12 key diagrams for as economics
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12 Key Diagramsfor AS Microeconomics
Advice on drawing diagrams in the exam
The right size is about 1/3 of a side of A4 dont make them too small
Avoid wrapping text around the diagram
Avoid directional arrows label each curve clearly so that it is clear which curves are shifting
Remember to label both the x and the y axis
Always draw dotted lines to the x and y axis to show changing prices, quantities etc.
Draw in pencil
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(1) The Production Possibility Frontier (PPF)
A PPF shows the different combinations of goods and services that can be
produced with a given amount of resources in their most efficient way
Any point inside the curve suggests resources are not being utilised efficiently
Any point outside the curve not attainable with the current level of resources
An outward shift of the PPF implies that an economy has achieved economic
growth
OUTPUTOF GOOD
Y
DC
A
X
B
PPF1 PPF2
OUTPUT OF GOOD X
Point X is an allocative inefficient combination it lies within the PPF
Points, C, A and B are all allocatively efficient
D is unattainable unless there is an outward shift if the PPF
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(2) The Effects of an Indirect Tax on Producers and Consumers
Ain direct tax increases the costs faced by producers. The amount of the tax is shown
by the vertical distance between the two supply curves. Because of the tax, less can be
supplied at each price level. The result is an increase in the equilibrium market price
and a contraction in market demand to a new e uilibrium out ut of 2
Price
Quantity
Demand
Supplypost-tax Supply pre-tax
P2
Q2
P1
Tax per unit
P3
Q1
P2 is the price paid by consumers after the introduction of the tax
P2-P3 is the tax per unit received by the government
(P2-P3) x Q2 is the total tax revenue received by the government
The producer keeps price P3 after the tax has been paid
The consumer pays P2-P1 of the tax
The producer pays P1-P3 of the tax
The effect of the tax depends on the price elasticity of demand & supply for the good
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3) A Government Subsidy to Producers
A government subsidy encourages an increase in supply at each price level because the
subsidy provides a reduction in a firms costs of production. The extent of the subsidy
per unit is shown by the vertical distance between the two supply curves.
S1Price
Quantity
Demand
P1
Q1
P2
Supply +Subsidy
P3
Subsidy per unit
Q2
The price before the subsidy is offer is P1 and the equilibrium quantity is Q1
Following the subsidy, the price falls to P2 (this is the price paid by consumers)
Output rises to Q2 i.e. the lower price has encouraged an expansion of demand
The producer then receives the subsidy P2-P3 and received price P3
Total government spending on the subsidy equals Q2 x (P2P3)
Once again, the elasticities of demand and supply affect how a subsidy causes changes
in price and quantity in the market
Most students forget to show the subsidy payment to producers in their diagrams!
Governments may use subsidies for a variety of reasons including reducing the price
and increasing the consumption of merit goods check your notes on subsidies for the
arguments for and against government subsidies for producers
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4) Drawing shifts in demand and supply and their effects on market price
An Outward Shift in Demand and a Rise in SupplyAn Inward Shift in Demand and a fall in Supply
Price
Quantity
D1
S1
P1
Q1
Price
Quantity
D1
S1
P1
Q1
D3
Q2
P3
D2
Q2
P2
S2
S2
When drawing price theory diagrams
Avoid any use of arrows clear labelling does that job for you!
Always draw to the axis to show prices and quantities
It is often a good idea to draw two diagrams in the latter parts of questions this allows you to change the elasticities of demand and supply and see how
this changes your analysis
Shifts in demand do not normally cause a shift in supply
Likewise shifts in supply cause movements along the demand curve and notshifts in the demand curve
Inelastic demand and supply curves mean that equilibrium prices tend to bevolatile when conditions of demand and supply change
Think about the implications of such shifts in price and quantity on theincomes of producers applying the concept of price elasticity of demand is
often very helpful when discussing the incomes and profits of suppliers
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5) Economies of large scale production
Economies of scale are the advantages of large scale production that result in lower unit
(average) costs (cost per unit)
Costs
Output (Q)Q1 Q2 Q3
AC1
AC2
AC3
Long run averagecost
Demand
Economies of scale lead to a fall in the long run average cost curve
It is more cost efficient to produce output Q2 at an AC of AC2 than it is to produce Q1
Q3 is the output where the economies of scale have been fully exploited
This is known as the output of productive efficiency in the long run
Depending on the elasticity of the demand curve, output Q3 gives higher total profits at
output Q2 and the consumer also benefits from lower prices
Economies of scale therefore increase both consumer and producer surplus
Important when discussing the economics of large scale production and also the potential
costs and benefits of monopoly power in a market
Make sure you have examples of the different types of economy of scale that a business can
ex loit
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6) Consumer and producer surplus and allocative efficiency in a market
CostsRevenues Supply
Consumer
Surplus (CS)
Output (Q)
Demand
ConsumerSurplus (CS)
P1
ProducerSurplus (PS)
ProducerSurplus
Allocative efficiency isachieved here where themarket clears and the pricereflects the costs of supply.Consumer and producer
surplus is maximised!
Q1
Supply
CS
Demand
P1
Q1
ProducerSurplus
P2
ProducerSurplus
If output is reduced to Q2and the price is raised to P2,then there is a loss ofallocative efficiency leading to a deadweight lossof consumer and producesur lus
Q2
Allocative efficiency occurs when the market clears at a price when the price charged to
consumers reflects the true cost of factors of production used in supplying the product
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7) Market failure when there are negative externalities
Social Cost
Output (Q)
Demand = PrivateBenefit = Social Benefit
Private Cost(Supply)
Price
P2
P1
Q1Q2
ExternalCost
When there are negativeproduction externalities thenthe social cost of supplying
the product is greater thanthe private costThe product is over-suppliedand under-priced by the
market i.e. market failure
Demand = PrivateBenefit
Private Cost = Social CostPrice
Q1Q2
P1
P2
When there are negativeconsumption externalitiesthen the social benefit ofconsuming the product isless than the private benefit- The product is over-consumed by the market i.e. market failure
Social Benefit
Output (Q)
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8) Price elasticity of demand two important applications
(i) Price elasticity of demand and the total revenue to a supplier
Relatively Inelastic Demand
Price Price
P2
P1
P1
P2
(ii) Price elasticity of demand and the profit margins of a business
Price
Demand
P2
P1
Q2 Q1
Price
Demand
P2
P1
Q2 Q1
Relatively Inelastic Demand Relatively Elastic Demand
AC
AC
Higher profit
mar in
Lower profit
mar in
Demand
Relatively Elastic Demand
Demand
Q2 Q1 Q1 Q2
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9) Merit Goods positive externalities
Merit goods could be provided by the market but consumers may not be able to
afford or feel the need to purchase thus the free-market economy would notprovide them in the quantities society needs
Costs
Benefits
Output (Q)
Private
Benefit
Supply
SocialBenefit
Welfare loss because merit goods
tend to be under-consumed by the
free marketA
Qp Qs
External BenefitC
B
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10) Market failure due to information failure
Market failure with demerit goods the free market may fail to take into account the
negative externalities of consumption (because the social cost > private cost).
Consumers too may experience imperfect information about the long term costs to
themselves of consuming products deemed to be de-merit goods
CostsBenefits
Social Cost
Quantity
Demand (Limited Information)
Private Cost
Q1
External costs (negativeexternalities)
Demand (Full Information)
Q2Q3
The social optimal level of consumption would be Q3 an output that takes into account the
information failure of consumers and also the negative externalities.
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11) Maximum and minimum prices when governments intervene in a market
Rent
s
Quantity of Rented Property
Demand
Supply
P max
Q1
Pe
Price (Rent) Ceiling
Q2
Free MarketEquilibrium
A maximum price for rented accommodation or for a foodstuff
ExcessDemand
A minimum wage in the labour market
Wages
Supply ofLabour
Minimum WageW1
We
Demand forLabour
Ee E2E2 Employment of Labour
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12) Buffer stock schemes to support prices and incomes in a market
Buffer stock schemes seek to stabilize the market price of agricultural products by buying
up supplies of the product when harvests are plentiful and selling stocks of the product
onto the market when supplies are low
Supply S2
Price
Quantity
Demand
P min
Q1
Pe
Price Floor (Guaranteed)
Q3 Q4
The government offers a guaranteed minimum price (P min) to farmers of wheat. The price
floor is set above the normal free market equilibrium price.
If the government is to maintain the guaranteed price at P min, then it must buy up the
excess supply (Q3-Q1) and put these purchases into intervention storage. Should there be a
large rise in supply putting downward pressure on the free market equilibrium price. In this
situation, the government will have to intervene once more in the market and buy up the
surplus stock of wheat to prevent the price from falling.
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