Important diagrams to remember
Chapter 2 Competitive markets: demand and supply
price of chocolate bars ($)
(a) Demand of consumer A
(b) Demand curve of consumer B
(c) Market demand
P ($)
5
5
4
4
+
3
P ($)
5
+
3
2
2
1
DA
1
0
2 4 6 8 10 12
quantity of chocolate
bars (per week)
0
demands
of other
consumers
in the
market
4
=
3
2
1
DB
0
2 4 6 8 10 12
quantity of chocolate
bars (per week)
Dm
2 4 6 8 10 12 14
quantity of chocolate bars
(thousands per week)
Figure 2.2 Market demand as the sum of individual demands
(a) A movement along the demand curve,
caused by a change in price, is called a
‘change in quantity demanded’
(b) A shift of a demand curve, caused by a change in
a determinant of demand, is called a ‘change in
demand’
P
P
change in demand
P1
A
change in
quantity
demanded
decrease
in D
B
P2
D2
D3
D
0
increase
in D
Q1
Q2
Q
0
D1
Q
Figure 2.4 Movements along and shifts of the demand curve
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1
(a) Supply of firm A
(b) Supply of firm B
(c) Market supply
price of chocolate bars ($)
Important diagrams to remember
P$
P$
SA
5
4
4
3
+ 3
2
2
1
1
0
SB
5
+
supplies
of other
firms in
the market
4
= 3
2
1
0
200
400
600
quantity of chocolate
bars (per week)
Sm
5
0
200
400
600
quantity of chocolate
bars (per week)
2 4 6 8 10 12
quantity of chocolate
bars (thousands per week)
Figure 2.6 Market supply as the sum of individual supplies
(a) A movement along the supply curve,
caused by a change in price, is called a
‘change in quantity suppied’
P
(b) A shift of the supply curve, caused by a
change in a determinant of supply, is called a
‘change in supply’
P
S
B
P2
change in
quantity
supplied
A
P1
0
Q1
Q2
P1
0
Q
S1
S3
Q3
decrease
in supply
increase
in supply
Q1
Q2
S2
Q
price of chocolate bars ($)
Figure 2.8 Movements along and shifts of the supply curve
S
5
surplus
4
3
equilibrium
price
market equilibrium
2
shortage
1
D
equilibrium quantity
0
2
4
6
8 10 12
quantity of chocolate bars
(thousands per week)
14
Figure 2.9 Market equilibrium
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Important diagrams to remember
(a) Increase in demand
P
(b) Decrease in demand
initial
equilibrium
c
P2
a
P1
S
P
final
equilibrium
P1
b
D2
final
equilibrium
S
a
P3
c
D1
0
Q1
initial
equilibrium
b
D1
D3
Q2
0
Q
Q3
Q1
Q
Figure 2.10 Changes in demand and the new equilibrium price and quantity
(a) Increase in supply
(b) Decrease in supply
S1
initial
equilibrium
P
a
P1
c
P
S2
b
P2
S3
final
equilibrium
final
equilibrium
P1
S1
c
P3
a
b
D
0
Q2
Q1
initial
equilibrium
D
0
Q
Q3
Q1
Q
Figure 2.11 Changes in supply and the new equilibrium price and quantity
(a) Adjustment of price to increased demand
P
S
C
P2
P1
A
B
D2
D1
0
Q1
Q3
Figure 2.16 Price as a signal and incentive
© Cambridge University Press 2012
shortage =
excess demand
Q2 Q
P1
S = MC
P2
P3 consumer
surplus
Pe
producer
surplus
P4
P5
Allocative
efficiency:
at market
equilibrium
MB = MC and
social surplus
is maximum
D = MB
P6
0
Qa Qb
Qe
Q
Figure 2.17 Consumer and producer surplus in a competitive market
Economics for the IB Diploma
3
Important diagrams to remember
Higher level topic
P ($)
Qd = 14 – 2P
5
4 Qd = 10 – 2P
3
P ($)
Qd = 19 – 2P
4
a
decreases
2
5
a
increases
1
3
2
Qd = 14 – 2P
Qd = 14 – 4P
absolute
value of b
increases
1
0
2 4 6 8 10 12 14 16 18 20
quantity of chocolate bars (thousands per week)
Figure 2.12 Shifts of the demand curve (changes in a in the
function Qd = a – bP )
P ($)
5
Qs = –1 + 2P
Qs = 2 + 2P Qs = 6 + 2P
Figure 2.13 Changing the slope of the demand curve (changes in b in the
function Qd = a – bP )
P($)
5
4
4
3
0
2 4 6 8 10 12 14 16 18 20
quantity of chocolate bars (thousands per week)
c
decreases
c
increases
3
2
2
1
1
0
2 4 6 8 10 12 14 16 18
quantity of chocolate bars (thousands per week)
Figure 2.14 Shifts of the supply curve (changes in c in the supply
function Qs = c + dP )
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Qs = 2 + 2P
value
of d
increases
Qs = 2 + 4P
0
2 4 6 8 10 12 14 16 18
quantity of chocolate bars (thousands per week)
Figure 2.15 Changing the slope of the supply curve (changes in d in the
function Qs = c + dP )
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Important diagrams to remember
Chapter 3 Elasticities
Frequently encountered cases
(a) Price inelastic demand: 0 < PED <1
(b) Price elastic demand: 1 < PED < ∞
P
P
5%
P2
P2
P1
10%
P1
D
D
Q2 Q1
0
0
Q
5%
P
(d) Perfectly inelastic demand: PED = 0
(e) Pefectly elastic demand: PED = ∞
P
P
D
P1
P2
5%
P1
Q
10%
Special cases
(c) Unit elastic demand: PED = 1
Q2 Q1
D
D
Q2
0
Q1
Q
0
Q1
Q
0
Q
5%
Figure 3.1 Demand curves and PED
P ($)
50
45
40
35
30
25
20
15
10
5
0
f
PED = 4
e
d
elastic portion of
demand curve
PED = 1
c
inelastic portion
of demand curve
b PED = 0.25
a
10 20 30 40 50 60 70 80 90 100
units of good A
Figure 3.2 Variability of PED along a straight-line demand curve
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Important diagrams to remember
(a) PED > 1 (elastic demand)
P
(c) PED = 1 (unit elastic demand)
P
P
PED > 1
P2
P1 C
PED > 1
PED = 1
PED < 1
PED = 1
P2
P1
A B
0
(b) PED < 1 (inelastic demand)
Q2 Q1
Q
D
0
PED < 1
C
A
P2
B
Q2 Q1 Q
P1
C
A
D
Q2
0
D
B
Q1
Q
Figure 3.5 PED and total revenue
(a) Primary commodities: supply shifts with inelastic demand
(b) Manufactured products: supply shifts with elastic demand
S2
S2
S1
P
P2
S1
P
S3
S3
P2
P1
P1
P3
P3
D
D
Q2 Q1 Q3
0
0
Q
Q2
Q1
Q3
Q
Figure 3.6 Price fluctuations are larger for primary commodities because of low PED
(a) Inelastic demand
P
(b) Elastic demand
tax
per
unit
Pt
P
S2
final
equilibrium
S1
initial
equilibrium
P1
final
equilibrium
Pt
P1
Qt
Q
tax
per
unit
S1
initial
equilibrium
D
D
0
S2
0
Qt
Q
Figure 3.7 PED, indirect taxes and government tax revenue
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Important diagrams to remember
(a) Substitutes and positive XED : demand for Pepsi®
P
P
S
YED < 0 0 < YED < 1 YED > 1
inferior
good
D2
D3 D1
D increases
as price of
Coca-Cola®
increases
D decreases as price
of Coca-Cola® decreases
0
income
inelastic
demand,
normal
good
D2
0
D1
income
elastic
demand,
normal
good
D3
D4
Q
Q
Figure 3.9 Demand curve shifts in response to increases in income for
different YEDs
(b) Complements and XED : demand for tennis balls
P
S
D2
D1
D3
D decreases as
price of tennis rackets increases
0
D increases
as price of
tennis rackets
decreases
Q
Figure 3.8 Cross-price elasticities
Frequently encountered cases
(a) Price inelastic supply: PES < 1
P
10%
(b) Price elastic supply: PES > 1
P
S
S
P2
10%
P1
0
Q1 Q2
P2
P1
0
Q
5%
Q2
Q
15%
Special cases
(c) Unit elastic supply: PES = 1
(d) Perfectly inelastic supply: PES = 0
P
P
S1
Q1
(e) Perfectly elastic supply: PES = ∞
P
S
S2
S3
0
P1
Q
0
Q1
Q
0
S
Q
Figure 3.11 Supply curves and PES
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Important diagrams to remember
(a) Primary commodities: demand shifts with inelastic supply
S
P
P2
P1
P3
0
D3
D1
(b) Manufactured products: demand shifts with elastic supply
P
S
P2
P1
P3
D2
Q
0
D2
D3
D1
Q
Figure 3.13 Price fluctuations are larger for primary commodities because of low PES
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Important diagrams to remember
Chapter 4 Government intervention
(a) Market outcomes: specific tax
(a) Specific tax
P
S2 (= S1 + tax)
tax per S
1
unit
P
government
revenue
Pc
S2 (= S1 + tax)
tax per
unit S1
P*
Pp
0
Q
(b) Ad valorem tax
0
Q t Q*
D
Q
(b) Market outcomes: ad valorem tax
S2 (= S1 + tax)
P
tax per
unit
P
government
revenue
S1
tax per
unit S
Pc
tax per
unit
S2 = S1 + tax
1
P*
PP
0
Q
Figure 4.1 Supply curve shifts due to indirect (excise) taxes
0
D
Qt Q*
Q
Figure 4.2 Impacts of specific and ad valorem taxes on market outcomes
S1
P
Pp
P*
subsidy
per unit
S2 = S1 – subsidy
Pc
D
0
Q*
Qsb
Q
Figure 4.8 Impacts of subsidies on market outcomes
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Important diagrams to remember
P
P
S
welfare loss
Pe
Pe
Pc
Pc
shortage =
excess demand
0
Qs
Qe
D
Qd
P
b
d
c
e
Q
0
Figure 4.12 Price ceiling (maximum price) and market outcomes
S
excess supply =
surplus
Pf
D = MB
Qs
Qe
Qd
Q
Figure 4.13 Welfare impacts of a price ceiling (maximum price)
P
excess supply =
surplus
S
Pf
Pe
D+
government
purchases
Pe
D
Qd
0
Qe
Qs
Q
Figure 4.15 Price floor (minimum price) and market outcomes
P
D
0
Qd
Qe
Qs
Q
Figure 4.16 An agricultural product market with price floor and
government purchases of the surplus
excess supply =
surplus
S = MC
a
Pf
Pe
S = MC
a
b
c
e
d
f
D+
government
purchases
welfare
loss
D = MB
0
Qd
Qe
Qs
Q
Figure 4.17 Welfare impacts of a price floor (minimum price) for
agricultural products and government purchases of the
surplus
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price of labour (wage)
Important diagrams to remember
P
excess supply of labour
= labour surplus
= unemployment
supply
of
labour
Wm
Wm
We
We
Qd
Qe Qs
quantity of labour
S
welfare loss
b
c
e
d
demand
for
labour
0
a
D
Q
0
Figure 4.19 Labour market with minimum wage (price floor)
Qd
Qe
Qs
Q
Figure 4.20 Welfare impacts of a minimum wage
Higher level topics
(a) Inelastic supply
(a) Inelastic demand
P
S2 = S1 + tax
S1
Pc
P*
consumers
producers
0
Pp
Qt Q*
Q
P
S2 = S1 + tax
tax per
unit
0
consumers
producers
0
Qt Q*
Q
P
S2 = S1 + tax
S1
Pc
consumers
P*
Pp
producers
tax per
unit
consumers
Q*
Q
Figure 4.6 Incidence of an indirect tax with inelastic and elastic demand
© Cambridge University Press 2012
0
S1
producers
D
Qt
D
(b) Elastic supply
(b) Elastic demand
Pp
S1
tax per
unit
D
Pc
P*
S2 = S1 + tax
tax per
unit
Pc
P*
Pp
P
Qt
Q*
D
Q
Figure 4.7 Incidence of an indirect tax with inelastic and elastic supply
Economics for the IB Diploma
11
Important diagrams to remember
P
P
S = MC
Pc
consumer
surplus
P*
P*
S2 = S1 + tax
S1 = MC
tax per
unit
consumer
surplus
after the tax
government
revenue from
the tax
a
welfare loss = a + b
b
Pp
producer
surplus
producer
surplus
after the
tax
D = MB
D = MB
Q*
0
0
Q
(a) Consumer and producer surplus in a competitive
free market: maximum social surplus
Q*
Qt
Q
(b) Consumer and producer surplus with an indirect
(excise) tax: welfare loss
Figure 4.4 Effects of indirect taxes on consumer and producer surplus
(a) Consumer and producer surplus in a competitive
free market: maximum social surplus
P
(b) Consumer and producer surplus with a subsidy: welfare loss
P
S1 = MC
S = MC
P*
subsidy
per unit
S2 = S1 – subsidy
Pp
gain in producer
P * surplus
gain in consumer
surplus
Pc
consumer
surplus
producer
surplus
a
welfare loss
D = MB
0
Q*
D = MB
Q
0
Q*
Qsb
Q
Figure 4.10 Effects of subsidies on consumer and producer surplus
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Important diagrams to remember
Chapter 5 Market failure
P
S = MPC = MSC
Popt
D = MPB = MSB
0
Qopt
allocative efficiency
is achieved
Q
Figure 5.1 Demand, supply and allocative efficiency with
no externalities
(a) Welfare loss
MSC
P
external
cost
S = MPC
Popt
external
cost S = MPC
Popt
Pm
Pm
0
MSC
P
D = MPB = MSB
Q
Qopt Qm
Figure 5.2 Negative production externality
welfare loss
D = MPB = MSB
0
Qopt Qm
Q
Figure 5.3 Welfare loss (deadweight loss) in a negative
production externality
MSC
P
S = MPC
Popt
Pm
0
Qopt Qm
D = MPB = MSB
Q
Figure 5.4 Government regulations to correct negative production
externalities
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Important diagrams to remember
(b) Effects on external costs of a tax on
emissions (carbon tax)
(a) Imposing an indirect tax on
output or on pollutants
MSC = MPC + tax
tax = external cost
P
Pc = Popt
(c) Tradable permits
P
S = MPC
P2
S = MPC
Pm
Pm
Pp
P1
D = MPB = MSB
0
Qopt Qm
Q
S of tradable
permits
P
MSC1 = MPC + tax
MSC2
D2
D1
D = MPB = MSC
0
Qopt1 Qopt2 Qm
Q
Q1
0
Q
Figure 5.5 Market-based policies to correct negative production externalities
(a) Welfare loss
P
S = MPC = MSC
P
Pm
D = MPB
Popt
0
external
cost
Qopt
Qm
Q
external
cost
D = MPB
0
MSB
Q
Qopt Qm
(b) Market-based: imposing an indirect tax
P
external
cost
S = MPC = MSC
MPC + tax
tax =
external
cost
Pc
S = MPC = MSC
Pm
Pm
D1 = MPB
Popt
Qopt
D2 = MSB
after demand decreases
Qm
S = MPC = MSC
Figure 5.7 Welfare loss (deadweight loss) in a negative
consumption externality
(a) Government regulations and advertising
0
Pm
Popt
MSB
Figure 5.6 Negative consumption externality
P
welfare loss
Q
Pp
D = MPB
MSB
0
Qopt
Qm
Q
Figure 5.8 Correcting negative consumption externalities
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Important diagrams to remember
(a) Welfare loss
S = MPC
P
external
benefits
Pm
P
S = MPC
MSC
external
benefits
MSC
Pm
Popt
Popt
Qm Qopt
0
D = MPB = MSB
Q
D = MPB = MSB
0
Figure 5.9 Positive production externality
Q
(b) Granting a subsidy
S = MPC
P
Qm Qopt
Figure 5.10 Welfare loss (deadweight loss) in a positive
production externality
(a) Direct government provision
spillover
benefit
Pm
MSC
Popt
0
welfare loss
P
S = MPC
subsidy =
spillover benefit
MSC
Pm
Popt
Qm Qopt
D = MPB
Q
0
Qm Qopt
D = MPB
Q
Figure 5.11 Correcting positive production externalities
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Important diagrams to remember
P
P
S = MPC = MSC
Popt
Pm
MSB
welfare loss
S = MPC = MSC
external
benefit
0
Qm Qopt
D = MPB
Q
Popt
Pm
external
benefits
0
MSB
D = MPB
Q
Figure 5.12 Positive consumption externality
(a) Legislation or advertising
Qm Qopt
Figure 5.13 Welfare loss (deadweight loss) in a positive
consumption externality
P
S = MPC = MSC
Popt
D2 = MSB
Pm
external
benefit
D1 = MPB
0
Qm Qopt
Q
(b) Direct government provision
P
S = MPC = MSC
S + government
provision
Pm
MSB
Pc
D = MPB
0
Qm
Qopt
Q
(c) Granting a subsidy
P
S = MPC = MSC
subsidy =
external
benefit
MPC –
subsidy
Pm
MSB
Pc
D = MPB
0
Qm
Qopt
Q
Figure 5.14 Correcting positive consumption externalities
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Important diagrams to remember
Chapter 6 The theory of the firm I: Production, costs, revenues and profit
Higher level topics
units of output
(c) Total product curve
(c) Total cost, total variable cost and total
fixed cost curves
TP
TC
0
units of output
TVC
costs
units of variable input (labour)
TFC
0
output, Q
AP
0
MP
units of variable input (labour)
MC
(d) Marginal and average product curves
ATC
units of output (AP, MP)
costs
Figure 6.1 Total, marginal and average products
AVC
AFC
AP
0
0
MP
units of variable input (labour)
output, Q
(d) Average cost and marginal cost curves
Figure 6.2 Total, average and marginal cost curves
costs (AVC, MC)
MC
AVC
0
output, Q
© Cambridge University Press 2012
Figure 6.3 Product curves and cost curves are mirror images due to the law of
diminishing returns
Economics for the IB Diploma
17
Important diagrams to remember
(c) Economies and diseconomies of scale
(b) Long-run average total cost curve in relation to
short-run average total cost curves
LRATC
SRATC1
SRATC2
economies
of scale
costs
b
SRATCm
costs
a
0
0
Q1 Q2
diseconomies
of scale
LRATC
output, Q
output, Q
Figure 6.5 The long-run average total cost curve
(b) Profit-maximising firm produces at Q2 and
makes zero economic profit: TR – TC = 0
(it earns normal profit)
a
b
e
c
f
d
Q1 Q2 Q3
0
costs, revenues
costs, revenues
TC
TR
Q
0
(c) The loss-minimising firm produces at Q2
(if it produces) and makes a loss = TC – TR
= a – b (negative economic profit since
TR < TC )
TC
TC
costs, revenues
(a) Profit-maximising firm produces at Q2 and
makes economic profit: TR – TC = c – d
TR
a
Q1 Q2 Q3 Q
a
TR
b
Q1
0
Q2 Q3
Q
Figure 6.10 Profit maximisation using the total revenue and total cost approach when the firm has no control over price
(a) Profit maximisation
TC,
TR
(b) Loss minimisation
TC
TC,
TR
TC
b
TR
a
0
TR
Q
max
Q
Q1min
0
Q
Figure 6.11 Profit maximisation using the total revenue and total cost approach when the firm has control over price
© Cambridge University Press 2012
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Important diagrams to remember
Chapter 7 The theory of the firm II: Market structures
Higher level topic
P
P
S
Pe
Pe
D
D
Q
0
(a) Individual firm
Figure 7.1
(b) Market/industry
Market (industry) demand and supply determine demand faced by the perfectly competitive firm
P, MR, AR
TR
40
TR
70
60
50
40
30
20
10
0
Q
0
30
20
10
1 2 3 4 5 6 7 Q
D = P = MR = AR
0
1 2 3 4 5 6 7 Q
(b) Marginal and average revenue
(a) Total revenue
Figure 7.2 Revenue curves under perfect competition
ATC
price,
revenue,
costs
P = minimum ATC = break-even price
firm makes normal profit,
or zero economic profit
P = minimum AVC = shut-down price
firm is indifferent between producing
at a loss or not producing
P > ATC
firm makes economic
(supernormal) profit
ATC > P > AVC
firm makes loss but
continues to produce
P < AVC
firm makes loss
and shuts down
MC
1
P1
2
P2
3
P3
P4
P5
0
AVC
4
5
Q5 Q4 Q3 Q2 Q1
output, Q
Figure 7.4 Summary of the perfectly competitive firm’s short-run decisions, and the firm’s short-run supply curve
© Cambridge University Press 2012
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Important diagrams to remember
MC
P1
ATC AVC
a
total profit
P1 = MR1 = AR1 = D1
b
profit
Q
Q1
Q
MC
ATC
P2
P2 = MR2 = AR2 = D2
= break-even price
(break-even point)
Q
Q2
0
AVC
(c) Economic loss: the firm continues to produce
(d) Loss in the short run and the shut-down price
price, revenue, costs
0
price, revenue, costs
(b) Zero economic profit (normal profit)
price, revenue, costs
price, revenue, costs
(a) Economic profit
MC
ATC
c
P3
total loss
P3 = MR3 = AR3 = D3
d
loss
Q
Q3
0
AVC
MC
AVC
e
P4
Q
ATC
total loss
f
loss
= AFC
Q
Q4
0
P4 = MR4 = AR4 = D4
= short-run
shut-down price
Q
price, revenue, costs
(e) The loss-making firm that will not produce
MC
ATC
g
P5
P5 = MR5 = AR5 = D5
h
Q5
0
AVC
Q
Figure 7.3 Short-run equilibrium positions of the perfectly competitive firm
(a) The firm
(b) The industry
price, costs, revenue
P
MC
SRATC
D = MR
Pe
S
LRATC
Pe
D
0
Qf
Q
0
Qi
Q
Figure 7.5 The firm and industry long-run equilibrium position in perfect competition
© Cambridge University Press 2012
Economics for the IB Diploma
20
Important diagrams to remember
From economic (supernormal) profit to normal profit
(a) The firm
(b) The industry
costs, revenue, P
P
MC
a
P1
2
P2
Q2 Q1
0
S2
1
P1
b
P2
S1
ATC
Q
D
Q2
Q1
0
Q
From loss to normal profit
costs, revenue, P
(c) The firm
(d) The industry
P1
P2
P
ATC
MC
S2
a
P2
2
P1
b
S1
1
D
0
Q1 Q2
Q
0
Q2
Q1
Q
costs, revenue, P
Figure 7.6 From short-run equilibrium to long-run equilibrium
P
MC
S = MC
ATC
Pe
0
P = MR = Pe
Qe
(a) The firm
Q
Pe
consumer
surplus
producer
surplus
Qe
0
D = MB
Q
(b) The market/industry
Figure 7.7 Productive and allocative efficiency in perfect competition in the long run
© Cambridge University Press 2012
Economics for the IB Diploma
21
Important diagrams to remember
(a)
price, costs, revenue
40
35
30
25
20
15
10
5
TR
0
Pe
profit
PED = 1
(unit elastic demand)
PED > 1
(price-elastic
demand)
15
PED < 1
(price-inelastic
demand)
10
P = AR = D
Q
1 2 3 4 5 6 7 8 9 10 11
D = AR
Q
MR
Q
max
MC
Pe loss
0
5
0
ATC
b
(b)
Q
1 2 3 4 5 6 7 8 9 10 11
(b) Marginal and average revenue
price, revenue ( )
MC
a
0
price, costs, revenue
total revenue ( )
(a) Total revenue
ATC
c
d
MR
Qlmin
D = AR
Q
Figure 7.11 Profit maximisation and loss minimisation
in monopoly: marginal revenue and cost approach
-5
MR
MC
Pπ
costs
price, costs, revenue
Figure 7.10 Revenue curves in monopoly
Pr
D = AR
0
Qπ
Qr
MR
© Cambridge University Press 2012
D
0
minimum efficient
scale
Q
Figure 7.12 Comparison of profit maximisation and revenue maximisation
by the monopolist
LRATC
Q
Figure 7.13 Natural monopoly
Economics for the IB Diploma
22
Important diagrams to remember
(a) Industry in perfect competition
(b) Monopoly
MC
a
Ppc
P = MRpc
D = MB
0
Qpc
price, costs, revenue
price, costs, revenue
S = MC
b
Pm
a
Ppc
D = MB
0
Q
Qm
Q
Qpc
MRm
Figure 7.14 Higher price, lower output by the firm in monopoly
(a) Perfect competition
P
Ppc
(b) Monopoly
consumer
surplus
P
S = MC
A
consumer
surplus
Pm
producer
surplus
B
C
D
Qpc
E
F
welfare (deadweight) loss
producer
surplus
D = MB
0
MC
Q
0
Qm
D = MB
Qpc
MRm
Q
Figure 7.15 Consumer and producer surplus and welfare (deadweight) loss in monopoly compared with perfect competition
MC
(b) Monopoly
price, costs, revenue
price, costs
(a) Perfectly competitive firm
ATC
Pe
0
Qpe
Q
at long-run equilibrium
production takes place at min ATC
(productive efficiency), and
Pe = MC (allocative efficiency)
MC
Pe
ATC
D
0
Qm
Q
MR
at long-run equilibrium
production takes place at greater than
min ATC (productive inefficiency), and
Pe > MC (allocative inefficiency)
Figure 7.16 Allocative and productive inefficiency in perfect competition and monopoly
© Cambridge University Press 2012
Economics for the IB Diploma
23
Important diagrams to remember
economic
(supernormal)
profit
MC
Pe
ATC
D = AR
0
Qe
MC
ATC
Pe
D = AR
0
Q
(c) Losses
Qe
price, costs, revenue
(b) Normal profit
price, costs, revenue
price, costs, revenue
(a) Economic profit
losses
Pe
D = AR
0
Q
Qe
Q
MR
MR
MR
ATC
MC
Figure 7.21 Short-run equilibrium positions of the firm in monopolistic competition
Intergalactic Space Travel’s price
High price
Low price
ATC
Pe
D = AR
Qe
0
Qc
MR
Q
40
million
Zs
Universal Space Line’s price
Low price
High price
price, costs, revenue
MC
40
million
Zs
70
million
Zs
10
million
Zs
4
10
million
Zs
70
million
Zs
2
20
million
Zs
20
million
Zs
3
1
Figure 7.23 Game theory: the prisoner’s dilemma
Figure 7.22 Long-run equilibrium of the firm in monopolistic
competition
price, costs, revenue
P
MC
a
Pe
MC1
ATC
MC2
b
profit
0
Z
P1
Q
MR
max
Figure 7.24 Profit maximisation by a price-fixing cartel
© Cambridge University Press 2012
D
D = AR
Q
0
Q1
Q
MR
Figure 7.25 The kinked demand curve
Economics for the IB Diploma
24
Important diagrams to remember
P
P
P1
P
P2
MR = MR1 + MR2
D2
D1
0
MC
Q1
MR1
Q
(a) Market 1
0
Q2
(b) Market 2
MR2
Q
0
Q3
Q
(c) Market 1 and market 2
Figure 7.26 Third-degree price discrimination
© Cambridge University Press 2012
Economics for the IB Diploma
25
Important diagrams to remember
u
in (
ho
n
tio
households
(consumers)
ip
rsh
eu
uc
land
, la
bo
land, lab
rship
our,
reneu
cap
p
e
r
i ta
en t
resource
l, e
,
l
a
t
nt
i
markets c
p
re
a
o
c
e
s
t
m
s
o
o
c
n
f
i
p
ld
ro
s,
d
age fit)
ho
se
t, wt, pro
n
re eres
t
en
pr
ur
,
Chapter 8 The level of overall economic activity
firms
(businesses)
h
ou
pe sehol
d
nd
itur
e
go
o
ds
an
ds
erv
product
markets
ices
es
ex
s
nue
reve
ds
goo
ic
rv
se
d
n
a
Figure 8.1 Circular flow of income model in a closed economy with no
government
factor incomes
(wages, rents, interest, profit)
households
(consumers)
firms
(businesses)
consumer expenditure
(spending on goods and services)
di
en
sp
ng
o
tax
es
ni
mp
or t
s
ng
financial markets
t
en
st m
inve
government
ern
gov
nt
spe
di
ng
ndi
ng
on
e xp
orts
savi
me
en
sp
other countries
Figure 8.3 Circular flow of income model with leakages and injections
© Cambridge University Press 2012
Economics for the IB Diploma
26
Important diagrams to remember
real GDP actually achieved
peak contraction
real GDP
expansion
long term growth trend,
or potential GDP
peak
trough
trough
0
time (years)
Figure 8.4 The business cycle
actual GDP > potential GDP;
there is an output gap:
unemployment < natural
rate of unemployment
actual GDP
expansion:
unemployment
falls
contraction:
unemployment
increases
c
real GDP
d
b
a
e
actual GDP < potential GDP; there is an
output gap: unemployment > natural
rate of unemployment
long term
growth trend, or
potential GDP =
full employment GDP;
unemployment =
natural rate of
unemployment
0
time (years)
Figure 8.5 Illustrating actual output, potential output and unemployment in the business cycle
© Cambridge University Press 2012
Economics for the IB Diploma
27
Important diagrams to remember
Chapter 9 Aggregate demand and aggregate supply
(a) The aggregate demand curve
(a) The upward-sloping SRAS curve
price level
price level
SRAS
AD
0
real GDP
(b) Shifts in the aggregate demand curve
(b) Shifts in the SRAS curve
AD1
AD2
0
real GDP
(a) The economy with a deflationary
(recessionary) gap
(b) The economy with an inflationary gap
price level
price level
SRAS
Ple
SRAS
Ple
AD
Ye Yp
real GDP
Figure 9.2 The short-run aggregate supply curve (SRAS )
Figure 9.1 The aggregate demand (AD) curve
0
SRAS3 SRAS
1 SRAS
2
price level
price level
AD3
0
real GDP
(c) The economy at the full employment
level of output
price level
0
SRAS
Ple
AD
0
real GDP
Yp
Ye
real GDP
AD
0
Yp = Ye
real GDP
Figure 9.4 Three short-run equilibrium states of the economy
© Cambridge University Press 2012
Economics for the IB Diploma
28
Important diagrams to remember
(a) Changes in aggregate demand
(b) Changes in short-run aggregate supply
SRAS3
Pl2
Pl1
Pl3
AD2
AD3
0
AD1
Y3 Y1 Y2
price level
price level
SRAS
SRAS1
SRAS2
Pl3
Pl1
Pl2
AD
0
Y3 Y1 Y2
real GDP
real GDP
Figure 9.5 Impacts of changes in short-run macroeconomic equilibrium
(a) Changes in aggregate demand
(b) Changes in short-run aggregate supply
LRAS
LRAS
Pl1
AD3
Pl2
AD2
0
AD1
Pl2
SRAS3
Pl1
Pl3
AD
Yrec Yp Yinfl
recessionary
(deflationary) gap
price level
price level
SRAS
Pl3
SRAS2
SRAS1
real GDP
inflationary
gap
Y2 Yp Y3
0
recession with
inflation
('stagflation')
real GDP
higher real
GDP with lower
price level
Figure 9.6 Possible causes of the business cycle
LRAS
price level
SRAS
AD
0
Yp
real GDP
Figure 9.7 The LRAS curve and long-run equilibrium in the monetarist/
new classical model
© Cambridge University Press 2012
Economics for the IB Diploma
29
Important diagrams to remember
(a) Creating and eliminating a deflationary gap
Pl1
a
Pl2
b
0
SRAS2
c
Pl3
Yrec Yp
LRAS
SRAS1
price level
price level
LRAS
(b) Creating and eliminating an inflationary gap
AD1
AD2
Pl3
c
Pl2
Pl1
SRAS1
SRAS2
b
a
AD1
AD2
0
Yp Yinfl
real GDP
real GDP
Figure 9.8 Returning to long-run full employment equilibrium in the monetarist/new classical model
LRAS
Keynesian AS
Pl1
price level
price level
SRAS1
AD1
SRAS2
Pl2
section III
section II
AD2
0
Yp
section I
0
real GDP
(b) Inflationary gap
0
(c) Full employment equilibrium
AD
Ye
real GDP
Keynesian AS
price level
Keynesian AS
price level
price level
Keynesian AS
AD
Yp
0
real GDP
Figure 9.11 The Keynesian aggregate supply curve
Figure 9.9 Changes in long-run equilibrium in the monetarist/new
classical AD-AS model
(a) Recessionary (deflationary) gap
Yp Ymax
Yp Ye
real GDP
AD
0
Yp = Ye
real GDP
Figure 9.12 Three equilibrium states of the economy in the Keynesian model
© Cambridge University Press 2012
Economics for the IB Diploma
30
Important diagrams to remember
(a) The monetarist/new classical model
(b) The Keynesian model
Keynesian AS
Pl1
Pl2
price level
price level
LRAS
AD3
Pl3
AD2
AD1
0
Yp
AD2
AD1
0
real GDP
Y1
Y2
AD3
AD4
Y3 Yp real GDP
Figure 9.13 Effects of increases in aggregate demand on real GDP and the price level
(a) The monetarist/new classical model
LRAS2
AS1
0
AS2
price level
price level
LRAS1
(b) The Keynesian model
Yp1
0
Yp2 real GDP
Yp1
Yp2 real GDP
Figure 9.14 Increasing potential output, shifts in aggregate supply curves and long-term economic growth
(a) The monetarist/new classical model
AS1
LRAS2
SRAS1
SRAS2
Pl1
AD1
0
Y1
AD2
Y2
real GDP
AS2
price level
price level
LRAS1
(b) The Keynesian model
AD2
AD1
0
Y1
Y2
real GDP
Figure 9.15 Long-term economic growth: achieving potential (full employment) output in a growing economy
© Cambridge University Press 2012
Economics for the IB Diploma
31
Important diagrams to remember
Higher level topic
Keynesian AS
induced
spending
$8
million
Pl3
price level
price level
autonomous
spending
$24
million
$32 million
AD1
0
Y1
AD2
Y2
AD3
Y3
real GDP
Figure 9.17 Aggregate demand, real GDP and the multiplier in the
Keynesian model
© Cambridge University Press 2012
Pl2
Pl1
AD1
0
Y1
AD2
Y2
real GDP
AD3
AD4
Y3
Figure 9.18 How the effect of the multiplier changes depending on the
price level
Economics for the IB Diploma
32
Important diagrams to remember
Chapter 10 Macroeconomic objectives I: Low unemployment, low and stable
rate of inflation
P
S2
S1
price
price
S
P1
P2
P
D1
P2
P1
D
D2
0
Q2
Q1
0
Q
Q2
Q1
labour surplus =
unemployment
supply
of
labour
Wm
We
Q
(b) Labour market rigidities lead to an
increase in costs of production (supply
shifts to the left), causing a fall in
Q produced; employers hire fewer
workers
(a) Fall in demand for a product produced
in a declining industry, or produced in
a local industry that relocates, causes
a fall in Q produced; employers fire
workers with inappropriate skills or
local workers no longer needed due to
relocation
price of labour (wage)
P
0
Qd
Qe Qs
quantity of labour
demand
for
labour
Q
(c) Minimum wage legislation and labour union
activities lead to higher than equilibrium wages
and lower quantity of labour demanded
Figure 10.1 Structural unemployment
(b) The Keynesian model
(a) The monetarist/new classical model
Keynesian AS
SRAS
Pl1
Pl2
price level
price level
LRAS
AD1
Pl1
Pl2
AD1
AD2
AD2
0
0
Yrec Yp
Yrec
real GDP
Yp
real GDP
Figure 10.2 Cyclical unemployment
(a) The monetarist/new classical model
(b) The Keynesian model
LRAS
AS
LRAS
Pl1
0
AD2
AD1
Yp
Yinfl
real GDP
Figure 10.4 Demand-pull inflation
© Cambridge University Press 2012
Pl2
Pl1
0
AD2
AD1
Yp Yinfl
real GDP
price level
Pl2
price level
price level
SRAS
SRAS2
SRAS1
Pl2
Pl1
AD1
0
Yrec
Yp
real GDP
Figure 10.5 Cost-push inflation
Economics for the IB Diploma
33
Important diagrams to remember
Higher level topic
(b) The reasoning behind SRAS shifts in
terms of the AD-AS model
(a) The shifting Phillips curve
price level
rate of inflation
SRAS3
c
a
b
PC3
PC2
PC1
unemployment rate
0
Pl3
SRAS2
c
Pl2
SRAS1
b
a
Pl1
AD
0
Y3 Y2 Y1
real GDP
Figure 10.7 Stagflation: outward shifts of the short-run Phillips curve due to decreasing SRAS
(a) The shape of the LRPC and SRPC
(b) The reasoning behind the two curves in
terms of the AD-AS model
9%
7%
5%
0
LRAS
c
b
a
SRPC2
SRPC1
3% 5%
unemployment rate
5% = natural rate
of unemployment
price level
rate of inflation
LRPC
Pl3
c
Pl2
Pl1
SRAS2
b SRAS1
AD2
a
AD1
0
Yp Yinfl
real GDP
Figure 10.8 The short-run and long-run Phillips curves
© Cambridge University Press 2012
Economics for the IB Diploma
34
Important diagrams to remember
Chapter 11 Macroeconomic objectives II: Economic growth and equity in the
distribution of income
100
Y
B
A
0
X
(b) Economic growth as an increase in production possibilities
caused by increases in resource quantities or improvements in
resource quality
cumulative percentage of income
(a) Economic growth as an increase in actual output caused by
reductions in unemployment and productive inefficiency
80
60
d
Belarus
f
20
c
e
a
0
B
h
g
40
Y
C
perfect
income
equality
b
Bolivia
40
80
20
60
cumulative percentage of population
100
Figure 11.3 Lorenz curves: Belarus achieves greater income equality than
Bolivia
A
100
PPC1 PPC2 PPC3 X
Figure 11.1 Using the production possibilities model to illustrate economic
growth
cumulative percentage of income
0
80
60
increased income
equality after
redistribution
40
20
0
Figure 11.4
© Cambridge University Press 2012
perfect income
equality
before
redistribution
40
80
20
60
cumulative percentage of population
100
Lorenz curves and income redistribution
Economics for the IB Diploma
35
Important diagrams to remember
Chapter 12 Demand-side and supply-side policies
(a) The monetarist/new classical model
(a) The monetarist/new classical model
LRAS
price level
price level
LRAS
SRAS
Pl2
Pl1
AD2
SRAS
Pl1
Pl2
AD1
AD2
AD1
0
Yrec Yp
0
real GDP
Yp Yinfl real GDP
potential output
(b) The Keynesian model
(b) The Keynesian model
AS
Pl2
Pl1
price level
price level
Keynesian AS
Pl1
Pl2
AD1
AD2
AD2
AD1
Yrec
Figure 12.1 Effects of expansionary policy: eliminating a recessionary
(deflationary) gap
price level
(a)
due to G
SRAS
due to I
Y1 Y3
real GDP
potential output
Figure 12.2 Effects of contractionary policy: eliminating an
inflationary gap
(b)
Partial crowding out
AD1
0
Yp Yinfl real GDP
Yp real GDP
AD2
Complete crowding out
price level
0
0
due to I
AD3
Y2
SRAS
due to G
AD2
AD1
0
Y1
Y2
real GDP
Figure 12.3 Crowding out of private investment
© Cambridge University Press 2012
Economics for the IB Diploma
36
Important diagrams to remember
(a) Equilibrium rate of interest
(b) Changes in the supply of money cause
changes in the equilibrium rate of interest
Sm3
rate of interest
rate of interest
Sm
i
Dm
0
Qe
quantity of money
Sm1
Sm2
i3
i1
i2
0
Dm
Q3
Q1 Q2
quantity of money
Figure 12.4 The money market and determination of the rate of interest
© Cambridge University Press 2012
Economics for the IB Diploma
37
Important diagrams to remember
(a) Country A: absolute
advantage in good Y;
Country B: absolute
advantage in good X
(b) Country A: comparative
advantage in good Y;
Country B: comparative
advantage in good X
good Y
Chapter 13 International trade
country A’s PPC
country B’s PPC
0
good Y
good Y
0
country A
country B
0
good X
good X
country A
country B
Figure 13.5 Identical opportunity costs:
no gains from trade
good X
Figure 13.3 Absolute and comparative advantage
Opportunity cost of cotton
Opportunity cost of microchips
(2)
Microchips
(3)
(4)
Production possibilities when each
country produces only cotton or
only microchips
(1)
Cotton
Cottonia
Microchippia
20
or
10
10 units of microchips 1
=
20 units of cotton
2
20 units of cotton
=2
10 units of microchips
25
or
50
50 units of microchips
=2
25 units of cotton
25 units of cotton
1
=
50 units of microchips 2
Table 13.2 Comparative advantage
(a) Cottonia exports 10 units of cotton and
imports 10 units of microchips
25
25
cotton
20
Microchippia’s PPC
15
0
15
B consumption
10
5
10
5
cotton
20 A production
Cottonia’s
PPC
10 20 30 40 50 60
microchips
0
10 20 30 40 50
microchips
(b) Microchippia exports 10 units of
microchips and imports 10 units of cotton
25
Figure 13.2 Comparative advantage
cotton
20
15
10
D consumption
5
C production
0
10 20 30 40 50
microchips
Figure 13.4 The gains from specialisation and trade based on comparative
advantage: both countries consume outside their PPC
© Cambridge University Press 2012
Economics for the IB Diploma
38
Important diagrams to remember
(a) Effects on imports
Sd =
P
domestic
supply
Pd
Pw + t
government revenue
world price + tariff
tariff
Pw
0
world price =
world supply curve
Q1
Q2
Q3
Q4
Dd = domestic demand
Q
Pq
0
Q1
Q2
Q3
imports without quota
domestic supply
b
e
a
d
Q
tariff
f
world price =
world supply curve
Q2
Q3
Q4
Sd = domestic supply
P
a
world price + tariff
Dd = domestic demand
Q1
Q4
Dd = domestic demand
(b) Welfare effects
Sd =
welfare loss = d + f
0
world price =
world supply curve
imports with quota
c
plus quota
Pw
imports with tariff
P
Pw g
Sdq = domestic supply
quota
quota
revenue
imports without tariff
(b) Welfare effects
Pw + t
Sd = domestic supply
P
(a) Effects on imports
Pq
Pw g
b
c
Sdq = domestic supply
plus quota
quota
d e
welfare loss = d + e + f
e f
world price =
world supply curve
Q
0
imports with tariff
imports without tariff
Q1
Q2
Q3
Q4
Dd = domestic demand
Q
imports with quota
imports without quota
Figure 13.7 Effects of a tariff
Figure 13.9 Effects of a quota
(a) Production subsidy: quantity of imports falls
Sd = domestic supply
Sds = domestic
P
subsidy
Ps
supply minus subsidy
world price =
world supply curve
Pw
Dd = domestic demand
0
Q1
Q3
Q2
Q
imports after subsidy
imports before subsidy
Figure 13.11 Production subsidies
© Cambridge University Press 2012
Economics for the IB Diploma
39
Important diagrams to remember
Chapter 14 Exchange rates and the balance of payments
(a) Demand for $ increases: $ appreciates
per $ = price of $ in terms of
per $ = price of $ in terms of
(a) The market for US dollars
S of $
excess supply of $
(dollars)
0.80
equilibrium
exchange rate
0.67
0.50
excess demand for $
D for $
(dollars)
0
Q of $ (dollars)
2.00
equilibrium
exchange rate
1.50
1.25
D for
excess demand for
(euros)
Q of (euros)
$ per bople = price of boples in terms of $
(a) Shifting the currency demand curve
S of boples
A
1. fall in demand for Bopland's
exports reduces demand
for boples
C
D2 for boples
0
D2 for $
D1 for $
0
Q of $ (dollars)
S1 of
S2 of
D
1.50
E
F
1.11
D for
0
Q of (euros)
Figure 14.2 Exchange rate changes in a freely floating exchange rate system
(b) Shifting the currency supply curve
2. central bank buys excess
boples, increasing demand
for boples
B
B
A
0.67
$ per = price of in terms of $
(euros)
Q of boples
D1 for boples
$ per bople = price of boples in terms of $
$ per = price of in terms of $
S of
excess supply of
Figure 14.1 Exchange rate determination in a freely floating exchange
rate system
2.00
1.50
C
0.90
(b) Supply of € increases: € depreciates
(b) The market for euros
0
S of $
S1 of boples
S2
2.00
B
2. imports are reduced,
therefore the supply
of boples falls
A
1. fall in demand for Bopland's
exports reduces demand
for bople
D2 for boples
0
D1 for boples
Q of boples
Figure 14.3 Fixed exchange rates: maintaining the value of the bople at 1 bople = $2.00
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Important diagrams to remember
(a) With a trade deficit, country consumes outside its PPC
good A
C
PPC
0
good B
good A
(b) With a trade surplus, country consumes inside its PPC
D
PPC
0
good B
Figure 14.6 Using a PPC to illustrate a trade deficit and a trade surplus
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Important diagrams to remember
Chapter 15 Economic integration and the terms of trade
Higher level topic
global price of internationally
traded good
S
global supply
of wheat
P2
P1
D2
global demand
D1 for wheat
P3
D3
0
Q3
Q1
Q2
quantity of internationally
traded good
global price of internationally
traded good
(b) Changes in global supply: effects of terms of trade changes on
the balance of trade depend on PEDs for exports and imports
(a) Changes in global demand: terms of trade and
balance of trade change in same direction
S3
S1
global supply
P3
S2
P1
P2
global demand
D
Q3 Q1
0
Q2
quantity of internationally
traded good
Figure 15.1 Changes in global demand or supply: terms of trade impacts on the balance of trade
P
S1
S2
P1
P2
D2
D1
0
Q
Figure 15.2 Long-term declines in primary product prices due to low
growth in demand (due to low YEDs) and high growth in supply
(due to technological advances)
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Important diagrams to remember
Chapter 16 Understanding economic development
industrial goods
A→B: no economic growth with some development
B→C: economic growth with no development
B→D or E: economic growth with development
C
D
A
E
B
PPC1
0
PPC2
merit goods
Figure 16.1 Economic growth and economic development
low
income
low
savings
low
investment
low physical
capital
low growth
in income
low
human
capital
low natural
capital
low productivity
of labour
and land
Figure 16.2 The poverty cycle (poverty trap)
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