Important diagrams to remember

Chapter 5 Market failure

P Marginal private cost

S = MPC = MSC
marginal social cost
Popt

D = MPB = MSB

0 Qopt Q
allocative efficiency
is achieved

Figure 5.1 Demand, supply and allocative efficiency with

no externalities

(a) Welfare loss

MSC
P external MSC
cost P
S = MPC external
Popt cost S = MPC

Pm Popt
Pm welfare loss

D = MPB = MSB D = MPB = MSB

0 Qopt Qm Q
0 Qopt Qm Q

Figure 5.2 Negative production externality Figure 5.3 Welfare loss (deadweight loss) in a negative
production externality

MSC
P
S = MPC
Popt
Pm

D = MPB = MSB
0 Qopt Qm Q

Figure 5.4 Government regulations to correct negative production

externalities

© Cambridge University Press 2012 Economics for the IB Diploma 13

 Important diagrams to remember

(a) Imposing an indirect tax on (b) Effects on external costs of a tax on (c) Tradable permits
output or on pollutants emissions (carbon tax)
MSC = MPC + tax MSC1 = MPC + tax P S of tradable
P tax = external cost P MSC2 permits
P2
Pc = Popt S = MPC S = MPC

Pm Pm P1 D2
Pp

D = MPB = MSB D = MPB = MSC

D1
0 Qopt Qm Q 0 Qopt1 Qopt2 Qm Q 0 Q1 Q

Figure 5.5 Market-based policies to correct negative production externalities

(a) Welfare loss

P
S = MPC = MSC P
Pm S = MPC = MSC
D = MPB welfare loss
Popt Pm external
external
cost cost
Popt
D = MPB
MSB
0 MSB
Qopt Qm Q
0 Qopt Qm Q

Figure 5.6 Negative consumption externality Figure 5.7 Welfare loss (deadweight loss) in a negative
consumption externality

(a) Government regulations and advertising (b) Market-based: imposing an indirect tax
P P MPC + tax
external
cost tax =
external
cost
S = MPC = MSC Pc
S = MPC = MSC
Pm Pm
Pp
D1 = MPB D = MPB
Popt
D2 = MSB MSB
after demand decreases
0 Qopt Qm Q 0 Qopt Qm Q

Figure 5.8 Correcting negative consumption externalities

© Cambridge University Press 2012 Economics for the IB Diploma 14

 Important diagrams to remember

(a) Welfare loss

S = MPC
P P
external
benefits
S = MPC
MSC external
Pm benefits
MSC
Popt Pm

Popt welfare loss

D = MPB = MSB
0 Qm Qopt Q
D = MPB = MSB
0 Qm Qopt Q

Figure 5.9 Positive production externality Figure 5.10 Welfare loss (deadweight loss) in a positive
production externality

(a) Direct government provision (b) Granting a subsidy

S = MPC P S = MPC
P
spillover
benefit subsidy =
MSC spillover benefit
Pm Pm MSC

Popt Popt

D = MPB
D = MPB 0 Qm Qopt Q
0 Qm Qopt Q

Figure 5.11 Correcting positive production externalities

© Cambridge University Press 2012 Economics for the IB Diploma 15

 Important diagrams to remember

P
P
S = MPC = MSC
Popt
Pm S = MPC = MSC
MSB welfare loss
external
benefit
D = MPB Popt
0 Qm Qopt Q external
Pm benefits
Figure 5.12 Positive consumption externality
MSB
D = MPB
0 Qm Qopt Q

(a) Legislation or advertising

Figure 5.13 Welfare loss (deadweight loss) in a positive
P consumption externality
S = MPC = MSC

Popt

Pm D2 = MSB
external
benefit

D1 = MPB
0 Qm Qopt Q

(b) Direct government provision

P
S = MPC = MSC

S + government
provision
Pm

Pc MSB
D = MPB
0 Qm Qopt Q

(c) Granting a subsidy

P S = MPC = MSC

subsidy = MPC –
external subsidy
benefit
Pm

Pc MSB
D = MPB
0 Qm Qopt Q

Figure 5.14 Correcting positive consumption externalities

© Cambridge University Press 2012 Economics for the IB Diploma 16

 Important diagrams to remember
Chapter 6 The theory of the firm I: Production, costs, revenues and profit
Higher level topics

(c) Total product curve

units of output

(c) Total cost, total variable cost and total

TP fixed cost curves

TC

0 TVC
units of variable input (labour)

costs
units of output

TFC

0 output, Q

AP

0 MP MC
units of variable input (labour)
(d) Marginal and average product curves

Figure 6.1 Total, marginal and average products ATC

costs

AVC
units of output (AP, MP)

AP AFC
0 output, Q
MP
0
units of variable input (labour)
(d) Average cost and marginal cost curves

Figure 6.2 Total, average and marginal cost curves

MC
costs (AVC, MC)

AVC

0 Figure 6.3 Product curves and cost curves are mirror images due to the law of
output, Q diminishing returns

© Cambridge University Press 2012 Economics for the IB Diploma 17

 Important diagrams to remember

(b) Long-run average total cost curve in relation to (c) Economies and diseconomies of scale
short-run average total cost curves

economies diseconomies
a LRATC of scale of scale
b SRATC1 LRATC

costs
SRATC2
SRATCm
costs

0
output, Q

0 Q1 Q2
output, Q

Figure 6.5 The long-run average total cost curve

(a) Profit-maximising firm produces at Q2 and (b) Profit-maximising firm produces at Q2 and (c) The loss-minimising firm produces at Q2
makes economic profit: TR – TC = c – d makes zero economic profit: TR – TC = 0 (if it produces) and makes a loss = TC – TR
(it earns normal profit) = a – b (negative economic profit since
TR < TC )

TC
TR TC TC
e
costs, revenues

costs, revenues

costs, revenues
c TR a
a TR
f a
d b
b

0 Q1 Q2 Q3 Q 0 Q1 Q2 Q3 Q 0 Q1 Q2 Q3 Q

Figure 6.10 Profit maximisation using the total revenue and total cost approach when the firm has no control over price

(a) Profit maximisation (b) Loss minimisation

TC, TC TC, TC
TR TR
b
TR
a
TR

0 Q max Q 0 Q1min Q

Figure 6.11 Profit maximisation using the total revenue and total cost approach when the firm has control over price

© Cambridge University Press 2012 Economics for the IB Diploma 18