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 (b) Demand curve of consumer B (c) Market demand
P ($) P ($)
price of chocolate bars ($)
5 5 5
4 4 demands 4
of other
3 + 3 + consumers = 3
in the
2 2 market 2
1 DA 1 DB 1 Dm
0 2 4 6 8 10 12 0 2 4 6 8 10 12 0 2 4 6 8 10 12 14
quantity of chocolate quantity of chocolate quantity of chocolate bars
bars (per week) bars (per week) (thousands per week)
Figure 2.2 Market demand as the sum of individual demands
(a) A movement along the demand curve, (b) A shift of a demand curve, caused by a change in
caused by a change in price, is called a a determinant of demand, is called a ‘change in
‘change in quantity demanded’ demand’
P P
change in demand
A change in
P1 quantity decrease increase
demanded in D in D
B
P2 D2
D D3 D1
0 Q1 Q2 Q 0 Q
Figure 2.4 Movements along and shifts of the demand curve
© Cambridge University Press 2012 Economics for the IB Diploma 1

(a) Supply of firm A (b) Supply of firm B (c) Market supply

P$ P$
5 SA 5 SB 5 Sm
4 4 supplies 4
of other
3 + 3 + firms in
= 3
2 2 the market 2
1 1 1
0 200 400 600 0 200 400 600 0 2 4 6 8 10 12

quantity of chocolate quantity of chocolate quantity of chocolate
bars (per week) bars (per week) bars (thousands per week)
Figure 2.6 Market supply as the sum of individual supplies
(a) A movement along the supply curve, (b) A shift of the supply curve, caused by a
caused by a change in price, is called a change in a determinant of supply, is called a
‘change in quantity suppied’ ‘change in supply’
P P
S S3 S1
S2
B decrease increase
P2 in supply in supply
change in
A quantity P1
P1 supplied
0 Q1 Q2 Q 0 Q3 Q1 Q2 Q
Figure 2.8 Movements along and shifts of the supply curve
S
5
surplus
4
equilibrium
3 price
market equilibrium
2
shortage D
1
equilibrium quantity
0 2 4 6 8 10 12 14
quantity of chocolate bars
(thousands per week)
Figure 2.9 Market equilibrium

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

final
initial equilibrium
P equilibrium S P S
c final a initial
P2 equilibrium
P1 equilibrium
b
a
P1 b P3 c
D2 D1
D1 D3
0 Q1 Q2 Q 0 Q3 Q1 Q
Figure 2.10 Changes in demand and the new equilibrium price and quantity
(a) Increase in supply (b) Decrease in supply

initial S1 final S3
equilibrium equilibrium
P P
S2 S1
P1 a b P3 c
c final b a
P2 P1 initial
equilibrium equilibrium
D
D
0 Q1 Q2 Q 0 Q3 Q1 Q
Figure 2.11 Changes in supply and the new equilibrium price and quantity
(a) Adjustment of price to increased demand P1 S = MC
P P2
S Allocative
P3 consumer efficiency:
C surplus at market
P2 Pe equilibrium
producer MB = MC and
A surplus social surplus
B P4
P1 is maximum
D2 P5
shortage =
D1 excess demand P6 D = MB
0 Q1 Q3 Q2 Q 0 Qa Qb Qe 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 ($) P ($)
Qd = 14 – 2P
5 Qd = 19 – 2P 5
Qd = 14 – 2P
4 Qd = 10 – 2P 4
Qd = 14 – 4P
3 3
a a absolute
decreases increases value of b
2 2 increases
1 1
0 2 4 6 8 10 12 14 16 18 20 0 2 4 6 8 10 12 14 16 18 20
quantity of chocolate bars (thousands per week) quantity of chocolate bars (thousands per week)
Figure 2.12 Shifts of the demand curve (changes in a in the Figure 2.13 Changing the slope of the demand curve (changes in b in the
function Qd = a – bP ) function Qd = a – bP )
P ($) P($)
Qs = –1 + 2P Qs = 2 + 2P Qs = 6 + 2P Qs = 2 + 2P
5 5
4 4
value Qs = 2 + 4P
3 3 of d
c c increases
decreases increases
2 2
1 1
0 2 4 6 8 10 12 14 16 18 0 2 4 6 8 10 12 14 16 18
quantity of chocolate bars (thousands per week) quantity of chocolate bars (thousands per week)
Figure 2.14 Shifts of the supply curve (changes in c in the supply Figure 2.15 Changing the slope of the supply curve (changes in d in the
function Qs = c + dP ) function Qs = c + dP )

Chapter 3 Elasticities
Frequently encountered cases
(a) Price inelastic demand: 0 < PED <1 (b) Price elastic demand: 1 < PED < ∞
P P
P2
5% P1
P2
10%
P1
D
D
0 Q2 Q1 Q 0 Q2 Q1 Q
5% Special cases 10%
(c) Unit elastic demand: PED = 1 (d) Perfectly inelastic demand: PED = 0 (e) Pefectly elastic demand: PED = ∞
P P D P
D
P2 P1
5%
P1
D
0 Q2 Q1 Q 0 Q1 Q 0 Q
5%
Figure 3.1 Demand curves and PED
P ($)
elastic portion of
50 demand curve
45 f PED = 4
e
40
35 inelastic portion
30 d PED = 1 of demand curve
25 c
20
15 b PED = 0.25
10 a
5
0 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 P P
PED > 1 PED > 1

P2
P1 C
PED = 1 PED = 1 P2
PED < 1 C
P2 PED < 1
A B C P1
P1 D
A B A B
D D
0 Q2 Q1 Q 0 Q2 Q1 Q 0 Q2 Q1 Q
Figure 3.5 PED and total revenue
(a) Primary commodities: supply shifts with inelastic demand (b) Manufactured products: supply shifts with elastic demand
S2
S2
S1 S1
P P
P2
S3 S3
P2
P1 P1
P3 P3
D
D
0 Q2 Q1 Q3 Q 0 Q2 Q1 Q3 Q
Figure 3.6 Price fluctuations are larger for primary commodities because of low PED
(a) Inelastic demand (b) Elastic demand

P final S2 P
equilibrium S2
tax final
per S1 equilibrium tax
Pt unit per S1
unit
initial Pt initial
P1 equilibrium P1 equilibrium
D D
0 Qt Q 0 Qt Q
Figure 3.7 PED, indirect taxes and government tax revenue

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

P S
YED < 0 0 < YED < 1 YED > 1
inferior income income
good inelastic elastic
D increases demand, demand,
D2 normal normal
as price of
Coca-Cola® good good
increases
D3 D1 D2 D1 D3 D4
D decreases as price 0
of Coca-Cola® decreases Q
0 Q
Figure 3.9 Demand curve shifts in response to increases in income for
different YEDs
(b) Complements and XED : demand for tennis balls
P S
D increases
D2 as price of
tennis rackets
decreases
D1
D decreases as D3
price of tennis rackets increases
0 Q
Figure 3.8 Cross-price elasticities
Frequently encountered cases

(a) Price inelastic supply: PES < 1 (b) Price elastic supply: PES > 1
P P
S
S
P2 P2
10% 10%
P1 P1
0 Q1 Q2 Q 0 Q1 Q2 Q
5% 15%
Special cases
(c) Unit elastic supply: PES = 1 (d) Perfectly inelastic supply: PES = 0 (e) Perfectly elastic supply: PES = ∞
P S1 P S P
S2
S3 P1 S
0 Q 0 Q1 Q 0 Q
Figure 3.11 Supply curves and PES

(a) Primary commodities: demand shifts with inelastic supply (b) Manufactured products: demand shifts with elastic supply
P S P
P2 P2 S
P1 P1
P3 P3 D2
D2
D1
D1 D3
D3
0 Q 0 Q
Figure 3.13 Price fluctuations are larger for primary commodities because of low PES

Chapter 4 Government intervention
(a) Specific tax (a) Market outcomes: specific tax
P P government S2 (= S1 + tax)
S2 (= S1 + tax)
revenue
tax per
tax per S unit S1
1
unit Pc
P*
Pp
D
0
0 Q Q t Q* Q
(b) Ad valorem tax (b) Market outcomes: ad valorem tax

P S2 (= S1 + tax) P government S2 = S1 + tax
revenue
tax per
unit S1 tax per
unit S
Pc 1
tax per
unit P*
PP
0 D
Q 0
Qt Q* Q
Figure 4.1 Supply curve shifts due to indirect (excise) taxes Figure 4.2 Impacts of specific and ad valorem taxes on market outcomes
S1
P
Pp subsidy
per unit
P*
S2 = S1 – subsidy
Pc
D
0 Q* Qsb Q
Figure 4.8 Impacts of subsidies on market outcomes

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

agricultural products and government purchases of the
surplus

P
excess supply of labour
= labour surplus supply
price of labour (wage)
= unemployment of
labour
Wm S
a welfare loss
Wm
We b c
We e
demand d
for
labour
D
0 Qd Qe Qs Q
quantity of labour 0 Qd Qe Qs Q
Figure 4.19 Labour market with minimum wage (price floor) Figure 4.20 Welfare impacts of a minimum wage
Higher level topics
(a) Inelastic demand (a) Inelastic supply
P P S2 = S1 + tax
S2 = S1 + tax
S1
tax per
unit tax per
Pc S1 unit
Pc
consumers consumers
P* P*
producers
Pp producers
Pp
D D
0 0 Qt Q* Q
Qt Q* Q
(b) Elastic supply

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

P
P S2 = S1 + tax
consumer tax per S1 = MC

S = MC surplus
after the tax unit
Pc
consumer government a
surplus P* revenue from
the tax b welfare loss = a + b
P*
producer Pp
producer
surplus surplus
after the
tax
D = MB
D = MB
0 Q* Q 0 Qt Q* Q
(a) Consumer and producer surplus in a competitive (b) Consumer and producer surplus with an indirect
free market: maximum social surplus (excise) tax: welfare loss
Figure 4.4 Effects of indirect taxes on consumer and producer surplus
(a) Consumer and producer surplus in a competitive (b) Consumer and producer surplus with a subsidy: welfare loss
free market: maximum social surplus
P
P
S1 = MC
subsidy
S = MC per unit
Pp
gain in producer
S2 = S1 – subsidy
consumer P * surplus a
surplus gain in consumer
P* surplus
Pc welfare loss
producer
surplus
D = MB
D = MB
0 Q* Q
0 Q* Qsb Q
Figure 4.10 Effects of subsidies on consumer and producer surplus

Chapter 5 Market failure
P
S = MPC = MSC
Popt
D = MPB = MSB
0 Qopt Q
allocative efficiency
is achieved
Figure 5.1 Demand, supply and allocative efficiency with

no externalities
(a) Welfare loss

MSC
P external MSC
cost P
S = MPC external
Popt cost S = MPC
Pm Popt
Pm welfare loss
D = MPB = MSB D = MPB = MSB

0 Qopt Qm Q
0 Qopt Qm Q
Figure 5.2 Negative production externality Figure 5.3 Welfare loss (deadweight loss) in a negative
production externality
MSC
P
S = MPC
Popt
Pm
D = MPB = MSB
0 Qopt Qm Q
Figure 5.4 Government regulations to correct negative production

externalities

(a) Imposing an indirect tax on (b) Effects on external costs of a tax on (c) Tradable permits
output or on pollutants emissions (carbon tax)
MSC = MPC + tax MSC1 = MPC + tax P S of tradable
P tax = external cost P MSC2 permits
P2
Pc = Popt S = MPC S = MPC
Pm Pm P1 D2
Pp
D = MPB = MSB D = MPB = MSC

D1
0 Qopt Qm Q 0 Qopt1 Qopt2 Qm Q 0 Q1 Q
Figure 5.5 Market-based policies to correct negative production externalities
(a) Welfare loss

P
S = MPC = MSC P
Pm S = MPC = MSC
D = MPB welfare loss
Popt Pm external
external
cost cost
Popt
D = MPB
MSB
0 MSB
Qopt Qm Q
0 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 (b) Market-based: imposing an indirect tax
P P MPC + tax
external
cost tax =
external
cost
S = MPC = MSC Pc
S = MPC = MSC
Pm Pm
Pp
D1 = MPB D = MPB
Popt
D2 = MSB MSB
after demand decreases
0 Qopt Qm Q 0 Qopt Qm Q
Figure 5.8 Correcting negative consumption externalities

(a) Welfare loss
S = MPC
P P
external
benefits
S = MPC
MSC external
Pm benefits
MSC
Popt Pm
Popt welfare loss
D = MPB = MSB
0 Qm Qopt Q
D = MPB = MSB
0 Qm Qopt 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
S = MPC P S = MPC
P
spillover
benefit subsidy =
MSC spillover benefit
Pm Pm MSC
Popt Popt
D = MPB
D = MPB 0 Qm Qopt Q
0 Qm Qopt Q
Figure 5.11 Correcting positive production externalities

P
P
S = MPC = MSC
Popt
Pm S = MPC = MSC
MSB welfare loss
external
benefit
D = MPB Popt
0 Qm Qopt Q external
Pm benefits
Figure 5.12 Positive consumption externality
MSB
D = MPB
0 Qm Qopt Q
(a) Legislation or advertising

Figure 5.13 Welfare loss (deadweight loss) in a positive
P consumption externality
S = MPC = MSC
Popt
Pm D2 = MSB
external
benefit
D1 = MPB
0 Qm Qopt Q
(b) Direct government provision
P
S = MPC = MSC
S + government
provision
Pm
Pc MSB
D = MPB
0 Qm Qopt Q
(c) Granting a subsidy
P S = MPC = MSC
subsidy = MPC –
external subsidy
benefit
Pm
Pc MSB
D = MPB
0 Qm Qopt Q
Figure 5.14 Correcting positive consumption externalities

Chapter 6 The theory of the firm I: Production, costs, revenues and profit
Higher level topics
(c) Total product curve

units of output
(c) Total cost, total variable cost and total

TP fixed cost curves
TC
0 TVC
units of variable input (labour)
costs
units of output
TFC
0 output, Q
AP
0 MP MC
(d) Marginal and average product curves
Figure 6.1 Total, marginal and average products ATC

costs
AVC
units of output (AP, MP)
AP AFC
0 output, Q
MP
0
(d) Average cost and marginal cost curves
Figure 6.2 Total, average and marginal cost curves

MC
costs (AVC, MC)
AVC
0 Figure 6.3 Product curves and cost curves are mirror images due to the law of
output, Q diminishing returns

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

TC, TC TC, TC
TR TR
b
TR
a
TR
0 Q max Q 0 Q1min Q
Figure 6.11 Profit maximisation using the total revenue and total cost approach when the firm has control over price

Chapter 7 The theory of the firm II: Market structures
Higher level topic
P P
S
Pe Pe D
D
0 Q 0 Q
(a) Individual firm (b) Market/industry
Figure 7.1 Market (industry) demand and supply determine demand faced by the perfectly competitive firm
P, MR, AR
TR
TR 40
70
60 30
50
40 20
30
20 10
10 D = P = MR = AR
0 1 2 3 4 5 6 7 Q 0 1 2 3 4 5 6 7 Q
(a) Total revenue (b) Marginal and average revenue
Figure 7.2 Revenue curves under perfect competition
price, ATC
revenue,
costs MC
P > ATC 1 AVC

P1
firm makes economic
P = minimum ATC = break-even price (supernormal) profit
2
firm makes normal profit, P2
or zero economic profit ATC > P > AVC
firm makes loss but P3 3
continues to produce
P = minimum AVC = shut-down price 4
firm is indifferent between producing P4
at a loss or not producing P < AVC P5 5
firm makes loss
and shuts down 0 Q5 Q4 Q3 Q2 Q1
output, Q
Figure 7.4 Summary of the perfectly competitive firm’s short-run decisions, and the firm’s short-run supply curve

(a) Economic profit (b) Zero economic profit (normal profit)

price, revenue, costs

MC MC
ATC AVC ATC
P1 a AVC
total profit P1 = MR1 = AR1 = D1
b P2 P2 = MR2 = AR2 = D2
profit
Q = break-even price
(break-even point)
0 Q1 Q 0 Q2 Q
(c) Economic loss: the firm continues to produce (d) Loss in the short run and the shut-down price

MC MC
ATC ATC
AVC AVC
c e
total loss P3 = MR3 = AR3 = D3
P3 d total loss P4 = MR4 = AR4 = D4
loss f
P4 loss = short-run
Q = AFC
Q shut-down price
0 Q3 Q 0 Q4 Q
(e) The loss-making firm that will not produce

MC
ATC
AVC
g
P5 = MR5 = AR5 = D5
P5
h
0 Q5 Q
Figure 7.3 Short-run equilibrium positions of the perfectly competitive firm
(a) The firm (b) The industry

P
MC S
price, costs, revenue
LRATC
SRATC
Pe D = MR Pe
D
0 Qf Q 0 Qi Q
Figure 7.5 The firm and industry long-run equilibrium position in perfect competition

From economic (supernormal) profit to normal profit

(a) The firm (b) The industry
P
ATC S1
costs, revenue, P
MC
a 1 S2
P1 P1
b 2
P2 P2
D
0 Q2 Q1 Q 0 Q1 Q2 Q
From loss to normal profit

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

(a) Total revenue (a)

40 MC
35 a
Pe ATC
total revenue ( )
30 profit b
25 TR
20
15 MR D = AR
10 0 Q Q
max
5
0 (b)
1 2 3 4 5 6 7 8 9 10 11 Q
MC

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

(a) Industry in perfect competition (b) Monopoly
S = MC MC
Pm b

a a
Ppc P = MRpc Ppc
D = MB D = MB
0 Qpc Q 0 Qm Qpc Q
MRm
Figure 7.14 Higher price, lower output by the firm in monopoly
(a) Perfect competition (b) Monopoly

consumer
P P surplus
S = MC MC
A C
consumer Pm
Ppc
surplus E
welfare (deadweight) loss
producer F
surplus D
B
producer
D = MB surplus D = MB
0 Qpc Q 0 Qm Qpc Q
MRm
Figure 7.15 Consumer and producer surplus and welfare (deadweight) loss in monopoly compared with perfect competition
(a) Perfectly competitive firm (b) Monopoly

MC MC
price, costs
ATC ATC
Pe
Pe
D
0 Qpe Q 0 Qm MR Q
at long-run equilibrium at long-run equilibrium
production takes place at min ATC production takes place at greater than
(productive efficiency), and min ATC (productive inefficiency), and
Pe = MC (allocative efficiency) Pe > MC (allocative inefficiency)
Figure 7.16 Allocative and productive inefficiency in perfect competition and monopoly

(a) Economic profit (b) Normal profit (c) Losses

economic
(supernormal) ATC
profit losses MC

MC MC ATC
Pe Pe
ATC Pe
D = AR D = AR D = AR
0 Qe Q 0 Qe Q 0 Qe Q
MR
MR MR
Figure 7.21 Short-run equilibrium positions of the firm in monopolistic competition
Intergalactic Space Travel’s price

High price Low price
MC 40 70
million million
High price
Pe ATC Zs Zs
Universal Space Line’s price
40 10
million million
Zs Zs
4 2
D = AR
10 20
million million
Low price
0 Qe Qc Q Zs Zs
MR 70 20
million million
Zs Zs
3 1
Figure 7.22 Long-run equilibrium of the firm in monopolistic Figure 7.23 Game theory: the prisoner’s dilemma
competition
MC Z
P1 MC1
a
Pe ATC
MC2
profit b
D = AR D
MR
0 Q max Q 0 Q1 Q
MR
Figure 7.24 Profit maximisation by a price-fixing cartel Figure 7.25 The kinked demand curve

P P P
MC
P1
P2
D2 MR = MR1 + MR2
D1
MR2
0 Q1 Q 0 Q2 Q 0 Q3 Q
MR1
(a) Market 1 (b) Market 2 (c) Market 1 and market 2
Figure 7.26 Third-degree price discrimination

Chapter 8 The level of overall economic activity
rship land, lab

reneu our,
re p cap
l, en t resource i ta
l, e
i ta markets c nt
ap o re
c om e sts
in c of
pr
,
p
ur
ld s, ro
en
ho age fit)
bo
d
se t, wt, pro
eu
, la n
uc
re eres
rsh
u
land
ho
tio
t
ip
in (
n
households firms
(consumers) (businesses)
ou
h
pe sehol s
ex
nd d nue
itur reve
go e
es
o ic
ds product rv
an d se
ds markets a n
erv ds
ices goo
Figure 8.1 Circular flow of income model in a closed economy with no

government
factor incomes
(wages, rents, interest, profit)
households firms
(consumers) (businesses)
consumer expenditure
(spending on goods and services)
t
savi
ng en
financial markets st m
inve
ng
ndi
orts
spe
tax
me
nt
e xp
es
ern
sp
government gov
on
en
ng
di
ng
o ni en
di
mp sp
or t
s
other countries
Figure 8.3 Circular flow of income model with leakages and injections

real GDP actually achieved

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

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 0
real GDP real GDP
(b) Shifts in the aggregate demand curve (b) Shifts in the SRAS curve
SRAS3 SRAS
1 SRAS
2
price level
price level
AD3 AD1 AD2

0 0
real GDP 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 deflationary (b) The economy with an inflationary gap (c) The economy at the full employment
(recessionary) gap level of output
SRAS
SRAS
SRAS
price level
price level
price level
Ple
Ple Ple
AD
AD
AD
0 Ye Yp 0 Yp Ye 0 Yp = Ye
real GDP real GDP real GDP
Figure 9.4 Three short-run equilibrium states of the economy

(a) Changes in aggregate demand (b) Changes in short-run aggregate supply
SRAS SRAS3
SRAS1
SRAS2
price level
price level
Pl2 Pl3
Pl1 Pl1
Pl3 AD2 Pl2
AD3 AD1 AD
0 Y3 Y1 Y2 0 Y3 Y1 Y2
real GDP real GDP
Figure 9.5 Impacts of changes in short-run macroeconomic equilibrium
(a) Changes in aggregate demand (b) Changes in short-run aggregate supply

LRAS LRAS
SRAS2
SRAS SRAS1
Pl3 Pl2
price level
price level
SRAS3
Pl1
Pl1
Pl2 AD3
Pl3
AD1
AD2
AD
0 Yrec Yp Yinfl real GDP 0 Y2 Yp Y3 real GDP
recessionary inflationary recession with higher real

(deflationary) gap gap inflation GDP with lower
('stagflation') price level
Figure 9.6 Possible causes of the business cycle
LRAS
SRAS
price level
AD
0 Yp
real GDP
Figure 9.7 The LRAS curve and long-run equilibrium in the monetarist/
new classical model

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

price level
price level
price level
AD AD
AD
0 Ye Yp 0 Yp Ye 0 Yp = Ye
real GDP real GDP real GDP
Figure 9.12 Three equilibrium states of the economy in the Keynesian model

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

Keynesian AS
LRAS
Pl1
price level
price level
Pl2
AD3
Pl3 AD2
AD1 AD1 AD2 AD3 AD4

0 Yp real GDP 0 Y1 Y2 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
price level
0 Yp1 Yp2 real GDP 0 Yp1 Yp2 real GDP
Figure 9.14 Increasing potential output, shifts in aggregate supply curves and long-term economic growth
LRAS1 LRAS2 AS1 AS2

price level
SRAS1 SRAS2
price level
Pl1
AD1 AD2 AD2

AD1
0 Y1 Y2
0 Y1 Y2
real GDP
real GDP
Figure 9.15 Long-term economic growth: achieving potential (full employment) output in a growing economy

Higher level topic
Keynesian AS
autonomous induced
spending spending Pl3
price level
price level
$8 $24
million million
Pl2
$32 million Pl1 AD3 AD4
AD2 AD3
AD1 AD2
0 AD1
Y1 Y2 Y3
0 Y1 Y2 Y3
real GDP
real GDP
Figure 9.17 Aggregate demand, real GDP and the multiplier in the Figure 9.18 How the effect of the multiplier changes depending on the
Keynesian model price level

Chapter 10 Macroeconomic objectives I: Low unemployment, low and stable

rate of inflation
P P supply
S2 P of
labour surplus =
S1 labour
price of labour (wage)

S unemployment
P1 P2 Wm
price
price
P2 P1
D1 We
D
demand
D2 for
0 0 Q2 Q1 Q labour
Q2 Q1 Q
0 Qd Qe Qs Q
(a) Fall in demand for a product produced (b) Labour market rigidities lead to an quantity of labour
in a declining industry, or produced in increase in costs of production (supply
shifts to the left), causing a fall in (c) Minimum wage legislation and labour union
a local industry that relocates, causes
Q produced; employers hire fewer activities lead to higher than equilibrium wages
a fall in Q produced; employers fire
workers and lower quantity of labour demanded
workers with inappropriate skills or
local workers no longer needed due to
relocation
Figure 10.1 Structural unemployment

LRAS Keynesian AS
SRAS
price level
price level
Pl1
Pl2 Pl1
AD1 Pl2
AD1
AD2
AD2
0 Yrec Yp 0 Yrec Yp
real GDP real GDP
Figure 10.2 Cyclical unemployment

LRAS
SRAS2
AS
LRAS
SRAS
SRAS1
price level
Pl2
price level
price level
Pl2 Pl2
Pl1
Pl1
Pl1 AD2 AD2
AD1
AD1 AD1
0
0 Yrec Yp
0 Yp Yinfl Yp Yinfl
real GDP
real GDP
real GDP
Figure 10.4 Demand-pull inflation Figure 10.5 Cost-push inflation

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
Pl3 SRAS2
c
price level
c
Pl2 SRAS1
b b
a PC3 Pl1 a
PC2
PC1 AD
0 unemployment rate
0 Y3 Y2 Y1
real GDP
Figure 10.7 Stagflation: outward shifts of the short-run Phillips curve due to decreasing SRAS
(a) The shape of the LRPC and SRPC (b) The reasoning behind the two curves in
terms of the AD-AS model
LRPC
LRAS
rate of inflation
SRAS2
Pl3 c
price level
9% c b SRAS1
Pl2
7% AD2
b SRPC2
5% Pl1 a
a SRPC1
AD1
0 3% 5%
unemployment rate 0 Yp Yinfl
real GDP
5% = natural rate
of unemployment
Figure 10.8 The short-run and long-run Phillips curves

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

distribution of income
100
(a) Economic growth as an increase in actual output caused by
reductions in unemployment and productive inefficiency
Y
cumulative percentage of income

80
perfect
income h
60 equality
B
A g
40 d
0
Belarus
X
f
(b) Economic growth as an increase in production possibilities 20 c
caused by increases in resource quantities or improvements in e b
resource quality a Bolivia
0 20 40 60 80 100
Y
cumulative percentage of population
C Figure 11.3 Lorenz curves: Belarus achieves greater income equality than
Bolivia
B
A
100
0
PPC1 PPC2 PPC3 X
perfect income
cumulative percentage of income
80 equality
Figure 11.1 Using the production possibilities model to illustrate economic
growth
60 increased income
equality after
redistribution
40
20
before
redistribution
0 20 40 60 80 100
cumulative percentage of population
Figure 11.4 Lorenz curves and income redistribution

Chapter 12 Demand-side and supply-side policies
(a) The monetarist/new classical model (a) The monetarist/new classical model
LRAS LRAS
price level
SRAS
price level
SRAS
Pl2
Pl1
Pl1 Pl2
AD2 AD1
AD2
AD1
0 0 Yp Yinfl real GDP

Yrec Yp real GDP
potential output
(b) The Keynesian model

(b) The Keynesian model
AS
Keynesian AS price level
price level
Pl1
Pl2
Pl2
AD1
Pl1 AD2
AD2
AD1
0 Yp Yinfl real GDP
0 Yrec Yp real GDP
potential output
Figure 12.1 Effects of expansionary policy: eliminating a recessionary Figure 12.2 Effects of contractionary policy: eliminating an
(deflationary) gap inflationary gap
(a) Partial crowding out (b) Complete crowding out
due to G SRAS
SRAS
price level
price level
due to G
due to I AD2
due to I AD2
AD3
AD1 AD1
0 Y1 Y3 Y2 0 Y1 Y2
real GDP real GDP
Figure 12.3 Crowding out of private investment

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

Chapter 13 International trade

(a) Country A: absolute (b) Country A: comparative
advantage in good Y; advantage in good Y;
good Y
Country B: absolute Country B: comparative country A’s PPC
advantage in good X advantage in good X country B’s PPC
0
good X
country A
good Y
country A good Y
country B
country B Figure 13.5 Identical opportunity costs:
no gains from trade
0 0
good X good X
Figure 13.3 Absolute and comparative advantage
Production possibilities when each Opportunity cost of cotton Opportunity cost of microchips
country produces only cotton or
only microchips
(1) (2) (3) (4)
Cotton Microchips
20 or 10 10 units of microchips 1 20 units of cotton
Cottonia = =2
20 units of cotton 2 10 units of microchips
25 or 50 50 units of microchips 25 units of cotton 1
Microchippia =2 =
25 units of cotton 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 A production
cotton
20 15
15 Microchippia’s PPC 10 B consumption

cotton
5
10
5 Cottonia’s 0 10 20 30 40 50
PPC microchips
0
10 20 30 40 50 60 (b) Microchippia exports 10 units of
microchips microchips and imports 10 units of cotton
25
Figure 13.2 Comparative advantage 20
cotton
15
10 D consumption
5
C production
0 10 20 30 40 50
microchips
Figure 13.4 The gains from specialisation and trade based on comparative
advantage: both countries consume outside their PPC

(a) Effects on imports
(a) Effects on imports P Sd = domestic supply

P Sd = Sdq = domestic supply
domestic quota
quota plus quota
supply
revenue
Pd government revenue Pq
Pw + t world price + tariff
world price =
tariff Pw world supply curve
Pw world price =
world supply curve
Dd = domestic demand Dd = domestic demand
0 Q1 Q2 Q3 Q4 Q
0 Q1 Q2 Q3 Q4 Q
imports with tariff imports with quota
imports without tariff imports without quota
(b) Welfare effects (b) Welfare effects

P Sd = Sd = domestic supply
domestic supply P
welfare loss = d + f Sdq = domestic supply

a b a quota plus quota
Pw + t world price + tariff
c
d e f tariff Pq b welfare loss = d + e + f
Pw g world price =
c
world supply curve
Pw g d e e f world price =
Dd = domestic demand world supply curve
0 Q1 Q2 Q3 Q4 Q Dd = domestic demand
imports with tariff 0 Q1 Q2 Q3 Q4 Q
imports without tariff
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

Sd = domestic supply
P
Sds = domestic
subsidy supply minus subsidy
Ps
world price =
Pw world supply curve
Dd = domestic demand
0 Q1 Q3 Q2 Q
imports after subsidy
imports before subsidy
Figure 13.11 Production subsidies

Chapter 14 Exchange rates and the balance of payments
(a) The market for US dollars (a) Demand for $ increases: $ appreciates
per $ = price of $ in terms of
per $ = price of $ in terms of

excess supply of $ S of $ S of $
(dollars)
0.80
0.90 C
equilibrium
0.67 exchange rate B
0.67 A D2 for $
0.50
excess demand for $ D for $
(dollars) D1 for $
0 Q of $ (dollars) 0 Q of $ (dollars)
(b) The market for euros (b) Supply of € increases: € depreciates

$ per = price of in terms of $
$ per = price of in terms of $

S of
excess supply of (euros) S1 of
2.00 S2 of
equilibrium D
1.50 1.50
exchange rate E
1.25 F
1.11
excess demand for D for
(euros)
0 D for
Q of (euros)
0 Q of (euros)
Figure 14.1 Exchange rate determination in a freely floating exchange

rate system Figure 14.2 Exchange rate changes in a freely floating exchange rate system
(a) Shifting the currency demand curve (b) Shifting the currency supply curve
$ per bople = price of boples in terms of $
$ per bople = price of boples in terms of $
S of boples S1 of boples
2. central bank buys excess S2
boples, increasing demand 2. imports are reduced,
for boples therefore the supply
of boples falls
B A B A
2.00 2.00
1. fall in demand for Bopland's 1. fall in demand for Bopland's
1.50 exports reduces demand exports reduces demand
C for boples for bople
D2 for boples D1 for boples D2 for boples D1 for boples

0 Q of boples 0 Q of boples
Figure 14.3 Fixed exchange rates: maintaining the value of the bople at 1 bople = $2.00

(a) With a trade deficit, country consumes outside its PPC
C
good A
PPC
0
good B
(b) With a trade surplus, country consumes inside its PPC

good A
D
PPC
0
good B
Figure 14.6 Using a PPC to illustrate a trade deficit and a trade surplus

Chapter 15 Economic integration and the terms of trade
Higher level topic
(a) Changes in global demand: terms of trade and (b) Changes in global supply: effects of terms of trade changes on
balance of trade change in same direction the balance of trade depend on PEDs for exports and imports
S3 S1
global price of internationally
global price of internationally

global supply
S P3
P2 global supply
traded good
traded good
of wheat P1 S2
P1
P3 D2
P2 global demand
global demand
D1 for wheat
D
D3
0 Q3 Q1 Q2 0 Q3 Q1 Q2
quantity of internationally quantity of internationally
traded good traded good
Figure 15.1 Changes in global demand or supply: terms of trade impacts on the balance of trade
P 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)

Chapter 16 Understanding economic development
A→B: no economic growth with some development
B→C: economic growth with no development
B→D or E: economic growth with development
C
industrial goods
D
A
E
B
PPC1 PPC2
0
merit goods
Figure 16.1 Economic growth and economic development
low low low

income savings investment
low
low physical human low natural
capital capital capital
low productivity
low growth
of labour
in income
and land
Figure 16.2 The poverty cycle (poverty trap)

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

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 1

(a) Supply of firm A (b) Supply of firm B (c) Market supply

0 200 400 600 0 200 400 600 0 2 4 6 8 10 12

Figure 2.6 Market supply as the sum of individual supplies

Figure 2.8 Movements along and shifts of the supply curve

Figure 2.9 Market equilibrium

© Cambridge University Press 2012 Economics for the IB Diploma 2

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

(a) Increase in supply (b) Decrease in supply

(a) Adjustment of price to increased demand P1 S = MC

© Cambridge University Press 2012 Economics for the IB Diploma 3

Higher level topic

© Cambridge University Press 2012 Economics for the IB Diploma 4

Figure 3.1 Demand curves and PED

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

© Cambridge University Press 2012 Economics for the IB Diploma 5

PED > 1 PED > 1

Figure 3.5 PED and total revenue

(a) Inelastic demand (b) Elastic demand

Figure 3.7 PED, indirect taxes and government tax revenue

© Cambridge University Press 2012 Economics for the IB Diploma 6

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

Figure 3.8 Cross-price elasticities

Frequently encountered cases

Figure 3.11 Supply curves and PES

© Cambridge University Press 2012 Economics for the IB Diploma 7

© Cambridge University Press 2012 Economics for the IB Diploma 8

(b) Ad valorem tax (b) Market outcomes: ad valorem tax

Figure 4.8 Impacts of subsidies on market outcomes

© Cambridge University Press 2012 Economics for the IB Diploma 9

Figure 4.17 Welfare impacts of a price floor (minimum price) for

© Cambridge University Press 2012 Economics for the IB Diploma 10

Higher level topics

(a) Inelastic demand (a) Inelastic supply

(b) Elastic supply

© Cambridge University Press 2012 Economics for the IB Diploma 11

consumer tax per S1 = MC

Figure 4.4 Effects of indirect taxes on consumer and producer surplus

Figure 4.10 Effects of subsidies on consumer and producer surplus

© Cambridge University Press 2012 Economics for the IB Diploma 12

Figure 5.1 Demand, supply and allocative efficiency with

(a) Welfare loss

D = MPB = MSB D = MPB = MSB

Figure 5.4 Government regulations to correct negative production

© Cambridge University Press 2012 Economics for the IB Diploma 13

D = MPB = MSB D = MPB = MSC

Figure 5.5 Market-based policies to correct negative production externalities

(a) Welfare loss

Figure 5.8 Correcting negative consumption externalities

© Cambridge University Press 2012 Economics for the IB Diploma 14

(a) Welfare loss

Popt welfare loss

(a) Direct government provision (b) Granting a subsidy

Figure 5.11 Correcting positive production externalities

© Cambridge University Press 2012 Economics for the IB Diploma 15

(a) Legislation or advertising

(b) Direct government provision

(c) Granting a subsidy

Figure 5.14 Correcting positive consumption externalities