Important Diagrams To Remember: Chapter 2 Competitive Markets: Demand and Supply

Important diagrams to remember
Chapter 2 Competitive markets: demand and supply

(a) Demand of consumer A price of chocolate bars ($) (b) Demand curve of consumer B P ($) 5 4 3 2 1 0 DA 2 4 6 8 10 12 quantity of chocolate bars (per week) 5 4
demands of other consumers in the market
(c) Market demand P ($) 5 4
+
DB 2 4 6 8 10 12 quantity of chocolate bars (per week)
3 2 1 0 Dm 2 4 6 8 10 12 14 quantity of chocolate bars (thousands per week)
2
1 0
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 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
P1 P2
change in
quantity demanded decrease in D increase in D
B D D3 Q 0 D1 Q
D2
Q1
Q2
Figure 2.4 Movements along and shifts of the demand curve
Cambridge University Press 2012
Economics for the IB Diploma

(a) Supply of rm A (b) Supply of rm B (c) Market supply
price of chocolate bars ($)
P$ 5 4 3 2 1 0 200 400 600 quantity of chocolate bars (per week) SA 5 4 SB
P$ 5 Sm
+ 3
2 1 0 200 400 600 quantity of chocolate bars (per week)
supplies of other firms in the market
= 3
2 1 0 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
(b) A shift of the supply curve, caused by a change in a determinant of supply, is called a change in supply
P P2 P1 A B
S
change in quantity supplied
S3
decrease in supply
S1
increase in supply
S2
P1
Q1
Q2
Q3
Q1
Q2
Figure 2.8 Movements along and shifts of the supply curve
price of chocolate bars ($)
5 4 3 2 1 0
equilibrium price
S
surplus
market equilibrium
shortage
D
equilibrium quantity
2 4 6 8 10 12 quantity of chocolate bars (thousands per week)
14
Figure 2.9 Market equilibrium

(a) Increase in demand P P2 P1 a
initial equilibrium
(b) Decrease in demand S c

final equilibrium
P P1 P3
final equilibrium
S a
initial equilibrium
b c D3
b D2 D1
D1
Q1
Q2
Q3
Q1
Figure 2.10 Changes in demand and the new equilibrium price and quantity
(a) Increase in supply

initial equilibrium
(b) Decrease in supply S1 b c S2 P P3 P1 b c a

final equilibrium
S3 S1
P P1 P2 a
final equilibrium
initial equilibrium
D 0 Q1 Q2 Q 0 Q3 Q1
D Q
Figure 2.11 Changes in supply and the new equilibrium price and quantity
(a) Adjustment of price to increased demand P P2 P1 A C B D2 D1 0 Q1 Q3

shortage = excess demand
P1 P2 P3 consumer surplus Pe producer surplus P4 P5 P6 0 Qa Qb Qe
S = MC Allocative efficiency: at market equilibrium MB = MC and social surplus is maximum D = MB Q
Q2 Q
Figure 2.16 Price as a signal and incentive
Figure 2.17 Consumer and producer surplus in a competitive market

Higher level topic P ($)
5 Qd = 14 2P
P ($)
Qd = 19 2P 5 4 Qd = 14 2P Qd = 14 4P
absolute value of b increases
4 Qd = 10 2P 3 2 1 0
a decreases
a increases
3 2 1
2 4 6 8 10 12 14 16 18 20 quantity of chocolate bars (thousands per week)
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 )
Figure 2.13 Changing the slope of the demand curve (changes in b in the function Qd = a bP )
P ($)
5 4 3 2 1
Qs = 1 + 2P
Qs = 2 + 2P Qs = 6 + 2P
P($) 5 4
Qs = 2 + 2P Qs = 2 + 4P
c decreases
c increases
3 2 1
value of d increases
Figure 2.14 Shifts of the supply curve (changes in c in the supply function Qs = c + dP )
Figure 2.15 Changing the slope of the supply curve (changes in d in the function Qs = c + dP )
Chapter 3 Elasticities
(a) Price inelastic demand: 0 < PED <1 Frequently encountered cases (b) Price elastic demand: 1 < PED <
P 5% P2 10% P1 D 0 Q2 Q1 5%
(c) Unit elastic demand: PED = 1
P P2 P1
D Q
Special cases (d) Perfectly inelastic demand: PED = 0
Q2 Q1 10%
(e) Pefectly elastic demand: PED =
P2 5% P1 D Q2 Q1 5%
Figure 3.1 Demand curves and PED
P1
Q1
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

(a) PED > 1 (elastic demand) (b) PED < 1 (inelastic demand) (c) PED = 1 (unit elastic demand)
P P2 P1 C A B 0 Q2 Q1 Q D PED > 1 PED = 1 PED < 1
P PED > 1 PED = 1 P2 P1 0 C A B Q2 Q1 Q PED < 1 D
P2 P1 0
C A Q2 B Q1 Q D
Figure 3.5 PED and total revenue
(a) Primary commodities: supply shifts with inelastic demand
(b) Manufactured products: supply shifts with elastic demand
S2 P P2 P1 P3 D 0 Q2 Q1 Q3 Q 0 Q2 Q1 Q3 S1 S3 P P2 P1 P3
S2 S1 S3
D Q
Figure 3.6 Price uctuations are larger for primary commodities because of low PED
(a) Inelastic demand
(b) Elastic demand
final equilibrium
S2
tax per unit
P S1 Pt P1
final equilibrium tax per unit
S2 S1
Pt P1
initial equilibrium
initial equilibrium
D 0 Qt Q 0 Qt
D Q
Figure 3.7 PED, indirect taxes and government tax revenue

(a) Substitutes and positive XED : demand for Pepsi
S YED < 0 0 < YED < 1 YED > 1

inferior good income inelastic demand, normal good income elastic demand, normal good
D2 D3 D1 Q
D increases as price of Coca-Cola increases
D decreases as price of Coca-Cola decreases
D2
D1
D3
D4 Q
Figure 3.9 Demand curve shifts in response to increases in income for different YEDs (b) Complements and XED : demand for tennis balls
D2 D1 D3 D decreases as price of tennis rackets increases 0

Figure 3.8 Cross-price elasticities
D increases as price of tennis rackets decreases
(a) Price inelastic supply: PES < 1
Frequently encountered cases
(b) Price elastic supply: PES > 1
P P2 P1 0
P S 10% P2 P1 0
Special cases (d) Perfectly inelastic supply: PES = 0
10%
Q1 Q2 5%
Q1 15%
Q2
(c) Unit elastic supply: PES = 1
(e) Perfectly elastic supply: PES =
S1 S2 S3
P1 Q 0 Q1 Q 0
S Q
0
Figure 3.11 Supply curves and PES

(a) Primary commodities: demand shifts with inelastic supply (b) Manufactured products: demand shifts with elastic supply
P P2 P1 P3 D3 D1
P P2 P1 P3 D3 D1 Q S D2
D2 Q
Figure 3.13 Price uctuations are larger for primary commodities because of low PES
Chapter 4 Government intervention

(a) Specic tax P S2 (= S1 + tax) tax per S 1 unit (a) Market outcomes: specic tax
P government revenue S2 (= S1 + tax) tax per unit S1
Pc P* Pp 0
Q t Q*
D Q
(b) Ad valorem tax P S2 (= S1 + tax) tax per unit tax per unit 0 Q S1
(b) Market outcomes: ad valorem tax

P government revenue S2 = S1 + tax tax per unit S
Pc P* PP 0
D Qt Q* Q
Figure 4.1 Supply curve shifts due to indirect (excise) taxes
Figure 4.2 Impacts of specic and ad valorem taxes on market outcomes
P Pp P* Pc
S1
subsidy per unit
S2 = S1 subsidy
D 0 Q* Qsb Q
Figure 4.8 Impacts of subsidies on market outcomes

P
S
welfare loss a Pe
shortage = excess demand
Pe Pc D Q
0 Pc
S = MC
c e
b d D = MB Qs Qe Qd Q
Qs
Qe
Qd
Figure 4.12 Price ceiling (maximum price) and market outcomes
Figure 4.13 Welfare impacts of a price ceiling (maximum price)
P Pf Pe
excess supply = surplus
P Pf Pe
excess supply = surplus
D+ government purchases
D 0 Qd Qe Qs Q 0 Qd Qe Qs
D
Q
Figure 4.15 Price oor (minimum price) and market outcomes
Figure 4.16 An agricultural product market with price oor and government purchases of the surplus
P a Pf Pe b d
excess supply = surplus S = MC f D+ government purchases D = MB
c e
welfare loss
Qd
Qe
Qs
Figure 4.17 Welfare impacts of a price oor (minimum price) for agricultural products and government purchases of the surplus
10

P
supply of labour
price of labour (wage)
excess supply of labour = labour surplus = unemployment
Wm We
Wm We
demand for labour
a b d
welfare loss c e
Qd Qe Qs quantity of labour
Q
0 Qd Qe Qs
D Q
Figure 4.19 Labour market with minimum wage (price oor)
Figure 4.20 Welfare impacts of a minimum wage
Higher level topics
(a) Inelastic demand P S2 = S1 + tax

tax per unit
(a) Inelastic supply P S2 = S1 + tax S1

tax per unit
Pc P* Pp
consumers producers
S1
Pc P* Pp Q 0
consumers producers
D 0 Qt Q*
Qt Q*
(b) Elastic demand P S2 = S1 + tax

tax per unit
(b) Elastic supply P
S1
S2 = S1 + tax Pc P* Pp D 0
consumers producers tax per unit
Pc P* Pp 0
consumers producers
S1
Qt
Q*
Qt
Q*
D Q
Figure 4.6 Incidence of an indirect tax with inelastic and elastic demand
Figure 4.7 Incidence of an indirect tax with inelastic and elastic supply
11

P P S2 = S1 + tax
consumer surplus after the tax
S = MC consumer surplus producer surplus D = MB 0 Pc P* Pp
tax per unit

a b
S1 = MC
P*
government revenue from the tax

producer surplus after the tax
welfare loss = a + b
D = MB Qt Q* Q
(a) Consumer and producer surplus in a competitive free market: maximum social surplus
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 consumer surplus producer surplus D = MB 0 Q* Q
P*
gain in producer P * surplus gain in consumer surplus Pc
Pp
subsidy per unit S2 = S1 subsidy welfare loss
D = MB 0 Q* Qsb Q
Figure 4.10 Effects of subsidies on consumer and producer surplus
12
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 efciency with no externalities
P Popt Pm
MSC
external cost
(a) Welfare loss
S = MPC
P Popt Pm
MSC
external cost S = MPC
welfare loss D = MPB = MSB
Qopt Qm
D = MPB = MSB Q
Qopt Qm
Figure 5.2 Negative production externality
Figure 5.3 Welfare loss (deadweight loss) in a negative production externality
P Popt Pm
MSC S = MPC
Qopt Qm
D = MPB = MSB Q
Figure 5.4 Government regulations to correct negative production externalities
13

(a) Imposing an indirect tax on output or on pollutants
P Pc = Popt Pm Pp D = MPB = MSB 0 Qopt Qm Q 0 Qopt1 Qopt2 Qm MSC = MPC + tax tax = external cost S = MPC Pm
(b) Effects on external costs of a tax on emissions (carbon tax)

P MSC1 = MPC + tax MSC2 S = MPC
(c) Tradable permits
P P2 P1
S of tradable permits
D2 D1
D = MPB = MSC Q
Q1
Figure 5.5 Market-based policies to correct negative production externalities
P Pm Popt
(a) Welfare loss S = MPC = MSC D = MPB

external cost
P
welfare loss
S = MPC = MSC
external cost
Pm Popt
D = MPB Qopt Qm MSB Q
MSB Qopt Qm Q
Figure 5.6 Negative consumption externality
Figure 5.7 Welfare loss (deadweight loss) in a negative consumption externality
(a) Government regulations and advertising P

external cost
(b) Market-based: imposing an indirect tax P MPC + tax

tax = external cost
S = MPC = MSC Pm Popt 0 Qopt Qm D1 = MPB

D2 = MSB after demand decreases
Pc Pm Pp
S = MPC = MSC D = MPB MSB
Qopt
Qm
Figure 5.8 Correcting negative consumption externalities
14

(a) Welfare loss
P Pm Popt
S = MPC
external benefits
P S = MPC external benefits MSC
MSC
Pm Popt
welfare loss
Qm Qopt
D = MPB = MSB Q
0 Qm Qopt
D = MPB = MSB Q
Figure 5.9 Positive production externality
Figure 5.10 Welfare loss (deadweight loss) in a positive production externality
(a) Direct government provision
(b) Granting a subsidy
P Pm Popt
S = MPC
spillover benefit
S = MPC
subsidy = spillover benefit
MSC
Pm Popt
MSC
Qm Qopt
D = MPB Q
Qm Qopt
D = MPB Q
Figure 5.11 Correcting positive production externalities
15

P S = MPC = MSC Popt Pm MSB
external benefit
welfare loss Popt Pm
S = MPC = MSC
Qm Qopt
D = MPB Q
external benefits MSB D = MPB Q
Figure 5.12 Positive consumption externality

0 Qm Qopt
(a) Legislation or advertising P Popt Pm D2 = MSB

external benefit
Figure 5.13 Welfare loss (deadweight loss) in a positive consumption externality S = MPC = MSC
D1 = MPB 0 Qm Qopt Q
(b) Direct government provision P S = MPC = MSC S + government provision Pm Pc D = MPB 0 Qm Qopt Q MSB
(c) Granting a subsidy P S = MPC = MSC

subsidy = external benefit
MPC subsidy
Pm Pc D = MPB 0 Qm Qopt Q MSB
Figure 5.14 Correcting positive consumption externalities
16
Chapter 6 The theory of the rm I: Production, costs, revenues and prot

Higher level topics (c) Total product curve
units of output
TP
(c) Total cost, total variable cost and total xed cost curves
TC 0 units of variable input (labour) TVC
units of output
costs
TFC 0 AP output, Q
MP units of variable input (labour)
MC
(d) Marginal and average product curves Figure 6.1 Total, marginal and average products
ATC costs AVC
units of output (AP, MP)
AP 0 MP units of variable input (labour)
AFC 0 output, Q
(d) Average cost and marginal cost curves Figure 6.2 Total, average and marginal cost curves
costs (AVC, MC)
MC AVC
output, Q
Figure 6.3 Product curves and cost curves are mirror images due to the law of diminishing returns
17

(b) Long-run average total cost curve in relation to short-run average total cost curves (c) Economies and diseconomies of scale
a costs
SRATC2
SRATCm
costs
SRATC1
LRATC
economies of scale
diseconomies of scale
LRATC
0 0 Q1 Q2
output, Q
output, Q
Figure 6.5 The long-run average total cost curve
(a) Prot-maximising rm produces at Q2 and makes economic prot: TR TC = c d
(b) Prot-maximising rm produces at Q2 and makes zero economic prot: TR TC = 0 (it earns normal prot)
(c) The loss-minimising rm produces at Q2 (if it produces) and makes a loss = TC TR = a b (negative economic prot since TR < TC )
costs, revenues
a b
c d
e f
costs, revenues
TR a
costs, revenues
TC TR
TC
TC a b TR
Q1 Q2 Q3
Q1 Q2 Q3 Q
Q1
Q2 Q3
Figure 6.10 Prot maximisation using the total revenue and total cost approach when the rm has no control over price
(a) Prot maximisation
(b) Loss minimisation
TC, TR
TC b TR a
TC, TR
TC
TR Q Q
max
Q1min
Figure 6.11 Prot maximisation using the total revenue and total cost approach when the rm has control over price
18
Chapter 7 The theory of the rm II: Market structures

Higher level topic
P S
Pe
Pe
D 0 (a) Individual rm
Figure 7.1
0 (b) Market/industry
Market (industry) demand and supply determine demand faced by the perfectly competitive rm
TR 70 60 50 40 30 20 10 0
P, MR, AR TR 40 30 20 10 1 2 3 4 5 6 7 Q 0 D = P = MR = AR 1 2 3 4 5 6 7 Q
(a) Total revenue

Figure 7.2 Revenue curves under perfect competition
(b) Marginal and average revenue
price, revenue, costs 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 P1 P2 P3 P4 P5 0 4 5 Q5 Q4 Q3 Q2 Q1 output, Q 3 2 1
ATC MC AVC
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
Figure 7.4 Summary of the perfectly competitive rms short-run decisions, and the rms short-run supply curve
19

(a) Economic prot price, revenue, costs MC P1
total profit
(b) Zero economic prot (normal prot) price, revenue, costs ATC AVC P1 = MR1 = AR1 = D1
profit
a b Q1
MC
ATC
AVC
P2 Q2
P2 = MR2 = AR2 = D2 = break-even price (break-even point) Q
(c) Economic loss: the rm continues to produce price, revenue, costs MC c

total loss
(d) Loss in the short run and the shut-down price price, revenue, costs MC e
total loss
ATC
AVC
ATC
AVC
P3 0
d Q3
P3 = MR3 = AR3 = D3
loss Q
P4 0
f Q4
loss = AFC Q
P4 = MR4 = AR4 = D4 = short-run shut-down price Q
(e) The loss-making rm that will not produce price, revenue, costs MC g P5 0 ATC
AVC
Q5
P5 = MR5 = AR5 = D5 Q
Figure 7.3 Short-run equilibrium positions of the perfectly competitive rm
(a) The rm MC SRATC Pe
(b) The industry P
price, costs, revenue
LRATC D = MR Pe
D 0 Qf Q 0 Qi Q
Figure 7.5 The rm and industry long-run equilibrium position in perfect competition
20

From economic (supernormal) prot to normal prot
(a) The rm
costs, revenue, P MC P1 P2 a b ATC
(b) The industry

P S1 1 2 D Q1 Q2 Q S2
P1 P2
Q2 Q1
From loss to normal prot
(c) The rm
costs, revenue, P MC P1 P2 a ATC
(d) The industry

P S2 P2 P1 2 1 D S1
b Q1 Q2 Q
Q2
Q1
Figure 7.6 From short-run equilibrium to long-run equilibrium
costs, revenue, P
MC ATC Pe P = MR = Pe
P S = MC Pe
consumer surplus producer surplus
0 (a) The rm
Qe
Qe (b) The market/industry
D = MB Q
Figure 7.7 Productive and allocative efciency in perfect competition in the long run
21

(a) Total revenue 40 35 30 25 20 15 10 5 0 (a) price, costs, revenue MC Pe
profit
total revenue ( )
a
b
ATC
TR
0 1 2 3 4 5 6 7 8 9 10 11 Q (b) price, costs, revenue
MR
max
D = AR Q
MC Pe loss c d ATC
(b) Marginal and average revenue 15

price, revenue ( )
PED > 1 (price-elastic demand) PED = 1 (unit elastic demand) PED < 1 (price-inelastic demand)
10 5
MR Qlmin
D = AR Q
P = AR = D 0 -5 MR 1 2 3 4 5 6 7 8 9 10 11 Q
Figure 7.11 Prot maximisation and loss minimisation in monopoly: marginal revenue and cost approach
Figure 7.10 Revenue curves in monopoly
MC
costs
P Pr
LRATC D
D = AR 0 Q Qr MR Q
0 minimum efficient scale
Figure 7.12 Comparison of prot maximisation and revenue maximisation by the monopolist
Figure 7.13 Natural monopoly
22

(a) Industry in perfect competition S = MC price, costs, revenue price, costs, revenue Pm Ppc b a (b) Monopoly MC
Ppc
P = MRpc
D = MB 0 Qpc Q
D = MB 0 Qm MRm Qpc Q
Figure 7.14 Higher price, lower output by the rm in monopoly
(a) Perfect competition P

A consumer surplus producer surplus B
(b) Monopoly S = MC P Pm C E F
producer surplus consumer surplus
MC
Ppc
welfare (deadweight) loss
D D = MB
D = MB Q
Qpc
Qm
Qpc MRm
Figure 7.15 Consumer and producer surplus and welfare (deadweight) loss in monopoly compared with perfect competition
(a) Perfectly competitive rm
(b) Monopoly
price, costs
MC Pe
ATC
MC Pe
ATC
D 0 Q MR at long-run equilibrium production takes place at greater than min ATC (productive inefficiency), and Pe > MC (allocative inefficiency) Qm
Qpe
at long-run equilibrium production takes place at min ATC (productive efficiency), and Pe = MC (allocative efficiency)
Figure 7.16 Allocative and productive inefciency in perfect competition and monopoly
23

(a) Economic prot
economic (supernormal) profit MC Pe ATC D = AR 0 Qe MR Q
(b) Normal prot
(c) Losses
losses Pe MC ATC
MC Pe
ATC
D = AR 0 Qe MR Q
D = AR 0 Qe MR Q
Figure 7.21 Short-run equilibrium positions of the rm in monopolistic competition
Intergalactic Space Travels price High price Low price
MC Pe ATC
Universal Space Lines price Low price High price
40 million Zs 40 million Zs 10 million Zs
70 million Zs
4 10 million Zs
2 20 million Zs
D = AR 0 Qe Qc MR Q
70 million Zs
20 million Zs
Figure 7.22 Long-run equilibrium of the rm in monopolistic competition
Figure 7.23 Game theory: the prisoners dilemma
P price, costs, revenue MC Pe

profit
a
b
P1 ATC
MC1 MC2
MR
max
D = AR Q 0 Q1
D Q MR
Figure 7.24 Prot maximisation by a price-xing cartel
Figure 7.25 The kinked demand curve
24

P P1 P P MC
P2 D2 D1 MR = MR1 + MR2 Q3 Q
Q1
MR1
Q2
MR2 Q
(a) Market 1
Figure 7.26 Third-degree price discrimination
(b) Market 2
(c) Market 1 and market 2
25
Chapter 8 The level of overall economic activity

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
land , la bo
ur ,
ip rsh eu
uc
ho
n tio
households (consumers)
in (
firms (businesses)
go o
ou pe sehol d nd itur e
ds
an ds erv
product markets
ices
ds goo
ic rv se d n a
Figure 8.1 Circular ow of income model in a closed economy with no government
factor incomes
households (consumers)
(wages, rents, interest, profit)
es
s nue reve
ex
firms (businesses)
consumer expenditure
(spending on goods and services)
tax es
ni mp
ng o
government
ern gov
me
or t
other countries
Figure 8.3 Circular ow of income model with leakages and injections
nt spe di ng ndi ng on e xp orts

en sp
savi
ng
financial markets
t en st m inve
di en sp
26

real GDP actually achieved peak contraction real GDP expansion peak trough trough long term growth trend, or potential GDP
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
d real GDP b a e
c
long term growth trend, or potential GDP = full employment GDP; unemployment = natural rate of unemployment
actual GDP < potential GDP; there is an output gap: unemployment > natural rate of unemployment
0 time (years)
Figure 8.5 Illustrating actual output, potential output and unemployment in the business cycle
27
Chapter 9 Aggregate demand and aggregate supply

(a) The aggregate demand curve (a) The upward-sloping SRAS curve
SRAS price level price level AD 0 real GDP 0 real GDP

(b) Shifts in the SRAS curve
(b) Shifts in the aggregate demand curve
price level
AD3 0 real GDP
AD1
AD2 0 real GDP
Figure 9.1 The aggregate demand (AD) curve
Figure 9.2 The short-run aggregate supply curve (SRAS )
(a) The economy with a deationary (recessionary) gap
price level
SRAS3 SRAS 1 SRAS 2
(b) The economy with an inationary gap
(c) The economy at the full employment level of output
SRAS
price level
price level
Ple
AD
Ple
AD
price level
SRAS
SRAS
Ple
AD
Ye Yp real GDP
Yp
Ye
Yp = Ye real GDP
real GDP
Figure 9.4 Three short-run equilibrium states of the economy
28

(a) Changes in aggregate demand
SRAS
(b) Changes in short-run aggregate supply

SRAS3
SRAS1
price level
Pl2 Pl1 Pl3

AD3 AD2 AD1
price level
Pl3 Pl1 Pl2

AD
SRAS2
Y3 Y1 Y2 real GDP
Y3 Y1 Y2 real GDP
Figure 9.5 Impacts of changes in short-run macroeconomic equilibrium
(a) Changes in aggregate demand

LRAS SRAS
(b) Changes in short-run aggregate supply

LRAS SRAS2 SRAS1 SRAS3
price level
Pl1 Pl2 AD2
price level
Pl3 AD3 AD1
Pl2 Pl1 Pl3
AD real GDP inflationary gap
Yrec Yp Yinfl
0
recession with inflation ('stagflation')
Y2 Yp Y3
real GDP
recessionary (deflationary) gap
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
29

(a) Creating and eliminating a deationary gap
LRAS SRAS1
(b) Creating and eliminating an inationary gap

LRAS SRAS1 SRAS2
price level
Pl1 Pl2 Pl3 0 Yrec Yp b
price level
a c
SRAS2
Pl3 Pl2 Pl1
c a
b
AD1
AD1 AD2
real GDP
Yp Yinfl real GDP
AD2
Figure 9.8 Returning to long-run full employment equilibrium in the monetarist/new classical model
LRAS SRAS1 Keynesian AS
price level
price level
Pl1 Pl2
AD1 SRAS2 AD2
section III
section II section I
Yp
real GDP
Yp Ymax
real GDP
Figure 9.9 Changes in long-run equilibrium in the monetarist/new classical AD-AS model
Figure 9.11 The Keynesian aggregate supply curve
(a) Recessionary (deationary) gap

Keynesian AS
(b) Inationary gap

Keynesian AS
(c) Full employment equilibrium

Keynesian AS
price level
price level
Ye real GDP
AD
AD
price level
AD
Yp
Yp Ye real GDP
Yp = Ye real GDP
Figure 9.12 Three equilibrium states of the economy in the Keynesian model
30

(a) The monetarist/new classical model
LRAS
(b) The Keynesian model

Keynesian AS
price level
Pl2 Pl3
AD1
AD3 AD2
price level
Pl1
AD1
AD2 Y2
AD3
AD4
Yp
real GDP
Y1
Y3 Yp real GDP
Figure 9.13 Effects of increases in aggregate demand on real GDP and the price level

LRAS1 LRAS2

AS1 AS2
price level
Yp1
Yp2 real GDP
price level 0
Yp1
Yp2 real GDP
Figure 9.14 Increasing potential output, shifts in aggregate supply curves and long-term economic growth
LRAS1 price level SRAS1 Pl1 AD1 0 Y1 real GDP
LRAS2 price level SRAS2
AS1
AS2
AD2 Y2 0 Y1 real GDP
AD1
AD2
Y2
Figure 9.15 Long-term economic growth: achieving potential (full employment) output in a growing economy
31

Higher level topic
Keynesian AS
price level
autonomous spending $8 million
induced spending $24 million
Pl3 price level
Pl2 Pl1
AD1 AD2 AD3 AD4
AD1
AD2
$32 million
AD3
Y1
Y2 real GDP
Y3
Y1
Y2 real GDP
Y3
Figure 9.17 Aggregate demand, real GDP and the multiplier in the Keynesian model
Figure 9.18 How the effect of the multiplier changes depending on the price level
32
Chapter 10 Macroeconomic objectives I: Low unemployment, low and stable rate of ination
P S price P1 P2 price P2 P1 D P S2
price of labour (wage) P
S1
labour surplus = unemployment
supply of labour
Wm We demand for labour Q
D1 D2
Q2
Q1
Q2
Q1
(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 re workers with inappropriate skills or local workers no longer needed due to relocation Figure 10.1 Structural unemployment
(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
Qd Qe Qs quantity of labour
(c) Minimum wage legislation and labour union activities lead to higher than equilibrium wages and lower quantity of labour demanded

LRAS

Keynesian AS
price level
Pl1 Pl2
price level
SRAS
AD1 AD2
Pl1 Pl2
AD2
AD1
Yrec Yp real GDP
Yrec
Yp
real GDP
Figure 10.2 Cyclical unemployment (a) The monetarist/new classical model

LRAS SRAS

AS
LRAS
SRAS2
price level
price level
price level
Pl2
AD2 AD1
Pl2 Pl1 AD2 AD1 Yp Yinfl real GDP
Pl2 Pl1
SRAS1
Pl1
AD1
Yp
Yinfl
Yrec
Yp
real GDP Figure 10.4 Demand-pull ination
real GDP Figure 10.5 Cost-push ination
33

Higher level topic
(a) The shifting Phillips curve
(b) The reasoning behind SRAS shifts in terms of the AD-AS model
SRAS3
rate of inflation
c PC3 PC2 PC1 unemployment rate a b
price level
Pl3 Pl2 Pl1
c b a
SRAS2 SRAS1
AD 0 Y3 Y2 Y1 real GDP
Figure 10.7 Stagation: outward shifts of the short-run Phillips curve due to decreasing SRAS
(a) The shape of the LRPC and SRPC

LRPC
(b) The reasoning behind the two curves in terms of the AD-AS model
LRAS SRAS2
rate of inflation
9% 7% 5% 0
c b a
SRPC2 SRPC1
price level
Pl3 Pl2 Pl1 0
c a
b SRAS1
AD2 AD1
3% 5% unemployment rate 5% = natural rate of unemployment
Yp Yinfl real GDP
Figure 10.8 The short-run and long-run Phillips curves
34
Chapter 11 Macroeconomic objectives II: Economic growth and equity in the distribution of income
(a) Economic growth as an increase in actual output caused by reductions in unemployment and productive inefciency
cumulative percentage of income
Y
100
80 perfect income equality h
60
B A 0
40 f 20 e a 0 b
g Belarus
(b) Economic growth as an increase in production possibilities caused by increases in resource quantities or improvements in resource quality
Y
c
Bolivia 100
40 80 20 60 cumulative percentage of population
C B A
Figure 11.3 Lorenz curves: Belarus achieves greater income equality than Bolivia
100
0 PPC1 PPC2 PPC3 X
cumulative percentage of income
80
Figure 11.1 Using the production possibilities model to illustrate economic growth
perfect income equality
60
increased income equality after redistribution
40
20
before redistribution
40 80 20 60 cumulative percentage of population Lorenz curves and income redistribution
100
Figure 11.4
35
Chapter 12 Demand-side and supply-side policies

LRAS

LRAS
price level
price level
Pl2 Pl1
SRAS
SRAS
AD2 AD1
Pl1 Pl2
AD1 AD2
Yrec Yp
real GDP
Yp Yinfl real GDP

potential output
(b) The Keynesian model (b) The Keynesian model

AS Keynesian AS
price level
price level
Pl2 Pl1
AD1
Pl1 Pl2
AD2
AD1 AD2
Yp Yinfl real GDP

potential output
Yrec
Yp real GDP
Figure 12.1 Effects of expansionary policy: eliminating a recessionary (deationary) gap
Figure 12.2 Effects of contractionary policy: eliminating an inationary gap
(a)
Partial crowding out
(b)
Complete crowding out
price level
price level
due to G
SRAS
SRAS
due to G
due to I
AD2
AD1
AD3
due to I
AD2
AD1 0 Y1 Y2 real GDP
Y1 Y3 real GDP
Y2
Figure 12.3 Crowding out of private investment
36

(a) Equilibrium rate of interest Sm rate of interest rate of interest i3 i1 i2 0 Q3 Q1 Q2 quantity of money Dm (b) Changes in the supply of money cause changes in the equilibrium rate of interest Sm3 Sm1 Sm2
i Dm 0 Qe quantity of money
Figure 12.4 The money market and determination of the rate of interest
37
Chapter 13 International trade

(a) Country A: absolute advantage in good Y; Country B: absolute advantage in good X
good Y
(b) Country A: comparative advantage in good Y; Country B: comparative advantage in good X

good Y
good Y
country As PPC country Bs PPC good X
0 country A country B 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 Production possibilities when each country produces only cotton or only microchips (1) Cotton Cottonia Microchippia 20 25 or or (2) Microchips 10 50 Opportunity cost of cotton Opportunity cost of microchips
(3) 10 units of microchips 1 = 20 units of cotton 2 50 units of microchips =2 25 units of cotton
(4) 20 units of cotton =2 10 units of microchips 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 20 cotton 15 10 5 0
Cottonias PPC Microchippias PPC cotton
20 A production 15 10 5 0 10 20 30 40 50 microchips B consumption
10 20 30 40 50 60 microchips
(b) Microchippia exports 10 units of microchips and imports 10 units of cotton

25
Figure 13.2 Comparative advantage

cotton
20 15 10 5 C production 0 10 20 30 40 50 microchips D consumption
Figure 13.4 The gains from specialisation and trade based on comparative advantage: both countries consume outside their PPC
38

(a) Effects on imports (a) Effects on imports
P
Sd =
domestic supply government revenue world price + tariff
Sd = domestic supply
quota revenue quota
P Pd Pw + t Pw 0 Q1 Q2 Q3
Sdq = domestic supply

plus quota
Pq Pw 0
tariff
world price = world supply curve
Q4
Dd = domestic demand
Q1
Q2
Q3
Q4
imports with tariff imports without tariff
imports with quota imports without quota
(b) Welfare effects
(b) Welfare effects
Sd =
domestic supply welfare loss = d + f
P a Pq Pw g 0 b c d e e f
quota
Sd = domestic supply Sdq = domestic supply

plus quota welfare loss = d + e + f world price = world supply curve
Pw + t Pw g 0
a c d
b e
world price + tariff
tariff
Q1
Q2
Q3
Q4
imports with tariff imports without tariff
Q1
Q2
Q3
Q4
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
P Ps Pw
Sd = domestic supply Sds = domestic

subsidy
supply minus subsidy
Dd = domestic demand 0 Q1 Q3 Q2 Q
imports after subsidy imports before subsidy
Figure 13.11 Production subsidies
39
Chapter 14 Exchange rates and the balance of payments

(a) The market for US dollars per $ = price of $ in terms of S of $ (a) Demand for $ increases: $ appreciates
per $ = price of $ in terms of
excess supply of $
(dollars)
S of $ 0.90 0.67 A C B D2 for $
0.80 0.67 0.50

excess demand for $ equilibrium exchange rate
D for $
(dollars)
D1 for $ 0 Q of $ (dollars)
Q of $ (dollars)
(b) The market for euros $ per = price of in terms of $ S of
(b) Supply of increases: depreciates
$ per = price of in terms of $
excess supply of
(euros)
S1 of D E F D for 0 Q of (euros) S2 of
2.00 1.50 1.25

excess demand for equilibrium exchange rate
1.50 1.11
D for
(euros)
Q of (euros)
Figure 14.1 Exchange rate determination in a freely oating exchange rate system
Figure 14.2 Exchange rate changes in a freely oating exchange rate system
(a) Shifting the currency demand curve

$ per bople = price of boples in terms of $
(b) Shifting the currency supply curve

$ per bople = price of boples in terms of $
S of boples
2. central bank buys excess boples, increasing demand for boples
S2 B A
S1 of boples
2. imports are reduced, therefore the supply of boples falls 1. fall in demand for Bopland's exports reduces demand for bople
2.00 1.50
B C
A
1. fall in demand for Bopland's exports reduces demand for boples
2.00
D2 for boples 0 Q of boples
D1 for boples
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
40

(a) With a trade decit, country consumes outside its PPC
C good A
PPC
good B
(b) With a trade surplus, country consumes inside its PPC
good A
D PPC
good B
Figure 14.6 Using a PPC to illustrate a trade decit and a trade surplus
41
Chapter 15 Economic integration and the terms of trade

Higher level topic (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
global price of internationally traded good
P2 P1 P3 D3 0 Q3 Q1 Q2
S global supply of wheat D2 global demand D1 for wheat
global price of internationally traded good
S3 P3 P1 P2
S1 global supply S2 global demand D
Q3 Q1
Q2
quantity of internationally traded good
quantity of internationally traded good
Figure 15.1 Changes in global demand or supply: terms of trade impacts on the balance of trade
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)
42
Chapter 16 Understanding economic development

AB: no economic growth with some development BC: economic growth with no development BD or E: economic growth with development
industrial goods
C A B PPC1 PPC2 D E
merit goods
Figure 16.1 Economic growth and economic development
low income
low savings
low investment
low physical capital
low human capital
low natural capital
low growth in income
low productivity of labour and land
Figure 16.2 The poverty cycle (poverty trap)
43

Important Diagrams To Remember: Chapter 2 Competitive Markets: Demand and Supply

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Important Diagrams To Remember: Chapter 2 Competitive Markets: Demand and Supply

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Important diagrams to remember

Chapter 2 Competitive markets: demand and supply

(c) Market demand P ($) 5 4

3 2 1 0 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

Figure 2.4 Movements along and shifts of the demand curve

Cambridge University Press 2012

Economics for the IB Diploma