PPFs and Other Diagrams. Output of capital goods Output of consumer goods and services A B C.

PPFs and Other Diagrams

Output of capital goods

Heart Operations

Output (Q)

CostsRevenues

AR (Demand)

Basic Supply and Demand Analysis

Demand Curve

Quantity Demanded

Demand

Q1Q2 Q3

Shift in demand

Quantity Demanded

Q1Q2 Q3

Demand

Relatively Inelastic Demand

Consumer Surplus and Price Elasticity of Demand

Relatively Elastic Demand

Demand

Relatively Inelastic Demand

Consumer Surplus and Price Elasticity of Demand

Relatively Elastic Demand

Quantity Demanded Quantity Demanded

Price Price

Perfectly Elastic Demand Perfectly Inelastic Demand

Demand

Quantity Quantity Q1Q2 Q3

Price Price

Perfectly Elastic Supply Perfectly Inelastic Supply

Supply

Price Price

Relatively Elastic Supply

Supply responds quickly to a change in demand

Relatively Inelastic Supply

Supply responds less than proportionately to a change in price

Supply

D3D2D1

Quantity

Supply

Price of DVD

players

Quantity demanded

Supply of DVD

players

Price of Sterling in

Quantity of Pounds Sterling

Demand 1

Supply

Demand 2

Quantity

Quantity of Council Housing

Demand

Supply + Sub

Government Subsidy

Subsidy per unit

Average Weekly Rent £

Quantity of Council Housing

Demand

Supply + Subsidy

Government Subsidy

Subsidy per unit

Quantity

Demand

Supply pre subsidy

Supply + Export Subsidy

Quantity

Demand

Supply post tax Supply pre tax

Quantity

SupplySupply

Supply Supply

Supply curves with different price elasticity

Quantity

Demand

Supply

Demand

Demand curves with different price elasticity

Demand

Quantity

Supply

Price of Good S

Quantity demanded of Good T

Demand

Quantity

S pre subsidy

Quantity

S pre subsidy

Quantity

Demand

Supply

Maximum Prices

Price Ceiling

Free Market Equilibrium

Excess Demand

Quantity of Rented Property

Demand

Supply

Maximum Prices

Price (Rent) Ceiling

Free Market Equilibrium

Excess Demand

Quantity

Demand

Supply

Maximum Prices

Maximum Price

Quantity of output

Demand

Supply

Price Floor (Guaranteed)

Excess Supply

Quantity

Demand

Supply

Price Support Schemes – Buffer Stocks

Minimum Price

Quantity

Demand

Supply

Price Support Schemes – Buffer Stocks

Price Floor (Guaranteed)

Quantity

Demand

Quantity

Demand

Increasing Market Supply – Consumer Benefits

Quantity

Demand

Supply

Equilibrium Point

Producer Surplus

Quantity

Demand

Supply

Producer Surplus

Quantity

Demand

Supply

Equilibrium Point

Consumer Surplus

Quantity

Demand

Supply

Equilibrium Point

Market Equilibrium

Market Failure Diagrams

Social Efficiency / Welfare Losses

Output (Q)

Demand = Private Benefit = Social Benefit

Private Marginal Cost (Supply)

Revenues

Social Marginal Cost

External Cost

Benefits

Quantity of Output (Q)

Demand (Private Marginal Benefit)

Marginal Private Cost

Social Equilibrium

Negative Externalities

Marginal Social Cost

Tackling Externalities

Taxation

Pollution Trading Schemes

Tax Credits

Voluntary Agreement

Regulation

Aggregates Levy

Landfill Tax

Fuel Duty

Climate Change Levy (CCL)

Emissions trading scheme

Landfill permits

Pesticides

EU C02 from cars agreement

Water quality legislation

Reduced VAT on installation of central heating

Benefits

Demand (Private Marginal Benefit) =

Social Marginal Benefit (SMB)

Social Equilibrium

Loss of Social Welfare from Externalities

Deadweight loss of economic welfare

Marginal External Cost

Merit Goods

CostsBenefits

Quantity of Housing

Private Demand

Supply

Demand + External Benefits

External Benefit

Merit Goods and Welfare Loss

CostsBenefits

Output (Q)

PMC = SMC

External Benefit

Welfare loss where SMB>PMB above output

The Demand Curve for Public Goods

CostsBenefits

Output (Q)

Demand from A

Value 1

Demand from B

Value 1

Value 2

CostsBenefits

Output (Q)

Demand A

Value 1

Demand B

Value 1

Value 2

Demand A+B

Socially Efficient Provision of Public Goods

CostsBenefits

Output (Q)

Demand A Demand B

Demand A+B

CostsBenefits

Output (Q)

PMB = SMB

External Cost

Net Welfare Loss

Negative Externalities – Pollution Tax

CostsBenefits

Output (Q)

PMB = SMB

PMC + TAX

Quantity

Demand (Limited Information)

De-Merit Goods and Health Awareness

Demand (Full Information)

Quantity

Domestic Demand

Domestic Supply

Export Subsidy

Domestic Price

World Price

World Price + Sub

Price per

Quantity

Domestic Demand

Domestic Supply of Coal

Coal Export Subsidy

Domestic Price

World Price

World Price of Coal + Subsidy

Quantity

Domestic Demand

Domestic Supply

Import Tariffs

World Price

World Price + Tariff

Q4Q3 Q2

Quantity

Supply

Consumer Surplus

Outward Shift in Demand

Quantity

Demand

Consumer Surplus

Outward Shift in Supply

Quantity

An Outward Shift in DemandAn Inward Shift in Demand

Quantity

An Outward Shift in Market Demand –

Long Run Market Supply is more Elastic

An Outward Shift in Market Demand –

Short Run Market Supply is Inelastic

Quantity

An Outward Shift in Demand and a Rise in SupplyAn Inward Shift in Demand and a Fall in Supply

Quantity

An Outward Shift in Coffee Demand and a Rise in Coffee Supply

Quantity

An Outward Shift in Oil Demand when Supply is Inelastic

Quantity of DVD players

Price of DVD players

Quantity

An Outward Shift in SupplyAn Inward Shift in Supply

Quantity

S + Tax

A Tax when Demand is Price InelasticA Tax When Demand is Price Elastic

S + Tax

Indirect Taxes and Elasticity of Demand

Quantity

Supply

Q1Q3 Q2

Quantity

Q2Q1 Q3

Supply

Quantity

Q1Q3 Q2

Increase in Supply

Decrease in Supply

Theory of the Firm Diagrams

Output (Q)

Fixed Costs

Total Fixed Cost

Average Fixed Cost

£2000

£1000

Output (Q)

Short Run Cost Curves

Average Fixed Cost (AFC)

Average Variable Cost (AVC)

Average Total Cost (ATC)

Marginal Cost (MC)

Output (Q)

Short Run Cost Curves

Output (Q)

Increase in Variable Costs

Average Variable Cost (AVC)

Average Total Cost (ATC)

Marginal Cost (MC)

MC2 AC2

Output (Q)

The Long Run Average Cost Curve

SRAC2SRAC3

Q1 Q2 Q3

Output (Q)

The Long Run Average Cost Curve

SRAC2SRAC3

Q1 Q2 Q3

Output (Q)

The Minimum Efficient Scale (MES)

SRAC2SRAC3

Minimum Efficient Scale

Economies of scale (falling LRAC) due to increasing returns

Diseconomies of scale (rising LRAC) due to decreasing returns to scale

Output (Q)

Economies of Scale and Profits

AR (Demand)

Profit at Price P1

Profit at Price P2

Output (Q)

Different output levels (1)

AR (Demand)

A B C D

Output (Q)

Different output levels (2)

AR (Demand)

A B C D

Monopoly Price and Output in the Short Run

Demand (AR)

RevenueCost and

Profit

Output (Q)

Monopoly versus Competition

LRAC = LRMC

Monopoly Demand (AR)

RevenueCost and

Profit

Output (Q)

Monopoly versus Competition (Welfare Loss)

LRAC = LRMC

Monopoly Profit at Price P1

RevenueCost and

Profit

Output (Q)

Deadweight Welfare Loss

Natural Monopoly

Demand (AR)

RevenueCost and

Profit

Output (Q)

Natural Monopoly – losses and profits

Demand (AR)

RevenueCost and

Profit

Output (Q)

Profit at price P1

Loss at price P2

Benefits from Cross Subsidisation

RevenueCost and

Profit

Output (Q)

RevenueCost and

Profit

Output (Q)

Barriers to Entry – Blockaded Entry

LRAC = LRMC (Existing Monopolist)

RevenueCost and

Profit

Output (Q)

AC = MC (Potential Entrant into the market)

Costs,

Revenues

Output (Q)

The Shut Down Price

AR (Demand)

Costs,

Revenues

Output (Q)

The Shut Down Price

Costs,

Revenues

Output (Q)

The Short Run Supply Curve

ATCMC = supply

P1The Shut Down Price

P2Break-Even Price

Output (Q)

Profits and an Increase in Variable Costs

AR (Demand)

Profit at Price P2

Profit at Price P1

Revenues

Output (Q)

Total Cost (TC)RevenueCost and

Profit

Q1Q2 Q3

Total Profit

Max Profit

Min Profit

Total Revenue (TR)

Profit Max Revenue Max

Total Revenue and Cost (1)

Output (Q)

Profit

Total Revenue (TR)

Break Even TR=TC

Total Revenue and Cost under Perfect Competition

Output (Q)

Profit Total Revenue (TR)

Multi Choice Questions on This

Output (Q)

RevenueCost and

ProfitTotal Revenue

Total Revenue with a Perfectly Elastic Demand Curve

Average Revenue (AR) = Marginal Revenue (MR)

Output (Q)

RevenueCost and

Profit

Total Revenue (TR)

Total Revenue with a downward sloping demand curve

Marginal Revenue (MR)

Average Revenue (Demand) AR

Output (Q)

RevenueCost and

Profit

Total Revenue (TR)

Total Revenue with a downward sloping demand curve

Marginal Revenue (MR)

Average Revenue (Demand) AR

Total Revenue is maximised when

MR = 0

Price elasticity of demand = 1 at

this output

Demand Curves with Different Elasticity and Total Revenue

Market A Market B

QuantityQuantity

PricePrice

Higher revenue from reducing the price from Pa to Pb (the gain in quantity sold more than offsets the lower price per unit)

Demand in segment B of the market is relatively inelastic. A higher unit price is charged and total revenue also increases

QbQa Qb

Output (Q)

Profit Maximisation and Sales Revenue Max

AR (Demand)

Profit Max at Price P1

Revenue Max at Price P2

Revenues

Output (Q)

Contestable Markets and The Conduct of Firms

AR (Monopoly)

Normal Profit output where

The Kinked Demand Curve

Assume we start out at P1 and Q1:

Will a firm benefit from raising price above P1?

Will it benefit from cutting price below P1?

Raising price above P1

Demand is relatively elastic

Firm loses market share and some total revenue

Reducing price below P1

Demand is relatively inelastic

Little gain in market share – other firms have followed suit

Total revenue may still fall

Revenues

Output (Q)

The Kinked Demand Curve – Rising MC

Revenues

Output (Q)

The Kinked Demand Curve – Rising MC

Revenues

Output (Q)

Introduction to Game Theory

Two prisoners are held in a separate room and cannot communicateThey are both suspected of a crimeThey can either confess or they can deny the crimePayoffs shown in the matrix are years in prison from their chosen course of actionDecisions made under uncertainty

Prisoner A

Confess Deny

Prisoner B

Confess (3 years, 3 years)

(1 year, 10 years)

Deny (10 years, 1 year)

(2 years, 2 years)

Introduction to Game Theory (2)

The equilibrium in the Prisoners’ Dilemma occurs when each player takes the best possible action for themselves given the action of the other playerThe dominant strategy is each prisoners’ unique best strategy regardless of the other players’ action

Best strategy? Confess?A bad outcome – prisoners could do better by both denying – but once collusion sets in, each prisoner has an incentive to cheat!

Prisoner A

Confess Deny

Prisoner B

Confess (3 years, 3 years) (1 year, 10 years)

Deny (10 years, 1 year) (2 years, 2 years)

Individual Firm Industry

Firms Output Industry Output

MC (industry)

Demand

Price Fixing Cartels

Firms Output

MC (industry)

Demand

P(cartel)

Quota IndustryOutput

P(cartel)

Firms Output

MC (industry)

Demand

P(cartel)

Quota IndustryOutput

P(cartel)

Revenues

Allocative Efficiency

Output (Q)

AR (Demand)

MC (Supply)

Consumer Surplus (CS)

Producer Surplus (PS)

Revenues

Natural Monopoly and Efficiency

Output (Q)

AR (Demand)

Long Run Marginal Cost (LRMC)

Profit Maximisation

Long Run Average Cost (LRAC)

Cost per Unit

Natural Monopoly and Efficiency

Output (Q)

Long Run Average Cost (LRAC)

Constant returns to scale

Minimum Efficient Scale

Price Discrimination (1st Degree)

Price (P)

AR (Market Demand)MR

AC = MC

Equilibrium output with perfect price discrimination – the monopolist will sell an extra unit providing that the next unit adds as much to revenue as it does to cost

Supply (Marginal Cost)

Off-Peak Demand

Peak Demand

MR Off-Peak

MR Peak

Price Off-Peak

Price Peak

Output Off-Peak Output Peak

Price (P) and Costs

Output

Peak and Off Peak Pricing

Market A Market B

QuantityQuantity

PricePrice

MRb ARb

Profit from selling to market A – with a relatively elastic demand – and charging a lower price

Demand in segment B of the market is relatively inelastic. A higher unit price is charged

Price Discrimination (1)

Perfect Competition (1)

Output (Q)Output (Q)

Market Demand and Supply Individual Firm’s Costs and Revenues

Price (P) Price (P)

Market Demand

Market Supply

AR (Demand) = MR

MC (Supply)

Perfect Competition – Sub Normal Profits

Price (P) Price (P)

Market Demand

Market Supply

AR = MR

Perfect Competition (2) Increase in Market Supply

Price (P) Price (P)

Market Demand

Market Supply

AR1 = MR1

MC (Supply)

AR2 = MR2

Comparing Monopoly with Perfect Competition

Output (Q)

Competitive Market Pure Monopoly

Price (P) Price (P)

Market Supply

Market Demand

Market Supply

Monopoly Demand

P comp

Net loss of producer surplus

Welfare Loss Under Pure Monopoly

Output (Q)

Price (P) Price (P)

Market Supply

Market Demand

Market Supply

Monopoly Demand

P comp

Net loss of consumer surplus

Net loss of producer surplus

Pure Monopoly and Scale Economies

Output (Q)

Price (P) Price (P)

Market Supply

Market Demand

Competitive Supply (MC)

Monopoly Demand

P comp

Monopoly Supply with

Scale Economies

Output (Q)

Profit Maximisation and a Rise in Demand

AR1 (Demand)

Cost per

unit in the

long run

Output (Q)

Minimum Efficient Scale (MES)

Falling LRAC – Economies of Scale (Increasing Returns to Scale)

Rising LRAC – Diseconomies of Scale (Decreasing Returns to Scale)

Costs per

unit in the

long run

Output (Q)

Minimum Efficient Scale (MES) and Market Size

MES2MES1 MES3

Benefits

Demand (Private Marginal Benefit) =

Social Marginal Benefit (SMB)

Social Equilibrium

Loss of Social Welfare from Externalities

Deadweight loss of economic welfare

Merit Goods

CostsBenefits

Quantity of Housing

Private Demand

Supply

Demand + External Benefits

External Benefit

Merit Goods and Welfare Loss

CostsBenefits

Output (Q)

PMC = SMC

External Benefit

Welfare loss where SMB>PMB above output

CostsBenefits

Output (Q)

Demand from A

Value 1

Demand from B

Value 1

Value 2

CostsBenefits

Output (Q)

Demand A

Value 1

Demand B

Value 1

Value 2

Demand A+B

Socially Efficient Provision of Public Goods

CostsBenefits

Output (Q)

Demand A Demand B

Demand A+B

CostsBenefits

Output (Q)

PMB = SMB

External Cost

Net Welfare Loss

Negative Externalities – Pollution Tax

CostsBenefits

Output (Q)

PMB = SMB

PMC + TAX

Quantity

Demand (Limited Information)

De-Merit Goods and Health Awareness

Demand (Full Information)

Quantity

Q2Q1 Q3

Supply

Macroeconomics Diagrams for IB Economics

Market interest rates e.g. savings rates & credit cards

Asset pricese.g. house prices

Expectations andConfidence

Businesses & consumers

Exchange rate

Official Interest Rate

Set by the MPC

Domestic Demand

i.e. C + I + G

Net External Demandi.e. X - M

AggregateDemand

ADDrives short-term

Economicgrowth

Domesticinflationary

Pressurei.e. changes

in the output gap(actual GDP relative

to potential GDP)

ImportPrices

Consumer Price Inflation

How interest rates affect us

Aggregate Demand and Supply Analysis

General Price Level

Real National Income

Aggregate Demand and Supply

General Price Level

National Income

General Price Level

National Income

Negative Output Gap

General Price Level

AD-AS Analysis Causes of Deflation

General Price Level

LRAS1 LRAS2

YFC2Y2

Fall in AD Rise in LRAS greater than increase in AD

General Price Level

LRAS1 LRAS2

YFC2Y2

General Price Level

National Income

An Increase in Long Run Aggregate Supply

LRAS1 LRAS2

YFC2Y1

General Price Level

An Increase in Long Run Aggregate Supply

LRAS1 LRAS2

YFC2YFC1

General Price Level

National Income

General Price Level

National Income

AD1SRAS

Shifts in Aggregate Demand

General Price Level

The Risk of Demand Pull Inflation

General Price Level

External Shock – Higher Oil Prices and a Tightening of Monetary Policy

General Price Level

National Income

Shifts in Short Run Aggregate Supply

General Price Level

National Income

An Increase in Aggregate Demand

General Price Level

National Income

A Fall in Aggregate Demand

Market interest rates e.g. savings rates & credit cards

Asset pricese.g. house prices

Expectations andConfidence

Businesses & consumers

Exchange rate

Official Interest Rate

Set by the MPC

Domestic Demand

i.e. C + I + G

Net External Demandi.e. X - M

AggregateDemand

ADDrives short-term

Economicgrowth

Domesticinflationary

Pressurei.e. changes

in the output gap(actual GDP relative

to potential GDP)

ImportPrices

Consumer Price Inflation

Short Run Phillips Curve

Wage Inflation

Unemployment Rate (%)U1

Short Run Phillips Curve

Expectations-Augmented Phillips Curve

Wage Inflation

Unemployment Rate (%)U1

Real Wage Rate

Hours of Work Supplied (LS)

Individual Labour Supply Curve

Individual Labour Supply (1)

Individual Labour Supply (2)

L1 L3 L2

The Supply of Labour

Wage Rate

Employment

Wage Rate

An Outward Shift in Labour Demand when Labour Supply is Inelastic

An Outward Shift in Labour Demand when Labour Supply is Elastic

Employment

Labour Supply (short run)

Long Run Labour Supply

The Supply of Labour

Wage Rate

Employment

Labour Supply (short run)

Long Run Labour Supply

Natural Rate of Unemployment

Real Wage Rate

Employment

Labour Supply

Labour Force

Labour Demand

Reducing the Natural Rate of Unemployment

Real Wage Rate

Employment

Labour Force

Labour Demand

Union Control of Labour Supply

Wage Rate

Employment

Labour Supply (union controlled)

Labour Demand

Wage Rate

Employment

Labour Supply (union controlled)

Labour Demand

Labour Supply to the Economy

Core Group of Workers

(Permanent Staff)

Short Term Contract Workers

Sub-Contracted

Trainees on Government Employment

Projects

Agency Staff (Temp

Workers)

Workers with Job Share

Agreements

Flexible Employment Patterns

National Minimum Wage

Wage Rate (W)

Employment of Labour (E)

Demand = MRPL

Labour Supply

Minimum Wage (Wage Floor)

Monopsony Buyer of Labour

Wage Rate

Demand = MRPL

Labour Supply (ACL)

Marginal Cost of Labour (MCL)

Monopsony Buyer of Labour

Wage Rate

Demand = MRPL

Labour Supply (ACL)

Marginal Cost of Labour (MCL)

Monopsony Buyer of Labour with a NMW

Wage Rate

Demand = MRPL

Labour Supply (ACL)

National Minimum Wage

Marginal Cost with NMW

Demand

Economic Profit (Price > AC)

Monopoly and Profit Margins

Total Cost (AC x Output)

International Trade Diagrams

Freezers FreezersPPF FOR THE UK

International Trade and Production Possibility Frontiers

PPF FOR ITALY

Dishwashers Dishwashers

500 1000

400200

Good Y Good Y

PPF FOR GERMANY

PPF FOR FRANCE

Good S Good S

Good W Good W

PPF FOR the UNITED STATES

PPF FOR CANADA

Good X Good X

Freezers Freezers

PPF FOR THE UK

PPF FOR ITALY

Dishwashers Dishwashers

500 1000

400200

Import Tariffs

Output (Q)

Domestic Demand

Domestic Supply

World Price

World Price + Tariff

Qd2Qs2

Pw + T

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