Economic diagrams

Economic Diagrams

Demand Curve

Features of the Demand Curve

As price (P) increases quantity the demand (Q) for this good or serves will decrease. Likewise if the price decreases then quantity demanded will increase. So therefore:

As P↑ then Q↓

and as P ↓ then Q ↑

Price

Quantity0

D

D

P1

Q1

P2

Q2

Supply Curve

Features of the Supply Curve

As price (P) increases quantity the supplied (Q) for this good or serves will increase. Likewise if the price decreases then quantity supplied will decrease. So therefore:

As P↑ then Q ↑

and as P ↓ then Q ↓

Price

0

S

S

P1

Q1

P2

Q2 Quantity

The Price Mechanism

Features of the Price Mechanism.

In a perfectly competitive market, if the price of a good or service is too high or low it will adjust accordingly so that Supply

equals Demand. The point at which supply equals

demand is called the equilibrium point (market clearing point).

Price

0

S

S

P1

Q1

P2

Q2

D

D

Q3 Q4

Equilibrium

Quantity

The Price Mechanism cont.

If the price was set above the equilibrium point at P1 there will be an excess supply

Thus supply outstrips demand. Forcing prices down to e

If the price was set below the equilibrium point at P2 there will be excess demand.

Thus demand outstrips supply. Forcing prices up to e

Price

0

S

S

P1

Q1

P2

Q2

D

D

Q3 Q4 Quantity

e

Excess Supply

Excess Demand

Price elasticityThe measurement of how a

change in price of the product will affect the quantity being demanded or supplied.

Unitary elastic: A change in price will lead to no change in revenue for the firm.

Inelastic: A change in price brings about a less-than-proportional change in the quantity demanded or supplied. In the case of inelastic demand, a rise in the price leads to an increase in the total revenue of a firm.

Elastic: A change in price brings about more-than-proportional change in quantity demanded or supplied. In the case of elastic demand, a rise in the price leads to a fall in the total revenue of the firm.

Elasticity Price Change Total Revenue

Elastic ↑

↓

↓

↑Unitary Elastic ↑

↓

None

None

Inelastic ↑

↓

↑

↓

Price elasticity of demandPrice

Quantity0

D

D

P1

Q1

P2

Q2 Q3

P3

Price

Quantity

0

D

D

P1

Q1

P2

Q2 Q3

P3

Price

Quantity0

DP1

Price

Quantity0

D

P1

Inelastic demand Elastic demand

Perfectly elastic demand Perfectly inelastic demand

Methods of Protection: TariffsTariff: A tax on imported goods. The

most common form of protection. Provides revenue to the government.

Tariff = P2 – P1

At Price P1

Domestic demand = 0Q2

Domestic supply = 0Q1

Imported = 0Q2 – 0Q1

Domestic Revenue = 0Q1 x 0P1 or area 0P1aQ1

Foreign Revenue = (0Q2 – 0Q1) x 0P1 or area Q1abQ2

At Price P2 (tariff imposed)Domestic demand = 0Q4



Domestic Revenue = 0Q3 x 0P2 or area 0P2cQ3

Foreign Revenue = (0Q4 – 0Q3) x 0P2 or area Q3cdQ4

Government Receives Revenue of ecdf

Price

0

S

S

P1

Q1

P2

Q2

D

D

Q3 Q4 Quantity

dc

fea b

Methods of Protection: QuotasQuota: A legal limit on the quantity of

a particular good that can be imported in a specified period. Does not provide revenue to the government.

Quota = 0Q4 – 0Q3

At Price P1Total demand = 0Q2



Domestic Revenue = 0Q1 x 0P1 or area 0P1aQ1

Foreign Revenue = (0Q2 – 0Q1) x 0P1 or area Q1abQ2

At Price P2 (quota imposed)




Domestic Revenue = 0Q3 x 0P2 or area 0P2cQ3

Foreign Revenue = (0Q4 – 0Q3) x 0P2 or area Q3cdQ4

Price

0

S

S

P1

Q1

P2

Q2

D

D

Q3 Q4 Quantity

dc

fea b

Methods of Protection: Subsidies

Subsidies: Cash payments made by the government to domestic producers in an attempt to increase their international competitiveness. Government spending needed.

DD and SS are domestic demand and supply for a particular good. P1 is the domestic price and P2 is the international price.

If domestic firms were to sell at P2 then: (without subsidy)



Imported = 0Q2 - 0Q1

Domestic Revenue = 0P2aQ1

If domestic firms were to sell at P2 then: (with subsidy)



Imported = 0Q2 - 0Q3

Domestic Revenue = 0P2cQ3

The cost per unit of the subsidy given by the government is the vertical differences between the two supply curves in this case P3 – P4

Price S

S

P1

Q3

P2

Q2

D

D

Quantity

P3

S1

S1

P4

Q10

a bc

Aggregate Demand

AD = C + I + G + (X – M)Where:AD = Aggregate demandC = ConsumptionI = Investment spending by businessesG = Government spendingX = Exports revenueM = Spending on imports

Aggregate Supply

Y = C + S + T

Where:

Y = Aggregate supply or national income

C = Consumption

S = Savings by households

T = Taxation by the government

Equilibrium in the Economy

Y = AD

C + S + T = C + I G + (X – M)

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Economic diagrams