44 Diagrams for A-level Economics: Microeconomics

This article below contains some key diagrams for A-level microeconomics exams. Suitable for AQA, Edexcel A and other exam boards.

Contents

Section 1: PPFs and supply and demand basics

Production possibility frontier

The PPF 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 car. – As more and more cars are produced, producing one extra car requires giving up even more planes. – This is because car production runs into diminishing marginal returns / gets progressively more difficult. – So opportunity cost increases. PPF topic notes: Edexcel | AQA

Supply and demand – demand shifts right

A 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. This results in higher price (from p1 to p2) and higher quantity from q1 to q2. Demand topic notes: Edexcel | AQA

Supply and demand – supply shift right

A supply shift to the right can be caused by: – Reduced labour costs due to reduced wages. – Higher labour productivity for given wages. – Reduced costs for any other factor of production. – Technological improvements that reduce the cost of production. A supply shift to the right reduces the price from p1 to p2 and increases quantity from q1 to q2. Supply topic notes: AQA

Price mechanism – response to a shortage

This shows the response of the price mechanism to a shortage at price p1 of (q3-q1). 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 rises, 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 p1 to the new price p2, at the equilibrium. The price mechanism also eliminates the shortage.  Price mechanism topic notes: Edexcel

Section 2: Market failure and government intervention diagrams

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. Air pollution could lead to worse breathing problems for those nearby. Externality topic notes: Edexcel

Positive externality in consumption

Free market outcome MPB=MPC: E Socially optimal outcome where MSB=MSC: B Underconsumption of q2-q1. This results in a welfare loss of area ABE. Example: consuming healthcare benefits the rest of society. For instance, healthier, more productive individuals increase firm productivity. Externality topic notes: Edexcel

Negative externality in consumption

Free market outcome MPB=MPC: B Socially optimal outcome where MSB=MSC: E Overconsumption of q1-q2. Welfare loss ABE. Example: air pollution caused by car consumption of petrol. May lead to breathing problems for third parties.

Positive externality in production

Free market outcome MPB=MPC: B Socially optimal outcome where MSB=MSC: E Underproduction of q1-q2. Welfare loss ABE. Example: job training benefits other firms who can then hire the already trained workers.

Maximum price

Maximum 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. This welfare loss occurs because the quantity (q-q2) would be produced by the free market and would deliver a net benefit to consumers and firms. However, under the maximum price, these extra units are not produced. Maximum price notes: Edexcel

Minimum price

Minimum price set at p1, above the free market equilibrium price p. Results in surplus (excess supply) of q1-q2.  Leads to welfare loss shown by shaded area.  Example: alcohol minimum unit pricing in Scotland. Minimum price notes: Edexcel

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. Tax incidence notes: Edexcel | AQA

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. Subsidy incidence notes: Edexcel | AQA

Pollution permits

The supply of permits is set by the government. So permit supply is perfectly price-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.

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.

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. Notes on taxes in the context of market failure: Edexcel | AQA

Subsidy plus externality

Subsidy shifts the cost curve right from MPC to MPC with subsidy.  This increases quantity from q (free market outcome) to q1 (socially optimal outcome). This eliminates the welfare loss ABE, the green area in the diagram. Notes on subsidies in the context of market failure: Edexcel | AQA

Section 3: Cost and revenue basics

Total cost, fixed cost and variable cost

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. Notes on cost curves: Edexcel

Average cost (including AVC and AFC) and marginal cost

AFC is 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. Notes on cost curves: Edexcel

Revenue lines for a price maker

A price maker can influence the market price. In this case, educing 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. However, 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. Notes on revenue: Edexcel

Revenue lines for a price taker

The market 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. Notes on revenue: Edexcel

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. Notes on economies of scale: Edexcel

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. Notes on economies of scale: Edexcel

SRATC and 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. Notes on cost curves: Edexcel

Section 4: Market structures

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. Notes on monopoly: Edexcel | AQA

Natural monopoly

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. Notes on monopoly: Edexcel | AQA

Oligopoly – kinked demand curve

Oligopoly – kinked demand The AR or firm 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. Notes on oligopoly: Edexcel | AQA

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. Notes on oligopoly: Edexcel | AQA

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. Notes on monopolistic competition: Edexcel | AQA

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 falls.So  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. Notes on monopolistic competition: Edexcel | AQA

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. Notes on perfect competition: Edexcel | AQA

Perfect competition – short run to 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. Notes on perfect competition: Edexcel | AQA

Price discrimination

The left diagram shows no price discrimination. The middle and right diagram show price discrimination, for the PED inelastic and PED elastic groups respectively. 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. 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. The areas shaded show firm profit. The green area (profit under no price discrimination) is smaller than the sum of profits under price discrimination (both orange areas). This is one way of showing that price discrimination increases profits. Notes on price discrimination: Edexcel | AQA

Price cap on a cost and 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. The green area shows the welfare gain from the price cap. Here, this is equivalent to the welfare loss from monopoly.

Increase in firm costs

An increase in business costs, e.g. due to an increase in labour costs 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. Note this diagram assumes that the cost increasing is a variable cost. If there is an increase in a fixed cost instead, only the ATC curve shifts upwards. Marginal cost is unaffected by changes in fixed cost.

Decrease in firm revenue

Any factor that reduces demand for an individual firm’s product for a given price, 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.

Business objectives

Profit maximisation: MC=MR. This occurs at (q,p) on the diagram. Revenue maximisation: MR=0. This occurs at (q1, p1) on the diagram. Sales maximisation: AR=ATC. This occurs at (q2, p2) on the diagram. Notes on business objectives: Edexcel | AQA

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. Notes on business objectives: Edexcel | AQA

Section 5: Labour markets

Labour supply and demand

The labour market can be thought of like any other market, where there is supply of and demand for labour.  Notes on labour supply and labour demand: Edexcel labour demand | Edexcel labour supply  AQA labour supply and labour demand

Labour demand shifts

One example of a shift factor for labour demand is 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.

Labour market discrimination

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).

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.

Monopsony

A perfectly competitive labour market sets wages where supply (ACL) equals demand (MRPL).  However, 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.

Monopsony plus minimum 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.

Microeconomics diagrams PDF

A PDF file of the diagrams is here:

The most important microeconomics diagrams

Here are five important sets of diagrams you should be reviewing ahead of your exams.

Supply and demand

You can use supply and demand to show:

• The effects of changes in costs (shifting supply) on market outcomes. [Supply notes for AQA].
• The effect of changes to income, advertising, tastes and so on on market outcomes. [Demand notes for Edexcel and AQA]
• The role of the price mechanism in the market adjusting to equilibrium. [Price mechanism notes for Edexcel]

Supply and demand diagrams do not need to be simple. For the 25 marker essays, consider levelling up these supply and demand diagrams. This could include:

• Showing the price mechanism following a shift in demand.
• Showing changes in consumer surplus and/or producer surplus.

Economic policy with supply and demand

Supply and demand diagrams can also show the effects of microeconomic policies. This includes:

• Taxes
• Subsidies
• Maximum and minimum prices.
• Tradable pollution permits.
• Regulation.

For these policies, you can also level up these diagrams for your essays. For example:

• Taxes and subsidies: Show the incidence or burden of the tax or subsidy.
• All policies: Show the change in consumer surplus, producer surplus or the effect on social welfare.

Externality diagrams

• Market failures from positive and negative externalities.
• Layer with taxes or subsidies to show how policies can increase social welfare.
• Show how technological change can reduce the extent of externalities.

Monopoly cost and revenue

The monopoly cost-revenue diagram is one of the most flexible diagrams in economics.

Depending on the essay, this diagram can show different things:

• The effect of market power on prices.
• Different business objectives such as profit maximisation and sales maximisation.
• Contestable markets and how they affect the behaviour of incumbent firms.
• The effect of a price cap or privatisation.
• The consequences of cost or revenue changes for individual firms. This could involve showing shifts in cost or revenue curves.

Labour market supply and demand

Labour markets are another key topic for A-Level Economics courses.

Supply and demand diagrams for labour markets can be used to illustrate several points:

• Effects of education policy.
• Effects of other changes in labour supply or labour demand.
• The causes of wage gaps.
• Minimum wages and trade unions and how they may cause unemployment in (competitive) labour markets.

There are other diagrams you should revise, including those in the file above. These five sets of diagrams are the most important.

Related questions

How to use paper 1 diagrams – basics

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?”.

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 lines or 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.

How to draw high level diagrams for your economics essays.

For microeconomics, high level diagrams 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

The above list of diagrams is not comprehensive. It covers almost all diagrams but not every diagram.

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 – perfectly inelastic, perfectly 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.
• 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.
• Collusion in a cost-revenue diagram.
• 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.

Related posts

For more Economics A-level resources, check out the links below: