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# Important diagrams to remember

## (c) Market demand

P (\$)

P (\$)

2
1

DA

2 4 6 8 10 12
quantity of chocolate
bars (per week)

demands
of other
consumers
in the
market

3
2
1

DB

2 4 6 8 10 12
quantity of chocolate
bars (per week)

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

## (a) A movement along the demand curve,

caused by a change in price, is called a
change in quantity demanded

## (b) A shift of a demand curve, caused by a change in

a determinant of demand, is called a change in
demand

P
change in demand

P1

change in

quantity
demanded

decrease
in D

P2

D2
D

increase
in D

Q1

Q2

D3
Q

D1
Q

## Economics for the IB Diploma

(a) Supply of rm A

(b) Supply of rm B

## Important diagrams to remember

P\$

P\$

SA

5
4

+ 3

SB

supplies
of other
firms in
the market

= 3
2
1

200
400
600
quantity of chocolate
bars (per week)

Sm

200
400
600
quantity of chocolate
bars (per week)

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

## (a) A movement along the supply curve,

caused by a change in price, is called a
change in quantity suppied

## (b) A shift of the supply curve, caused by a

change in a determinant of supply, is called a
change in supply

S
B

P2

change in
quantity
supplied

P1

Q1

Q2

P1

S1

S3

Q3

decrease
in supply

increase
in supply

Q1

Q2

S2

## Figure 2.8 Movements along and shifts of the supply curve

S
5

surplus

4
3

equilibrium
price

market equilibrium

2
shortage

D
equilibrium quantity

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

14

## Important diagrams to remember

(a) Increase in demand
P

## (b) Decrease in demand

initial
equilibrium

P2
a

final
equilibrium

P1

b
D2

P1

final
equilibrium

S
a
c

P3

D1

D1
0

Q1

initial
equilibrium

D3

Q2

Q3

Q1

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

## (b) Decrease in supply

initial
equilibrium

final
equilibrium

S1

P
a

P1

P2

S2

S3

final
equilibrium

P1

S1

P3

D
0

Q2

Q1

initial
equilibrium

D
0

Q3

Q1

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

P

S
C

P2
P1

B
D2
D1

Q1

Q3

shortage =
excess demand

Q2 Q

P1

S = MC

P2
P3 consumer
surplus
Pe
producer
surplus
P4
P5

Allocative
efficiency:
at market
equilibrium
MB = MC and
social surplus
is maximum

D = MB

P6
0

Qa Qb

Qe

## Important diagrams to remember

Higher level topic
P (\$)

P (\$)

Qd = 14 2P

Qd = 19 2P

4 Qd = 10 2P

a
decreases

a
increases

Qd = 14 2P
Qd = 14 4P
absolute
value of b
increases

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

## Figure 2.12 Shifts of the demand curve (changes in a in the

function Qd = a bP )

P (\$)
5

0
2 4 6 8 10 12 14 16 18 20
quantity of chocolate bars (thousands per week)

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

P(\$)
Qs = 1 + 2P

Qs = 2 + 2P Qs = 6 + 2P

c
decreases

c
increases

0
2 4 6 8 10 12 14 16 18
quantity of chocolate bars (thousands per week)

## Figure 2.14 Shifts of the supply curve (changes in c in the supply

function Qs = c + dP )

## Cambridge University Press 2012

Qs = 2 + 2P

value
of d
increases

Qs = 2 + 4P

0
2 4 6 8 10 12 14 16 18
quantity of chocolate bars (thousands per week)

Figure 2.15 Changing the slope of the supply curve (changes in d in the
function Qs = c + dP )

## Important diagrams to remember

Chapter 3 Elasticities
Frequently encountered cases

P
5%

P2

P2
P1

10%
P1

D
0

Q2 Q1

5%

P1

P2

5%

P1

10%

Special cases

## (c) Unit elastic demand: PED = 1

Q2 Q1

Q2

Q1

Q1

5%
Figure 3.1 Demand curves and PED

P (\$)
50
45
40
35
30
25
20
15
10
5
0

PED = 4
e
d

elastic portion of
demand curve

PED = 1
c

inelastic portion
of demand curve

b PED = 0.25
a

10 20 30 40 50 60 70 80 90 100
units of good A

## Important diagrams to remember

(a) PED > 1 (elastic demand)

PED > 1

P2
P1 C

PED > 1

PED = 1
PED < 1

PED = 1
P2
P1

A B
0

D
Q2 Q1

C
A

P2
C

PED < 1
B

P1
A

Q2 Q1 Q

Q2

Q1

## (b) Manufactured products: supply shifts with elastic demand

S2

S2
S1

P
P2

S3

P1

P3

P3
D

D
Q2 Q1 Q3

S3

P2

P1

S1

Q2

Q1

Q3

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

final
equilibrium

Pt

S2
tax
per
unit

S1

initial
equilibrium

P1

final
equilibrium

Pt
P1

Qt

tax
per
unit

S1

initial
equilibrium

D
0

S2

Qt

## Important diagrams to remember

(a) Substitutes and positive XED : demand for Pepsi

S
YED < 0 0 < YED < 1 YED > 1
inferior
good

D2
D3 D1

D increases
as price of
Coca-Cola
increases

D2

D decreases as price
of Coca-Cola decreases

income
inelastic
demand,
normal
good

D1

income
elastic
demand,
normal
good

D3

D4
Q

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

## (b) Complements and XED : demand for tennis balls

D2
D1
D3
D decreases as
price of tennis rackets increases
0

D increases
as price of
tennis rackets
decreases

## Figure 3.8 Cross-price elasticities

Frequently encountered cases

P
S
S

P2
10%

P2
10%

P1

Q1 Q2

P1

5%

Q2

15%

Special cases

S1

Q1

S2
S3
0

P1

Q1

## Important diagrams to remember

(a) Primary commodities: demand shifts with inelastic supply

P
P2
P1
P3

D3

D1

## (b) Manufactured products: demand shifts with elastic supply

P
S

P2
P1
P3

D2
Q

D2
D3

D1
Q

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

## Chapter 4 Government intervention

(a) Market outcomes: specic tax

P

S2 (= S1 + tax)
tax per S
1
unit

government
revenue

Pc

S2 (= S1 + tax)
tax per
unit S1

P*
Pp

Q t Q*

D
Q

S2 (= S1 + tax)

tax per
unit

government
revenue

tax per
unit S

S1
Pc

tax per
unit

S2 = S1 + tax

P*
PP

D
Qt Q*

S1

P
Pp
P*

subsidy
per unit

S2 = S1 subsidy

Pc

D
0

Q*

Qsb

P

Pe

welfare loss

a
Pe

Pc
shortage =
excess demand

Qs

Qe

Pc

Qd

excess supply =
surplus

Pf

S = MC

b
d

c
e

D = MB
Qs

Qe

Qd

excess supply =
surplus

Pf

Pe

D+
government
purchases

Pe
D

Qd

Qe

Qs

D
0

Qd

Qe

Qs

## Figure 4.16 An agricultural product market with price oor and

government purchases of the surplus

excess supply =
surplus

S = MC

a
Pf
b

c
e

Pe
d

f
D+
government
purchases

welfare
loss

D = MB
0

Qd

Qe

Qs

## Figure 4.17 Welfare impacts of a price oor (minimum price) for

agricultural products and government purchases of the
surplus

10

P

## excess supply of labour

= labour surplus
= unemployment

supply
of
labour

Wm
Wm

We

We

Qd
Qe Qs
quantity of labour

welfare loss

c
e

demand
for
labour

Q
0

Qd

Qe

Qs

## (a) Inelastic demand

tax per
unit

S1

Pc
P*

consumers
producers

Pp
D

Qt Q*

S2 = S1 + tax
tax per
unit

Pp
0

consumers
producers

Qt Q*

S2 = S1 + tax

S1
Pc

consumers

P*
Pp

producers

tax per
unit

consumers

Q*

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

S1

producers

D
Qt

## (b) Elastic demand

Pc
P*

S1

tax per
unit

Pc
P*
Pp

S2 = S1 + tax

S2 = S1 + tax

Qt

Q*

D
Q

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

11

## Important diagrams to remember

P

S1 = MC

tax per
unit

consumer
surplus
after the tax

S = MC
Pc

consumer
surplus

P*

S2 = S1 + tax

P*

government
revenue from
the tax

welfare loss = a + b

Pp

producer
surplus

producer
surplus
after the
tax

D = MB

D = MB
0

Q*

## (a) Consumer and producer surplus in a competitive

free market: maximum social surplus

Q*

Qt

## (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

P

P
S1 = MC
S = MC

P*

subsidy
per unit
S2 = S1 subsidy

Pp

gain in producer
P * surplus
gain in consumer
surplus
Pc

consumer
surplus
producer
surplus

welfare loss

D = MB
0

Q*

D = MB

Q
0

Q*

Qsb

12

## Chapter 5 Market failure

P
S = MPC = MSC
Popt
D = MPB = MSB
0

Qopt
allocative efficiency
is achieved

no externalities

MSC

external
cost

S = MPC

Popt

external
cost S = MPC

Popt
Pm

Pm

MSC

D = MPB = MSB
Q

Qopt Qm

welfare loss
D = MPB = MSB

Qopt Qm

## Figure 5.3 Welfare loss (deadweight loss) in a negative

production externality

MSC

S = MPC

Popt
Pm

Qopt Qm

D = MPB = MSB
Q

externalities

13

## Important diagrams to remember

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

## (a) Imposing an indirect tax on

output or on pollutants
MSC = MPC + tax
tax = external cost

P
Pc = Popt

P2

S = MPC

S = MPC
Pm

Pm

P1

Pp

Qopt Qm

D2
D1

D = MPB = MSC

D = MPB = MSB
0

permits

MSC2

Qopt1 Qopt2 Qm

Q1

P
S = MPC = MSC

Pm
D = MPB

Popt

external
cost

welfare loss

Pm
Popt

external
cost

D = MPB

MSB
0

Qopt

Qm

MSB
Q

Qopt Qm

## Figure 5.7 Welfare loss (deadweight loss) in a negative

consumption externality

P

## (b) Market-based: imposing an indirect tax

P

external
cost

S = MPC = MSC

MPC + tax
tax =
external
cost

Pc

S = MPC = MSC

Pm

Pm
D1 = MPB

Popt

Pp

D = MPB

D2 = MSB
after demand decreases

Qopt

Qm

S = MPC = MSC

MSB
0

Qopt

Qm

14

(a) Welfare loss

S = MPC

external
benefits

Pm

P
S = MPC

MSC

external
benefits
MSC

Pm

Popt

Popt

Qm Qopt

D = MPB = MSB
Q

D = MPB = MSB
0

S = MPC

Qm Qopt

## Figure 5.10 Welfare loss (deadweight loss) in a positive

production externality

## (a) Direct government provision

S = MPC

spillover
benefit

MSC

subsidy =
spillover benefit

Pm

Pm

Popt

Popt

welfare loss

Qm Qopt

D = MPB
Q

MSC

Qm Qopt

D = MPB
Q

15

P

S = MPC = MSC
Popt
Pm

MSB

welfare loss

S = MPC = MSC

external
benefit

Qm Qopt

D = MPB
Q

Popt
Pm

external
benefits

MSB
D = MPB
Q

Qm Qopt

## Figure 5.13 Welfare loss (deadweight loss) in a positive

consumption externality

P
S = MPC = MSC
Popt
D2 = MSB

Pm

external
benefit

D1 = MPB
0

Qm Qopt

P

S = MPC = MSC
S + government
provision

Pm
MSB

Pc
D = MPB
0

Qm

Qopt

P

S = MPC = MSC
subsidy =
external
benefit

MPC
subsidy

Pm
MSB

Pc
D = MPB
0

Qm

Qopt

16

## Chapter 6 The theory of the rm I: Production, costs, revenues and prot

Higher level topics

units of output

xed cost curves

TP

TC
0

units of output

TVC

costs

## units of variable input (labour)

TFC
0

output, Q

AP
0

MC

MP
units of variable input (labour)

ATC

costs

## Figure 6.1 Total, marginal and average products

AVC

AFC

AP
0

MP
units of variable input (labour)

output, Q

## (d) Average cost and marginal cost curves

Figure 6.2 Total, average and marginal cost curves

MC
AVC

output, Q

## Cambridge University Press 2012

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

17

## Important diagrams to remember

(c) Economies and diseconomies of scale

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

short-run average total cost curves

SRATC1
SRATC2

SRATCm

0
0

Q1 Q2

diseconomies
of scale

costs

economies
of scale

LRATC

costs

LRATC

output, Q

output, Q

## (b) Prot-maximising rm produces at Q2 and

makes zero economic prot: TR TC = 0
(it earns normal prot)

a
b

f
d

Q1 Q2 Q3

costs, revenues

costs, revenues

TC
TR

## (c) The loss-minimising rm produces at Q2

(if it produces) and makes a loss = TC TR
= a b (negative economic prot since
TR < TC )

TC

TC

costs, revenues

## (a) Prot-maximising rm produces at Q2 and

makes economic prot: TR TC = c d

TR
a

Q1 Q2 Q3 Q

TR
b

Q1

Q2 Q3

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

## (a) Prot maximisation

TC,
TR

TC

TC,
TR

TC
b
TR
a

TR
0

max

Q1min

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

18

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

Higher level topic

P
S

Pe

Pe

D
0

(a) Individual rm
Figure 7.1

(b) Market/industry

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

P, MR, AR
TR
40

TR
70
60
50
40
30
20
10
0

30
20
10
1 2 3 4 5 6 7 Q

D = P = MR = AR

1 2 3 4 5 6 7 Q

## (a) Total revenue

Figure 7.2 Revenue curves under perfect competition

ATC

price,
revenue,
costs

## P = minimum ATC = break-even price

firm makes normal profit,
or zero economic profit
P = minimum AVC = shut-down price
firm is indifferent between producing
at a loss or not producing

P > ATC
firm makes economic
(supernormal) profit
ATC > P > AVC
firm makes loss but
continues to produce
P < AVC
firm makes loss
and shuts down

MC
1

P1
2

P2
3

P3
P4
P5
0

AVC

4
5
Q5 Q4 Q3 Q2 Q1
output, Q

Figure 7.4 Summary of the perfectly competitive rms short-run decisions, and the rms short-run supply curve

19

## Important diagrams to remember

MC
P1

ATC AVC

total profit

P1 = MR1 = AR1 = D1

profit

Q1

MC

ATC

P2

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

Q2

AVC

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

price, revenue, costs

## (a) Economic prot

MC

ATC

c
total loss

P3

P3 = MR3 = AR3 = D3

loss
Q

Q3

AVC

MC

ATC

AVC

e
total loss

P4

loss
= AFC
Q

Q4

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

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

MC

ATC

g
P5

P5 = MR5 = AR5 = D5

Q5

AVC

(a) The rm

## price, costs, revenue

P
MC
SRATC

D = MR

Pe

LRATC
Pe

D
0

Qf

Qi

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

20

## Important diagrams to remember

From economic (supernormal) prot to normal prot

(a) The rm

## (b) The industry

costs, revenue, P

P
MC
a

P1

P1

P2

S1

ATC

S2
2

P2

D
0

Q2 Q1

Q2

Q1

## From loss to normal prot

costs, revenue, P

(c) The rm

P

ATC

MC

S2

a
P1
P2

P2

P1

S1
1
D

Q1 Q2

Q2

Q1

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

P
costs, revenue, P

MC

S = MC
ATC

Pe

consumer
surplus

P = MR = Pe

Qe

(a) The rm

Pe

producer
surplus

Qe

D = MB
Q

## (b) The market/industry

Figure 7.7 Productive and allocative efciency in perfect competition in the long run

21

## Important diagrams to remember

(a)
price, costs, revenue

40
35
30
25
20
15
10
5

TR

Pe
profit

PED = 1
(unit elastic demand)

PED > 1
(price-elastic
demand)

15

PED < 1
(price-inelastic
demand)

10

1 2 3 4 5 6 7 8 9 10 11

D = AR
Q

max

MC
Pe loss

P = AR = D

MR

5
0

ATC

(b)

1 2 3 4 5 6 7 8 9 10 11

## (b) Marginal and average revenue

price, revenue ( )

MC
a

## price, costs, revenue

total revenue ( )

ATC

c
d

MR
Qlmin

D = AR
Q

## Figure 7.11 Prot maximisation and loss minimisation

in monopoly: marginal revenue and cost approach

-5
MR

MC
P

costs

## Figure 7.10 Revenue curves in monopoly

Pr

LRATC
D

D = AR
0

Qr

MR

minimum efficient
scale

## Figure 7.12 Comparison of prot maximisation and revenue maximisation

by the monopolist

22

## Important diagrams to remember

(a) Industry in perfect competition

(b) Monopoly
MC

Ppc

P = MRpc

D = MB
0

Qpc

S = MC
b

Pm

Ppc

D = MB
0

Qm

Qpc
MRm

## (a) Perfect competition

P

Ppc

(b) Monopoly
consumer
surplus

S = MC
A
consumer
surplus

Pm

producer
surplus
B

Qpc

E
F

producer
surplus

D = MB
0

MC

Qm

D = MB

Qpc
MRm

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

(b) Monopoly

price, costs

## (a) Perfectly competitive rm

MC
ATC
Pe

Qpe

at long-run equilibrium
production takes place at min ATC
(productive efficiency), and
Pe = MC (allocative efficiency)

MC
ATC
Pe

D
0

Qm

Q
MR
at long-run equilibrium
production takes place at greater than
min ATC (productive inefficiency), and
Pe > MC (allocative inefficiency)

Figure 7.16 Allocative and productive inefciency in perfect competition and monopoly

23

economic
(supernormal)
profit
MC
Pe

ATC

D = AR
0

Qe

MC

ATC

Pe

D = AR
0

(c) Losses

Qe

losses
Pe

D = AR
0

Qe

MR

MR

MR

ATC

MC

High price
Low price
40
million
Zs

ATC

Pe

D = AR
0

Qe

Qc
MR

Low price
High price

MC
40
million
Zs

70
million
Zs
10
million
Zs

4
10
million
Zs

70
million
Zs

2
20
million
Zs

20
million
Zs

competition

P
MC
a

Pe

MC1

ATC

MC2

profit

MR
0

P1

max

D = AR
Q

Q1

Q
MR

24

P

P1

P2

Q1

MR1

MR = MR1 + MR2

D2

D1
0

MC

(a) Market 1

Q2

(b) Market 2

MR2
Q

Q3

25

in (

ho

n
tio

households
(consumers)

ip
rsh
eu

uc

land
, la
bo

ur
,

en
pr

land, lab
our,
eurship
cap
pren
e
r
t
i ta
n
e
resource
l, e
,
l
a
t
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i
markets
p
re
a
c
o
c
e
sts
of
com
n
i
p
d
,
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ro
es
d
ho
wag rofit)
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nt, st, p
e
r ere
t

firms

ou
pe sehol
d
nd
itur
e

go
o

ds

an
ds
erv

ices

product
markets

es

ex

s
nue
reve

ds
goo

vic
er
s
and

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

government

factor incomes
(wages, rents, interest, profit)

households
(consumers)

firms

consumer expenditure
(spending on goods and services)

di
en
sp

ng
o

tax
es
ni
mp

or t

ng

financial markets

t
en
tm
s
e
i nv

government

ern
gov

nt
spe
di
ng
ndi
ng
on
e xp
orts

savi

me

en
sp

other countries

26

## Important diagrams to remember

real GDP actually achieved

real GDP

peak contraction
peak

expansion

or potential GDP
trough

trough

time (years)

## actual GDP > potential GDP;

there is an output gap:
unemployment < natural
rate of unemployment
expansion:
unemployment
falls

real GDP

contraction:
unemployment
increases

b
a

actual GDP

## actual GDP < potential GDP; there is an

output gap: unemployment > natural
rate of unemployment

c
long term
growth trend, or
potential GDP =
full employment GDP;
unemployment =
natural rate of
unemployment

time (years)

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

27

## Chapter 9 Aggregate demand and aggregate supply

(a) The aggregate demand curve

price level

price level

SRAS

0

real GDP

0

real GDP

## (a) The economy with a deationary

(recessionary) gap

price level

SRAS

Ple

real GDP

price level

SRAS3 SRAS
1 SRAS
2

price level

price level

0

real GDP

SRAS

Ple

level of output

price level

SRAS

Ple

Ye Yp

real GDP

Yp

Ye

real GDP

Yp = Ye
real GDP

28

## Important diagrams to remember

(a) Changes in aggregate demand

SRAS3

Pl2
Pl1
Pl3

Y3 Y1 Y2

price level

price level

SRAS

SRAS1

SRAS2

Pl3
Pl1
Pl2

Y3 Y1 Y2

real GDP

real GDP

## (b) Changes in short-run aggregate supply

LRAS

LRAS
SRAS2
SRAS1

Pl3
Pl1

Pl2

Pl2

SRAS3

Pl1
Pl3

Yrec Yp Yinfl

recessionary
(deflationary) gap

price level

price level

SRAS

real GDP
inflationary
gap

Y2 Yp Y3

recession with
inflation
('stagflation')

real GDP

higher real
GDP with lower
price level

## Figure 9.6 Possible causes of the business cycle

LRAS
price level

SRAS

0

Yp
real GDP

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

29

## Important diagrams to remember

(a) Creating and eliminating a deationary gap

## (b) Creating and eliminating an inationary gap

LRAS

LRAS

SRAS1

Pl1

Pl2

price level

price level

SRAS1
SRAS2

b
c

Pl3

Pl3

Pl2
Pl1

b
a

SRAS2

Yrec Yp

Yp Yinfl
real GDP

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

LRAS
Keynesian AS

Pl1

price level

price level

SRAS1
SRAS2

Pl2

section III

section II

section I

Yp

real GDP

Keynesian AS

price level

Keynesian AS

price level

price level

Keynesian AS

real GDP

## (a) Recessionary (deationary) gap

Yp Ymax

Ye
real GDP

Yp

Yp Ye
real GDP

Yp = Ye
real GDP

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

30

## Important diagrams to remember

(a) The monetarist/new classical model

## (b) The Keynesian model

Keynesian AS

Pl1
Pl2

price level

price level

LRAS

Pl3

Yp

real GDP

Y1

Y2

Y3 Yp real GDP

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

LRAS2

AS1

AS2

price level

price level

LRAS1

Yp1

## Yp2 real GDP

Yp1

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

AS1

LRAS2
SRAS1

SRAS2

Pl1

Y1

Y2

real GDP

AS2

price level

price level

LRAS1

## (b) The Keynesian model

Y1

Y2

real GDP

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

31

## Important diagrams to remember

Higher level topic

Keynesian AS
induced
spending

\$8
million

Pl3
price level

price level

autonomous
spending

\$24
million
\$32 million

Y1

Y2

Y3

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

## Cambridge University Press 2012

Pl2
Pl1

Y1

Y2
real GDP

Y3

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

32

rate of ination
P

S2
S1

S
price

P1
P2

price

P2
P1

D1

D2
0

Q2

Q1

## (a) Fall in demand for a product produced

in a declining industry, or produced in
a local industry that relocates, causes
a fall in Q produced; employers re
workers with inappropriate skills or
local workers no longer needed due to
relocation

Q2

Q1

Wm
We

## (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

labour surplus =
unemployment

supply
of
labour

Qe Qs
Qd
quantity of labour

demand
for
labour
Q

## (c) Minimum wage legislation and labour union

activities lead to higher than equilibrium wages
and lower quantity of labour demanded

## Figure 10.1 Structural unemployment

(b) The Keynesian model

## (a) The monetarist/new classical model

Keynesian AS
SRAS

price level

price level

LRAS

Pl1
Pl2

Pl1
Pl2

Yrec Yp

Yrec

Yp

real GDP

real GDP
Figure 10.2 Cyclical unemployment
(a) The monetarist/new classical model

## (b) The Keynesian model

LRAS

AS

LRAS

Pl1

Pl2
Pl1

Yinfl

real GDP
Figure 10.4 Demand-pull ination

## Cambridge University Press 2012

SRAS1

Pl2
Pl1

Yp

price level

Pl2

price level

price level

SRAS

SRAS2

0

Yp Yinfl
real GDP

Yrec

Yp

real GDP
Figure 10.5 Cost-push ination

33

## Important diagrams to remember

Higher level topic

## (a) The shifting Phillips curve

price level

rate of inflation

SRAS3
c
b
a

PC3
PC2
PC1
unemployment rate

Pl3

SRAS2

Pl2

SRAS1

b
a

Pl1

0

Y3 Y2 Y1
real GDP

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

## (b) The reasoning behind the two curves in

LRAS
SRAS2

9%
7%
5%
0

c
b

SRPC2

SRPC1

3% 5%
unemployment rate

price level

rate of inflation

LRPC

Pl3

c
b SRAS1

Pl2
Pl1

Yp Yinfl
real GDP

5% = natural rate
of unemployment

34

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

distribution of income
100

B
A
0

## (b) Economic growth as an increase in production possibilities

caused by increases in resource quantities or improvements in
resource quality

## (a) Economic growth as an increase in actual output caused by

reductions in unemployment and productive inefciency

80

60

Belarus
f

20
e
a
0

40

perfect
income
equality

c
Bolivia

40
80
20
60
cumulative percentage of population

100

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

100
PPC1 PPC2 PPC3 X

growth

## cumulative percentage of income

80

60

perfect income
equality
increased income
equality after
redistribution

40

20

before
redistribution

40
80
20
60
cumulative percentage of population

100

35

## Chapter 12 Demand-side and supply-side policies

(a) The monetarist/new classical model

LRAS

price level

price level

LRAS
SRAS

Pl2
Pl1

SRAS

Pl1
Pl2

Yrec Yp

real GDP

potential output

## (b) The Keynesian model

(b) The Keynesian model

AS

Pl2
Pl1

price level

price level

Keynesian AS

Pl1
Pl2

Yrec

(deationary) gap

price level

(a)

potential output

inationary gap

(b)

due to G

SRAS

due to I

Y2

Y1 Y3
real GDP

SRAS
due to G

due to I

Yp real GDP

price level

Y1
Y2
real GDP

36

## Important diagrams to remember

(a) Equilibrium rate of interest

## (b) Changes in the supply of money cause

changes in the equilibrium rate of interest
Sm3
rate of interest

rate of interest

Sm

i
Dm
0

Qe
quantity of money

Sm1

Sm2

i3
i1
i2
0

Dm
Q3
Q1 Q2
quantity of money

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

37

## (a) Country A: absolute

Country B: absolute

## (b) Country A: comparative

Country B: comparative

good Y

good Y

good Y

0
country A
country B

good X

country As PPC
country Bs PPC
good X

country A
country B

good X

## Figure 13.3 Absolute and comparative advantage

Opportunity cost of cotton

(2)
Microchips

(3)

(4)

## Production possibilities when each

country produces only cotton or
only microchips
(1)
Cotton
Cottonia
Microchippia

20

or

10

10 units of microchips 1
=
20 units of cotton
2

20 units of cotton
=2
10 units of microchips

25

or

50

50 units of microchips
=2
25 units of cotton

25 units of cotton
1
=
50 units of microchips 2

(a) Cottonia exports 10 units of cotton and
imports 10 units of microchips
25

25

cotton

20
Microchippias PPC

15

15
B consumption

10
5

10
5

cotton

20 A production

Cottonias
PPC

10 20 30 40 50 60
microchips

10 20 30 40 50
microchips

## (b) Microchippia exports 10 units of

microchips and imports 10 units of cotton
25
20
cotton

15
10
5
0

D consumption
C production
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

38

## Important diagrams to remember

(a) Effects on imports

Sd =

domestic
supply

Pd
Pw + t

government revenue
world price + tariff

Pw

world price =
world supply curve

tariff

Q1

Q3

Q2

Q4

Dd = domestic demand

Dd = domestic demand

Q1

Q3

Q2

## imports without quota

domestic supply

b
e

a
d

tariff

world price =
world supply curve

Q2

Q3

Q4

Sd = domestic supply

P
a

## world price + tariff

Dd = domestic demand

Q1

Q4

## (b) Welfare effects

Sd =

welfare loss = d + f

world price =
world supply curve

Pw

plus quota

Pq

Pw g

quota

quota
revenue

## (b) Welfare effects

Pw + t

Sd = domestic supply

Pq
Pw g

b
c

## Sdq = domestic supply

plus quota

quota

d e

welfare loss = d + e + f

e f

world price =
world supply curve

## imports with tariff

Dd = domestic demand

Q1

Q2

Q3

Q4

## imports with quota

imports without quota

## (a) Production subsidy: quantity of imports falls

Sd = domestic supply
Sds = domestic

subsidy

Ps

## supply minus subsidy

world price =
world supply curve

Pw

Dd = domestic demand
0

Q1

Q3

Q2

## imports after subsidy

imports before subsidy

39

## Chapter 14 Exchange rates and the balance of payments

(a) Demand for \$ increases: \$ appreciates

## (a) The market for US dollars

S of \$

excess supply of \$

(dollars)

0.80

equilibrium
exchange rate

0.67
0.50

D for \$
(dollars)

Q of \$ (dollars)

2.00
equilibrium
exchange rate

1.50
1.25

D for

(euros)

Q of (euros)

## 2. central bank buys excess

boples, increasing demand
for boples

## 1. fall in demand for Bopland's

exports reduces demand
for boples

C
D2 for boples

D2 for \$

D1 for \$
0

Q of \$ (dollars)

S1 of
S2 of

1.50

1.11

D for
0

Q of (euros)

Figure 14.2 Exchange rate changes in a freely oating exchange rate system

S of boples

0.67

(euros)

Q of boples

D1 for boples

S of

excess supply of

rate system

2.00
1.50

0.90

S of \$

S1 of boples

S2

2.00

## 2. imports are reduced,

therefore the supply
of boples falls

## 1. fall in demand for Bopland's

exports reduces demand
for bople

D2 for boples
0

D1 for boples

Q of boples

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

40

## Important diagrams to remember

(a) With a trade decit, country consumes outside its PPC

good A

PPC

good B

good A

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

D
PPC

good B

Figure 14.6 Using a PPC to illustrate a trade decit and a trade surplus

41

## Chapter 15 Economic integration and the terms of trade

Higher level topic

## global price of internationally

S
global supply
of wheat

P2
P1

D2
global demand
D1 for wheat

P3
D3
0

Q3

Q1

Q2

quantity of internationally

## (b) Changes in global supply: effects of terms of trade changes on

the balance of trade depend on PEDs for exports and imports

## (a) Changes in global demand: terms of trade and

balance of trade change in same direction

S3

S1
global supply

P3

S2

P1
P2

global demand
D

Q3 Q1

Q2

quantity of internationally

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

S1

S2

P1
P2
D2
D1
0

## 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

42

industrial goods

## AB: no economic growth with some development

BC: economic growth with no development
BD or E: economic growth with development

C
D

A
B
PPC1

E
PPC2

merit goods

low
income

low
savings

low
investment

low physical
capital

low growth
in income

low
human
capital

low natural
capital

low productivity
of labour
and land

43

## World Bank country classication

The World Bank classifies countries into four groups
according to income levels (based on 2008 GNI per
capita):
Economically less developed countries:
low income, with GNI per capita of US\$975 or less
lower middle income, with GNI per capita of
\$976\$3855
upper middle income, with GNI per capita of
\$3856\$11 905.
Economically more developed countries:
high income, with GNI per capita of \$11 906 or
more.
Table 16 World Bank country groups by 2008 GNI per capita

Afghanistan
Benin
Burkina Faso
Burundi
Cambodia
Central
African Rep.
Comoros
Congo, Dem.
Rep.
Eritrea

Albania

Guatemala

Angola

Guyana

Armenia

Honduras

Vietnam

Bhutan
Bolivia
Cameroon

India
Indonesia
Iran, Islamic
Rep.

Nicaragua
Nigeria
Pakistan

Niger
Rwanda

Yemen, Rep.
Zambia

Cape Verde
China

Iraq
Jordan

Senegal

Zimbabwe

Congo, Rep.
Cte dIvoire
Djibouti

Kazakhstan
Kiribati
Kosovo

Palau
Papua New
Guinea
Paraguay
Philippines
Samoa

Lesotho

Egypt, Arab
Rep.

Macedonia,
FYR
Maldives

Ethiopia
Gambia, The
Ghana
Guinea
Guinea-Bissau
Haiti
Kenya

Malawi
Mali
Mauritania
Mongolia
Mozambique
Myanmar

Sierra Leone
Somalia
Tajikistan
Tanzania
Togo
Uganda
Uzbekistan

Korea, Dem.
Rep.
Kyrgyz Rep.
Lao PDR

Nepal

Liberia

Marshall
Islands
Micronesia,
Fed. Sts
Morocco

Sudan
Swaziland
Syrian Arab
Republic
Thailand
Timor-Leste
Tonga
Tunisia
Turkmenistan
Ukraine
Vanuatu
West Bank
and Gaza

So Tom and
Principe
Solomon
Islands
Sri Lanka
(continued over)