PPFs and Other Diagrams

Output of capital goods

O
u
t
p
u
t

o
f

c
o
n
s
u
m
e
r

g
o
o
d
s

a
n
d

s
e
r
v
i
c
e
s

A
B
C
Heart Operations
A
l
l

O
t
h
e
r

O
p
e
r
a
t
i
o
n
s

A
B
C
Output (Q)
Costs
Revenues
SAC1
SAC2
AR (Demand)
Basic Supply and Demand
Analysis
Demand Curve
Price
Quantity Demanded
Demand
P1
P2
P3
Q1 Q2 Q3
Shift in demand
Price
Quantity Demanded
D1
P1
Q1 Q2 Q3
D3 D2
Price
Demand
Price
Demand
Relatively Inelastic Demand
Consumer Surplus and Price Elasticity of Demand
P1
Q1 Q2
Relatively Elastic Demand
Price
Demand
Price
Demand
Relatively Inelastic Demand
Consumer Surplus and Price Elasticity of Demand
P1
Q1 Q2
Relatively Elastic Demand
Quantity Demanded
Quantity Demanded
Price Price
Perfectly Elastic Demand Perfectly Inelastic Demand
Demand
Demand
Quantity Quantity Q1 Q2 Q3
P1 P1
P2
P3
Q1
Price Price
Perfectly Elastic Supply Perfectly Inelastic Supply
Supply
Supply
Quantity Quantity Q1 Q2 Q3
P1 P1
P2
P3
Q1
Price Price
Relatively Elastic Supply
Supply responds quickly to a change in
demand
Relatively Inelastic Supply
Supply responds less than proportionately to a
change in price
Supply
Supply
Quantity Quantity Q1 Q2 Q3
P1
P1
P2
P3
Q1
D3 D2 D1
P2
P3
D3
D2
D1
Price
Quantity
D1
Supply
P1
Q1
D2
P2
Q2
Price of
DVD
players
Quantity
demanded
D1
Supply of
DVD
players
P1
Q1
D2
P2
Q2
Price of
Sterling in
Euros
Quantity of Pounds
Sterling
Demand 1
Supply
P1
Q1
Demand 2
P2
Q2
Price
Quantity
D1
S1
P1
Q1
D2
P2
Q2
S2
P3
Q3
Price
Quantity of
Council Housing
Demand
S1
P1
Q1
P2
Q2
Supply + Sub
P3
Government Subsidy
Subsidy per
unit
Average
Weekly
Rent
Quantity of
Council Housing
Demand
S1
P1
Q1
P2
Q2
Supply +
Subsidy
Government Subsidy
Subsidy per
unit
Price
Quantity
Demand
Supply pre
subsidy
Q1 Q2
Supply + Export
Subsidy
A
B
C
D
E
F
G
Price
Quantity
D1
S1
P1
Q1
S2
P2
Q2
Price
Quantity
D1
S2
A
S1
B
C
D
E
F
G H
I
J
Price
Quantity
Demand
Supply post tax
Supply pre tax
P2
P1
Q1
Price
Quantity
Price
Quantity
Price
Quantity
Price
Quantity
Supply
Supply
Supply
Supply
A B
C D
Supply curves with different price elasticity
Price
Quantity
Price
Quantity
Price
Quantity
Price
Quantity
Demand
Supply
Demand
A B
C D
Demand curves with different price elasticity
Demand
Demand
Price
Quantity
D1
Supply
P1
Q1
D2
P2
Q2
Price of
Good S
Quantity demanded of Good T
Demand
Price
Quantity
D2
S1
P2
Q2
D1
P1
Q1
S2
Price
Quantity
D2
P1
Q1
S pre
subsidy
Price
Quantity
D2
P1
Q1
S pre
subsidy
Price
Quantity
Demand
Supply
P max
Q1
Maximum Prices
Pe
Price Ceiling
Q2
Free Market
Equilibrium
Excess
Demand
Rent
s
Quantity of Rented
Property
Demand
Supply
P max
Q1
Maximum Prices
Pe
Price (Rent) Ceiling
Q2
Free Market
Equilibrium
Excess
Demand
Price
Quantity
Demand
Supply
P max
C
Maximum Prices
Pe
Maximum Price
A B D
Price
Quantity of output
Demand
Supply
P min
Q1
Pe
Price Floor (Guaranteed)
Q2
Excess
Supply
Q3
Price
Quantity
Demand
Supply
P min
Price Support Schemes Buffer Stocks
Pe
Minimum Price
B C A
Price
Quantity
Demand
Supply
P min
Q1
Price Support Schemes Buffer Stocks
Pe
Price Floor (Guaranteed)
Q4
Q3
S2
Price
Quantity
Demand
S1
P1
P2
Q3
Q2
S2
Price
Quantity
Demand
S1
P1
Increasing Market Supply Consumer Benefits
P2
Q3 Q2
S2
Price
Quantity
Demand
Supply
P1
Q1
Equilibrium
Point
Producer Surplus
Producer
Surplus
Price
Quantity
Demand
Supply
P1
Q1
Producer Surplus
B
A
C D
Price
Quantity
Demand
Supply
P1
Q1
Equilibrium
Point
Consumer Surplus
Consumer
Surplus
Price
Quantity
Demand
Supply
P1
Q1
Equilibrium
Point
Market Equilibrium
Market Failure Diagrams
Social Efficiency / Welfare Losses
Output (Q)
Demand = Private
Benefit = Social Benefit
Private Marginal
Cost (Supply)
Q1
Costs
Revenues
Social Marginal
Cost
Q2
External
Cost
P1
P2
Benefits
Costs
Quantity of
Output (Q)
Demand (Private Marginal Benefit)
Marginal Private
Cost
P1
Q1
Social
Equilibrium
Negative Externalities
Marginal Social
Cost
Q2
a
b
c
Tackling Externalities
Negative Externalities
Taxation
Pollution
Trading
Schemes
Tax Credits
Voluntary
Agreement
Regulation
Aggregates Levy
Landfill Tax
Fuel Duty
Climate Change Levy
(CCL)
Emissions trading
scheme
Landfill permits
Pesticides
EU C02 from cars
agreement
Water quality
legislation
Reduced VAT on
installation of central
heating
Benefits
Costs
Quantity of
Output (Q)
Demand (Private Marginal Benefit) =
Social Marginal Benefit (SMB)
Marginal Private
Cost
P1
Q1
Social
Equilibrium
Loss of Social Welfare from Externalities
Marginal Social
Cost
Q2
a
b
c
Deadweight loss of
economic welfare
Marginal External Cost
Merit Goods
Costs
Benefits
Quantity of
Housing
Private
Demand
Supply
Demand +
External
Benefits
Qp Qs
External Benefit
A
B
Merit Goods and Welfare Loss
Costs
Benefits
Output (Q)
PMB
PMC = SMC
SMB
Qp Qs
External Benefit
Welfare loss where SMB>PMB
above output Qp
A
B
C
The Demand Curve for Public Goods
Costs
Benefits
Output (Q)
Demand from A
Value 1
Q1
Demand from B
Value 1
Value 2
The Demand Curve for Public Goods
Costs
Benefits
Output (Q)
Demand A
Value 1
Q1
Demand B
Value 1
Value 2
Demand A+B
Socially Efficient Provision of Public Goods
Costs
Benefits
Output (Q)
Demand A Demand B
Demand A+B
Marginal Social
Cost (MSC)
Qp
Negative Externalities
Costs
Benefits
Output (Q)
PMB = SMB
PMC
SMC
Qp Qs
External Cost
Net Welfare Loss
Marginal
External Cost
Negative Externalities Pollution Tax
Costs
Benefits
Output (Q)
PMB = SMB
PMC
SMC
Qp Qs
PMC + TAX
Price
Quantity
Demand (Limited Information)
Marginal Private
Cost
P1
Q1
De-Merit Goods and Health Awareness
Marginal Social
Cost
Q2 Q3
Demand (Full Information)
Price
Quantity
Domestic
Demand
Domestic
Supply
P1
Q1
Export Subsidy
Domestic Price
World Price
World Price +
Sub
P2
P3
Q2 Q3
Price
per
tonne
Quantity
Domestic
Demand
Domestic Supply of
Coal
P1
Q1
Coal Export Subsidy
Domestic Price
World Price
World Price of Coal +
Subsidy
P2
P3
Q2 Q3
Price
Quantity
Domestic
Demand
Domestic
Supply
P1
Q1
Import Tariffs
World Price
World Price +
Tariff
P2
Q4 Q3 Q2
A B
C D
E F
G H
Price
Quantity
D1
Supply
P1
Q1
Consumer Surplus
Outward Shift in Demand
Price
Quantity
Demand
S1
P1
Q1
Consumer
Surplus
S2
P2
Q2
D2
P2
Q2
Outward Shift in Supply
Price
Quantity
D2
SRS
P2
Q1
Price
Quantity
D1
S1
P1
Q1
D3
Q3
P3
D1
Q2
P1
An Outward Shift in Demand An Inward Shift in Demand
Price
Quantity
D2
SRS
P1
Q2
Price
D1
Q1
P2
An Outward Shift in Market Demand
Long Run Market Supply is more Elastic
An Outward Shift in Market Demand
Short Run Market Supply is Inelastic
Quantity
SRS
P1
Q2
D1
Q1
P2
D2
LRS
Q3
a
b
Price
Quantity
D1
S1
P1
Q1
Price
Quantity
D1
S1
P1
Q1
D3
Q2
P2
D2
Q2
P2
An Outward Shift in Demand and a Rise in Supply An Inward Shift in Demand and a Fall in Supply
S2
S2
Quantity
D1
S1
P1
Q1
D2
Q2
P2
An Outward Shift in Coffee Demand and a Rise in Coffee Supply
S2
Quantity
D1
S1
P1
Q1
D2
Q2
P2
An Outward Shift in Oil Demand when Supply is Inelastic
Quantity of
DVD players
D1
S1
P1
Q1
D2
Q2
P2
Price of DVD
players
Price
Quantity
D1
S1
P1
Q1 Q2
P2
S2
Price
Quantity
S1
Q1
Price
Quantity
D1
S1
P1
Q1 Q3
P3
D2
Q2
P1
An Outward Shift in Supply An Inward Shift in Supply
S2
P2
S3
Price
Quantity
S1
Q1
Price
Quantity
D1
S + Tax
P2
Q2 Q1
P1
D1
Q2
P1
A Tax when Demand is Price Inelastic A Tax When Demand is Price Elastic
S + Tax
P2
S1
Indirect Taxes and Elasticity of Demand
Price
Quantity
Supply
P1
P2
P3
Q1 Q3 Q2
Price
Quantity
P2
P3
P1
Q2 Q1 Q3
P4
P5
Supply
Q4 Q5
Price
Quantity
S1
P1
Q1 Q3 Q2
S2
S3
Increase in
Supply
Decrease in
Supply
Theory of the Firm Diagrams
Costs
Output (Q)
Fixed Costs
Total
Fixed Cost
Average Fixed
Cost
1
2000
1000
2
Costs
Output (Q)
Short Run Cost Curves
Average Fixed
Cost (AFC)
Average
Variable Cost
(AVC)
Average Total
Cost (ATC)
Marginal Cost
(MC)
Costs
Output (Q)
Short Run Cost Curves
A
Costs
Output (Q)
Increase in Variable Costs
Average
Variable Cost
(AVC)
Average Total
Cost (ATC)
Marginal Cost
(MC)
MC2 AC2
AVC2
Costs
Output (Q)
The Long Run Average Cost Curve
SRAC1
SRAC2
SRAC3
Q1 Q2 Q3
AC1
AC2
AC3
Costs
Output (Q)
The Long Run Average Cost Curve
SRAC1
SRAC2
SRAC3
Q1 Q2 Q3
AC1
AC2
AC3
LRAC
Costs
Output (Q)
The Minimum Efficient Scale (MES)
SRAC1
SRAC2
SRAC3
Minimum
Efficient
Scale
LRAC
Economies of scale (falling LRAC) due to
increasing returns
Diseconomies of scale (rising LRAC) due to
decreasing returns to scale
Costs
Output (Q)
Economies of Scale and Profits
SRAC1
SRAC2
AR
(Demand)
MR
MC1
MC2
P1
P2
Q1 Q2
Profit at Price P1
Profit at Price P2
Costs
Output (Q)
Different output levels (1)
ATC
AR
(Demand)
MR
MC
A B C D
Costs
Output (Q)
Different output levels (2)
ATC
AR
(Demand)
MR
MC
A B C D
Monopoly Price and Output in the Short Run
ATC
Demand (AR)
MR
MC
Q1
Revenue
Cost and
Profit
Output (Q)
P1
AC1
Monopoly versus Competition
LRAC = LRMC
Monopoly
Demand (AR)
MR
Q1
Revenue
Cost and
Profit
Output (Q)
D
E
Qc
B
A
C
Monopoly versus Competition (Welfare Loss)
LRAC = LRMC
Monopoly
Demand (AR)
MR
Q1
Monopoly Profit
at Price P1
Revenue
Cost and
Profit
Output (Q)
P1
Pc
Qc
B
A
C
Deadweight
Welfare Loss
Natural Monopoly
Demand (AR)
Revenue
Cost and
Profit
Output (Q)
LRMC
LRAC
Natural Monopoly losses and profits
Demand (AR)
Revenue
Cost and
Profit
Output (Q)
MR
LRMC
LRAC
P1
AC1
Q1 Q2
P2
AC2
Profit at
price P1
Loss at
price P2
Benefits from Cross Subsidisation
Monopoly
Demand (AR)
Revenue
Cost and
Profit
Output (Q)
MR
MC
AC
Revenue
Cost and
Profit
Output (Q)
AC
AR
MC
MR
Barriers to Entry Blockaded Entry
LRAC = LRMC (Existing
Monopolist)
Monopoly
Demand (AR)
MR
Q1
Revenue
Cost and
Profit
Output (Q)
P1
Pc
Qc
B
A
C
AC = MC (Potential
Entrant into the market)
D
E
Costs,
Revenues
Output (Q)
The Shut Down Price
ATC
AR
(Demand)
MR
P1
Q1 Q2
MC
AVC
AR2
MR2
P2
Costs,
Revenues
Output (Q)
The Shut Down Price
ATC
Q1
MC
AVC
AR2
MR2
P1
AC1
A
B
C
Costs,
Revenues
Output (Q)
The Short Run Supply Curve
ATC
MC = supply
AVC
P1
The Shut Down Price
P2
Break-Even Price
Q1
Output (Q)
Profits and an Increase in Variable Costs
SRAC1
AR
(Demand)
MR
MC1
Q2 Q1
Profit at Price P2
Profit at Price P1
Costs
Revenues
P1
AC1
SRAC2
MC2
P2
AC2
Output (Q)
Total Cost (TC)
Revenue
Cost and
Profit
Q1 Q2 Q3
Total Profit
Max Profit
Min Profit
Q4
Total Revenue
(TR)
Profit Max Revenue Max
Total Revenue and Cost (1)
Output (Q)
Total Cost (TC)
Revenue
Cost and
Profit
Q1 Q2
Total Revenue
(TR)
Break Even
TR=TC
Total Revenue and Cost under Perfect Competition
Output (Q)
Total Cost (TC)
Revenue
Cost and
Profit
Total Revenue
(TR)
Multi Choice Questions on This
A
0
B
C
D E
F
G
H
Output (Q)
Revenue
Cost and
Profit
Total Revenue
(TR)
Total Revenue with a Perfectly Elastic Demand Curve
Average Revenue
(AR) = Marginal
Revenue (MR)
3
1 2
6
Output (Q)
Revenue
Cost and
Profit
Total Revenue
(TR)
Total Revenue with a downward sloping demand curve
Marginal Revenue
(MR)
Average Revenue
(Demand) AR
Output (Q)
Revenue
Cost and
Profit
Total Revenue
(TR)
Total Revenue with a downward sloping demand curve
Marginal Revenue
(MR)
Average Revenue
(Demand) AR
Total Revenue is
maximised when
MR = 0
Price elasticity of
demand = 1 at
this output
Demand Curves with Different Elasticity and Total Revenue
Market A Market B
Quantity
Quantity
Price
Price
Pa
Pb
ARb
ARa
Higher revenue from reducing the
price from Pa to Pb (the gain in
quantity sold more than offsets
the lower price per unit)
Demand in segment B of the
market is relatively inelastic. A
higher unit price is charged and
total revenue also increases
Qb Qa Qb
Pb
Qa
Pa
Costs
Output (Q)
Profit Maximisation and Sales Revenue Max
SRAC
AR
(Demand)
MR
MC
Q1
P1
AC1
Profit Max at Price P1
P2
AC2
Q2
Revenue Max at Price P2
Costs
Revenues
Output (Q)
Contestable Markets and The Conduct of Firms
SRAC
AR (Monopoly)
MR
MC
Q1
P1
Profit Max at
Price P1
P2
Q2
Normal Profit
output where
AC=AR
The Kinked Demand Curve
Assume we start out at P1 and Q1:
Will a firm benefit from raising price above P1?
Will it benefit from cutting price below P1?
Raising price above P1
Demand is relatively elastic
Firm loses market share and some
total revenue
Reducing price below P1
Demand is relatively inelastic
Little gain in market share other firms
have followed suit
Total revenue may still fall
Costs
Revenues
Output (Q)
P1
Q1
MR
AR
MC1
The Kinked Demand Curve Rising MC
Costs
Revenues
Output (Q)
P1
Q1
MR
AR
MC1
The Kinked Demand Curve Rising MC
Costs
Revenues
Output (Q)
P1
Q1
MR
AR
MC1
MC2
MC3
P2
Q2
Introduction to Game Theory
Two prisoners are held in a separate
room and cannot communicate
They are both suspected of a crime
They can either confess or they can
deny the crime
Payoffs shown in the matrix are years
in prison from their chosen course of
action
Decisions made under uncertainty


Prisoner A




Confess




Deny


Prisoner B
Confess (3 years, 3 years) (1 year, 10 years)
Deny (10 years, 1 year) (2 years, 2 years)
Introduction to Game Theory (2)
The equilibrium in the Prisoners
Dilemma occurs when each player takes
the best possible action for themselves
given the action of the other player
The dominant strategy is each prisoners
unique best strategy regardless of the
other players action

Best strategy? Confess?
A bad outcome prisoners could do
better by both denying but once
collusion sets in, each prisoner has an
incentive to cheat!


Prisoner A




Confess




Deny


Prisoner B
Confess (3 years, 3 years) (1 year, 10 years)
Deny (10 years, 1 year) (2 years, 2 years)
Individual Firm
Industry
Firms Output Industry Output
MC (industry)
Demand
MC
Price Fixing Cartels
AC
MR
Individual Firm
Industry
Firms Output
MC (industry)
Demand
MR
P(cartel)
MC
AC
Quota Industry
Output
P(cartel)
AC
Price Fixing Cartels
Individual Firm
Industry
Firms Output
MC (industry)
Demand
MR
P(cartel)
MC
AC
Quota Industry
Output
P(cartel)
AC
Price Fixing Cartels
Costs
Revenues
Allocative Efficiency
Output (Q)
AR
(Demand)
MC (Supply)
P1
Q1
Consumer
Surplus (CS)
Producer
Surplus (PS)
Costs
Revenues
Natural Monopoly and Efficiency
Output (Q)
AR (Demand)
Long Run Marginal
Cost (LRMC)
P1
Q1
Profit Maximisation
Q2
Long Run Average
Cost (LRAC)
MR
AC1
Cost per
Unit
Natural Monopoly and Efficiency
Output (Q)
Long Run Average
Cost (LRAC)
Constant returns to scale
Minimum Efficient
Scale
Price Discrimination (1
st
Degree)
Quantity of Output (Q)
Price (P)
AR (Market Demand)
MR
P1
AC = MC
Q1
P2
P4
Q3 Q2
Equilibrium output with perfect price
discrimination the monopolist will sell
an extra unit providing that the next
unit adds as much to revenue as it
does to cost
P3
P5
Q4 Q5
Supply (Marginal
Cost)
Off-Peak
Demand
Peak Demand
MR Off-Peak
MR Peak
Price Off-Peak
Price Peak
Output Off-Peak Output Peak
Price (P) and
Costs
Output
Peak and Off Peak Pricing
Market A Market B
MC=AC
Quantity Quantity
Price
Price
Pa
Pb
MRa
MRb ARb
ARa
Profit from selling to
market A with a
relatively elastic
demand and
charging a lower price
Demand in segment B of
the market is relatively
inelastic. A higher unit
price is charged
MC=AC
Qb Qa
Price Discrimination (1)
Perfect Competition (1)
Output (Q) Output (Q)
Market Demand and Supply Individual Firms Costs and Revenues
Price (P) Price (P)
Market
Demand
Market
Supply
P1
Q1
AR (Demand) = MR
MC (Supply)
AC
P1
AC1
Q2
Perfect Competition Sub Normal Profits
Output (Q) Output (Q)
Market Demand and Supply Individual Firms Costs and Revenues
Price (P) Price (P)
Market
Demand
Market
Supply
P1
Q1
AR = MR
MC
AC
AC1
Q2
Perfect Competition (2) Increase in Market Supply
Output (Q) Output (Q)
Market Demand and Supply Individual Firms Costs and Revenues
Price (P) Price (P)
Market
Demand
Market
Supply
P1
Q1
AR1 = MR1
MC (Supply)
AC
P1
Q3
P2
P2
AR2 = MR2
Q2
MS2
P2
Comparing Monopoly with Perfect Competition
Output (Q)
Competitive Market Pure Monopoly
Price (P) Price (P)
Market
Supply
Market
Demand
Market
Supply
Monopoly
Demand
Q1 Q1
MR
P comp
P mon
Q2
Net loss of
producer surplus
Welfare Loss Under Pure Monopoly
Output (Q)
Competitive Market Pure Monopoly
Price (P) Price (P)
Market
Supply
Market
Demand
Market
Supply
Monopoly
Demand
Q1 Q1
MR
P comp
P mon
Q2
Net loss of
consumer surplus
Net loss of
producer surplus
A
B
C
D
Pure Monopoly and Scale Economies
Output (Q)
Competitive Market Pure Monopoly
Price (P) Price (P)
Market
Supply
Market
Demand
Competitive
Supply (MC)
Monopoly
Demand
Q1 Q1
MR
P comp
P mon
Q2
Monopoly
Supply with
Scale
Economies
Costs
Output (Q)
Profit Maximisation and a Rise in Demand
SRAC
AR1
(Demand)
MR1
MC
Q1
P1
AC1
Profit Max at Price P1
P2
AC2
Q2
Profit Max at Price P2
AR2
MR2
Cost
per
unit in
the
long
run
Output (Q)
Minimum Efficient Scale (MES)
LRAC
MES
Falling LRAC Economies of Scale (Increasing
Returns to Scale)
Rising LRAC Diseconomies of Scale (Decreasing
Returns to Scale)
Costs
per
unit in
the
long
run
(ATC)
Output (Q)
Minimum Efficient Scale (MES) and Market Size
LRAC1
LRAC3
LRAC2
MES2 MES1 MES3
Benefits
Costs
Quantity of
Output (Q)
Demand (Private Marginal Benefit) =
Social Marginal Benefit (SMB)
Marginal Private
Cost
P1
Q1
Social
Equilibrium
Loss of Social Welfare from Externalities
Marginal Social
Cost
Q2
a
b
c
Deadweight loss of
economic welfare
Marginal External Cost
Merit Goods
Costs
Benefits
Quantity of
Housing
Private
Demand
Supply
Demand +
External
Benefits
Qp Qs
External Benefit
A
B
Merit Goods and Welfare Loss
Costs
Benefits
Output (Q)
PMB
PMC = SMC
SMB
Qp Qs
External Benefit
Welfare loss where SMB>PMB
above output Qp
A
B
C
The Demand Curve for Public Goods
Costs
Benefits
Output (Q)
Demand from A
Value 1
Q1
Demand from B
Value 1
Value 2
The Demand Curve for Public Goods
Costs
Benefits
Output (Q)
Demand A
Value 1
Q1
Demand B
Value 1
Value 2
Demand A+B
Socially Efficient Provision of Public Goods
Costs
Benefits
Output (Q)
Demand A Demand B
Demand A+B
Marginal Social
Cost (MSC)
Qp
Negative Externalities
Costs
Benefits
Output (Q)
PMB = SMB
PMC
SMC
Qp Qs
External Cost
Net Welfare Loss
Marginal
External Cost
Negative Externalities Pollution Tax
Costs
Benefits
Output (Q)
PMB = SMB
PMC
SMC
Qp Qs
PMC + TAX
Price
Quantity
Demand (Limited Information)
Marginal Private
Cost
P1
Q1
De-Merit Goods and Health Awareness
Marginal Social
Cost
Q2 Q3
Demand (Full Information)
Price
Quantity
P2
P3
P1
Q2 Q1 Q3
P4
P5
Supply
Q4 Q5
Macroeconomics Diagrams for IB
Economics
Market interest rates
e.g. savings rates & credit cards
Asset prices
e.g. house prices
Expectations and
Confidence
Businesses & consumers
Exchange rate
Official Interest
Rate
Set by the MPC
Domestic
Demand
i.e. C + I + G
Net
External
Demand
i.e. X - M
Aggregate
Demand
AD
Drives short-term
Economic
growth
Domestic
inflationary
Pressure
i.e. changes
in the output gap
(actual GDP relative
to potential GDP)
Import
Prices
Consumer Price
Inflation
How interest rates affect us
Aggregate Demand and
Supply Analysis
General
Price Level
Real National
Income
AD
Aggregate Demand and Supply
A
B
General
Price Level
Real National
Income
AD
Aggregate Demand and Supply
A
B
P1
P2
Y1 Y2
SRAS2
SRAS2
General
Price Level
National Income
AD
SRAS
Pe
Ye
Aggregate Demand and Supply
LRAS
Yfc
General
Price Level
National Income
AD1
SRAS
Pe
Ye
Negative Output Gap
LRAS
Yfc
AD2
Y2
P2
General
Price Level
Real National Income
AD1
SRAS
P1
Y1
AD-AS Analysis Causes of Deflation
LRAS
Yfc
AD2
Y2
P2
General
Price Level
AD1
SRAS
P1
Y1
LRAS1 LRAS2
YFC2 Y2
AD2
P2
Fall in AD Rise in LRAS greater than increase in AD
General
Price Level
AD1
SRAS
P1
Y1
LRAS1 LRAS2
YFC2 Y2
AD2
P2
General
Price Level
National Income
AD1
SRAS
Pe
Y1
An Increase in Long Run Aggregate Supply
LRAS1 LRAS2
YFC2 Y1
AD2
General
Price Level
Real National Income
An Increase in Long Run Aggregate Supply
LRAS1 LRAS2
YFC2 YFC1
SRAS1
SRAS2
General
Price Level
National Income
AD
SRAS1
P1
Y1
Aggregate Demand and Supply
LRAS
Yfc
SRAS2
P2
Y2
General
Price Level
National Income
AD1
SRAS
P1
Y1
Shifts in Aggregate Demand
LRAS
Yfc
AD2
P2
Y2
AD3
Y3
P3
General
Price Level
Real National Income
AD1
SRAS
P1
Y1
The Risk of Demand Pull Inflation
LRAS
Yfc
AD2
P2
Y2
AD3
P3
General
Price Level
Real National Income
AD1
SRAS1
P1
Y1
External Shock Higher Oil Prices and a Tightening of Monetary Policy
LRAS
Yfc
SRAS2
P2
Y2
AD2
Y3
General
Price Level
National Income
AD
SRAS1
P1
Y1
Shifts in Short Run Aggregate Supply
LRAS
Yfc
SRAS2
P2
Y2
SRAS3
Y3
General
Price Level
National Income
AD1
SRAS
P1
Y1
An Increase in Aggregate Demand
LRAS
Yfc
AD2
P2
Y2
General
Price Level
National Income
AD2
SRAS
P2
Y2
A Fall in Aggregate Demand
LRAS
Yfc
AD1
P1
Y1
Market interest rates
e.g. savings rates & credit cards
Asset prices
e.g. house prices
Expectations and
Confidence
Businesses & consumers
Exchange rate
Official Interest
Rate
Set by the MPC
Domestic
Demand
i.e. C + I + G
Net
External
Demand
i.e. X - M
Aggregate
Demand
AD
Drives short-term
Economic
growth
Domestic
inflationary
Pressure
i.e. changes
in the output gap
(actual GDP relative
to potential GDP)
Import
Prices
Consumer Price
Inflation
Short Run Phillips Curve
Wage
Inflation
(%)
Unemployment Rate (%) U1
P1
U2
P2
U3
P3
Short Run Phillips Curve
Expectations-Augmented Phillips Curve
Wage
Inflation
(%)
Unemployment Rate (%) U1
P1
U2
P2
U3
P3
SRPC1
SRPC2
SRPC3
Real
Wage
Rate
Hours of Work
Supplied (LS)
Individual Labour Supply Curve
Individual Labour
Supply (1)
Individual Labour
Supply (2)
L1 L3 L2
The Supply of Labour
Wage
Rate
Employment
LD2
LS
W2
E2
Wage
Rate
LD1
E1
W1
An Outward Shift in Labour Demand when Labour Supply
is Inelastic
An Outward Shift in Labour Demand when Labour Supply
is Elastic
Employment
Labour Supply
(short run)
W1
E2
D1
E1
W2
D2
Long Run
Labour
Supply
E3
a
b
W3
c
The Supply of Labour
Wage
Rate
Employment
Labour Supply
(short run)
W1
E2
D1
E1
W2
D2
Long Run
Labour
Supply
E3
a
b
W3
c
Natural Rate of Unemployment
Real
Wage
Rate
Employment
Labour Supply
Labour
Force
Labour
Demand
W1
a b
E1 E2
Reducing the Natural Rate of Unemployment
Real
Wage
Rate
Employment
LS1
Labour
Force
Labour
Demand
W1
a b
E1 E2
LS2
c
E3
Union Control of Labour Supply
Wage
Rate
Employment
Labour Supply
(union controlled)
E1 E2
Labour
Demand
W1
W2
Wage
Rate
Employment
Labour Supply
(union controlled)
E1 E2
Labour
Demand
Labour
Supply to
the
Economy
W1
W2
Core Group of
Workers
(Permanent Staff)
Short Term
Contract
Workers
Sub-
Contracted
Work
Trainees on
Government
Employment
Projects
Agency Staff
(Temp
Workers)
Workers with
Job Share
Agreements
Flexible Employment Patterns
National Minimum Wage
Wage
Rate
(W)
Employment of
Labour (E)
Demand =
MRPL
Labour
Supply
W min
Q1
W1
Minimum Wage (Wage Floor)
Q2 Q3
Monopsony Buyer of Labour
Wage
Rate
(W)
Employment of
Labour (E)
Demand =
MRPL
Labour
Supply
(ACL)
Wq
Eq
Marginal Cost
of Labour
(MCL)
MRPL
Monopsony Buyer of Labour
Wage
Rate
(W)
Employment of
Labour (E)
Demand =
MRPL
Labour
Supply
(ACL)
W1
E2
Marginal Cost
of Labour
(MCL)
W2
E3
W3
E1
W4
E4
Monopsony Buyer of Labour with a NMW
Wage
Rate
(W)
Employment of
Labour (E)
Demand =
MRPL
Labour
Supply
(ACL)
Wq
Eq
MRPL
National
Minimum Wage
Marginal
Cost with
NMW
NMW
E2
Price
Demand
P2
Q2
Price
Demand
P2
Q2
Economic Profit (Price > AC)
Monopoly and Profit Margins
AC AC
AC AC
Total Cost (AC x Output)
International Trade Diagrams
Freezers Freezers PPF FOR THE UK
International Trade and Production Possibility Frontiers
2000
PPF FOR ITALY
Dishwashers Dishwashers
1000
500 1000
1600
400 200
Good Y Good Y
PPF FOR GERMANY
International Trade and Production Possibility Frontiers
PPF FOR FRANCE
Good S Good S
1500
2000
1500
1500
Good W Good W
PPF FOR the UNITED STATES
International Trade and Production Possibility Frontiers
PPF FOR CANADA
Good X Good X
250
1000
750
500
Freezers Freezers
PPF FOR THE UK
International Trade and Production Possibility Frontiers
2000
PPF FOR ITALY
Dishwashers Dishwashers
1000
500 1000
1600
400 200
3000
533
Import Tariffs
Price
Output (Q)
Domestic Demand
Domestic Supply
World Price
Qd Qs
Pw
World Price + Tariff
Qd2 Qs2
M
Pw + T