All Diagrams (Still in Progress) Flashcards
1 Production Possibility Curves
Draw a PPF
4.1 Indirect Taxation
Indirect Tax Diagram analysis
1) Supply Curve: Shifts upwards from $1 to S1+tax
2) Price & Quantity: Price increases from P1 to P2 and Quantity decreases from Q1 to Q2
3) Producer Revenue: Decreases from P1AQ10 to DCQ20
4) Government Revenue: P2BCD
5) Consumer Burden: P1P2BE
6) Producer Burden: P1ECD
7) Welfare Loss: ABC
4.2 Subsidy
Subsidy Diagram Analysis
1) Supply Curve: Shifts downwards from S1 to S1+sub
2) Price & Quantity: Price decreases from P1 to P2 and quantity increases from Q1 to Q2
3) Producer Revenue: Increases from P1XQ10 to BCQ20
4) Government Cost: BCDP2
5) Consumer Savings: P1XYP2
6) Welfare Loss: CDX
4.3 Minimum Price
Minimum Price (Price Floor Diagram)
- with intervention buying, revenues for the producer increase from P1CQ10 to P2BQsO.
- This is known as intervention buying, which has a cost equal to the rectangle ABQdQs.
4.4 Maximum Price
Maxiumum Price Diagram Analysis
Implementing maximum prices or price ceilings results in a decrease in prices from P1 to P2, causing an extension of demand to Qd and a contraction of supply to Qs. This creates an excess demand (a shortage) of AB in the market.
Producers lose out considerably with lower revenue from P1CQ10 to PZAQs0 and lower producer surplus.
5.1 Externalities
Neagtive Production Externality diagram analysis
5.1 Externalities
Negative Externality in consumption diagram analysis
5.1 Externalities
Positive Externality in Consumption diagram analysis
5.1 Externalities
Positive Externality in Production diagram analysis
5.2 Merit/Demerit Goods
De-Merit Good Diagram
It is just a negative externality diagram
5.2 Merit/Demerit Goods
Merit Good Diagram Analysis
5.3 Tragedy of the Commons
Tragedy of the Commons Diagram Analysis
It’s just a negative production externality diagram
5.5 Information Failure
Information Failure Diagram (overestimating benefit of good)
- E.g. Overestimating the benefit of food supplements, cosmetic surgery
- This diagram shows effect of Over-estimating the private benefit of consumption
- 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
5.5 Information Failure
Information Failure Diagram (underestimating benefit of good)
- E.g. underestimating the benefit of healthy eating, giving up smoking, education
- 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 upwards leading to a greater equilibrium quantity
5.8 Monopoly Power
Monopoly Power Diagram
6.1 Indirect Tax and Market Failure
How does a carbon tax affect the market?
Indirect taxation to solve negative externality in production diagram
A carbon tax increases the costs of production for polluting firms, shifting the MPC curve upwards from MPC to MPC+tax, equal to MSC. The price increases in the market from P1 to P, with quantity decreasing from Q1 to Q, the socially optimum level of output. The externality has now been fully internalised with the price reflecting the full social cost of production, hence the polluter is now paying the full cost of their actions. The overproduction and overconsumption that existed in the market is now solved with resources allocated efficiently at Q*.
6.1 Indirect Tax and Market Failure
What is the impact of an indirect tax on consumption of cigarettes, alcohol, and sugar?
Indirect taxation to solve negative externality in consumption diagram
An indirect tax such as a cigarette, alcohol or sugar tax increases the costs of production for firms, shifting the MPC curve upwards from MPC to MPC+tax. The price increases in the market from P1 to P2 and due to the law of demand, consumption is discouraged, decreasing quantity from Q1 to Q, the socially optimum level of output. The externality has now been fully internalised with the overconsumption and overproduction issues now solved. There is no longer a misallocation of resources with resources allocated efficiently at Q.
Government revenue: P*ABC
6.1 Indirect Tax and Market Failure
What is the first disadvantage of using an indirect tax to solve market failure?
Cons/Evaluation
The demand for cigarettes, alcohol, sugar and fuel is price inelastic, meaning that as price increases, quantity decreases, but proportionately less than the price increase. This is because they are eitherm necesseities, addicitive. or there aren’t many good subsitutes available. Therefore as price increases, quantity decreases from Q1 to Q2 due to the law of demand, but proportionately less than price increase from P1 to P2. Therefore, the decrease in quantity will help to reduce the misallocation of resources but not by enough to fully solve the market failure if Q* is below Q2. Any overconsumption and overproduction problems will remain.
6.2 Subsidy and Market Failure
What is a subsidy used for in solving positive externality in consumption/merit good market failure?
A subsidy such as public transport, solar panel, vaccination, electric car, gym/leisure centre and museum subsidies will reduce the costs of production for firms shifting the MPC curve downwards from MPC to MPC+sub. The price decreases in the market from P1 to P2 and due to the law of demand, consumption is encouraged, increasing quantity from Q1 to Q, the socially optimum level of output. The under consumption and under production issues are fully solved. There is no longer a misallocation of resources with resources allocated efficiently at Q. Welfare is now maximised due to this intervention.
6.2 Subsidy and Market Failure
How does a subsidy solve positive externality in production market failure?
A subsidy such as in work training or R&D subsidies will reduce the costs of production for firms shifting the MPC curve downwards from MPC to MPC+sub, equal to MSC. The price decreases in the market from P1 to P* and quantity increases from Q1 to Q, the socially optimum level of output. The under production and under consumption issues are fully solved. There is no longer a misallocation of resources with resources allocated efficiently at Q. Welfare is now maximised due to this intervention.
6.4 Tradeable Pollution Permits
Pollution permit Diagram Analysis
- The level of permits is fixed in supply by the government at S1, a pollution cap that matches the socially optimum level of pollution at Q1*. Where demand for permits meets the supply of permits, a price of P1 is generated. Firms can then decide at this price whether to invest in green technology to reduce pollution or to buy excess permits at the market price. If the price of P1 is too low, firms will decide to buy permits in the market increasing demand for them from D1 to D2, pushing up the price from P1 to P2. For many firms the incentive will now change to investing in green technology.
- The fact that firms have this choice to reduce the cost burden on them is a large benefit compared to blanket regulation which may destroy the profitability of a firm and lead to unintended consequences of the firm shutting down or producing elsewhere in the world.
- If the scheme is successful over time with firms finding a way to efficiently become greener, the government can increase the cap and reduce the number of permits, shifting the supply curve from st to S2 and reducing quantity from 01* to Q2*, increasing the price of permits from P2 to P3, promoting an even stronger incentive to become green in production.
- In this way the socially optimum level of output can be reached solving the misallocation of resources and the overproduction issues. Allocative efficiency and welfare maximisation will result.
6.5 State Provision
State Provision Diagram Analysis
The diagram shows how resources are now allopcated at Q*, the sociallly optimum, a supply fizxed by the government with a price of 0.
6.6 Information Provision
How can negative advertising or information provision help solve de-merit good market failure?
Negative advertising or information provision in the form of TV campaigns, print advertising, changes to the school curriculum or packaging changes will help to solve de-merit good market failure where information failure is the root cause of the problem. Individual consumers who are now well informed when making decisions about smoking cigarettes for example will consume less, fully understanding how bad the product is for them shifting the MPB curve to the left from MPB to MPB+neg advertising which now equals MSB. The market will then operate at the socially optimum level of output at Q* with overconsumption and production issues solved and allocative efficiency attained.
6.6 Information Provision
How can positive advertising or information provision help solve merit good market failure?
Positive advertising or information provision in the form of TV campaigns, print advertising, changes to the school curriculum or packaging changes will help to solve merit good market failure where information failure is the root cause of the problem. Individual consumers who are now well informed when making decisions about using sun cream for example will consume more, fully understanding how good the product is for them shifting the MPB curve to the right from MPB to MPB+pos advertising which now equals MSB. The market will then operate at the socially optimum level of output at Q* with under consumption and production issues solved and allocative efficiency attained.
6.7 Price Controls & Market Failure
What is a minimum price and how can it solve market failure in de-merit goods?
Minimum prices are price floors set above the equilibrium price in the market to discourage consumption of de-merit goods. For goods like alcoholic drinks, minimum prices can be used to raise the price above equilibrium levels from P1 to P2 to internalize the negative externality and discourage consumption, solving overconsumption issues and bringing the market to the allocative efficient production level from Q1 to Q*, eradicating a prior misallocation of resources.
6.7 Price Controls & Market Failure
How can a maximum price or price ceiling solve income inequality market failure?
A maximum price or price ceiling is set below the free market equilibrium price, decreasing prices from P1 to P2. As a result there is an extension of demand to Qd improving the affordability of essential goods and services like housing or food. Implementing rent control will allow those who need accommodation but cannot afford it in the free market to access housing, improving their living standards, reducing any under consumption issues and thus improving the allocation of resources.
6.9 Buffer Stock Schemes
Buffer Stock Scheme Diagram Analysis
- If the price of a commodity came under falling pressure as Figure 1 shows with supply shifting to the right from S1 to S2 perhaps due to a bumper harvest, a price fall from P1 to P2 would not be allowed harming the livelihoods of producers. The government would step in buy some of the stock in the market increasing demand for the commodity from D1 to D2 pushing the price back up to P1 within the permitted bands. The government would store the stock and release it onto the market if ever the price rose too high.
6.9 Buffer Stock Schemes
Buffer Stock Scheme Diagram Analysis
- If the price of a commodity came under rising pressure as Figure 2 shows due to demand shifting to the right from D1 to D2, a price rise from P1 to P2 would not be allowed harming the living standards of consumers who may not being able to afford this staple. The government would step in and sell stocks of the commodity it has stored up in the market increasing supply for the commodity from $1 to 52 pushing the price back down to P1 within the permitted bands. Selling stored stock allows the government to earn income to buy excess stock when the price falls too low.
- Periodic intervention like this allows the government to manipulate commodity prices, keeping them within the permitted bands, protecting the living standards of both consumers and producers thus solving a market failure on the grounds of inequitable free market outcomes.
8.2 Costs
Law of Diminishing Returns and Short Run Costs: Variable Factor
The variable factor is assumed to be labour and the fixed factors are land and capital. By adding more labour, initially there are productivity improvements as under utilised fixed factors are used up and sepcialisation gains take place. This leads to an initial rise in marginal product and fall in marginal cost, stage 1. Eventually however, when more workers are hired they get in the way of one another, with the fixed factors of production constraining production. Therefore labour productivity falls, reducing marginal product and increasing marginal cost, stage 2.
8.2 Costs
Long Run Costs and Returns to Scale
In the long run all factors of production are variable where the return on investment decisions when increasing output is needed to understand the average cost relationship. The long run average cost curve is shaped due to increasing and decreasing returns to scale as a result of economies and diseconomies of scale. The minimum efficient scale of production occurs where full economies of scale have been exploited.
