This article contains 12 graphs which pretty much summarize everything an undergraduate economics student would need to learn.
- Linearized Competitive Supply and Demand
- Supply and Demand with Monopoly
- Firm Production in the Short Run with Technical Efficiency
- Firm Production in the Short Run with Profit Maximization
- Firm Production in the Long Run
- Hicksian and Marshallian Demand
- Two-Period Intertemporal Consumption with Savings
- Microfounded Aggregate Demand
- IS-LM with Dynamics
- Phillips Curve
- Solow Model
- Lorenz Curve
#1: Linearized Competitive Supply and Demand
- This is the most basic graph in economics. Supply is the upward sloping line and demand is the downward sloping line.
- The x-axis is quantity and the y-axis is price. The point where supply intersects demand is the market equilibrium of price and quantity.
- Producer surplus is the area to the left of equilibrium quantity and between the demand line and the price. Consumer surplus is below the price but above the supply line. Add them together to get total surplus.
- Firms and consumers are price-taking in the free market. For firms this means MR = MC = AC = P*.
#2: Supply and Demand with Monopoly
- The line that is downward sloping with smaller P at each Q is the marginal revenue curve.
- A monopoly produces Q* such that MR = MC, but unlike a free market it will charge P* > MR = MC = AC.
- Monopolies and monopsonies decrease total surplus by an amount which is called deadweight loss. DWL takes the shape of a triangle on linearized graphs. It is shown as a shaded region in this graph.
#3: Firm Production in the Short Run with Technical Efficiency
- This is a graph of the marginal cost, average total cost, and averaged fixed cost of producing at each quantity for a particular firm.
- Notice that averaged fixed cost goes down as more quantity is produced. This is a major reason that economies of scale exist.
- Without price information, the firm will prefer to produce in a way that is technically efficient. Technical efficiency means the firm minimizes cost of production for a particular quantity.
- Technical efficiency occurs when average total cost is minimized. This occurs at the intersection of marginal cost and average total cost, which is also the point where the derivative of the average total cost is 0.
- If the market price is lower than the technically efficient price of production for the firm, the firm will shut down in the long run. If the market price is even lower than the minimum average variable cost, the firm will shut down in the short run.
#4: Firm Production in the Short Run with Profit Maximization
- The graph shows the total cost and total revenue curves. The firm will produce the highest quantity at which marginal revenue equals marginal cost. This is not an intersection on this graph because marginal values are slopes on this graph. Instead, it’s where total revenue minus total cost is as large as possible.
#5: Firm Production in the Long Run
- The short run is where at least one factor of production is held constant. In the long run all factors are variable.
- Firms are able to produce as much or more in the long run compared to the short run because they will only adjust factors if it reduces the average total cost of production.
- The long run average cost curve is the collection of the intertemporal minimum average cost points for each quantity produced.
#6: Hicksian and Marshallian Demand
- People often change the basket of goods they consume when prices change. Two well studied ways consumption changes due to a change in price are called the income effect and the substitution effect.
- The change in utility is called the income effect and the change in relative consumption is called the substitution effect.
- Hicksian demand is used to determine the substitution effect. Using Hicksian and Marshallian curves together let us isolate the income effect.
- Hicksian demand is compensated demand which means it is the demand which would have occurred if the consumer’s utility were held constant after a price change. By observing the change in consumption which occurs without a change in utility, we isolate the substitution effect.
- Marshallian demand is uncompensated demand which means it is the actual demand after a price change. This actual change in behavior is a combination of income and substitution effects, but we can subtract the difference in consumption attributed to substitution and the remainder is the income effect.
#7: Two-Period Intertemporal Consumption with Savings
- Consumers can either save or spend their income in the first period, and they consume whatever is left in the second period. However, deferred consumption gains a rate of return equal to the interest rate.
- A 0% interest rate is a horizontal line.
- Consumers are never worse off by having the option to save. They choose whichever point is on a higher utility curve: The point where the interest rate line and utility curve are tangent or the point where the consumption possibilities frontier and utility curve are tangent.
#8: Microfounded Aggregate Demand
- Each person has their own preferences which are expressed as a utility curve. Each person maximizes utility by consuming the basket of goods on the highest utility curve which intersects with their budget constraint. It will be a point of tangency.
- A person’s utility-maximizing point at consumption will differ at each price. If you draw the collection of all such points for different prices it be their individual demand curve.
- If you add up all individual quantities demanded at each price in the economy you get the aggregate or total demand curve, which is just called the demand curve.
- Notice that summing linear individual demand curves creates a non-linear aggregate demand curve. Real economies exhibit non-linear aggregate demand curves which is one reason that microfounded curves can be a bit more precise than linearized macroeconomic models.
#9: IS-LM with Dynamics
- The IS-LM model is a general equilibrium model which means it shows equilibrium in multiple markets at once. The intersection of the IS and LM curves is an equilibrium interest rate, r, and total output, Y. Y is often measured as GDP.
- IS means investment-savings. As the interest rate increases output decreases because it indicates that consumers are saving instead of consuming and producers are investing in capital instead of producing current output, so the IS curve slopes down and to the right.
- LM means liquidity-money. People need to hold a certain amount of their income as cash in order to conduct daily transactions. As the interest rate rises prices also rise, so people increase their demand for cash. This means the LM curve slopes up and to the right.
- This version incorporates equilibria dynamics. Dynamics refer to behaviors, movements, or changes over time. The point of dynamics in this model is to show what would happen over time if the current equilibrium was shocked by some sort of shift. If the equilibrium point was temporarily shocked into a location away from the long run equilibrium, the arrows show the direction that equilibrium point would move in over time. Ultimately it would return to the long run equilibrium.
#10: Phillips Curve
- An X-intercept exists, but the Y-axis is approached asymptotically rather than intercepted.
- The classic Phillips Curve has been disproved, but augmented versions seems to hold to some extent in the short run due to sticky prices. So the Phillips Curve shows a short run trade-off between unemployment and inflation.
#11: Solow Model
- The Solow Model is a macroeconomic model of capital allocation which shows the relationship between savings and economic output.
- The key result is that there is a long run steady state equilibrium rate of capital allocation which maximizes the growth rate of consumption over time. This optimal rate of capital allocation is also referred to as the golden-rule savings rate.
#12: Lorenz Curve
- The Lorenz Curve is a graphical representation of income distribution in an economy. It is usually graphed to the right of a 45 degree line which is called the Line of Equality.
- The Line of Equality is how the economy would be represented if income was perfectly equally distributed.
- If you take the area between the Line of Equality and the Lorenz Curve and divide it by the total area under the Line of Equality, you get the Gini Coefficient.
- The Gini Coefficient indicates high inequality if it is close to 1 and low inequality if it is close to 0.