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12 Key Diagrams
for AS Microeconomics

Advice on drawing diagrams in the exam

• The right size is about 1/3 of a side of A4 – don’t 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

OUTPUT
OF GOOD
Y

C D

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 equilibrium output of Q2

Price Supply
post-tax Supply pre-tax

Tax per unit

P2

P1

P3

Demand

Q2 Q1 Quantity

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 firm’s costs of production. The extent of the subsidy
per unit is shown by the vertical distance between the two supply curves.

Price S1
Supply +
Subsidy

P3

P1

Subsidy per unit

P2

Demand

Q1 Q2 Quantity

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 Inward Shift in Demand and a fall in Supply An Outward Shift in Demand and a Rise in Supply

Price Price
S2

S1 S1

S2

P2

P1 P1
P3

D3

D1 D1

D2

Q2 Q1 Quantity Q1 Q2 Quantity

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 not
shifts in the demand curve
• Inelastic demand and supply curves mean that equilibrium prices tend to be
volatile when conditions of demand and supply change
• Think about the implications of such shifts in price and quantity on the
incomes 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 Demand

AC1

AC2

Long run average

cost

AC3

Q1 Q2 Q3 Output (Q)

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
exploit

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6) Consumer and producer surplus and allocative efficiency in a market

Costs
Revenues Supply

Consumer
Surplus (CS)
Consumer
Surplus (CS)
P1
Producer
Surplus (PS)

Producer
Surplus

Demand
Allocative efficiency is
achieved here where the
market clears and the price
reflects the costs of supply.
Consumer and producer
surplus is maximised!

Q1 Output (Q)

Supply

CS

P2
Producer
Surplus
P1

Producer
Surplus

Demand
If output is reduced to Q2
and the price is raised to P2,
then there is a loss of
allocative efficiency –
leading to a deadweight loss
of consumer and produce
surplus

Q2 Q1

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
Price
Private Cost
(Supply)

P2

P1

Demand = Private
When there are negative
Benefit = Social Benefit
production externalities then
the social cost of supplying
the product is greater than
External the private cost
Cost The product is over-supplied
and under-priced by the
market – i.e. market failure

Q2 Q1 Output (Q)

Price
Private Cost = Social Cost

When there are negative

consumption externalities
then the social benefit of
consuming the product is
P1 less than the private benefit
- The product is over-
consumed by the market –
P2 i.e. market failure

Demand = Private
Benefit

Social Benefit

Q2 Q1 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 Relatively Elastic Demand

Price Price

P2

P1
P1

P2
Demand

Demand

Q2 Q1 Q1 Q2

(ii) Price elasticity of demand and the profit margins of a business

Relatively Inelastic Demand Relatively Elastic Demand

Price Price

Higher profit
P2 margin

Lower profit
margin
P2
AC
P1
AC

P1 Demand

Demand

Q2 Q1 Q2 Q1

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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 not
provide them in the quantities society needs

Costs
Benefits
Welfare loss because merit goods
tend to be under-consumed by the
A
free market

Supply

C
External Benefit

Social
Benefit
Private
Benefit
Qp Qs
Output (Q)

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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

Costs
Benefits
Social Cost

External costs (negative

externalities)
Private Cost

Demand (Limited Information)

Demand (Full Information)

Q3 Q2 Q1 Quantity

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

A maximum price for rented accommodation or for a foodstuff

Rent Supply
£s
Free Market
Equilibrium

Pe

P max Price (Rent) Ceiling

Excess
Demand

Demand

Q2 Q1 Quantity of Rented Property

A minimum wage in the labour market

Wage
£s

Supply of
Labour

W1 Minimum Wage

We

Demand for
Labour

E2 Ee E2 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

P min Price Floor (Guaranteed)

Pe

Demand

Q3 Q1 Q4 Quantity

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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