ECN113 Principles of Economics 2011-12 some useful diagrams for the lectures

8 7 6 5 4 3 2 1 0 0 1

A production possibility curve

Units of food (millions)

Units of food Units of clothing (millions) (millions) 8m 7m 6m 5m 4m 3m 2m 1m 0 0.0 2.2m 4.0m 5.0m 5.6m 6.0m 6.4m 6.7m 7.0m

Units of clothing (millions)

The demand for potatoes (monthly)

The demand curve:

(2) Tracey's demand
(kg)

(pence per kg)

(1) Price

(3) Darren's demand

(kg)

(4) Total market demand

(tonnes: 000s)

A B C D E

20 40 60 80 100

28 15 5 1 0

16 11 9 7 6

700 500 350 200 100

Market demand for potatoes (monthly)

100

E D C

Point Price Market demand (pence per kg) (tonnes 000s) A B C D E B A 20 40 60 80 100 700 500 350 200 100

Price (pence per kg)

80

60

40

20

Demand
0 100 200 300 400 500 600 700 800

Quantity (tonnes: 000s)

The determination of market equilibrium

(potatoes: monthly)

100

e Supply d
Cc

Price (pence per kg)

80

60

40

b
a

B
A

20

Demand
0 0 100 200 300 400 500 600 700 800

Quantity (tonnes: 000s)

Effect of a shift in the supply curve

S1

Pe

D
O Qe
1

Stabilising speculation: initial price fall

P

S1

P1

P2

b D2

D1

Destabilising speculation: initial price fall

P

S1

P1 P2

a b

D1 D2
O Q

Market supply and demand

S1

Price

a
P1

D
O Q1 Quantity

10

Measuring elasticity using the arc method

m n

P ()
4

Demand

0 0 10 20 30 40 50

Q (000s)

Measuring elasticity at a point

50 Pd = (1 / slope) x P/Q

30

40 Q

100

Elastic demand between two points

Expenditure falls as price rises
P() 5 4

b a D

10

20

Q (millions of units per period of time)

Effect of a tax on the supply curve

P

Incidence of tax: inelastic demand

P

S + tax S

P1

D
O

Q1

Minimum price: price floor

P

S surplus

minimum price

Pe

D
O

Qd

Qs

Effect of price control on black-market prices

P

Pe

Pg

D
O
Qs Qd

The market for an illegal drug

P

Slegal

Plegal

Dlegal
O Qlegal Q

Darrens utility from consuming crisps (daily)

16 14 12

TU
Packets of crisps 0 1 2 3 4 5 6 TU in utils 0 7 11 13 14 14 13

Utility (utils)

10 8 6 4 2 0 -2 0 1 2 3 4

Packets of crisps consumed (per day)

Deriving an individual persons demand curve

MU, P

P1

Consumption at Q1 where P1 = MU

MU = D

Q1

Consumer surplus
MU, P

P1

MU

Q1

Total utility of income

TU
U2 Total utility a b

U1

5000

10 000

15 000

Income ()

30 28 26 24 22 20 18 16 14 12 10 8 6 4 2 0 0

Constructing an indifference curve

a b
Pears Oranges 30 24 20 14 10 8 6 6 7 8 10 13 15 20 Point a b c d e f g

Pears

10

12

14

16

18

20

22

Oranges

30

A budget line
Units of good X Units of Point on good Y budget line 30 20 10 0 a b

Units of good Y

20

0 5 10 15

10

Assumptions PX = 2 PY = 1 Budget = 30

0 0 5 10 15 20

Units of good X

Effect on the budget line of a fall in the price of good X

30
Assumptions PX = 2 PY = 1 Budget = 30

Units of good Y

20

10

0 0 5 10 15 20 25 30

Units of good X

Effect of an increase in income on the budget line

40

30

Units of good Y

20
Assumptions

10

PX = 2 PY = 1 Budget = 30

0 0 5 10 15 20

Units of good X

Finding the optimum consumption

Units of good Y

Budget line

O Units of good X

I1

I2

I3

I4

I5

Effect of a rise in income on the demand for an inferior good

Units of good Y (normal good)

I2

a B1 O Units of good X (inferior good) I1 B2

Income and substitution effects: normal good

Rise in the price of good X Units of good Y

h f

I1 I2 I3 I4 I5 I6

B2 QX3 QX1

B1

Units of Good X

Income and substitution effects: Giffen good

Rise in the price of good X Units of good Y

I1
h

B2 QX1QX3

I2

B1 Units of Good X

Supply essential story: deriving indiv. supply from cost function background, variations, etc.: 1) background to cost function: production function 2) market-power: downward-sloping demand curve faced 3) long run: - switch production method - entry, exit 4) choice production factors: isoquants, iso-cost curves

Total revenue for a price-taking firm

6000 5000 4000 3000 2000 1000 0 0 200 400 600 800 1000 1200

TR

TR ()

Quantity

Deriving a firms AR and MR: price-taking firm

Price ()

Pe

D O Q (millions) O Q (hundreds)

(a) The market

AR, MR ()

(b) The firm

100

Output TFC TVC (Q) () () 0 1 2 3 4 5 6 7 12 12 12 12 12 12 12 12 0 10 16 21 28 40 60 91

Total costs for firm X

TVC

80

60

40

20

TFC
0 0 1 2 3 4 5 6 7 8

Marginal cost
MC

Costs ()

Diminishing marginal returns set in here

Output (Q)

Wheat production per year from a particular farm

d
40

Tonnes of wheat produced per year

TPP
30

Maximum output Diminishing returns set in here

20

10

0 0 1 2 3 4 5 6 7 8

Number of farm workers

mraf ralucitrap a morf raey rep noitcudorp taehW

d PPT
raey rep decudorp taehw fo sennoT tuptuo mumixaM
03 04

snruter gnihsinimiD ereh ni tes

02

b
01

0 8 7 6 5 4 3 2 1 0

srekrow mraf fo rebmuN

Wheat production per year from a particular farm

Tonnes of wheat per year
40 30 20 10 0 0 1 2 3 4 5 6 7 8

Slope = TPP / L = APP

TPP

Tonnes of wheat per year

14 12 10 8 6 4 2 0 -2 0 1 2

b c

Number of farm workers (L)

APP d
3 4 5 6 7 8

Number of farm workers (L)

MPP

Deriving long-run average cost curves: factories of fixed size

SRAC1 SRAC SRAC5 SRAC4

SRAC3

Costs

1 factory 2 factories 3 factories4 factories

5 factories

Output

A typical long-run average cost curve

LRAC Costs O

Output

Average and marginal costs

MC AC AVC

Costs ()

z y x AFC

Output (Q)

45 40 35

An isoquant
a Units of K 40 20 10 6 4 Units of L 5 12 20 30 50 Point on diagram a b c d e

Units of capital (K)

30 25 20 15 10 5 0 0 5 10 15 20 25

30

35

40

45

50

Units of labour (L)

Diminishing marginal rate of factor substitution

14 12

g
=

. h

Units of capital (K)

MRS = K / L

10 8 6 4 2 0 0 2
. .

j
L = 1

. k

isoquant
4 6 8 10 12 14 16 18 20

Units of labour (L)

30 25

An isocost
Assumptions PK = 20 000 W = 10 000 TC = 300 000 a b c TC = 300 000 d
0 5 10 15 20 25 30 35 40

Units of capital (K)

20 15 10 5 0

Units of labour (L)

35 30 25 20 15 10 5 0

Finding the least-cost method of production

Units of capital (K)

TC = 500 000

TC = 400 000

TPP1
50

10

20

30

40

Units of labour (L)

Deriving a firms AR and MR: price-taking firm

Price ()

Pe

D O Q (millions) O Q (hundreds)

(a) The market

AR, MR ()

(b) The firm

TR curve for a firm facing a downward-sloping D curve

20

16

12

TR ()

Quantity P = AR () (units) 1 2 3 4 5 6 7
0 1 2 3 4

TR () 8 14 18 20 20 18 14
6 7

TR

8 7 6 5 4 3 2
5

Quantity

Finding maximum profit using total curves

24 20

TC

TR, TC, T ()

16 12 8 4 0 1 -4 -8

TR

c
2 3 4

d
5 6 7

Quantity

AR and MR curves for a firm facing a downward-sloping D curve

8
Q P =AR (units) () 8 1 7 2 6 3 5 4 4 5 3 6 2 7 TR MR () () 8 6 14 4 18 2 20 0 20 -2 18 -4 14

AR, MR ()

AR

0 1 -2 2 3 4 5 6 7

Quantity

-4

MR

Finding the profit-maximising output using marginal curves 16 MC

12

Costs and revenue ()

Profit-maximising output
4 5 6 7

0 1 -4 2 3

Quantity

MR

Profit maximising under monopoly

Total profit

MC AC

AR

AC

AR MR
O

Qm

Short-run equilibrium of industry and firm under perfect competition

P
MC AC

Pe

AR AC

D = AR = MR

D O Q (millions) O Qe Q (thousands)

(a) Industry

(b) Firm

Natural Monopoly

LRAC D1
Q

D2
O

Limit pricing

AC new entrant
PL

AC monopolist

A contestable monopoly

P1

a
LRAC

D = AR O

Q1

First-degree price discrimination

P

P1

D
O

200

Profit-maximising output under third degree price discrimination

DY DX O MRX O MRY O MRT

(a) Market X

(b) Market Y

(c) Total (markets X + Y)

Profit-maximising cartel

Industry MC P1

Industry MR
O

Industry D AR
Q

Q1

Dominant firm price leadership

Sall other firms

P1

a Dmarket b

Dleader
P2

Division of the market between leader and followers

Price leader aiming to maximise profits for a given market share

Assume constant market share for leader

AR D market

AR D leader MR leader
O Q

Kinked demand for a firm under oligopoly

P1

Current price and quantity give one point on demand curve

Q1

The prisoners' dilemma

Amanda's alternatives
Not confess Not confess Confess

Nigel's alternatives C Nigel gets

Confess

Each gets 1 year

Nigel gets 10 years Amanda gets 3 months Each gets 3 years

3 months Amanda gets 10 years

A decision tree
Airbus 500 se decides
te r
r ate

Boeing 10m (1) Airbus 10m

B1

400

Boeing decides A

50 0

40 0

se a

sea te

Boeing +30m (2) Airbus +50m

se at e

500

r ate se

Boeing +50m (3) Airbus +30m

Airbus decides

B2

400

sea

t er

Boeing 10m (4) Airbus 10m

A labour market: whole market Sall workers

in the market

Hourly wage

Wm

in the market

Dall firms

O Labour hours

A labour market: individual employer

Hourly wage

Wm

Slabour

Dindividual employer
O

Q1
Labour hours

A labour market: individual worker

Sindividual worker

Hourly wage

Wm

Dlabour

Q2
Labour hours

Backward-bending supply curve of labour

S

Hourly wage

WI

Hours

The choice of hours worked at different wage rates

150

Daily income

120

60 40

B1 x I1

Daily hours of leisure

The profit-maximising level of employment

Wm

MCL= W

MRPL = MPPL Pgood

MRPL
O

Q of labour

Qe

Monopsony
MCL

(supply curve)

ACL W

MRPL
O Q of labour

Trade union facing producers under perfect competition

S

W1

D
O Q1 Q of labour

Bilateral monopoly

W2

MCL

MCL = ACL
2

Wage can rise to W2 with no fall in employment ACL

W1
1

MRPL O
Q1 Q of labour

Black workers employed by discriminating monopsonist

W

MCB

ACB

WB

MRPB
QB
1

Black workers

White workers employed by discriminating monopsonist

W

MCW

ACW

WW

MRPW
Qw
1

White workers

Maximum total surplus under perfect competition

MC

Pe

D = MU
O

Qe

External costs in production

MC = S

Costs and benefits

O Quantity

Q1

External benefits in production

MC = S MSC

Costs and benefits

External benefit P

Q1 Quantity

Q2

Social optimum

External costs in consumption

Costs and benefits

(MB) MU = D
O

Q1 Quantity

External benefits in consumption

External benefit Costs and benefits

S MSB (MB) MU = D

Q1 Quantity

Q2

Social optimum

Using taxes to correct a market distortion (first-best world) MSC MC = S

Costs and benefits

P External cost

O Social optimum

Q2 Quantity

Q1

A monopolist producing less than the social optimum

MC = MSC

P1 P2 = MSB
= MSC

MC1

MR
O

AR = MSB Q
Perfectly competitive output

Monopoly output

Q1

Q2

100

Lorenz curve

Percentage share of national income (cumulative)

80 Line of complete equality

60

40

20

20

40

60

80

100

Percentage of population

Deadweight loss from an indirect tax

Before-tax situation

P1

D
O
Q1

Using taxes to correct a market distortion (first-best world) MSC MC = S

Costs and benefits

P External cost

O Social optimum

Q2 Quantity

Q1

Sales revenue maximising output

TC

TR

Q1

Choosing the output and profit mark-up

P1

f AC h j

P2

D
O Q1 Q2

How do UK companies determine their prices?

1st Market level Competitors prices Direct cost plus variable mark-up Direct cost plus fixed mark-up Customer set Regulatory agency 257 161 131 108 33 1

% 39 25 20 17 5 2

2nd 140 229 115 49 52 3

% 21 35 18 8 8 1

3rd 78 100 88 42 47 5

% 12 15 14 6 7 1

Factors leading to a rise or fall in price

Rise Rise in material costs Rival price increase Rise in demand Prices never rise Rise in interest rates Higher market share Fall in productivity Number % 421 105 101 26 18 14 5 64 16 15 4 3 2 1 Fall Fall in material costs Rival price reduction Fall in demand Prices never fall Fall in interest rates Lower market share Rise in productivity Number 186 235 146 75 8 69 22 % 28 36 22 12 1 11 3