Important diagrams with tips on how to use them
Important diagrams with tips on how to
use them
Every diagram you need to know for your IB exams is listed in the IB Economics syllabus. Each of these diagrams
is also explained in the learning objectives appearing at the beginning of each section of the coursebook.
These diagrams are reproduced here by chapter so that you can easily refer to all of them for review. They include
all the diagrams that appear in the IB economics syllabus. The tip given under each diagram tells you what you
should be able to illustrate by use of these diagrams.
Unit 1 Introduction to economics
Chapter 1 The foundations of economics
40 A
B
microwave ovens
35
30
G
C
25
20
F
15
D
10
5
0
5
E
10 15 20 25 30 35 40
computers
Figure 1.1: Production possibilities curve
TIP
a Increasing opportunity costs
b Constant opportunity costs
microwave ovens
basketballs
This diagram illustrates choice, opportunity cost and unemployment of resources.
computers
volleyballs
Figure 1.2: Production possibilities curve with increasing and constant opportunity costs
TIP
This illustrates the difference between constant and increasing opportunity costs.
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a Economic growth
as an increase
in actual output
caused by
reductions in
unemployment
and inefficiency in
production
c Decrease in
production
possibilities
Y
b Economic growth
as an increase
in production
possibilities caused
by increases in
resource quantities
or improvements in
resource quality
Y
C
B
B
A
A
0
0
X
PPC1 PPC2 PPC3 X
Y
Y
PPC2
0
PPC1
X
d Non-parallel shifts of
the PPC
PPC1
0
PPC2
X
Figure 1.3: Using the production possibilities model to illustrate economic growth
TIP
This diagram illustrates the difference between actual growth and growth in production possibilities.
factor incomes
(wages, rents, interest, profit)
firms
(businesses)
consumer expenditure
(spending on go
ods and services)
en
di
ng
on
im
p
ort
s
in
tm
ve s
en
t
government
other countries
e
rnm
e
v
o
g
in
go
sp
tax
es
financial markets
nt
savi
ng
sp
en
ding
ne
xpo
rts
households
(consumers)
d
en
sp
Figure 1.6: Circular flow of income model with leakages and injections
TIP
This diagram shows the interdependence between households and firms, along with financial
markets (banks), the government and other countries. It also shows the role of leakages from and
injections into the flow of income.
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Important diagrams with tips on how to use them
Unit 2 Microeconomics
Chapter 2 Competitive markets: Demand and supply
a A
movement along the demand curve, caused by a
change in price, is called a ‘change in quantity demanded’
P
b A shift of a demand curve, caused by a change in a
determinant of demand, is called a ‘change in demand’
P
change in demand
A
P1
change in
quantity
demanded
decrease
in D
increase
in D
B
P2
D2
D
0
Q1
D3
Q2
Q
D1
0
Q
Figure 2.4: Movements along and shifts in the demand curve
TIP
Part (a) shows the downward sloping demand curve illustrating the law of demand. It also illustrates
movements along the demand curve: as P falls from P1 to P2, quantity demanded increases from Q1
to Q2. Part (b) shows that if there is any change in a non-price determinant of demand, the demand
curve will shift.
a A movement along the supply curve, caused by a
change in price, is called a ‘change in quantity supplied’
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
A
P1
0
Q1
change in
quantity
supplied
Q2
P1
0
Q
S1
S3
Q3
decrease
in supply
increase
in supply
Q1
Q2
S2
Q
Figure 2.8: Movements along and shifts of the supply curve
TIP
Part (a) shows the upward sloping supply curve illustrating the law of supply. It also illustrates
movements along the supply curve: as P increases from P1 to P2, quantity supplied increases from Q1
to Q2. Part (b) shows that if there is any change in a non-price determinant of supply, the supply curve
will shift.
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price of chocolate bars ($)
ECONOMICS FOR THE IB DIPLOMA: COURSEBOOK
S
5
4
surplus
equilibrium
market
equilibrium
3 price
2
shortage
1
D
equilibrium quantity
0
2 4 6 8 10 12 14
quantity of chocolate bars
(thousands per week)
Figure 2.11: Market equilibrium
TIP
Demand and supply determine an equilibrium P and Q at market equilibrium.
b Decrease in demand
a Increase in demand
P
initial
equilibrium
c
P2
a
P1
S
P
final
equilibrium
P1
b
D2
final
equilibrium
S
a
c
P3
D1
D1
0
Q1
initial
equilibrium
b
D3
Q2
Q
0
Q3
Q1
Q
Figure 2.12: Changes in demand and the new equilibrium price and quantity
TIP
If demand changes, there is a new market equilibrium due to the creation of shortages or surpluses.
b Decrease in supply
a Increase in supply
initial
equilibrium
final
equilibrium
S1
P
a
P1
b
c
P2
S2
final
equilibrium
S3
P
P1
S1
c
P3
a
b
D
0
Q1
Q2
initial
equilibrium
D
Q
0
Q3
Q1
Q
Figure 2.13: Changes in supply and the new equilibrium price and quantity
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Important diagrams with tips on how to use them
TIP
If supply changes, there is a new market equilibrium due to the creation of shortages or surpluses.
a Adjustment of price to increased demand
P
S
C
P2
A
P1
B
D2
D1
0
Q3
Q1
shortage =
excess demand
Q2 Q
Figure 2.16a: Price as a signal and incentive
TIP
This diagram shows the signalling and incentive functions of price in allocating and reallocating
resources.
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
TIP
This diagram shows that consumer surplus and producer surplus are maximum at competitive
market equilibrium, therefore social surplus (consumer surplus + producer surplus) is also maximum.
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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
0
Q2 Q1
0
Q
5%
Q2 Q1
Q
10%
Special cases
c Unit elastic demand: PED = 1
P
5%
d Perfectly inelastic demand: PED = 0
e Pefectly elastic demand: PED = ∞
P
P
D
P1
P2
P1
0
D
D
Q2
Q1
Q
0
Q1
Q
0
Q
5%
Figure 3.1: Demand curves and PED
TIP
Parts (a) and (b) show that the flatter the demand curve, the more elastic the demand. Parts (c), (d)
and (e) show the special cases where PED is constant along the full range of the demand curve.
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Important diagrams with tips on how to use them
P ($)
50
45
40
35
30
25
20
15
10
5
f
elastic portion of
demand curve
PED = 4
e
d
inelastic portion
of demand curve
PED = 1
c
b PED = 0.25
a
0
10 20 30 40 50 60 70 80 90 100
units of good A
Figure 3.4: (HL only) Variability of PED along a straight-line demand curve
TIP
This diagram shows that the value of PED decreases as we move down the demand curve.
a PED > 1 (elastic demand)
b PED < 1 (inelastic demand)
P
P
$
$
P2 = 5
P1 = 4
C
A
0
P2 = 7
B
D
Q2 = 8 Q1 = 11 Q (Units)
P1 = 5
P
P2
C
A
0
c PED = 1 (unit elastic demand)
P1
B
D
Q2 = 12 Q1 = 14
C
A
Q (Units)
0
Q2
D
B
Q1
Q
Figure 3.6: PED and total revenue
TIP
These diagrams show how a firm’s total revenue changes in response to changes in price depending
on whether PED>1, PED<1 or PED=1.
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Income per week ($)
450
400
350
YED < 0
inferior food
Engel curve
E
D
YED = 0
250
C
YED < 1
necessity
150
YED > 1
luxury or service
100
A
0
B
4
7 8 9
Q of hot dogs per week
Figure 3.10: The Engel curve showing different YEDs
TIP
The Engel curve is used to show how income elasticity of demand (YED) changes as income
increases; it can be used to show if a good is normal or inferior, and a necessity or luxury (or service).
Frequently encountered cases
b Price elastic supply: PES > 1
a Price inelastic supply: PES < 1
P
P
S
S
10%
P2
P2
10%
P1
0
Q1 Q2
P1
0
Q
Q1
5%
Special cases
Q2
Q
15%
c Unit elastic supply: PES = 1
d Perfectly inelastic supply: PES = 0
e Perfectly elastic supply: PES = ∞
P
P
P
S1
S
S2
S3
0
P1
Q
0
Q1
Q
0
S
Q
Figure 3.13: Supply curves and PES
TIP
Parts (a) and (b) show relatively inelastic and elastic supply, depending on which axis intersects the
supply curve. Parts (c), (d) and (e) show the special cases where PES is constant along the full range
of the supply curve.
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Important diagrams with tips on how to use them
Chapter 4 Government intervention in microeconomics
P
S
Pe
Pc
shortage =
excess demand
0
Qs
Qe
D
Q
Qd
Figure 4.1: Price ceiling (maximum price) and market outcomes
TIP
This illustrates a price ceiling; it results in a shortage of the good.
a Consumer and producer surplus in a competitive
free market: maximum social surplus
b Welfare impacts of a price ceiling
(maximum price)
P
P
S = MC
Pe
welfare loss
consumer
surplus
Pe
producer
surplus
Pc
b
d
c
e
D = MB
D = MB
0
S = MC
a
Qe
Q
0
Qs
Qe
Qd
Q
Figure 4.2: Effects of a price ceiling (maximum price) on consumer and producer surplus
TIP
Part (b) shows the loss of consumer and producer surplus, which is compared to maximum social
surplus in part (a). It can also be used to illustrate the effects of the price ceiling on consumers,
producers, workers and government.
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P
S
excess supply =
surplus
Pf
Pe
D
0
Qd
Qe
Qs
Q
Figure 4.5: Price floor (minimum price) and market outcomes
TIP
This illustrates a price floor; it results in a surplus of the good.
a Consumer and producer surplus in a competitive free
market: maximum social surplus
b Welfare impacts of a price floor (minimum price)
P
excess supply =
surplus
P
S = MC
Pf
consumer
surplus
P*
producer
surplus
Pe
S = MC
a
b
d
f
c
e g
welfare
loss
D+
government
purchases
D = MB
D = MB
0
Q*
Q
0
Qd
Qe
Qs
Q
Figure 4.7: Welfare impacts of a price floor (minimum price) for agricultural products and government purchases of
the surplus
TIP
Part (b) shows the loss of consumer and producer surplus, which is compared to maximum social
surplus in part (a). It can also be used to illustrate the effects of the price ceiling on consumers,
producers, workers and government.
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Important diagrams with tips on how to use them
b Market outcomes due to an indirect tax
a How the supply curve shifts
P
P
S2 (= S1 + tax)
government
revenue
S1
Pc
S2 (= S1 + tax)
tax per
unit S1
P*
Pp
0
Q
0
D
Q
Qt Q*
Figure 4.11: Supply curve shifts due to an indirect tax
TIP
Part (a) shows how the supply curve shifts when an indirect tax is imposed. Part (b) illustrates the
market outcomes and consequences for stakeholders.
a Consumer and producer surplus in a competitive
free market: maximum social surplus
b C
onsumer and producer surplus with an indirect tax:
welfare loss
P
P
S = MC
Pc
P*
consumer
surplus
P*
Pp
producer
surplus
S2 = S1 + tax
tax per
unit
consumer
surplus after
the tax
government
revenue from
the tax
a
b
S1 = MC
welfare loss = a + b
producer surplus
after the
tax
D = MB
D = MB
0
Q*
Q
0
Qt
Q*
Q
Figure 4.12: Effects of indirect taxes on consumer and producer surplus
TIP
Part (b) shows the loss of consumer and producer surplus (welfare loss) due to the indirect
tax, compared to part (a). It can also be used to show the market outcomes consequences for
stakeholders.
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S1
P
Pp
subsidy
per unit
P*
S2 = S1 – subsidy
Pc
D
0
Q*
Qsb
Q
Figure 4.15: Impacts of subsidies on market outcomes
TIP
The diagram illustrates the market outcomes and consequences for stakeholders.
a C
onsumer 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*
Pp
P*
consumer
surplus
Pc
producer
surplus
gain in
producer surplus
gain in
consumer surplus
subsidy per unit
a
Q*
Q
welfare loss
D = MB
D = MB
0
S2 = S1 – subsidy
0
Q* Qsb
Q
Figure 4.16: Effects of subsidies on consumer and producer surplus
TIP
Part (b) shows the gain of consumer and producer surplus due to the subsidy, as well as welfare
loss, compared to part (a). It can also be used to show the market outcomes consequences for
stakeholders.
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Important diagrams with tips on how to use them
Chapter 5 Market failure and socially undesirable outcomes I:
Common pool resources and negative externalities
P
S = MPC = MSC
Popt
D = MPB = MSB
0
Qopt
allocative efficiency
is achieved
Q
Figure 5.2: Demand, supply and allocative efficiency with no externalities
TIP
This diagram shows that when there are no externalities, the free market achieves allocative efficiency,
producing the socially optimum output, where MSB = MSC and social surplus is maximum.
MSC
P
external
cost
S = MPC
Popt
Pm
0
Qopt Qm
D = MPB = MSB
Q
Figure 5.3: Negative production externality
TIP
This shows the external costs and resource misallocation resulting from a negative production externality.
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MSC
P
external
cost S = MPC
Popt
Pm
welfare loss
D = MPB = MSB
0
Qopt Qm
Q
Figure 5.4a: Welfare loss in a negative production externality
TIP
The welfare loss is the shaded area between Qopt and Qm on the horizontal axis with the point of the
triangle pointing to Qopt.
MSC = MPC + tax
tax = external cost
P
Pc = Popt
S = MPC
Pm
Pp
D = MPB = MSB
0
Qopt Qm
Q
Figure 5.5a: Imposing an indirect tax on output or on pollutants
TIP
This diagram shows how a Pigouvian tax on output or a carbon tax can be used to correct the externality.
S of tradable
permits
P
P2
P1
D2
D1
0
Q1
Q
Figure 5.5c: Tradable permits
TIP
This shows how a market for tradable permits works.
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Important diagrams with tips on how to use them
MSC
P
S = MPC
Popt
Pm
0
Qopt Qm
D = MPB = MSB
Q
Figure 5.7: Government regulations to correct negative production externalities and promote sustainable use of
common pool resources
TIP
This diagram shows the effects on the market of government regulations to correct the externality.
P
S = MPC = MSC
Pm
Popt
D = MPB
external
cost
MSB
0
Qopt Qm
Q
Figure 5.9: Negative consumption externality
TIP
This shows the external costs and resource misallocation resulting from a negative consumption externality.
P
welfare loss
Pm
Popt
0
S = MPC = MSC
external
cost
D = MPB
Qopt Qm
MSB
Q
Figure 5.10a: Welfare loss in a negative consumption externality
TIP
The welfare loss is the shaded area between Qopt and Qm on the horizontal axis with the point of the
triangle pointing to Qopt.
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b Government regulations and advertising
a Market-based: imposing an indirect tax
P + tax
MPC
P
P
MPC
+ tax
tax external
=
cost
external
cost
tax =
external
cost
P
Pc
c
Pm
S = MPC = MSC
Pm
Pp
Pp
S = MPC = MSC
Pm
D = MPB
Popt
MSB
MSB
0
Qopt
Qm
0
Q Qopt
Qm
0
D = MPB
QQopt
P
external
cost
S = MPC = MSC
S = MPC = MSC
D1 = MPB
D1 = MPB
Pm
Popt
D2 = MSB
D2 = MSB
after demand decreases after demand decreases
Qm 0
Q Qopt
Qm
Q
Figure 5.11: Correcting negative consumption externalities
TIP
Part (a) shows how a Pigouvian tax can be used to correct the externality. Part (b) shows the effects
on the market of government regulations and advertising to correct the externality.
Chapter 6 Market failure and socially undesirable outcomes II:
Positive externalities, public goods, asymmetric information
and inability to achieve equity
S = MPC
P
external
benefits
Pm
MSC
Popt
0
Qm Qopt
D = MPB = MSB
Q
Figure 6.1: Positive production externality
TIP
This shows the external benefits and resource misallocation resulting from a positive production
externality
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Important diagrams with tips on how to use them
P
S = MPC
external
benefits
MSC
Pm
Popt
welfare loss
D = MPB = MSB
0
Qm Qopt
Q
Figure 6.2a: Welfare loss in a positive production externality
TIP
The welfare loss is the shaded area between Qm and Qopt on the horizontal axis with the point of the
triangle pointing to Qopt.
a Direct government provision
b Granting a subsidy
S = MPC
P
spillover
benefit
Pm
MSC
subsidy =
spillover benefit
MSC
Pm
Popt
0
S = MPC
P
Popt
Qm Qopt
D = MPB
Q
0
Qm Qopt
D = MPB
Q
Figure 6.3: Correcting positive production externalities
TIP
This figure shows how this externality can be corrected through: part (a) direct government
provision, and part (b) subsidies.
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P
S = MPC = MSC
Popt
Pm
MSB
external
benefit
0
Qm Qopt
D = MPB
Q
Figure 6.4: Positive consumption externality
TIP
This shows the external benefits and resource misallocation resulting from a positive consumption
externality.
P
S = MPC = MSC
welfare loss
Popt
Pm
external
benefits
0
MSB
D = MPB
Q
Qm Qopt
Figure 6.5a: Welfare loss in a positive consumption externality
TIP
The welfare loss is the shaded area between Qm and Qopt on the horizontal axis with the point of the
triangle pointing to Qopt.
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Important diagrams with tips on how to use them
a Legislation or advertising
P
b Direct government provision
P
S = MPC = MSC
S = MPC = MSC
S + government
provision
Popt
D2 = MSB
Pm
Pm
external
benefit
0
Qm Qopt
MSB
Pc
D1 = MPB
0
Q
D = MPB
Qm
Qopt
Q
c Granting a subsidy
P
S = MPC = MSC
MPC –
subsidy
subsidy =
external
benefit
Pm
MSB
Pc
0
D = MPB
Qopt
Q
Qm
Figure 6.6: Correcting positive consumption externalities
TIP
land, lab
o
ship
resource
markets
in
households
(consumers)
hip
ur s
me
inco
,
old
ages it)
h
se
t, wt, prof
n
(re eres
t
ur, c
api
tal
,e
nt
re
cost
so
fp
ro
d
n
tio
ho
u
r
reneu
uc
land
, la
ca
al,
pit
rep
en t
e
en
pr
bo
ur
,
Legislation, regulations, education, awareness creation and nudges have effects shown in part (a). The
effects of direct government provision are shown in part (b). The effects of subsidies are in part (c).
firms
(businesses)
s
nue
reve
ex
go
o
ds
an
d
ser
vice
s
product
markets
es
h
ou
pe sehol
d
nd
itur
e
ic
rv
se
d
an
ds
goo
Figure 6.8: (HL only) Circular flow of income model
TIP
This shows that household incomes determined in markets result in income inequalities.
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Chapter 7 Market failure and socially undesirable outcomes
III: Market power (HL only)
P
P
S
Pe
Pe
D=MR=AR
D
0
0
Q
Q
Figure 7.6: (HL only) Market (industry) demand and supply determine demand faced by the perfectly competitive firm
TIP
This diagram shows the perfectly competitive firm as price taker where P = D = MR = AR.
b Normal profit
MC
a
P1
AC1
b
Q1
AC
P1 = AR1 = MR1 = D1
price, revenue, costs
price, revenue, costs
a Abnormal profit
MC
P2 =
AC2
Q
AC
P2 = AR2 = MR2 = D2
Q2
Q
price, revenue, costs
c Loss
MC
AC3
P3
AC
c
d
Q3
P3 = AR3 = MR3 = D3
Q
Figure 7.8: (HL only) Short-run profit maximisation in perfect competition
TIP
This diagram shows how the profit maximising firm in perfect competition maximises profit, earning
abnormal profit in part (a), normal profit in part (b) and loss in part (c).
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Important diagrams with tips on how to use them
b The market/industry
a The firm
P
costs, revenue, P
MC
S = MC
ATC
Pe
Pe
P = AR = MR
0
Qe
consumer
surplus
producer
surplus
0
Q
D = MB
Q
Qe
Figure 7.10: (HL only) Allocative efficiency in perfect competition in the long run
TIP
This diagram is used to show that when the perfectly competitive firm is in long run equilibrium it
achieves allocative efficiency given by P = MC, where at the level of the industry social surplus is
maximum and MB = MC.
abnormal
profit
MC
Pe
AC
D = AR
0
Qe
MC
AC
Pe
D = AR
0
Q
c loss
Qe
Q
price, costs, revenue
b normal profit
price, costs, revenue
price, costs, revenue
a abnormal profit
losses
Pe
D = AR
0
Qe
MR
MR
AC
MC
MR
Q
Figure 7.14: (HL only) Profit maximisation and loss minimisation in monopoly: marginal revenue and cost approach
TIP
This shows how the monopolist maximises profit, making abnormal profit in part (a), normal profit in
part (b) and loss in part (c).
Average
costs
AC1
LRAC
AC*
0
Q1
Q*
Q
Figure 7.15: (HL only) Natural monopoly
TIP
This shows natural monopoly producing for the entire market when LRAC is still falling.
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ECONOMICS FOR THE IB DIPLOMA: COURSEBOOK
MC
a
Ppc
P = MRpc
D = MB
0
Qpc
Q
price, costs, revenue
price, costs, revenue
S = MC
b
Pm
a
Ppc
D = MB
0
Qm
Qpc
Q
MRm
Figure 7.16: (HL only) Higher price, lower output by the firm in monopoly
TIP
These diagrams can be used to show how monopoly charges a higher price while producing a lower
quantity than a perfectly competitive industry.
P
Ppc
S = MC
A
consumer
surplus
Pm
producer
surplus
B
Qpc
Q
MC
C
D
E
F
welfare loss
producer
surplus
D = MB
0
consumer
surplus
P
0
Qm
Qpc
MRm
D = MB
Q
Figure 7.17: (HL only) Consumer and producer surplus and welfare loss in monopoly compared with perfect competition
TIP
This shows that the monopolist’s higher price with lower quantity result in welfare loss.
22
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MC
price, costs, revenue
price, costs
Important diagrams with tips on how to use them
AC
Pe
0
Qpe
MC
D
0
Q
at long-run equilibrium
production takes place at
Pe = MC (allocative efficiency)
AC
Pe
Qm
Q
MR
at long-run equilibrium
production takes place at
Pe > MC (allocative inefficiency)
Figure 7.18: (HL only) Allocative efficiency in perfect competition and allocative inefficiency in monopoly
TIP
The perfectly competitive firm produces Q where P = MC, indicating allocative efficiency. The
monopolist produces a Q where P>MC (or AR>MC) indicating the presence of market power.
a Perfect competition
b Monopoly
c Monopolistic competition
P
P
P
D
D
D
0
Q
0
Q
0
Q
Figure 7.19: (HL only) Demand curves facing the firm under three market structures
TIP
The monopolistically competitive firm faces a more elastic demand curve than monopoly, being
somewhere in between monopoly and perfect competition.
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ECONOMICS FOR THE IB DIPLOMA: COURSEBOOK
price, costs, revenue
economic
(supernormal)
profit
MC
Pe
AC
D = AR
0
Qe
AC
Pe
D = AR
Qe
Q
losses
MC
AC
Pe
D = AR
0
MR
MR
MC
0
Q
c Losses
price, costs, revenue
b Normal profit
price, costs, revenue
a Economic profit
Qe
MR
Q
Figure 7.20: (HL only) Short-run equilibrium positions of the firm in monopolistic competition
TIP
This shows how the monopolistically competitive firm maximises profit; there are three possible
outcomes in the short run: abnormal profit in part (a), normal profit in part (b) and loss in part (c).
price, costs, revenue
MC
ATC
Pe
D = AR
0
Qe
Qc
MR
Q
Figure 7.21: (HL only) Long-run equilibrium of the firm in monopolistic competition
TIP
price, costs, revenue
This shows that in the long run the firm in monopolistic competition makes normal profit. It can
also be used to show that the firm has allocative inefficiency in long run equilibrium because at the
equilibrium level of output Qe, P>MC.
MC
a
Pe
profit
0
AC
b
Q
MR
max
D = AR
Q
Figure 7.23: (HL only) Profit maximisation by a price-fixing cartel
TIP
This is the same as the monopolist’s profit maximisation diagram where the monopolist earns
abnormal profit. It shows that the collusive oligopoly behaves like a monopoly.
24
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Important diagrams with tips on how to use them
Unit 3 Macroeconomics
Chapter 8 The level of overall economic activity
factor incomes
(wages, rents, interest, profit)
households
(consumers)
firms
(businesses)
consumer expenditure
rts
m
ern
gov
ing
on
exp
o
government
en
tax
es
on
im
p
t
en
st m
e
v
n
i
nd
d
en
sp
in
g
financial markets
ts
pe
savi
ng
ndi
ng
(spending on goods and services)
e
sp
ort
s
other countries
Figure 8.2: Circular flow of income model with leakages and injections
TIP
Refer to Figure 1.6, which appears under Chapter 1, which can be used here to show the
interactions between decision-makers, and that the income, output and expenditure approaches to
measuring GDP (national income accounting) are equivalent.
real GDP actually achieved
peak contraction
real GDP
expansion
peak
trough
trough
0
long-term growth trend,
or potential output
(potential GDP)
time (years)
Figure 8.3: The business cycle
TIP
Illustrates short-term fluctuations of real GDP and the long-term growth trend (potential output).
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ECONOMICS FOR THE IB DIPLOMA: COURSEBOOK
a The aggregate demand curve
b Shifts in the aggregate demand curve
price level
price level
Chapter 9 Aggregate demand and aggregate supply
AD
0
AD3
0
real GDP
AD1
AD2
real GDP
Figure 9.1: The aggregate demand (AD) curve
TIP
Part (a) shows the downward sloping aggregate demand curve; part (b) shows shifts in this curve due
to changes in any of the determinants of aggregate demand.
a The upward-sloping SRAS curve
b Shifts in the SRAS curve
price level
price level
SRAS
0
0
real GDP
SRAS3 SRAS
1 SRAS
2
real GDP
Figure 9.2: The short-run aggregate supply curve (SRAS)
TIP
Part (a) shows the upward sloping SRAS curve; part (b) shows shifts in this curve due to changes in
any of its determinants.
26
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Important diagrams with tips on how to use them
price level
SRAS
Pl1
Ple
Pl2
AD
0
Ye
real GDP
Figure 9.3: Short-run macroeconomic equilibrium
TIP
Short-run macroeconomic equilibrium occurs at the point of intersection of AD with SRAS.
a Changes in aggregate demand
b Changes in short-run aggregate supply
SRAS3
Pl2
Pl1
Pl3
AD2
AD3
0
price level
price level
SRAS
SRAS1
Pl3
Pl1
Pl2
AD
AD1
Y3 Y1 Y2
SRAS2
0
real GDP
Y3 Y1 Y2
real GDP
Figure 9.4: Impacts of changes in short-run macroeconomic equilibrium
TIP
Part (a) shows the impact on the price level and real GDP due to changes in AD; part (b) shows the
impact of changes in SRAS.
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ECONOMICS FOR THE IB DIPLOMA: COURSEBOOK
price level
LRAS
SRAS
Ple
AD
0
Y p = Ye
real GDP
Figure 9.5: The LRAS curve and long-run equilibrium in the monetarist/new classical model
TIP
This shows the LRAS curve that is vertical at the level of potential output, as well as long run
macroeconomic equilibrium that occurs when the AD and SRAS curves intersect on the LRAS curve.
LRAS
price level
price level
LRAS
SRAS
Ple
LRAS
SRAS
Ple
AD
0
Ye Yp
real GDP
c The economy at the full
employment level of output
b The economy with an
inflationary gap
price level
a The economy with a deflationary
(recessionary) gap
SRAS
Ple
AD
0
Yp
Ye
AD
0
real GDP
Yp = Ye
real GDP
Figure 9.6: Deflationary (recessionary) and inflationary gaps in relation to potential output
TIP
This shows a recessionary or deflationary gap, an inflationary gap, and full employment equilibrium
in the monetarist/new classical model
28
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Important diagrams with tips on how to use them
a Creating and eliminating a deflationary gap
b Creating and eliminating an inflationary gap
LRAS
LRAS
Pl1
Pl2
a
price level
price level
a SRAS1
SRAS2
b
c
Pl3
AD1
Pl3
Pl2
Pl1
c
SRAS1
b
a
AD2
AD2
0
SRAS2
AD1
0
Yrec Yp
real GDP
Yp Yinfl
real GDP
Figure 9.8: Automatic adjustment to long-run full employment equilibrium in the monetarist/new classical model
TIP
This can be used to illustrate how the economy automatically returns to full employment equilibrium
in the long run.
price level
Keynesian AS
section III
section II
section I
0
Yp Ymax
real GDP
Figure 9.10: The Keynesian aggregate supply curve
TIP
This diagram shows the three segments that compose the Keynesian AS curve.
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a Recessionary (deflationary) gap
b Inflationary gap
Keynesian AS
price level
price level
Keynesian AS
price level
Keynesian AS
c Full employment equilibrium
AD
AD
AD
0
Ye
real GDP
0
Yp
Yp Ye
real GDP
0
Yp = Ye
real GDP
Figure 9.11: Three equilibrium states of the economy in the Keynesian model
TIP
This shows a recessionary or deflationary gap, an inflationary gap, and full employment equilibrium
in the Keynesian model.
b The Keynesian model
a The monetarist/new classical model
AS1
AS2
price level
LRAS2
price level
LRAS1
0
Yp1
Yp2 real GDP
0
Yp1
Yp2 real GDP
Figure 9.13: Increasing potential output, shifts in aggregate supply curves and long-term economic growth
TIP
This shows how the LRAS and Keynesian AS curve shift over the long term, illustrating growth of
potential output.
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Important diagrams with tips on how to use them
Chapter 10 Macroeconomic objectives I:
Low unemployment, low and stable rate of inflation
b M
inimum wage legislation and
labour union activities lead to
higher than equilibrium wages
and lower quantity of labour
demanded
S = supply
of labour
W1
W2
D1 = demand
for labour
D2
0
Q3 Q2 Q1
quantity of labour
Q
P
labour surplus =
unemployment
c 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
supply
of
P
S2
labour
Wm
price
P
price of labour (wage)
price of labour (wage)
a M
ismatches between labour
demand and labour supply:
falling demand for labour
We
0
Qd
Qe Qs
quantity of labour
demand
for
labour
Q
S1
P2
P1
D
0
Q2
Q1
Q
Figure 10.1: Structural unemployment
TIP
Part (a) shows a labour market illustrating unemployment that arises from falling demand for
labour in a particular industry or geographical area. Part (b) shows a labour market illustrating how
unemployment can arise from a minimum wage. Part (c) shows a product market illustrating the
effects of labour market rigidities.
a The monetarist/new classical model
b The Keynesian model
Keynesian AS
SRAS
Pl1
Pl2
AD1
price level
price level
LRAS
Pl1
Pl2
AD1
AD2
AD2
0
Yrec Yp
real GDP
0
Yrec
Yp
real GDP
Figure 10.3: Cyclical unemployment
TIP
Using the monetarist/new classical model in part (a) and the Keynesian model in part (b) this figure
shows a deflationary gap resulting in lower real GDP which gives rise to cyclical unemployment.
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a The monetarist/new classical model
b The Keynesian model
AS
LRAS
Pl2
Pl1
0
AD2
price level
price level
SRAS
Pl2
Pl1
AD2
AD1
AD1
Yp
0
Yinfl
real GDP
Yp Yinfl
real GDP
Figure 10.5: Demand-pull inflation
TIP
Using the monetarist/new classical model in part (a) and the Keynesian model in part (b), this figure
shows how an increase in aggregate demand results in a higher price level together with an increase
in real GDP; this is demand-pull inflation.
LRAS
price level
SRAS2
SRAS1
Pl2
Pl1
AD1
0
Yrec
Yp
real GDP
Figure 10.6: Cost-push inflation
TIP
This figure shows how a fall in SRAS gives rise to a higher price level and lower real GDP; this is
cost-push inflation.
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Important diagrams with tips on how to use them
a Falling aggregate demand (AD)
b Increasing short-run aggregate supply (SRAS)
SRAS1
price level
price level
SRAS
Pl1
Pl2
SRAS2
Pl1
Pl2
AD1
AD2
0
AD
Y1 Y2
real GDP
Y2 Y1
real GDP
Figure 10.8: Causes of deflation
TIP
Deflation may arise from a fall in aggregate demand, shown in part (a), or an increase in SRAS, shown in
part (b).
b The reasoning behind the Phillips curve in terms
of the AD-AS model
a The shape of the Phillips curve
price level
rate of inflation
SRAS
d
c
b
e
0
a
Pl3
Pl2
Pl1
0
unemployment rate
d
Pl4
c
a
AD4
b
AD2
AD3
AD1
Y1 Y2 Y3 Y4
real GDP
Figure 10.11 (HL only): The short-run Phillips curve
TIP
Part (a) illustrates the trade-of between inflation and unemployment, shown by the short-run Phillips
curve. Part (b) uses the AD-AS model to explain why the short-run Phillips curve has a downward
slope illustrating this trade-off.
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a The shape of the LRPC and SRPC
b The reasoning behind the two curves in terms of
the AD-AS model
LRAS
9%
7%
5%
0
c
b
price level
rate of inflation
LRPC
SRPC2
a
SRPC1
3% 5%
unemployment rate
SRAS2
Pl3
c
b SRAS1
Pl2
AD2
a
Pl1
AD1
0
5% = natural rate
of unemployment
Yp Yinfl
real GDP
Figure 10.13: (HL only) The short-run and long-run Phillips curves
TIP
Part (a) shows two short-run Phillips curves, together with a long run Phillips curve that is vertical
at the natural rate of unemployment. Part (b) uses the AD-AS model to explain why the long-run
Phillips curve is vertical at the natural rate of unemployment.
Chapter 11 Macroeconomic objectives II: Economic growth,
sustainable level of debt
a The monetarist /new classical model: increase in
aggregate demand
b The Keynesian model: increase in aggregate demand
Keynesian AS
Pl2
price level
price level
SRAS
Pl1
Pl3
AD2
AD3
0
AD1
AD2
AD1
Y3 Y1 Y2
0
real GDP
Y1
Y2
AD3
AD4
Y3 Yp real GDP
Figure 11.1: Short-term growth in the AD-AS model
TIP
The figure shows how increases in aggregate demand lead to short-term growth using the
monetarist/new classical model in part (a) and the Keynesian model in part (b).
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Important diagrams with tips on how to use them
a The monetarist/new classical model
LRAS2
AS1
AS2
price level
price level
LRAS1
b The Keynesian model
0
Yp1
0
Yp2 real GDP
Yp1
Yp2 real GDP
Figure 11.2: Increasing potential output, shifts in aggregate supply curves and long-term economic growth
TIP
This figure illustrates long-term growth in the AD-AS model based on the monetarist/new classical
model in part (a) and the Keynesian model in part (b).
a Short-term growth: growth
as an increase in actual
output caused by reductions
in unemployment and
productive inefficiency
b Long-term growth: growth
as an increase in production
possibilities caused by increases
in resource quantities or
improvements in resource quality
c N
egative growth:
decrease in production
possibilities
C
B
A
military goods
B
military goods
military goods
Y
A
0
0
consumer goods
PPC1 PPC2 PPC3
consumer goods
0
PPC2
PPC1
consumer goods
Figure 11.4: Using the production possibilities model to illustrate economic growth
TIP
Part (a) illustrates short-term growth, shown by actual growth in the PPC model. Part (b) illustrates
long-term growth, shown by growth in production possibilities in the PPC model. Part (c) shows
negative long-term growth through a decrease in production possibilities.
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ECONOMICS FOR THE IB DIPLOMA: COURSEBOOK
Chapter 12 Economics of inequality and poverty
cumulative percentage of income
100
80
60
perfect income
equality
increased income
equality after
redistribution
40
20
0
before
redistribution
40
80
20
60
cumulative percentage of population
100
Figure 12.4: Lorenz curves and income redistribution in favour of greater income equality
TIP
This figure shows two Lorenz curves and how they change due to changes in the distribution of income
in favour of greater income equality.
Chapter 13 Demand-side and supply-side policies
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 13.1: (HL only) The money market and determination of the rate of interest
TIP
This figure shows how the rate of interest rate is determined by the interactions of the supply and
demand for money.
36
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Important diagrams with tips on how to use them
a The monetarist/new classical model
b The Keynesian model
Keynesian AS
SRAS
Pl2
Pl1
AD2
price level
price level
LRAS
Pl2
Pl1
AD2
AD1
AD1
0
Yrec Yp
0
real GDP
Yrec
Yp real GDP
Figure 13.2: Effects of expansionary policy: eliminating a recessionary/deflationary gap
TIP
This figure shows how expansionary monetary and fiscal policy work to eliminate a deflationary
or recessionary gap. Part (a) is based on the monetarist/new classical model and part (b) on the
Keynesian model. Note that the diagrams are the same for both monetary and fiscal policies.
a The monetarist/new classical model
b The Keynesian model
AS
SRAS
Pl1
Pl2
0
AD1
AD2
Yp Yinfl real GDP
price level
price level
LRAS
Pl1
Pl2
0
AD1
AD2
Yp Yinfl real GDP
potential output
potential output
Figure 13.3: Effects of contractionary policy: eliminating an inflationary gap
TIP
This figure shows how contractionary monetary and fiscal policy work to eliminate an inflationary
gap. Part (a) is based on the monetarist/new classical model and part (b) on the Keynesian model.
Note that the diagrams are the same for both monetary and fiscal policies.
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a Partial crowding out
b Complete crowding out
SRAS
due to I
price level
price level
due to G
AD2
due to I
AD3
Y1 Y3
real GDP
AD2
AD1
AD1
0
SRAS
due to G
0
Y2
Y1
Y2
real GDP
Figure 13.4: (HL only) Crowding out of private investment
TIP
This figure shows how expansionary fiscal policy based on deficit spending (borrowing by the
government) may crowd out investment.
a The monetarist/new classical model
AS1
LRAS2
SRAS2
SRAS1
Pl1
0
AD1
Y1
AD2
Y2
real GDP
AS2
price level
price level
LRAS1
b The Keynesian model
AD2
AD1
0
Y1
Y2
real GDP
Figure 11.3: Supply-side policies and long-term economic growth: achieving potential (full employment) output in a
growing economy
TIP
These two diagrams, based on the monetarist/new classical model in part (a) and the Keynesian
model in part (b), show how supply-side policies aim to shift the LRAS curve or Keynesian AS
curve to the right. Over the long term, the economy moves from one equilibrium to another. (This
figure from Chapter 11 has been included in the material for Chapter 13 because it illustrates the
objectives of supply-side policies.)
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Important diagrams with tips on how to use them
price of labour (wage)
P
supply
of
labour
labour surplus =
unemployment
Wm
We
0
demand
for
labour
Q
Qd
Qe Qs
quantity of labour
Figure 10.1b: Minimum wage legislation
TIP
This figure, which appears under Chapter 10, shows how eliminating or reducing the minimum wage
is expected to result in reduction of structural unemployment caused by minimum wage legislation.
(Reduction of minimum wages is a supply-side policy.)
Unit 4 The Global Economy
Chapter 14 International trade: Part I
b Bindle exports under
free trade
a World market price for
bindles
P
Sw
Pw
Dw
0
Sw
P
Sd = domestic supply
Sd = domestic supply
exports
Pw
Pd
Pw
Pd
Pw
0
P
P
P
c Bindle imports under free
trade
exports
world price =
world supply
curve
world price =
world supply
curve
Sd = domestic supply
Pd
Pw
world price =
world supply
curve
imports
Dd =
domestic
demand
Dd = domestic Dd = domestic
demand
demand
Dw
0
Q QQd 0 Qs
Qd
Qs
Q
0
Qs
Qd
Q
Figure 14.1: Using diagrams to illustrate free trade
TIP
Part a shows how global demand and global supply of a good determine its equilibrium world
price. Part b shows that if the world price is greater than a country’s domestic price, that country will
export the good because it has a comparative advantage in its production. Part c shows that if the
world price is lower than a country’s domestic price then the country will import the good as it has a
comparative disadvantage in its production.
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25
cotton
20
Microchippia’s PPC
15
10
Cottonia’s
PPC
5
0
10 20 30 40 50 60
microchips
Figure 14.4: (HL only) Comparative advantage
TIP
This figure illustrates comparative advantage of the country that has lower opportunity cost in
producing a good. The country with the flatter PPC has a comparative advantage in the good
measured on the horizontal axis (therefore Microchippia in microchips).
a Effects on imports
b Effects on welfare
Sd =
P
government revenue
world price + tariff
Pd
Pw + t
tariff
Pw
0
world price =
world supply curve
Q1
Q2
Q3
Q4
Dd = domestic demand
Q
Sd =
P
domestic
supply
domestic supply
welfare loss = d + f
Pw + t
Pw g
0
a
c
d
b
e
world price + tariff
tariff
f
world price =
world supply curve
Dd = domestic demand
Q1
Q2
Q3
Q4
imports with tariff
imports with tariff
imports without tariff
imports without tariff
Q
Figure 14.6: Effects of a tariff
TIP
The two figures are used to illustrate the effects of a tariff on price, quantity produced, quantity
consumed, quantity of imports, producer revenues, import expenditures and welfare.
40
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Important diagrams with tips on how to use them
a Effects on imports
b Effects on welfare
Sd = domestic supply
P
quota
revenue
Pq
Sdq = domestic supply
quota
0
Pq
world price =
world supply curve
Q1
Q2
a
plus quota
Pw
Q3
Q4
Dd = domestic demand
Q
Sd = domestic supply
P
Pw g
0
c
Q1
Sdq = domestic supply
plus quota
quota
b
d e
Q2
welfare loss = d + e + f
e f
Q3
imports with quota
imports with quota
imports without quota
imports without quota
world price =
world supply curve
Q4
Dd = domestic demand
Q
Figure 14.8: Effects of a quota
TIP
The two figures are used to illustrate the effects of a quota on price, quantity produced, quantity
consumed, quantity of imports, producer revenues, import expenditures and welfare.
P (£)
Sd
Ss
Pw+s
Pw
a
b
Q1 Q3
Dd
Q2
Q
Figure 14.12a: Effects of a production subsidy
TIP
This figure is used to illustrate the effects of a production subsidy on price, quantity produced,
quantity consumed, quantity of imports, producer revenues, import expenditures and welfare.
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P
Pw+s
Pw
a
c
b
Sd
Pw+s
d Ss
Pw
Dd
Q3 Q1
Q2 Q4 Q
Figure 14.13a: Effects of an export subsidy
TIP
This figure is used to illustrate the effects of an export subsidy on price, quantity produced, quantity
consumed, quantity of exports, producer revenues, export revenues and welfare.
per $ = price of $ in terms of
Chapter 16 Exchange rates and the balance of payments
excess supply of $
0.80
0.67
S of $
(dollars)
equilibrium
exchange rate
0.50
excess demand for $
D for $
(dollars)
0
Q of $ (dollars)
Figure 16.1a: Exchange rate determination in a freely floating exchange rate system: the market for dollars
TIP
This diagram shows that the demand for a currency and the supply of a currency determine the
equilibrium exchange rate in a floating exchange rate system.
42
Economics for the IB Diploma - Tragakes © Cambridge University Press 2020
Important diagrams with tips on how to use them
a $
appreciation due to
increase in demand for $
€/$
b $
appreciation due to
decrease in supply of $
S2
€/$
S
e2
e1
S1
e2
e1
D2
D1
0
D1
0
Q of $
Q of $
c $
depreciation due to
decrease in demand for $
d $
depreciation due to
increase in supply of $
€/$
€/$
S
e1
e2
S1
S2
e1
e2
D2
0
D1
D
0
Q of $
Q of $
Figure 16.2: Exchange rate changes in a floating exchange rate system
TIP
These diagrams show how changes in currency demand or currency supply result in a new
equilibrium exchange rate.
a Changes in aggregate demand
b Changes in short-run aggregate supply
SRAS3
Pl2
Pl1
Pl3
AD2
AD3
0
price level
price level
SRAS
SRAS1
Pl3
Pl1
Pl2
AD
AD1
Y3 Y1 Y2
SRAS2
0
real GDP
Y3 Y1 Y2
real GDP
Figure 9.4: Impacts of changes in short-run macroeconomic equilibrium
TIP
Refer to this figure, which appears under Chapter 9, in order to use the AD-AS model to show
consequences of changes in exchange rates. For example, currency depreciation may cause an
increase in AD (through an increase in X-M), resulting in demand-pull inflation. It can also cause a fall
in SRAS due to higher import costs leading to cost-push inflation.
43
Economics for the IB Diploma - Tragakes © Cambridge University Press 2020
ECONOMICS FOR THE IB DIPLOMA: COURSEBOOK
a Shifting the currency demand curve
b Shifting the currency supply curve
2.00
2.central bank buys
excess boples,
increasing demand
for boples
1. fall in demand for
Bopland's exports
reduces demand
for boples
A
B
1.50
C
D2 for boples
0
$ per bople = price of
boples in terms of $
$ per bople = price of
boples in terms of $
S of boples
S1 of boples
S2
B
2.00
2.imports are reduced,
therefore the supply
of boples falls
A
1. fall in demand for
Bopland's exports
reduces demand
for bople
D1 for boples
D2 for boples
0
Q of boples
D1 for boples
Q of boples
Figure 16.4: Fixed exchange rates: maintaining the value of the bople at 1 bople=$2.00
TIP
iIn both parts, there is a fall in the demand for exports, causing a fall in the demand for boples,
hence a bople depreciation. In part (a) the central bank buys boples increasing the demand
for boples to its original level, hence maintaining the fixed bople exchange rate. (Increases
in interest rates or borrowing from abroad could have achieved the same effect.) In part (b)
the government makes efforts to restrict imports, thus decreasing the supply of boples and
maintaining the fixed bople exchange rate.
iiThe same diagram can be used to illustrate managed exchange rates; the central bank or
government take actions to change currency demand or currency supply in order to influence
the value of the exchange rate.
a Current account surplus causes appreciation
b Current account deficit causes depreciation
/$ (price of $ in terms of )
$/ (price of in terms of $)
Chapter 17 Further topics on exchange rates and the
balance of payments (HL only)
S of $
C
0.90
0.67
B
A
D2 for $
D1 for $
0
Q of $ (dollars)
S1 of
1.50
1.11
S2 of
D
F
E
D for
0
Q of (euros)
Figure 17.1: (HL only) Current account and exchange rates
TIP
Part (a) shows that when there is a current account surplus, the extra demand for the currency is
likely to exert an upward pressure on the value of the currency, or appreciation. Part (b) shows that
when there is a current account deficit, the extra supply of the currency is likely to cause a downward
pressure on the value of the currency, or depreciation.
44
Economics for the IB Diploma - Tragakes © Cambridge University Press 2020
Important diagrams with tips on how to use them
a V
alue of exports is equal to value of imports
at time of devaluation/depreciation
trade
balance
(X – M)
trade
balance
(X – M)
trade
surplus
(X > M)
trade
surplus
(X > M)
(X = M) 0
trade
deficit
(X < M)
b Trade deficit at time of devaluation/depreciation
(X = M) 0
time
trade
deficit
(X < M)
time
time of devaluation/depreciation
time of devaluation/depreciation
Figure 17.3: (HL only) J-curve effect
TIP
The J-curve effect follows from the Marshall-Lerner condition that is unlikely to be satisfied over
short periods of time, while it is more likely to be satisfied over longer periods of time. The figure
shows how a current account deficit increases following a depreciation/devaluation which over time
begins to improve, turning into a current account surplus.
Chapter 19 Barriers to economic growth and economic
development
low
income
low
savings
low
investment
low physical
capital
low
human
capital
low natural
capital
low productivity
of labour
and land
low growth
in income
Figure 19.1: The poverty cycle (poverty trap)
TIP
This diagram shows how poverty can be a cause of poverty that is perpetuated from generation
to generation.
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Economics for the IB Diploma - Tragakes © Cambridge University Press 2020