Here is a selection of key diagrams on core topics in Year 1 microeconomics.

1. Key Diagrams Year 1 Micro

2. PRODUCTION POSSIBILITY FRONTIERS
Output of
Pizza
Output of Sugar
A
B
A, B and C are
all efficient
output
combinations
as they lie on
the existing PPF
C
D
E
F
D and E are
inefficient
combinations – i.e.
not all resources are
fully utilized
F is an output
combination
that is not yet
attainable as it
lies beyond the
PPF
Any point on
the PPF is an
efficient
allocation of
resources
whereas points
inside the PPF
is an inefficient
allocation of
resources since
it is possible to
produce more
of one good
without
sacrificing any
of the other.
ECONOMIC METHODOLOGY

3. INFORMATION GAPS – OVER-ESTIMATING BENEFITS
Costs,
Benefits
£s
MPC
P1
Q1
MPB (fuller
information)
P2
Q2
Individuals may have
imperfect information
about their own
private benefits. If
they had better/fuller
information on the
benefits to
themselves of
consuming a good or
service, the marginal
private benefit curve
would shift lower
leading to a smaller
equilibrium quantity
MPB (limited
information)
Market demand would
be lower if consumers
had better information
Output/Quantity
INDIVIDUAL DECISION MAKING

4. PRICES AND CHANGES IN MARKET SUPPLY
Price of Coffee
Quantity supplied of coffee
Market
Supply (1)
Pe
Qe
An inward shift of market supply of coffee (ceteris paribus) leads to a rise
in equilibrium price and a contraction of market demand
Market Demand (1)
P2
Q2
Market
Supply (2)
0
PRICE DETERMINATION

5. PRICES AND CHANGES IN MARKET DEMAND
Price of Coffee
Quantity of Coffee
Market Supply
P1
Q1
An outward shift of market demand (ceteris paribus) leads to a rise in
equilibrium price and an expansion of market supply
Market
Demand (1)
Market
Demand (2)
P2
Q2
If price did not rise from P1 after
a shift in demand from D1 to D,
there would be excess demand
PRICE DETERMINATION

6. CONSUMER SURPLUS
Consumer surplus rises or falls as the market price for a good or service changes
Price
Quantity
A
Q1
Demand
Higher supply costs leads to a
rise in market price and
therefore a fall in consumer
surplus from ABC to DBE
B
C
Price
Quantity
A
Q1
Demand
B
CS1
S2
Q2
D E
D2
S1
Q2
G
H
I
An increase in market demand
causes consumer surplus to
rise from area ABC to area GHI
PRICE DETERMINATION

7. PRODUCER SURPLUS
Price
QuantityQ2
D1
Lower supply costs cause price
to fall and the equilibrium
quantity to rise. Producer
surplus increases from area
ADB to area FEC
B
Price
QuantityQ1
D1
Q1
S1
Q2
An increase in market demand
leads to a higher price &
quantity leading a rise in
producer surplus from area
ABC to DEC
D2
S1
S2
A
C
D
E
F A
B
C
D
E
PRICE DETERMINATION

8. PRICE ELASTICITY OF DEMAND AND REVENUE
If demand for a product is price
elastic, a supplier gains extra
revenue if they lower their
prices.
Consider an example:
A firm sells 200 units at a
price of £10 (TR = £2000)
Reducing price by 10% to £9
causes demand to expand
to 250 units (a 25% increase
in demand) (TR therefore
rises to £2250)
Coefficient of Ped = (-)2.5
i.e. an elastic demand
Price
Qty
P2
P1
Q1 Q2
Demand
Gain in
revenue from
selling more
at a lower
price
Lost revenue
from selling at
a lower price
PRICE DETERMINATION

9. PRICE ELASTICITY OF SUPPLY
Price
Quantity
P2
P1
Q1
Price
Quantity
P1
Q1 Q2
S1
S1
D1 D2 D1
D2
Perfectly Elastic Supply
An increase in demand can be
met without any change in
market price
Perfectly Inelastic Supply
Supply is fixed and does not
respond to a change the market
price
PRICE DETERMINATION

10. PRICE ELASTICITY OF SUPPLY
Price
Quantity
P2
P1
Q1
Price
Quantity
P2
P1
Q1 Q2
S1
S2
Q2
D1
D2
D1
D2
Elastic supply Inelastic supply
PRICE DETERMINATION

11. INTER-RELATED MARKETS
Price of coal
Quantity of coal
P2
D1
P2
S1
Price
of
solar
Quantity of solar power
S2S1
P1
D2 D1
P1
How an increase in supply in one market may impact upon other markets
An outward shift
in supply of solar
power e.g. due
to improved
technology or
economies of
scale in solar
power output
Coal is a
substitute source
of energy – if
solar power is
cheaper, then
market demand
for coal used in
power stations
might fall –
causing an inward
shift of demand
PRICE DETERMINATION

12. INTER-RELATED MARKETS
Price of bricks
Qty (bricks)
P2
D1
P1
S1
Price
of
new
homes
Qty (housing)
S1
D2 D1
P1
How a decrease in demand in one market may impact upon other markets
P2
D2
Q1Q2
Falling demand
for new homes
Leads to an
inward shift of
demand for
bricks – as bricks
have a derived
demand
Q2 Q1
PRICE DETERMINATION

13. NEGATIVE EXTERNALITIES FROM PRODUCTION
Marginal
Private Cost
(MPC)P1
Q1
Marginal
Private Benefit
(MPB)
Costs,
Benefits
£s
Marginal
Social Cost
(MSC)
Q2
P2
The equilibrium
output delivered
by a free market is
at Q1 where MPB =
MPC and it is
allocatively
inefficient.
We assume here
that there are no
externalities from
consumption,
therefore
MSB=MPB
Note
If MSC pivots
away from
MPC then the
marginal
external cost
of extra
output is
increasing Output/Quantity
MARKET FAILURE & INTERVENTION

14. NEGATIVE EXTERNALITIES FROM CONSUMPTION
MARKET FAILURE & INTERVENTION
MSB
MPB
MPC = MSC
Benefit,
Cost
Quantity consumedQ1 Q2
Deadweight loss of social
welfare = ABC
A
C
B
Social optimum is where MSB
= MSC
With negative consumption
externalities, if consumption
of a product reduces benefits
enjoyed by third parties, the
benefits to society are less
than benefits obtained by
individuals consuming the
product. Negative
externalities lead to
overconsumption and hence
overproduction

15. POSITIVE EXTERNALITIES FROM CONSUMPTION
Costs, Benefits
£s
Output/Quantity
Marginal
Private Cost
P1
Q1
Marginal Private
Benefit
Marginal Social
Benefit
P2
Q2
If the market
price ignores
positive
externalities,
then there will
be under-
consumption
Social optimum position
is output Q2 whereas the
market equilibrium is Q1
This is the area of social welfare loss
because the market output Q1 is lower
than the socially efficient level
MARKET FAILURE & INTERVENTION

16. POSITIVE EXTERNALITIES FROM PRODUCTION
MARKET FAILURE & INTERVENTION
MPB
MPC
Benefit,
Cost
Quantity producedQ2 Q1
A
C
B
MSC
Deadweight loss
of social welfare
Social optimum is
where MSB = MSC
Because there are positive
externalities in
production, the marginal
social cost of production is
less than the marginal
private cost of production.
A good example arises
from universities making
their research available as
a public good.
Positive production
externalities shifts the
supply curve to the right.

17. MARKET FAILURE AND NET SOCIAL WELFARE LOSS
MPB
MSC
Benefit,
Cost
Q2 Q1
B
A
MPC
MSB
Social optimum is
where MSB = MSC
There are net social
costs in this market)
i.e. it is costing
society more to
produce these units
than society is
valuing these units.
As a result, the
social optimum
output is lower than
the free market
equilibrium output.
A: Where MPB=MPC
B: Where MSB = MSC Output/Quantity
MARKET FAILURE & INTERVENTION

18. MARKET FAILURE AND SOCIAL WELFARE LOSS
MPB
MSC
Benefit,
Cost
Q2 Q1
B
A
MPC
MSB
Social optimum is
where MSB = MSC
There are net social
costs in this market)
i.e. it is costing
society more to
produce these units
than society is
valuing these units.
As a result, the
social optimum
output is lower than
the free market
equilibrium output.
A: Where MPB=MPC
B: Where MSB = MSC Output/Quantity
MARKET FAILURE & INTERVENTION

19. INDIRECT TAXES AND ELASTICITY OF DEMAND
If the co-efficient of price elasticity of demand >1, then most of
the burden of an indirect tax will be absorbed by the supplier
Price
Quantity
P2
D
Q2
S1
S1 + tax
Q1
P1
P3
Paid by consumer
Paid by supplier
If the co-efficient of price elasticity of demand <1, most of
an indirect tax can be passed on to the final consumer
Price
P2
Demand
P1
Q2
S1
S1 + tax
Q1
P3 Paid by consumer
Paid by supplier
Tax Per Unit
Quantity
MARKET FAILURE & INTERVENTION

20. AD VALOREM TAXES
Value Added Tax (the standard rate in the UK
is 20%) is an ad valorem tax.
Quantity
P2
Demand
P1
Q2
S1
S1 + tax
Q1
Price
Tax Per Unit
VAT Insurance Premium Tax
Insurance Premium Tax is a tax on general
insurance premiums. There are two rate
bands, the standard rate of 9.5%, and a higher
rate of 20% which applies to travel insurance,
appliance insurance and some car insurance.
MARKET FAILURE & INTERVENTION

21. SUBSIDIES TO PRODUCERS - ANALYSIS
Price
Supply pre
subsidy
P1
Q1
A subsidy paid to producers causes an outward shift of the supply curve
leading to a lower equilibrium price and an increase in the quantity traded
Demand
Supply post
subsidy
P2
Q2
Subsidy
Subsidy per unit is
shown by the
vertical distance
Quantity
MARKET FAILURE & INTERVENTION

22. RENT CONTROLS
Quantity of rented housing
P1
Q1
A maximum price must be set below the normal free market equilibrium price
to have any effect on price and output
Market
Demand
Max rent
Q2
Rent
Q3
Market Supply
Max Price (rent ceiling)
Free Market
Equilibrium
An alternative to a
maximum rent is a rent
subsidy for housing which is
the equivalent of an
increase in disposable
income for the tenant.
MARKET FAILURE & INTERVENTION

23. CARBON TRADING
Price of
carbon
permit
Quantity of carbon permits
Demand for
carbon permits
Supply of permits
Euro 10
S2
Euro 20
Increasing the scarcity of carbon
permits leads to an increase in price.
This then makes it more expensive for
firms to emit carbon which in turn
increases the incentive for
investment in low carbon
technologies.
Carbon trading provides a quantity
adjustment to the volume of CO2
emissions.
S1
MARKET FAILURE & INTERVENTION

24. CARBON TAXES
MPB= MSB
MPC
Benefit,
Cost
Quantity suppliedQ1 Q2
A
B
C
MSC
• A tax on carbon increases the
private cost of emitting
carbon – in theory this will
cause output to contract
towards the social optimum.
• It will also raise tax revenues
that might be used by the
government to fund other
projects or use as a rebate to
those affected (e.g.
consumers)
MPC +
tax
Deadweight loss of social welfare
without a carbon tax = triangle
ABC
MARKET FAILURE & INTERVENTION