20 = 10.3 times.
9. Set 300 - 5w = 5w, so 10w = 300 and w = 30. Then Q = 5 x 30 = 150. Check: 300 - 5(30) = 150.
10. 0.06 x 250 = 15.
11. Scarce skills usually need costly training. A household with little income and no savings may be unable to pay for it, so the supply of the skill stays small and its price stays high.
12. The arrow from firms to households through the factor market.

Where marks are usually lost

• Leaving the factor market unlabelled, or omitting one of the four factor incomes.
• Adding a government to a diagram that is meant to show the free market’s own result.
• Confusing a stock with a flow when defining wealth and income.
• Giving one cause and no link back to the diagram.
• Writing about policy when the question asks you to explain why the inequality arises.
• Quoting an example without explaining what it shows. The guide says the example should be explained in relation to the question.
• Using unlabelled figures. Name any example as illustrative and show the working.
• Treating unequal as automatically unfair without saying that equity is a judgement.

Official syllabus

IB Diploma Programme Economics guide, first assessment 2022, published February 2020 by the International Baccalaureate Organization. Sub-topic 2.12, the market’s inability to achieve equity (HL only).