chapter 2 competitive markets: demand and supply · chapter 2 competitive markets: demand and...

© Cambridge University Press 2012 Economics for the IB Diploma 1

Important diagrams to rememberChapter 2 Competitive markets: demand and supply

0

1

2

3

4

5

2 4 6 8 10 12quantity of chocolate

bars (per week)

pric

e of

cho

cola

te b

ars

($)

DA

0

1

2

3

4

5


bars (per week)

DB

+ +

demandsof other

consumersin the

market

0

1

2

3

4

5

2 4 6 8 10 12 14quantity of chocolate bars

(thousands per week)

Dm

=

P ($) P ($)

(a) Demand of consumer A (b) Demand curve of consumer B (c) Market demand

Figure 2.2 Market demand as the sum of individual demands

Figure 2.4 Movements along and shifts of the demand curve

P

P1

0

P2

Q1 Q2 Q

A

B

D

change in quantity demanded

(a) A movement along the demand curve, caused by a change in price, is called a ‘change in quantity demanded’

P

0 Q

D3 D1

D2

change in demand

decreasein D

increasein D

(b) A shift of a demand curve, caused by a change in a determinant of demand, is called a ‘change in demand’


Important diagrams to remember

Figure 2.9 Market equilibrium

0

1

2

3

4

5

2 4 6 8 10 12 14quantity of chocolate bars

(thousands per week)

pric

e of

cho

cola

te b

ars

($)

equilibriumprice market equilibrium

surplus

equilibrium quantity

S

Dshortage

Figure 2.6 Market supply as the sum of individual supplies

0

1

2

3

4

5

200 400 600quantity of chocolate

bars (per week)

pric

e of

cho

cola

te b

ars

($)

SA

0

1

2

3

4

5

200 400 600quantity of chocolate

bars (per week)

SB

+ +suppliesof otherfirms in

the market

0

1

2

3

4

5


bars (thousands per week)

Sm

=

P$ P$

(a) Supply of fi rm A (b) Supply of fi rm B (c) Market supply

Figure 2.8 Movements along and shifts of the supply curve

0

P1

P

Q1 Q2 Q

S

A

BP2change inquantitysupplied

(a) A movement along the supply curve, caused by a change in price, is called a ‘change in quantity suppied’

0

P1

P

Q3 Q1 Q2 Q

S3 S1S2

decreasein supply

increasein supply

(b) A shift of the supply curve, caused by a change in a determinant of supply, is called a ‘change in supply’



(a) Increase in demand (b) Decrease in demand

0

a

a

b

c

c

bP1

P

Q1 Q2 Q

P2

S

D2

D1

initialequilibrium

finalequilibrium

0

P3

P

Q3 Q1 Q

P1

S

D1

D3

finalequilibrium

initialequilibrium

Figure 2.10 Changes in demand and the new equilibrium price and quantity

Figure 2.11 Changes in supply and the new equilibrium price and quantity

0

P1

P

Q1 Q2 Q

P2

S1

D

initialequilibrium

a b

c finalequilibrium

S2

(a) Increase in supply

ab

c

0

P3

P

Q3 Q1 Q

P1

S3

D

finalequilibrium

initialequilibrium

S1

(b) Decrease in supply

Figure 2.17 Consumer and producer surplus in a competitive market

0

P1

Qa Qb Q

P2

Qe

D = MB

P3

Pe

P4P5

P6

S = MC

Allocativeefficiency:at marketequilibriumMB = MC andsocial surplusis maximum

producersurplus

consumersurplus

Figure 2.16 Price as a signal and incentive

0

P1

P

Q1 Q3 Q

P2

D1

Q2

S

C

D2

A B

shortage =excess demand

(a) Adjustment of price to increased demand



Figure 2.12 Shifts of the demand curve (changes in a in the function Qd = a – bP )

0

1

2

3

4

5

2 4 6 8 10 12 14 16 18 20quantity of chocolate bars (thousands per week)

Qd = 14 – 2P

Qd = 10 – 2PQd = 19 – 2P

decreasesa a

increases

P ($)

Figure 2.13 Changing the slope of the demand curve (changes in b in the function Qd = a – bP )

0

1

2

3

4

5

Qd = 14 – 4P

Qd = 14 – 2P

absolute value of b

increases

2 4 6 8 10 12 14 16 18 20quantity of chocolate bars (thousands per week)

P ($)

0

1

2

c c3

4

5Qs = 2 + 2PQs = –1 + 2P Qs = 6 + 2P

increases

2 4 6 8 10 12 14 16 18quantity of chocolate bars (thousands per week)

decreases

P ($)

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 )

0

1

2

3

4

5Qs = 2 + 2P

Qs = 2 + 4Pvalueof d

increases

2 4 6 8 10 12 14 16 18quantity of chocolate bars (thousands per week)

P($)

Higher level topic



Chapter 3 Elasticities

Figure 3.1 Demand curves and PED

0

P

Q

P2

P1

Q1Q2

D

10%

5%

0

P

Q

P2P1

Q1Q2

D

5%

10%

0

P

Q

P2

P1

Q1Q2

D

5%

5%

0

P

QQ1

D

0

P

Q

P1D

(a) Price inelastic demand: 0 < PED <1 (b) Price elastic demand: 1 < PED < ∞

(c) Unit elastic demand: PED = 1 (d) Perfectly inelastic demand: PED = 0 (e) Pefectly elastic demand: PED = ∞

Frequently encountered cases

Special cases

0

51015

2025303540

10 20 30 40 50 60 70 80units of good A

4550

90 100

fe

dc

ba

PED = 4

PED = 1

PED = 0.25

elastic portion ofdemand curve

inelastic portionof demand curve

P ($)

Figure 3.2 Variability of PED along a straight-line demand curve



Figure 3.6 Price fl uctuations are larger for primary commodities because of low PED

0

P

Q

P1

P3

Q2

S1

S2

S3

D

Q1 Q3

P2

(a) Primary commodities: supply shifts with inelastic demand

0

P

Q

P1

P3

Q2

S1

S2

S3

D

Q1 Q3

P2

(b) Manufactured products: supply shifts with elastic demand

0

P

Q

Pt

P1

Qt

D

initialequilibrium

finalequilibrium

S2

S1taxperunit

(a) Inelastic demand (b) Elastic demand

0

P

Q

PtP1

Qt

D

initialequilibrium

finalequilibrium

S2

S1taxperunit

Figure 3.7 PED, indirect taxes and government tax revenue

0

P

Q

P2P1

Q1Q2

D

PED > 1

PED < 1PED = 1

0

P

Q

P2P1

Q1Q2

D

PED > 1

PED < 1

PED = 1

A B

C

A B

C

0

P

Q

P2

P1

Q1Q2

DA B

C

(a) PED > 1 (elastic demand) (b) PED < 1 (inelastic demand) (c) PED = 1 (unit elastic demand)

Figure 3.5 PED and total revenue



(a) Substitutes and positive XED : demand for Pepsi®

0

P

Q

D2

S

D1D3

D increases as price of tennis rackets decreases

D increasesas price ofCoca-Cola®increases

D decreases as priceof Coca-Cola® decreases

0

P

Q

D2

S

D1D3D decreases as

price of tennis rackets increases

(b) Complements and XED : demand for tennis balls

Figure 3.8 Cross-price elasticities

0

P

Q

D2 D1 D3 D4

YED > 1 income elastic demand, normal good

YED < 0 inferior good

0 < YED < 1 income inelastic demand, normal good

Figure 3.9 Demand curve shifts in response to increases in income for different YEDs

0

P

Q

S

P2

P1

Q1 Q2

10%

5%

0

P

Q

S

P2

P1

Q1 Q2

10%

15%

S1

Q10

P

Q

S2

S3

S

0

P

Q

P1 S

0

P

Q

Frequently encountered cases(a) Price inelastic supply: PES < 1 (b) Price elastic supply: PES > 1

Special cases

(c) Unit elastic supply: PES = 1 (d) Perfectly inelastic supply: PES = 0 (e) Perfectly elastic supply: PES = ∞

Figure 3.11 Supply curves and PES



0

P

Q

P2P1

D1

D2

D3

S

P3

(a) Primary commodities: demand shifts with inelastic supply

0

P

Q

P2P1

D1

D2

D3

S

P3

(b) Manufactured products: demand shifts with elastic supply

Figure 3.13 Price fl uctuations are larger for primary commodities because of low PES



Chapter 4 Government intervention

Figure 4.1 Supply curve shifts due to indirect (excise) taxes

0

P

Q

S2 (= S1 + tax)

S1tax perunit

(a) Specifi c tax

0

P

Q

(= S1 + tax)S2

S1tax perunit

tax perunit

(b) Ad valorem tax

Figure 4.2 Impacts of specifi c and ad valorem taxes on market outcomes

0QQt Q*

P

Pc

P*

Pp

S1

S2 (= S1 + tax)

D

tax per unit

governmentrevenue

(a) Market outcomes: specifi c tax

0 QQt Q*

P

Pc

P*

PP

S1

S2 = S1 + tax

D

tax per unit

governmentrevenue

(b) Market outcomes: ad valorem tax

0

P

Q

S2 = S1 – subsidy

S1

subsidyper unit

Pc

P*Pp

QsbQ*

D

Figure 4.8 Impacts of subsidies on market outcomes



0

P

Qs Qe QQd

Pe

Pc

D

S

shortage =excess demand

Figure 4.12 Price ceiling (maximum price) and market outcomes

0

P

Qe Q

Pe

Pf

excess supply = surplus

Qd Qs

D

S

Figure 4.15 Price fl oor (minimum price) and market outcomes

Figure 4.17 Welfare impacts of a price fl oor (minimum price) for agricultural products and government purchases of the surplus

0

P

Qe Q

Pe

Pf

Qd Qs

D = MB

D +government

purchaseswelfare

loss

S = MCa

b

d

cf

e

excess supply =surplus

0

a

e

db

c

QQe Qd

P

S = MC

Qs

D = MB

Pe

Pc

welfare loss

Figure 4.13 Welfare impacts of a price ceiling (maximum price)

Figure 4.16 An agricultural product market with price fl oor and government purchases of the surplus

0

P

Qe Q

Pe

Pf

Qd Qs

D

D +government

purchases

S

excess supply =surplus



0 Qd QQs

We

Wm

Qe

pric

e of

labo

ur (w

age)

quantity of labour

excess supply of labour= labour surplus

= unemployment

supplyof

labour

demandfor

labour

Figure 4.19 Labour market with minimum wage (price fl oor) Figure 4.20 Welfare impacts of a minimum wage

0

a

decb

QQe Qs

P

S

Qd

D

Wm

We

welfare loss

Figure 4.6 Incidence of an indirect tax with inelastic and elastic demand

0

P

Q

S2 = S1 + tax

S1

tax perunit

consumers

producers

Pc

Pp

P*

Qt Q*

D

(a) Inelastic demand

0

P

Q

S1

tax perunit

producers

PcP*

Pp

Qt Q*

D

S2 = S1 + tax

consumers

(b) Elastic demand

Figure 4.7 Incidence of an indirect tax with inelastic and elastic supply

S2 = S1 + tax

0

P

Q

S1

Pc

P*

Pp

Qt Q*D

tax perunit

consumers

producers

(a) Inelastic supply

0

P

Q

S2 = S1 + tax

S1Pc

P*Pp

Qt Q*D

tax perunit

producers

consumers

(b) Elastic supply

Higher level topics



Figure 4.4 Effects of indirect taxes on consumer and producer surplus

0 Q* Q

P

P *

consumersurplus

producersurplus

S = MC

D = MB

0 QQt Q*

P

Pp

Pc

P *

S2 = S1 + tax

S1 = MC

D = MB

welfare loss = a + b

tax perunit

producersurplusafter the tax

consumersurplus after the tax

a

b

governmentrevenue fromthe tax

(b) Consumer and producer surplus with an indirect (excise) tax: welfare loss

(a) Consumer and producer surplus in a competitive free market: maximum social surplus

Figure 4.10 Effects of subsidies on consumer and producer surplus

0 Q* Q

P

P *

consumersurplus

producersurplus

S = MC

D = MB

(a) Consumer and producer surplus in a competitive free market: maximum social surplus

0 QQ* Qsb

P

Pc

Pp

P*S2 = S1 – subsidy

S1 = MC

D = MB

welfare loss

subsidyper unit

again in producersurplusgain in consumersurplus

(b) Consumer and producer surplus with a subsidy: welfare loss



Chapter 5 Market failure

Figure 5.1 Demand, supply and allocative effi ciency with no externalities

0 QQopt

P

Popt

S = MPC = MSC

allocative efficiencyis achieved

D = MPB = MSB

Figure 5.2 Negative production externality

0 QQopt

P

Qm

Pm

Popt

MSC

S = MPC

D = MPB = MSB

externalcost

Figure 5.3 Welfare loss (deadweight loss) in a negative production externality

0 QQopt

P

Qm

Pm

Popt

MSC

S = MPC

D = MPB = MSB

externalcost

welfare loss

(a) Welfare loss

0 QQopt

P

Qm

Pm

Popt

MSC

S = MPC

D = MPB = MSB

Figure 5.4 Government regulations to correct negative production externalities



0 Q

MSB

Qopt

PS = MPC = MSC

Qm

D = MPBexternalcost

Pm

Popt

Figure 5.6 Negative consumption externality Figure 5.7 Welfare loss (deadweight loss) in a negative consumption externality

0 QQopt

P

Qm

Popt

Pm

MSB

S = MPC = MSC

D = MPB

externalcost

welfare loss

(a) Welfare loss

Figure 5.5 Market-based policies to correct negative production externalities

0 QQopt

P

Pc = Popt

tax = external cost

Qm

Pm

Pp

MSC = MPC + tax

S = MPC

D = MPB = MSB

(a) Imposing an indirect tax on output or on pollutants

0 QQopt1 Qopt2

P

Qm

Pm

MSC1 = MPC + tax

S = MPC

MSC2

D = MPB = MSC

(b) Effects on external costs of a tax on emissions (carbon tax)

0 Q

D1

Q1

P

P2

D2P1

S of tradablepermits

(c) Tradable permits

Figure 5.8 Correcting negative consumption externalities

0 QQopt

P

Popt

Pm

S = MPC = MSC

Qm

D1 = MPB

externalcost

D2 = MSBafter demand decreases

(a) Government regulations and advertising (b) Market-based: imposing an indirect tax

0 Q

MSB

Qopt

P

Pc

Pm

Pp

S = MPC = MSC

Qm

D = MPB

MPC + taxtax =externalcost



Figure 5.11 Correcting positive production externalities

0 Q

MSC

Qopt

PS = MPC

Qm

D = MPB

spilloverbenefit

Popt

Pm

(a) Direct government provision

0 Q

MSC

Qopt

P S = MPC

Qm

D = MPB

subsidy =spillover benefit

Popt

Pm

(b) Granting a subsidy

Figure 5.9 Positive production externality

0 Q

MSC

Qopt

PS = MPC

Qm

D = MPB = MSB

externalbenefits

Popt

Pm

Figure 5.10 Welfare loss (deadweight loss) in a positive production externality

0 Q

MSC

Qopt

P

S = MPC

Qm

D = MPB = MSB

externalbenefits

Popt

Pm

welfare loss

(a) Welfare loss



Figure 5.14 Correcting positive consumption externalities

0 QQopt

P

Popt

Pm

S = MPC = MSC

Qm

D1 = MPB

externalbenefit

D2 = MSB

(a) Legislation or advertising

0 QQopt

P

Pc

Pm

S = MPC = MSC

Qm

D = MPB

MSB

S + government provision

(b) Direct government provision

0 QQopt

P

Pc

Pm

S = MPC = MSC

Qm

D = MPB

MSB

MPC – subsidy

subsidy =externalbenefit

(c) Granting a subsidy

Figure 5.13 Welfare loss (deadweight loss) in a positive consumption externality

0 QQopt

P

Qm

D = MPB

S = MPC = MSC

externalbenefitsPm

Popt

welfare loss

MSB

0 Q

MSB

Qopt

P

S = MPC = MSC

Qm

D = MPB

externalbenefit

Pm

Popt

Figure 5.12 Positive consumption externality



Chapter 6 The theory of the fi rm I: Production, costs, revenues and profi t

Figure 6.2 Total, average and marginal cost curves

(d) Average cost and marginal cost curves

(c) Total cost, total variable cost and total fi xed cost curves

TC

TVC

TFCco

sts

output, Q

cost

s

MC

ATC

AVC

AFC

0

0 output, Q

Figure 6.1 Total, marginal and average products

(c) Total product curve

(d) Marginal and average product curves

units of variable input (labour)

TP

AP

MP

0

0

units of variable input (labour)

unit

s of

out

put

unit

s of

out

put

0units of variable input (labour)

unit

s of

out

put

(AP,

MP)

AP

MP

0output, Q

cost

s (AVC

, MC

)

AVC

MC

Figure 6.3 Product curves and cost curves are mirror images due to the law of diminishing returns

Higher level topics



Figure 6.5 The long-run average total cost curve

(b) Long-run average total cost curve in relation to short-run average total cost curves

0output, Q

cost

s

Q1 Q2

ab SRATC1

SRATC2SRATCm

LRATC

Figure 6.10 Profi t maximisation using the total revenue and total cost approach when the fi rm has no control over price

0

cost

s, re

venu

es

Q1 Q2 Q3 Q

TC

ac

e

bd

f

TR

0

cost

s, re

venu

es

Q1 Q2 Q3 Q

TC

aTR

0

cost

s, re

venu

es

Q1 Q2 Q3 Q

TC

a

b

TR

(a) Profi t-maximising fi rm produces at Q2 and makes economic profi t: TR – TC = c – d

(b) Profi t-maximising fi rm produces at Q2 and makes zero economic profi t: TR – TC = 0 (it earns normal profi t)

(c) The loss-minimising fi rm produces at Q2 (if it produces) and makes a loss = TC – TR = a – b (negative economic profi t since TR < TC )

Figure 6.11 Profi t maximisation using the total revenue and total cost approach when the fi rm has control over price

(a) Profi t maximisation

0 Q

TC, TR

TC

TRa

b

Q max

(b) Loss minimisation

0 Q

TC

TR

Q1min

TC, TR

(c) Economies and diseconomies of scale

0

cost

s

economiesof scale

diseconomiesof scale LRATC

output, Q



Chapter 7 The theory of the fi rm II: Market structures

(b) Market/industry

Figure 7.1 Market (industry) demand and supply determine demand faced by the perfectly competitive fi rm

0 Q

P

S

D

Pe

0 Q

P

DPe

(a) Individual fi rm

Figure 7.4 Summary of the perfectly competitive fi rm’s short-run decisions, and the fi rm’s short-run supply curve

0output, Q

MC

Q1

price, revenue, costs

P1

ATC

AVC

P2

P3

P4P5

Q2Q3Q4Q5

54

3

2

1

P < AVCfirm makes lossand shuts down

P > ATCfirm makes economic(supernormal) profitP = minimum ATC = break-even price

firm makes normal profit,or zero economic profit ATC > P > AVC

firm makes loss butcontinues to produce

P = minimum AVC = shut-down pricefirm is indifferent between producing

at a loss or not producing

Figure 7.2 Revenue curves under perfect competition

0

1020304050

1 Q2 3 4 5 6 7

6070

TRTR

(a) Total revenue

0 1 Q2 3 4 5 6 7

P, MR, AR

D = P = MR = AR10

20

30

40

(b) Marginal and average revenue

Higher level topic



Figure 7.3 Short-run equilibrium positions of the perfectly competitive fi rm

0 Q

MC

Q1

pric

e, re

venu

e, c

osts

P1

ATC AVCtotal profit

profitQ

P1 = MR1 = AR1 = D1

a

b

(a) Economic profi t

0 Q

MC

Q2

pric

e, re

venu

e, c

osts

P2

ATCAVC

P2 = MR2 = AR2 = D2= break-even price(break-even point)

(b) Zero economic profi t (normal profi t)

0 Q

MC

Q3

pric

e, re

venu

e, c

osts

P3

ATCAVC

total losslossQ

P3 = MR3 = AR3 = D3 c

d

(c) Economic loss: the fi rm continues to produce

0 Q

MC

Q4

pric

e, re

venu

e, c

osts

P4

ATCAVC

P4 = MR4 = AR4 = D4 = short-run shut-down price

e

flossQ

= AFC

total loss

(d) Loss in the short run and the shut-down price

(e) The loss-making fi rm that will not produce

0 Q

MC

Q5

pric

e, re

venu

e, c

osts

P5

ATCAVC

P5 = MR5 = AR5 = D5

g

h

0 Q

MC

Qf

pric

e, c

osts

, rev

enue

Pe

SRATCLRATC

D = MR

0 QQi

S

D

P

Pe

Figure 7.5 The fi rm and industry long-run equilibrium position in perfect competition

(b) The industry(a) The fi rm



Figure 7.6 From short-run equilibrium to long-run equilibrium

0 QQ2 Q1

P2

P1

ATCMC

a

b

cost

s, re

venu

e, P

0 Q

P

Q2Q1

P2

P1

S1

D

S21

2

From economic (supernormal) profi t to normal profi t

0 QQ2Q1

P2

P1

ATCMC

a

bcost

s, re

venu

e, P

0 QQ2 Q1

P1

P2

P

S1

D

S2

1

2

From loss to normal profi t

(b) The industry(a) The fi rm

(d) The industry(c) The fi rm

Figure 7.7 Productive and allocative effi ciency in perfect competition in the long run

(b) The market/industry(a) The fi rm

0 QQe

MC

cost

s, re

venu

e, P

Pe

ATC

P = MR = Pe

0 Q

Pe

S = MC

P

D = MB

consumersurplus

producersurplus

Qe



0 Q

Pr

Pπ

Qπ

MC

MR

D = AR

Qr

pric

e, c

osts

, rev

enue

Figure 7.12 Comparison of profi t maximisation and revenue maximisation by the monopolist

0 Q

cost

s

D

LRATC

minimum efficientscale

Figure 7.13 Natural monopoly

0

51015

2025

1 Q2 3 4 5 6 7 8

303540

TR

9 10 11

PED = 1(unit elastic demand)

tota

l rev

enue

( )

0

5

10

15

MR

pric

e, re

venu

e (

)

1 Q2 3 4 5 6 7 9 10 11

-5

P = AR = D

PED > 1(price-elasticdemand)

PED < 1(price-inelasticdemand)

8

(a) Total revenue

(b) Marginal and average revenue

Figure 7.10 Revenue curves in monopoly

Figure 7.11 Profi t maximisation and loss minimisation in monopoly: marginal revenue and cost approach

0 Q

MC

Q max

pric

e, c

osts

, rev

enue

Pe

profit

a

b

ATC

D = ARMR

(b)

(a)

0 Q

MC

Qlmin

pric

e, c

osts

, rev

enue

Peloss

cd

ATC

D = ARMR



0 Q

pric

e, c

osts

, rev

enue

aPpc

Qpc

P = MRpc

D = MB

S = MC

0 Q

pric

e, c

osts

, rev

enue

Ppc

Pm

Qm

D = MB

MC

a

b

QpcMRm

Figure 7.14 Higher price, lower output by the fi rm in monopoly

(b) Monopoly(a) Industry in perfect competition

Figure 7.15 Consumer and producer surplus and welfare (deadweight) loss in monopoly compared with perfect competition

(a) Perfect competition

0 Q

AconsumersurplusPpc

Qpc

D = MB

S = MCP

producersurplusB

0 Q

consumersurplus

Qpc

D = MB

MCP

C

Qm

D

Pm

welfare (deadweight) lossEF

MRm

producersurplus

(b) Monopoly

Figure 7.16 Allocative and productive ineffi ciency in perfect competition and monopoly

0 Q

Pe

pric

e, c

osts

MCATC

at long-run equilibriumproduction takes place at greater thanmin ATC (productive inefficiency), andPe > MC (allocative inefficiency)

at long-run equilibriumproduction takes place at min ATC(productive efficiency), andPe = MC (allocative efficiency)

0 Q

Pe

Qm

pric

e, c

osts

, rev

enue

MCATC

MR

D

Qpe

(a) Perfectly competitive fi rm (b) Monopoly



Figure 7.22 Long-run equilibrium of the fi rm in monopolistic competition

0 Q

Pe

Qe

MC

ATC

MR

D = AR

Qc

pric

e, c

osts

, rev

enue

4

40million

Zs40

millionZs

70million

Zs10

millionZs

10million

Zs70

millionZs

20million

Zs20

millionZs

3

2

1

Uni

vers

al S

pace

Lin

e’s p

rice

Low

pric

eH

igh

pric

e

Intergalactic Space Travel’s priceHigh price Low price

Figure 7.23 Game theory: the prisoner’s dilemma

0 Q

MC

Q max

pric

e, c

osts

, rev

enue

Pe

profit

a

b

ATC

D = ARMR

Figure 7.24 Profi t maximisation by a price-fi xing cartel

0 Q

P1

Q1

MR

D

P

ZMC1

MC2

Figure 7.25 The kinked demand curve

Figure 7.21 Short-run equilibrium positions of the fi rm in monopolistic competition

(a) Economic profi t (b) Normal profi t (c) Losses

0 Q

Pe

Qe

pric

e, c

osts

, rev

enue

MC

ATC

MR

D = AR

economic(supernormal)profit

0 Q

Pe

Qepr

ice,

cos

ts, r

even

ue

MC ATC

MR

D = AR

0 Q

Pe

Qe

pric

e, c

osts

, rev

enue MC ATC

MR

D = AR

losses



Figure 7.26 Third-degree price discrimination

0 Q

D1

Q1

P

P1

MR1

0 Q

D2

Q2

P

P2

MR20 Q

MC

Q3

P

MR = MR1 + MR2

(a) Market 1 (b) Market 2 (c) Market 1 and market 2



Chapter 8 The level of overall economic activity

land

, lab

our, c

apital, entrepreneurship land, labour, capital, entrepreneurship

goods and services goods and service

s

household revenues

expenditure

costs of production ho

usehold income

(rent, w

ages,

interest, profit)

resourcemarkets

productmarkets

households(consumers)

firms(businesses)

Figure 8.1 Circular fl ow of income model in a closed economy with no government

Figure 8.3 Circular fl ow of income model with leakages and injections

households(consumers)

firms(businesses)

other countries

government

financial markets

(wages, rents, interest, profit)

consumer expenditure

saving

taxes

spending on imports

investment

government sp

endin

g

spending o

n ex

port

s factor incomes

(spending on goods and services)



Figure 8.4 The business cycle

0time (years)

real

GD

Ppeak

trough

expansioncontraction

real GDP actually achieved

long term growth trend,or potential GDP

peak

trough

Figure 8.5 Illustrating actual output, potential output and unemployment in the business cycle

0time (years)

real

GD

P

a

d

b e

c

long termgrowth trend, orpotential GDP =

full employment GDP;unemployment =

natural rate ofunemployment

expansion:unemployment

falls

actual GDP > potential GDP;there is an output gap:

unemployment < naturalrate of unemployment

contraction:unemployment

increases

actual GDP

actual GDP < potential GDP; there is anoutput gap: unemployment > natural

rate of unemployment



Chapter 9 Aggregate demand and aggregate supply

0real GDP

AD

pric

e le

vel

0real GDP

AD3

pric

e le

vel

AD1 AD2

Figure 9.1 The aggregate demand (AD) curve

(a) The aggregate demand curve

(b) Shifts in the aggregate demand curve

Figure 9.2 The short-run aggregate supply curve (SRAS )

Figure 9.4 Three short-run equilibrium states of the economy

(a) The economy with a defl ationary (recessionary) gap

(b) The economy with an infl ationary gap (c) The economy at the full employment level of output

0

real GDP

SRAS

pric

e le

vel

Ye

AD

Ple

Yp 0

real GDP

SRAS

pric

e le

vel

Ye

AD

Ple

Yp 0

real GDP

SRAS

pric

e le

vel

AD

Ple

Yp = Ye

(a) The upward-sloping SRAS curve

0real GDP

SRAS

pric

e le

vel

(b) Shifts in the SRAS curve

0real GDP

SRAS3

pric

e le

vel SRAS1 SRAS2



Figure 9.5 Impacts of changes in short-run macroeconomic equilibrium

Figure 9.6 Possible causes of the business cycle

0 real GDP

SRAS

pric

e le

vel

Yrec

Pl3

AD1

Pl1Pl2

Yp Yinfl

AD2

AD3

recessionary(deflationary) gap

inflationarygap

0 real GDP

SRAS1pr

ice

leve

l

Y2

Pl2

Pl1

Pl3

Yp Y3

AD

SRAS2

LRASLRAS

SRAS3

recession withinflation

('stagflation')

higher realGDP with lower

price level

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

0real GDP

SRAS

pric

e le

vel

Yp

AD

LRAS

Figure 9.7 The LRAS curve and long-run equilibrium in the monetarist/new classical model

0

real GDP

SRAS

pric

e le

vel

Y3

Pl2

AD1

Pl1

Pl3

Y1 Y2

AD2

AD3

(a) Changes in aggregate demand

0

real GDP

SRAS1

pric

e le

vel

Y3

Pl3Pl1Pl2

Y1 Y2

AD

SRAS3

SRAS2

(b) Changes in short-run aggregate supply



Figure 9.12 Three equilibrium states of the economy in the Keynesian model

0real GDP

pric

e le

vel

Ye

Keynesian AS

Yp

AD0

real GDP

pric

e le

vel

Yp

Keynesian AS

Ye

AD

0real GDP

pric

e le

vel

Yp = Ye

Keynesian AS

AD

(a) Recessionary (defl ationary) gap (b) Infl ationary gap (c) Full employment equilibrium

(a) Creating and eliminating a defl ationary gap (b) Creating and eliminating an infl ationary gap

Figure 9.8 Returning to long-run full employment equilibrium in the monetarist/new classical model

0real GDP

LRAS

pric

e le

vel

Yrec

Pl1

AD1

Pl2Pl3

Yp

AD2

SRAS1

SRAS2a

bc

LRAS

AD1

AD2

SRAS1

SRAS2

a

b

c

0real GDP

pric

e le

vel

Yinfl

Pl3

Pl2Pl1

Yp

0 real GDP

pric

e le

vel

Yp

section I

Keynesian AS

Ymax

section II

section III

Figure 9.11 The Keynesian aggregate supply curve

0real GDP

LRAS

pric

e le

vel

Pl1AD1

Pl2

Yp

AD2

SRAS1

SRAS2

Figure 9.9 Changes in long-run equilibrium in the monetarist/new classical AD-AS model



0 real GDP

pric

e le

vel

LRAS

AD1

AD2

AD3

Pl1

Pl2

Pl3

0 real GDPY1Yp Y2 Y3

pric

e le

vel

AD1 AD2 AD3 AD4

Yp

Keynesian AS

Figure 9.13 Effects of increases in aggregate demand on real GDP and the price level

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

0 real GDPYp1

pric

e le

vel

Yp2

AS2AS1

(b) The Keynesian model

0 real GDPYp1

pric

e le

vel

Yp2

LRAS2LRAS1

(a) The monetarist/new classical model

Figure 9.14 Increasing potential output, shifts in aggregate supply curves and long-term economic growth

Figure 9.15 Long-term economic growth: achieving potential (full employment) output in a growing economy

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

0

real GDP

pric

e le

vel

AD1 AD2

SRAS1

LRAS1

Y1 Y2

Pl1

SRAS2

LRAS2

0

real GDP

pric

e le

vel

AD1AD2

Y1 Y2

AS1 AS2



Figure 9.17 Aggregate demand, real GDP and the multiplier in the Keynesian model

0

real GDP

pric

e le

vel

AD1

Y1 Y2 Y3

AD2 AD3

autonomousspending

inducedspending

$8million

$24million

$32 million

Figure 9.18 How the effect of the multiplier changes depending on the price level

0

real GDP

pric

e le

vel

Y1 Y2 Y3

AD1AD2

AD3AD4

Keynesian AS

Pl1

Pl2

Pl3

Higher level topic



Chapter 10 Macroeconomic objectives I: Low unemployment, low and stable rate of infl ation

Figure 10.1 Structural unemployment

0

pric

e

Q2

P1

P2

Q1 Q

S

D1

D2

P

(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 fi re workers with inappropriate skills or local workers no longer needed due to relocation

(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

0

pric

e

Q2

P2

P1

Q1 Q

D

S1

S2P

0

P

Qd QQs

We

Wm

Qe

pric

e of

labo

ur (w

age)

quantity of labour

labour surplus =unemployment

supplyof

labour

demandfor

labour

(c) Minimum wage legislation and labour union activities lead to higher than equilibrium wages and lower quantity of labour demanded

0

real GDP

pric

e le

vel

Yrec

Pl1Pl2

Yp

LRAS

SRAS

AD1

AD2

0

real GDP

pric

e le

vel

Yrec

Pl1Pl2

Yp

AD1

AD2

Keynesian AS

Figure 10.2 Cyclical unemployment

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

Figure 10.4 Demand-pull infl ation

0

real GDP

pric

e le

vel

Yp

LRAS

Yinfl

AD1

AD2

SRAS

Pl2

Pl1


0

real GDP

pric

e le

vel

Yp Yinfl

AD1

AD2

Pl2

Pl1

AS


0

real GDP

pric

e le

vel

Yrec Yp

LRASSRAS2

SRAS1Pl2

Pl1

AD1

Figure 10.5 Cost-push infl ation



Figure 10.8 The short-run and long-run Phillips curves

(a) The shape of the LRPC and SRPC

0

rate

of i

nfla

tion

c

ba

LRPC

SRPC1

SRPC2

9%7%

5%

unemployment rate5%3%

5% = natural rateof unemployment

(b) The reasoning behind the two curves in terms of the AD-AS model

0real GDP

pric

e le

vel c

b

a

AD1

Pl3

Pl2

Pl1

Yp Yinfl

SRAS2

SRAS1

AD2

LRAS

Figure 10.7 Stagfl ation: outward shifts of the short-run Phillips curve due to decreasing SRAS

0 unemployment rate

rate

of i

nfla

tion

cb

a

PC1

PC2

PC3

(a) The shifting Phillips curve (b) The reasoning behind SRAS shifts in terms of the AD-AS model

0real GDP

pric

e le

vel c

b

a

AD

SRAS3

Pl3Pl2

Pl1

Y1Y2Y3

SRAS2

SRAS1

Higher level topic



Chapter 11 Macroeconomic objectives II: Economic growth and equity in the distribution of income

Figure 11.1 Using the production possibilities model to illustrate economic growth

X

Y

0

A

B

(a) Economic growth as an increase in actual output caused by reductions in unemployment and productive ineffi ciency

XPPC3PPC2PPC1

Y

0

A

B

C

(b) Economic growth as an increase in production possibilities caused by increases in resource quantities or improvements in resource quality

0

cum

ulat

ive

perc

enta

ge o

f inc

ome

a

cumulative percentage of population

100

80

60

40

20

20 40 60 80 100

e bc

d

f

g

h

Bolivia

perfectincomeequality

Belarus

Figure 11.3 Lorenz curves: Belarus achieves greater income equality than Bolivia

0

cum

ulat

ive

perc

enta

ge o

f inc

ome

cumulative percentage of population

100

80

60

40

20

20 40 60 80 100

beforeredistribution

increased incomeequality afterredistribution

perfect incomeequality

Figure 11.4 Lorenz curves and income redistribution



Chapter 12 Demand-side and supply-side policies

Figure 12.1 Effects of expansionary policy: eliminating a recessionary (defl ationary) gap

0 real GDP

pric

e le

vel

AD1

AD2

SRAS

LRAS

Yrec Yp

Pl2

Pl1


0 real GDP

pric

e le

vel

Yrec Yp

Pl2Pl1

AD2

AD1

Keynesian AS


SRAS

LRAS

0 real GDP

pric

e le

vel

potential output

AD1AD2

YinflYp

Pl1Pl2


0 real GDP

pric

e le

vel

AD1AD2

YinflYp

Pl1Pl2

potential output

AS


Figure 12.2 Effects of contractionary policy: eliminating an infl ationary gap

Figure 12.3 Crowding out of private investment

0

real GDP

pric

e le

vel

Y1 Y2

AD3

AD2

AD1

Y3

SRASdue to G

due to I

0

real GDP

pric

e le

vel

Y1 Y2

AD2

SRASdue to G

due to I

AD1

(a) Partial crowding out (b) Complete crowding out



Figure 12.4 The money market and determination of the rate of interest

0

rate

of i

nter

est

Sm

Dm

Qe

i

quantity of money

0

rate

of i

nter

est

Sm1

Dm

Q1

i1

quantity of money

Sm3

Q3

Sm2

Q2

i3

i2

(a) Equilibrium rate of interest (b) Changes in the supply of money cause changes in the equilibrium rate of interest



Chapter 13 International trade

0

good

Y

good X

country A

country B

0

good

Y

good X

country A

country B

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

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

0

good

Y

good X

country A’s PPC

country B’s PPC

Figure 13.5 Identical opportunity costs: no gains from trade

Production possibilities when each country produces only cotton or

only microchips

Opportunity cost of cotton Opportunity cost of microchips

(1)Cotton

(2)Microchips

(3) (4)

Cottonia20 10 10 units of microchips = 1

20 units of cotton 220 units of cotton = 2

10 units of microchips

Microchippia25 50 50 units of microchips = 2

25 units of cotton25 units of cotton = 1

50 units of microchips 2

or

or

Table 13.2 Comparative advantage

Figure 13.2 Comparative advantage

0

cott

on

microchips

10

15

20

25

10 20 30 40 50 60

Cottonia’sPPC

Microchippia’s PPC

5

Figure 13.4 The gains from specialisation and trade based on comparative advantage: both countries consume outside their PPC

0

cott

on

microchips

5

10

15

20

25

10 20 30 40 50

D consumption

C production

(a) Cottonia exports 10 units of cotton and imports 10 units of microchips

(b) Microchippia exports 10 units of microchips and imports 10 units of cotton

0

cott

on

microchips

5

10

15

20

25

10 20 30 40 50

B

A production

consumption

Figure 13.3 Absolute and comparative advantage



Figure 13.7 Effects of a tariff

Pw

0 Q

P

Q1

Sd =domesticsupply

Dd = domestic demand

Q2

Pw + t

world price =world supply curve

Q3 Q4

imports with tariff

imports without tariff

Pd

tariffworld price + tariff

government revenue

(a) Effects on imports

Pw

0 Q

P

Q1

Sd =domestic supply


Q2

Pw + t


Q3 Q4

imports with tariff

imports without tariff

a bc d e f

g

world price + tariff

tariff

welfare loss = d + f

(b) Welfare effects

Figure 13.9 Effects of a quota

(a) Effects on imports

Pw

0 Q

P

Q1

Sd = domestic supply


Q2


Q3 Q4

imports with quota

imports without quota

Pq

Sdq = domestic supply plus quota quotaquota

revenue

(b) Welfare effects

Pw

0 Q

P

Q1



Q2


Q3 Q4

imports with quota

imports without quota

Pq

Sdq = domestic supply plus quotaquota

welfare loss = d + e + f

ab

c d e feg

Figure 13.11 Production subsidies

(a) Production subsidy: quantity of imports falls

Pw

Ps

0 Q

P

Q1



Q2


Q3

imports after subsidy

imports before subsidy

Sds = domesticsupply minus subsidysubsidy



Chapter 14 Exchange rates and the balance of payments

(a) The market for US dollars

0 p

er $

= p

rice

of $

in te

rms

of

0.80

0.67

0.50

Q of $ (dollars)

excess supply of $

excess demand for $ D for $(dollars)

S of $(dollars)

equilibrium exchange rate

(b) The market for euros

0$ pe

r =

pric

e of

in

term

s of

$

2.00

1.50

1.25

Q of (euros)

excess demand for D for (euros)

S of (euros)excess supply of

equilibrium exchange rate

Figure 14.1 Exchange rate determination in a freely fl oating exchange rate system Figure 14.2 Exchange rate changes in a freely fl oating exchange rate system

0 p

er $

= p

rice

of $

in te

rms

of

0.90

0.67

Q of $ (dollars)

D1 for $

S of $

D2 for $AB

C

(a) Demand for $ increases: $ appreciates

(b) Supply of € increases: € depreciates

Figure 14.3 Fixed exchange rates: maintaining the value of the bople at 1 bople = $2.00

(a) Shifting the currency demand curve

0

$ pe

r bop

le =

pric

e of

bop

les

in te

rms

of $

2.00

1.50

Q of boples

S of boples

AB

C

fall in demand for Bopland'sexports reduces demandfor boples

central bank buys excessboples, increasing demandfor boples

2.

1.

D1 for boplesD2 for boples

(b) Shifting the currency supply curve

0

$ pe

r bop

le =

pric

e of

bop

les

in te

rms

of $

2.00

Q of boples

D1 for boples

S2

D2 for boples

ABfall in demand for Bopland'sexports reduces demandfor bople

S1 of boples

imports are reduced, therefore the supply of boples falls

1.

2.

0$ pe

r =

pri

ce o

f i

n te

rms

of $

Q of (euros)

1.50

1.11

D for

S1 of

D

FE

S2 of



Figure 14.6 Using a PPC to illustrate a trade defi cit and a trade surplus

(a) With a trade defi cit, country consumes outside its PPC

0 good B

good

A

C

PPC

(b) With a trade surplus, country consumes inside its PPC

0 good B

good

A

D

PPC



Chapter 15 Economic integration and the terms of trade

Figure 15.1 Changes in global demand or supply: terms of trade impacts on the balance of trade

P2

0 Q1Q3 Q2

D1D3

D2

P1

P3

Sglobal supplyof wheat

global demandfor wheat

global supply

global demandP2

0glob

al p

rice

of in

tern

atio

nally

trad

ed g

ood

quantity of internationallytraded good

quantity of internationallytraded good

glob

al p

rice

of in

tern

atio

nally

trad

ed g

ood

Q1 Q2

D

S2P1

Q3

P3

S3 S1

(a) Changes in global demand: terms of trade and balance of trade change in same direction

(b) Changes in global supply: effects of terms of trade changes on the balance of trade depend on PEDs for exports and imports

0

P

Q

D2

D1

S2S1

P2

P1

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)

Higher level topic



Chapter 16 Understanding economic development

Figure 16.1 Economic growth and economic development

merit goods

indu

stri

al g

oods

0

A

B

C

PPC1 PPC2

D

E

A→B: no economic growth with some developmentB→C: economic growth with no developmentB→D or E: economic growth with development

Figure 16.2 The poverty cycle (poverty trap)

lowincome

lowsavings

lowinvestment

low physicalcapital

lowhumancapital

low naturalcapital

low productivityof labourand land

low growthin income

chapter 2 competitive markets: demand and supply · chapter 2 competitive markets: demand and...

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