Key Diagrams for Microeconomics: Economics A-level

Diagram Name

PPF (Production possibility

frontier)

Shows the possible production

combinations of two goods,
that a society can produce.

Points on the PPF are

productively efficient - they
maximise use of available
resources.

The slope of the PPF

represents the opportunity cost
of producing one more apple.
As more and more apples are
produced, producing one more
apple requires giving up even
more oranges (as apple
production runs into
diminishing marginal returns /
gets progressively more
difficult). So opportunity cost
increases.

Written by Tom Furber

For more A-level Economics resources, including practice papers, model answers and exam notes, check out my website: [Link]

Supply and demand - demand

shift right

Demand shift right could be

caused by:
● Change in tastes.
● Increase in advertising.
● Increase in real
incomes for a normal
good (and a decrease
in real incomes for an
inferior good).
● Decrease in price of a
complementary good or
an increase in the price
of a substitute.
● NOT a fall in the price
of the good itself, as
this would lead to a
MOVEMENT ALONG
the demand curve, not
a shift.

This results in higher price

(from p to p1) and higher
quantity from q to q1.

Written by Tom Furber

For more A-level Economics resources, including practice papers, model answers and exam notes, check out my website: [Link]
 Supply and demand - supply
shift right

Supply shift right can be

caused by:
● Reduced labour costs
due to reduced wages
or higher labour
productivity for given
wages.
● Reduced machinery /
capital costs.
● Technological
improvements that
reduce the cost of
production.

This reduces the price from p

to p1 and increases quantity
from q to q1.

Written by Tom Furber

For more A-level Economics resources, including practice papers, model answers and exam notes, check out my website: [Link]

Price mechanism

This shows the response of the

price mechanism to a shortage
at price p on (q2-q).
*
The rationing function means
the price rises to reduce
(“ration”) demand. This leads
to a contraction (movement
left) along the demand curve.

The incentive function means

as the price increases, this
incentivises greater production
as firms can make more profits.
This leads to an extension
(movement right) along the
supply curve.

The signalling function

strengthens these effects. The
rising price signals for some
firms to enter the market to
make profits. The rising price
also signals some consumers
to leave the market.

This helps move the free

market from price p to the new
price p1, at the equilibrium. The
price mechanism also
eliminates the shortage.

Written by Tom Furber

For more A-level Economics resources, including practice papers, model answers and exam notes, check out my website: [Link]
 Negative externality in
production

The free market produces

where MPB = MPC (it does not
account for external costs and
benefits). This occurs at point
E.

The socially optimal outcome is

where MSC=MSB. This occurs
at point B. This creates a
welfare loss due to
overproduction of the good.
The welfare loss is of size ABE.

Example: firm pollution of air

and water.

Written by Tom Furber

For more A-level Economics resources, including practice papers, model answers and exam notes, check out my website: [Link]

Positive externality in
consumption

Free market outcome

MPB=MPC: E

Socially optimal outcome

where MSB=MSC: B

Underconsumption of q1-q.

Welfare loss ABE.

Example: consuming
healthcare benefits the rest of
society (healthier, more
productive individuals are more
productive).

Written by Tom Furber

For more A-level Economics resources, including practice papers, model answers and exam notes, check out my website: [Link]
 Negative externality in
consumption

Free market outcome

MPB=MPC: B

Socially optimal outcome

where MSB=MSC: E

Overconsumption of q-q1.

Welfare loss ABE.

Example: air pollution caused

by car consumption of petrol.

Written by Tom Furber

For more A-level Economics resources, including practice papers, model answers and exam notes, check out my website: [Link]

Positive externality in
production

Free market outcome

MPB=MPC: B

Socially optimal outcome

where MSB=MSC: E

Underproduction of q1-q.

Welfare loss ABE.

Example: job training benefits

other firms who can then hire
the already trained workers.

Written by Tom Furber

For more A-level Economics resources, including practice papers, model answers and exam notes, check out my website: [Link]
 Maximum price

Max price at p1 below the free

market equilibrium.

Leads to a shortage of q1-q2.

Fall in firm revenue and

producer surplus.

Example: rent controls in

Stockholm, Sweden.

Welfare loss shown by green

area: (q-q2) would be produced
by the free market and would
deliver a net benefit to
consumers and firms. But
under the max price, these
extra units are not produced.

Written by Tom Furber

For more A-level Economics resources, including practice papers, model answers and exam notes, check out my website: [Link]

Minimum price

Min price set at p1, above the

free market equilibrium price p.

Results in surplus of q1-q2.

Leads to welfare loss shown by

shaded area.

Example: alcohol minimum unit

pricing in Scotland.

Written by Tom Furber

For more A-level Economics resources, including practice papers, model answers and exam notes, check out my website: [Link]
 Tax

Tax shifts supply left from S to

S1.

Increases price from p1 to p

and lowers quantity from q1 to
q.

The consumer incidence is

shown by the red area. The
producer incidence is shown by
the blue area.

This can be extended to show

welfare loss, change in
consumer surplus and change
in producer surplus.

Written by Tom Furber

For more A-level Economics resources, including practice papers, model answers and exam notes, check out my website: [Link]

Subsidy

Subsidy shifts supply right from

S to S1.

This lowers the price from p to

p1 and increases quantity from
q to q1.

The consumer incidence is

shown by the red area. The
producer incidence is shown by
the blue area.

This can be extended to show

welfare loss, change in
consumer surplus and change
in producer surplus.

Written by Tom Furber

For more A-level Economics resources, including practice papers, model answers and exam notes, check out my website: [Link]
 Pollution permits

The supply of permits is set by

the government. So it is
perfectly inelastic.

If the government reduces the

number of permits, supply
shifts left from S to S1. This
reduces the number of permits
and amount of pollution
allowed from q to q1. This
increases permit price from p to
p1, disincentivising pollution.

Written by Tom Furber

For more A-level Economics resources, including practice papers, model answers and exam notes, check out my website: [Link]

State provision

The National Health Service in

the UK provides healthcare
free at the point of use.

The government determines

the level of supply rather than
the free market, so the supply
does not respond to price.

This is likely to lead to excess

demand of q1-q.

Written by Tom Furber

For more A-level Economics resources, including practice papers, model answers and exam notes, check out my website: [Link]
 Tax plus externality

The tax reduces the quantity

from q (free market outcome)
to q1 (socially optimal
outcome).

This means firms “internalise”

(take into account) the
externality, leading to a welfare
gain of ABE.

Written by Tom Furber

For more A-level Economics resources, including practice papers, model answers and exam notes, check out my website: [Link]

Subsidy plus externality

Subsidy shits the cost curve

right from MPC to
MPC+subsidy.

This increases quantity from q

(free market outcome) to q1
(socially optimal outcome).

This eliminates the welfare loss

ABE.

Written by Tom Furber

For more A-level Economics resources, including practice papers, model answers and exam notes, check out my website: [Link]
 LRAC movement along
(internal economies of scale)

Economies of scale mean a

reduction in long-run average
cost (from c to c1) as output
increases (from q to q1).

For example, firms may have

purchasing economies of scale
(the ability to bulk buy inputs).

Note that the LRATC increases

as output rises (for high output
levels). This is where
“diseconomies of scale” take
place.

Written by Tom Furber

For more A-level Economics resources, including practice papers, model answers and exam notes, check out my website: [Link]

LRAC shift (external

economies of scale)

External economies of scale

occur at the industry level.

For example, the growth of

Silicon Valley, an area in the
US with lots of tech companies,
makes it easier for other
companies to find tech workers
and collaborate. This reduces
long run average total costs
from LRATC to LRATC1.

Written by Tom Furber

For more A-level Economics resources, including practice papers, model answers and exam notes, check out my website: [Link]
 Natural monopoly with
revenues and costs

A natural monopoly is a
monopoly with significant
economies of scale. Hence the
LRATC is downward sloping.

The firm produces where

MR=(LR)MC at q. This leads to
a price p and supernormal
profits of (p-c)q.

If the monopoly firm were split

into two, the price is likely to be
higher than p.

Written by Tom Furber

For more A-level Economics resources, including practice papers, model answers and exam notes, check out my website: [Link]

Monopoly

The monopoly produces where

MR=MC to maximise profits.
This occurs at output level q.

The price is the average

revenue at output q. This is p.

Supernormal profits are (p-c)q.

Monopoly leads to
underproduction, causing a
welfare loss as shaded.

Monopoly output q is below the

allocatively efficient level of
output where AR=MC.

In words, the monopoly holds

back supply to raise prices and
increase supernormal profits.
But this significantly reduces
consumer surplus.

Written by Tom Furber

For more A-level Economics resources, including practice papers, model answers and exam notes, check out my website: [Link]
 Oligopoly - kinked demand

The AR or demand curve is

“kinked” - it has a bend at price
p*.

If a firm raises its price above

p*, other firms do not follow. So
consumers switch to other
firms, significantly reducing the
demand for the firm that raised
the price. So demand is price
elastic above p*. So the rise in
price reduces revenue and
profit.

If a firm lowers its price below

p*, other firms follow to
maintain market share. So
consumers do not move
between firms, so demand is
price inelastic. So revenue falls
and profits fall.

To maximise profits, the firm is

best to price at p*. So, kinked
demand predicts price stability.

Written by Tom Furber

For more A-level Economics resources, including practice papers, model answers and exam notes, check out my website: [Link]

Oligopoly - game theory

Suppose the industry starts at

high price, high price.

Firm A is incentivised to lower

its price, as this increases its
profits from 4 to 5 (£ million).

Then from (low price, high

price), firm B is incentivised to
lower its price, as this
increases its profits from 1 to 2.

So the “Nash equilibrium” of

the game is low price, low
price.

Game theory predicts both

firms will lower prices when
there is no trust between firms.
This is also known as a “price
war”.

But if firms can work together

or “collude”, they will want to
increase their total profits. This
occurs when both firms price
high and receive £8 million total
profits.

Written by Tom Furber

For more A-level Economics resources, including practice papers, model answers and exam notes, check out my website: [Link]
 Monopolistic competition -
short run

Similar to monopoly but the AR

curve is more price elastic (less
steep) in monopolistic
competition. This is because
there are more substitutes.

As a result, the MR is also less

steep.

Written by Tom Furber

For more A-level Economics resources, including practice papers, model answers and exam notes, check out my website: [Link]

Monopolistic competition - long

run

There are low barriers to entry

in monopolistic competition.

So if there are supernormal

profits in the short run, firms
enter the market. This reduces
the market share of a firm
already in the market. So the
demand for the individual firm’s
products [Link] their AR and
MR curves shift left from AR to
AR1 and MR to MR1.

This lowers supernormal profit

to zero (at which point, firms
stop entering). This lowers
output from q to q1 and price
from p to p1.

Written by Tom Furber

For more A-level Economics resources, including practice papers, model answers and exam notes, check out my website: [Link]
 Perfect competition - short run

Firms are price takers in

perfect competition. So the
price (which is also average
revenue, AR) is taken as given
(fixed)

Firms can make supernormal

profits in the short run, here
supernormal profit is (p-c)q.

Written by Tom Furber

For more A-level Economics resources, including practice papers, model answers and exam notes, check out my website: [Link]

Perfect competition - long run

There are no barriers to entry

in perfect competition.

Suppose there are

supernormal profits in the short
run. Then firms enter the
market, shifting supply right
from S to S1.

This lowers the industry

equilibrium price from p to p1.

The perfectly competitive firm

now takes a lower price (p1) as
given. This shifts AR and MR
down from AR to AR1. This
lowers supernormal profit to
zero, at which point firms stop
entering the market.

Written by Tom Furber

For more A-level Economics resources, including practice papers, model answers and exam notes, check out my website: [Link]
 Price discrimination 3rd degree
- elastic subgroup

The price elastic group faces a

fall in price from p to p1 under
price discrimination. This
increases consumer surplus.

As demand is price elastic, firm

revenue and also profit
increase from a lower price too.

Written by Tom Furber

For more A-level Economics resources, including practice papers, model answers and exam notes, check out my website: [Link]

Price discrimination 3rd degree

- inelastic subgroup

The price inelastic group faces

a rise in price from p to p1
under price discrimination. This
reduces consumer surplus.

As demand is price inelastic,

firm revenue and also profit
increase from a higher price
too.

Written by Tom Furber

For more A-level Economics resources, including practice papers, model answers and exam notes, check out my website: [Link]
 SRATC / LRATC

In the short run, at least one

factor of production is fixed in
quantity.

In the long run, all factors of

production can be varied in
quantity. So in the long run,
there are more ways of
producing the same good using
different input combinations. So
long run average costs will be
the same or lower than short
run average costs.

Written by Tom Furber

For more A-level Economics resources, including practice papers, model answers and exam notes, check out my website: [Link]

ATC/AVC/AFC

AFC = TFC divided by output.

TFC (fixed cost) stays the

same as output changes. So as
output rises, the same fixed
cost is spread over a larger
output base. So AFC falls,
approaching zero.

ATC and AVC are U-shaped.

AVC is U-shaped because of

diminishing marginal returns at
high output levels and
increasing marginal returns at
low output levels.

ATC is U shaped for similar

reasons as AVC, and because
the importance of (average)
fixed costs diminishes as
output increases.

The marginal cost (MC) is

shaped like a tick. It passes
through the minimum points of
the ATC and AVC.

Written by Tom Furber

For more A-level Economics resources, including practice papers, model answers and exam notes, check out my website: [Link]
 TC/TVC/TFC

Fixed cost (TFC) does not

change with output.

Variable cost (TVC) changes

with output. For low output
levels, there are increasing
marginal returns. At high output
levels, there are diminishing
marginal returns.

Total cost (TC) is the sum of

variable and fixed costs.

Written by Tom Furber

For more A-level Economics resources, including practice papers, model answers and exam notes, check out my website: [Link]

MR/AR/TR with price maker

A price maker can change the

price set.

Reducing the price has two

effects on revenue:
● 1. Increases demand
via the law of demand.
Increases revenue.
● 2. Reduces the revenue
per unit on all previous
units.

As a result of 2, the average

revenue (revenue per unit of
output) falls as output
increases.

The marginal revenue (revenue

change with an extra unit of
output) falls more quickly and is
twice as steep as AR.

This is because as output

increases, price (=AR) falls to
be able to sell the extra output.
But this reduces the revenue
on all other units, so MR falls
by more than AR.

Total revenue is shaped like an

inverted U. At q, total revenue
is maximised. This also
coincides with where MR=0.

Written by Tom Furber

For more A-level Economics resources, including practice papers, model answers and exam notes, check out my website: [Link]
 MR/AR/TR with price taker

The price is fixed from the point

of view of the price taker.

So average revenue (revenue

per unit, which is also the price)
is also fixed.

So is marginal revenue, the

extra revenue per unit of output
is always just the price.

So total revenue increases at a

constant rate, as output
increases.

Written by Tom Furber

For more A-level Economics resources, including practice papers, model answers and exam notes, check out my website: [Link]

Price cap on cost / revenue

diagram

The price cap set at p1 reduces

the price from p
(profit-maximising price) to p1.

The quantity increases from q

to q1.

The price cap increases

consumer surplus but reduces
firm profits. If set at the right
level, the price cap can
increase social welfare, by
reducing the welfare loss
associated with monopoly.

Written by Tom Furber

For more A-level Economics resources, including practice papers, model answers and exam notes, check out my website: [Link]
 Increase in firm costs on cost /
revenue diagram

An increase in business costs,

e.g. due to government
regulation or carbon taxes,
shifts MC and ATC. In this
case, MC and ATC shift up to
MC1 and ATC1.

This increases the price from p

to p1, reduces the output from
q to q1.

This is likely to reduce the

firm’s supernormal profit.

Written by Tom Furber

For more A-level Economics resources, including practice papers, model answers and exam notes, check out my website: [Link]

Decrease in firm revenue on

cost / revenue diagram

Any factor that reduces

demand for an individual firm’s
products, such as falling real
incomes or changes in tastes,
shifts AR and MR.

Here AR and MR shift left from

AR to AR1 and MR to MR1.

This reduces supernormal

profit.

Written by Tom Furber

For more A-level Economics resources, including practice papers, model answers and exam notes, check out my website: [Link]
 Business objectives

Profit maximisation: MC=MR -

(q,p)

Revenue maximisation: MR=0 -

(q1, p1).

Sales maximisation: AR=ATC -

(q2, p2)

Written by Tom Furber

For more A-level Economics resources, including practice papers, model answers and exam notes, check out my website: [Link]

Profit satisficing objective

Profit satisficing means

achieving a reasonable amount
of supernormal profit, so that
efforts can be made to benefit
other stakeholders.

Satisficing at price p*, below

the profit-maximising price of p,
leads to supernormal profit
shown by the shaded area.
This is less supernormal profit
than under profit maximisation.

Written by Tom Furber

For more A-level Economics resources, including practice papers, model answers and exam notes, check out my website: [Link]
 Labour market supply /
demand

The labour market can be

thought of like any other
market, where there is supply
of and demand for labour.

Written by Tom Furber

For more A-level Economics resources, including practice papers, model answers and exam notes, check out my website: [Link]

Labour market monopsony

A perfectly competitive labour

market sets wages where
supply (ACL) equals demand
(MRPL).

But a monopsony is the

dominant buyer of a good or
service (in this case, the
dominant employer of labour).

A monopsony maximises
profits by setting MRPL = MCL.
So it employs q1 workers,
below the perfectly competitive
employment of q.

The monopsonist sets the

wage on the average cost of
labour (ACL) curve at w1,
below the perfectly competitive
wage w.

This leads to a welfare loss as

shown by the green area.

Written by Tom Furber

For more A-level Economics resources, including practice papers, model answers and exam notes, check out my website: [Link]
 Labour market monopsony +
minimum wage / trade union
wage

A minimum wage at w
increases the workers’ wages
from w1 to w and employment
rises from q1 to q.

This creates a welfare gain

shown by the shaded green
area.

In words, the monopsony

cannot reduce demand for
labour to lower wages and
costs (unless it breaks the law
by setting wages below the
minimum wage).

Trade unions have a similar

effect by bargaining for a higher
wage.

Written by Tom Furber

For more A-level Economics resources, including practice papers, model answers and exam notes, check out my website: [Link]

Discrimination in labour
markets

Suppose firms discriminate

against workers by perceiving
their marginal revenue product
of labour (MRPL) as lower than
it actually is.
This results in lower wages and
lower employment under
discrimination (w and q)
compared to without
discrimination (w1 and q1).

Written by Tom Furber

For more A-level Economics resources, including practice papers, model answers and exam notes, check out my website: [Link]
 Demand shift right due to
change in marginal revenue
product (e.g. due to worker
training).

More training or education

increases the marginal revenue
product of labour. So hiring an
extra worker offers more
benefit to firms in terms of
higher revenue.

So firms increase demand for

labour, demand shifts from D to
D1. This increases wage from
w to w1 and quantity of labour
from q to q1.

Written by Tom Furber

For more A-level Economics resources, including practice papers, model answers and exam notes, check out my website: [Link]

Wage differentials

High skilled workers take a

longer time to be trained, so
their wage elasticity of supply is
more inelastic.

Higher skilled workers are

more likely to be necessities in
the production process and
have fewer substitutes, so
demand is more
wage-inelastic.

Also, due to lower supply and

often greater demand for high
skilled workers, their wages will
be higher at w compared to low
skilled workers at w1.

How to use paper 1 diagrams

Use diagrams to make your analysis easier and think of points. If you’re unsure what point to make in a 25 marker, ask yourself:
“what diagram could I draw here?”.

Written by Tom Furber

For more A-level Economics resources, including practice papers, model answers and exam notes, check out my website: [Link]
The basics of diagrams - use the acronym SCALE:
● S for shift. Show the shift of curve in your diagram if a shift is needed (it often is)
● C for coordinates. Show the coordinates of any key points.
● A for axes - make sure the axes are labelled (price, quantity for example)
● L for label - label all curves e.g. S and S1.
● E for explanation - describe what happens in the diagram in the text and explain why this happens.

Use this to make sure you don’t forget the basics.

High level diagram use often involves labelling areas. This could include producer and consumer surplus, revenue for government or
firms, welfare loss or gain, the price mechanism and supernormal profit for example.

When writing 25 markers with 2 analysis points only, you need to extend the diagram analysis. To do so, consider these methods:
● For supply / demand, extend by showing the price mechanism or consumer / producer surplus changes.
● For cost / revenue diagrams, can extend by discussing effects on producers (“PIES: profits, investment,
employment/efficiency and shutdown) or consumers (quality and consumer surplus).
● For cost and benefit diagrams, can consider further welfare effects. If a tax eliminates a negative externality, maybe the tax
revenue can be used to further improve welfare.
● For labour market diagrams, consider the worker surplus (the surplus on the supply side) and associated effects on poverty
and inequality.
These are just examples and there are other ways to do it. This also only applies if you cannot write enough analysis - if you already
have enough analysis there is less need to extend further.

Other diagrams that are not included above, but that you may wish to revise, include (but are not limited to):
● Marginal, average and total product
● Lorenz curve (AQA micro, Edexcel A macro).
● Short run to long run elasticity change e.g. on agriculture market and PES.
● Price elasticities of demand - perf inelastic, perf elastic, elastic, inelastic unitary. Similarly for PES.
● Types of interrelationships between goods - complements, substitutes, joint demand, joint supply etc.
● PED varying along a linear demand curve
● Information gaps eg perceived vs actual MPB.
Written by Tom Furber
For more A-level Economics resources, including practice papers, model answers and exam notes, check out my website: [Link]

● Shutdown points for some exam boards (Edexcel A).

● Contestable market, where the monopoly produces where AR=ATC. / comparing monopoly and perfect competition
outcomes.
● Second-degree price discrimination / filling up capacity third degree // peak vs off peak pricing.
● First-degree price discrimination
● Perfectly competitive labour market
● Movement along demand or supply.
● Engel curves for some exam boards.
● Note that demand shifts in a supply-demand diagram can be used for adverse selection, moral hazard and behavioural bias /
nudge analysis.

Written by Tom Furber

For more A-level Economics resources, including practice papers, model answers and exam notes, check out my website: [Link]
Key diagrams for macroeconomics

Diagram About

AS-AD: AD shift right

Suppose government
spending (G) rises. G
is a component of
aggregate demand
(AD). So higher G
increases AD - AD
shifts right from AD to
AD1.

This results in rising

real GDP from Y to Y1
and a rising price level
from PL to PL1.

To move to the new

equilibrium, there is
an extension along
the aggregate supply
curve.

Written by Tom Furber ©

Website: [Link]

AS-AD: SRAS shift

right

Suppose the prices of

raw materials fall. This
lowers business costs.
So short-run
aggregate supply
shifts right from SRAS
to SRAS1.

This results in rising

real GDP (Y to Y1) and
falling price level (PL
to PL1).

To move to the new

equilibrium, there is
an extension along
the AD curve.

AS-AD: LRAS shift right

An improvement in
productivity shifts
long-run aggregate
supply (LRAS) right
from LRAS to LRAS1.

This raises real GDP

(from Y to Y1) and
lowers the price level
from PL to PL1.

To move to the new

equilibrium, there is
an extension along
the AD curve.

Written by Tom Furber ©

Website: [Link]
 AS-AD: SRAS and LRAS
shift right

An increase in
productivity will shift
the LRAS as above. It
may also mean lower
business costs,
shifting the SRAS to
the right as well.

This combines the two

previous diagrams.

AS-AD: AD shift right

plus multiplier

Adding to the “AD

shift right diagram”,
the multiplier effect
causes a second shift
right in aggregate
demand from AD1 to
AD2.

Higher government
spending on
construction materials
makes the suppliers
richer. This raises
incomes of the
suppliers’ workers, so
those workers spend
more in local shops.

Written by Tom Furber ©

Website: [Link]

Tariff

World supply is
assumed to be
perfectly elastic.

A tariff increases the

cost of foreign
producers supplying
to the domestic
economy. So the
world supply line
shifts upwards.

This decreases
imports from (Q3-Q)
to (Q2-Q1).

But there is a welfare

loss from the tariff, as
shown by the two
shaded areas.

The tariff leads to

higher domestic
producer surplus and
government tariff
revenue. But this is
outweighed by the fall
in domestic consumer
surplus.

In the exam, you can

also use this diagram
to show changes in
domestic producer
surplus or domestic
consumer surplus,
depending on the
point you want to
make.

Written by Tom Furber ©

Website: [Link]
 Laffer curve

An increase in tax
rate, for example
income tax rates, has
two effects:
1. Higher tax
revenue,
assuming that
incomes
remain the
same.
2. Reduced
incentives. For
example
higher income
taxes mean
less incentive
to work. So
pre-tax
incomes fall.

At low tax rates, an

increase in tax rates
raises revenue. But at
higher tax rates, an
increase in tax rate
may reduce tax
revenue.

Written by Tom Furber ©

Website: [Link]

Crowding out

Crowding out - higher

government spending
raises input prices,
which increases
business costs,
decreasing private
investment.

These inputs can be

raw materials,
workers or even
loanable funds.

Higher G shifts
demand for raw
materials right. Price
increases from p to
p1.

Private spending on
raw materials falls -
use the original
demand curve.

Written by Tom Furber ©

Website: [Link]
 Currency market -
shift in supply

Suppose there’s an
increase in supply of
pounds (more pounds
being sold). This could
be because of an
increase in interest
rates abroad. So there
are greater hot money
outflows - people sell
their pounds to buy
foreign currency to
spend on assets
abroad.

This shifts pound

supply right from S to
S1. So the pound
depreciates, with the
exchange rate falling
from p to p1.

Written by Tom Furber ©

Website: [Link]

Currency market -
shift in demand

Suppose there’s an
increase in demand
for pounds due to
increased export
demand (e.g. due to
lower inflation in the
UK relative to other
countries.)

Then demand for

pounds shifts right
from D to D1. So the
pound appreciates,
with the exchange
rate rising from p to
p1.

Written by Tom Furber ©

Website: [Link]
 Marshall Lerner
condition + J curve
Depreciation →
exports cheaper,
imports dearer →
higher export
demand, lower import
demand → higher net
export value overall.

But this assumes

export and import
demand are
sufficiently
price-elastic.

Marshall Lerner
condition: The sum of
the price elasticities of
demand for exports
and imports (absolute
values) is equal or
greater than 1.

J curve

Elasticities are likely to

be inelastic in the
short [Link] the
Marshall Lerner
condition does not
hold. Depreciation
lowers net trade.

But over the long run,

the Marshall Lerner
condition is more
likely to hold.
Contracts end and

Written by Tom Furber ©

Website: [Link]

consumers have more

time to respond. A
depreciation improves
net trade over time.

Written by Tom Furber ©

Website: [Link]
 Trade diversion -
joining a trading bloc
from a free trade
position

Joining a customs
union leads to a
common external
tariff on goods coming
from outside the
customs union. For
example, if the UK
joined a customs
union with the
European Union, the
UK will need to agree
to the common
external tariff on
other goods from
countries outside the
bloc, like New
Zealand.

The common tariff

shifts the New
Zealand supply
upwards, as the cost
of NZ exporting to the
UK is higher.

Before the tariff, NZ

goods were cheaper
than EU goods. So NZ
goods were imported.

But with the common

external tariff, EU

Written by Tom Furber ©

Website: [Link]

goods are now

cheaper to import.

The common external

tariff leads to a
welfare loss shown by
the shaded area.

Written by Tom Furber ©

Website: [Link]
 Comparative
advantage - PPFs

Comparative
advantage (CPA) - one
country can produce a
good with a lower
opportunity cost
relative to another
country.

To produce one
(more) Apple, the UK
has to give up fewer
oranges compared to
Spain.

So, the UK has a CPA

in apples and Spain
has a CPA in oranges.
The UK and Spain
should specialise in
apples and oranges
respectively under
this theory.

Why? Gains from

trade. Both countries
can consume beyond
their domestic PPF as
a result of trade. They
first specialise at
points A and B. Then
trade goods to
consume at point C.

Written by Tom Furber ©

Website: [Link]

Short run Phillips

curve

Short-run Phillips
curve is
downward-sloping.

Lower unemployment
(due to higher
government spending,
for example) → more
bargaining power for
workers → higher
wages → higher costs
for firms → higher
prices.

Short run Phillips

curve and long run
Phillips curve

See the last graph to

explain the move
between points A and
B.

At point B, workers
realise their wage
rises are below
inflation. So workers
ask for wage rises to
match inflation
(workers update their
“inflation
expectations”). This
shifts the short-run

Written by Tom Furber ©

Website: [Link]
 Phillips curve to the
right from SRPC to
SRPC1. Eventually the
economy moves to
point C.
So, an increase in
government spending
only leads to higher
inflation in the
long-run.

Another way to think

of this: the SRPC and
LRPC are the same as
the SRAS and LRAS,
except they are
reflected: higher
unemployment
corresponds with
lower real GDP.

Note this is not a full list of diagrams. You should revise all diagrams in your course and also the
opposite diagrams to the ones shown (AD shifts left and right, tariff increase and decrease).

Other possible diagrams could include, but are not limited to:
● Export subsidy and quota diagrams.
● Multiple currency supply and demand shifts to show how a central bank maintains a
fixed exchange rate.
● SRAS shift plus convergence to long-run equilibrium.
● Movements along various AD or AS curves.
● Automatic stabilisers - AD fall then AD shifts back inwards (or the other way around).
● Keynesian (LR)AS.
● Comparative advantage data table.

Written by Tom Furber ©

Website: [Link]