Principles of Economics/Graphs

Graph reading


The first step to understanding economics models is comprehending graphs. Here the x axis is Q, quantity, and the y axis is P, price. The point at the top right indicates Q* quantity of a good each being sold at price P*; the horizontal and vertical lines are there for facilitation/marker purposes. The point to its left has only half the extent x-axis-wise, and therefore involves half the quantity. The point below the first has only half the extent y-axis-wise, and therefore involves half the price.

This graph is used for demand / supply curves, and for production cost curves.

The supply curve is an upsloping curve from left to right, and shows that whenever the market price of a good increases, more producers are willing to produce, and there for there is more goods produced for price 2, if price 2 is greater than price 1.

The demand curve is a downsloping curve from left to right, and it shows that when the price is very high, there are few consumers demanding little quantity, but when the price is low, there are many more consumers, demanding more quantity. Ideally, if the price reaches zero, than infinite quantity is demanded.

Production costs curve show the Law of Diminishing Returns, which shows that total costs decline as more quantity is produced, because fixed costs are divided into more units. In fact, fixed costs always decline. Variable costs however, can decline because of gains in efficiency, but after a certain quantity, variable costs increase because of inefficiency e.g. due to congested access to fixed resources. Thus unit variable costs are drawn as a stretched out U shape. Unit total cost is a stretched out U shape, which sits above unit variable cost, and gets closer to it, because unit fixed cost is included in total cost, total cost never quite touches unit variable cost. Marginal cost is the cost of producing one more unit, and unlike unit total cost and unit variable cost, it is not an average unit cost, but determines the direction of change of average cost for the next unit. If the marginal cost equals the average total cost, than after the next unit is produced, the average total cost doesn't change, but if it is less than the average, then next average cost will be lower than the current average cost. Conversely, if marginal cost is greater than the average cost, than the next average cost will rise. This means marginal cost, which represents to the change in total cost over the change in quantity, or the additional total cost to produce 1 more unit, doesn't incorporate the fixed cost, as none of the additional total cost is additional fixed cost. So marginal cost will intersect average total cost at its minimum point, because average total cost will rise when the marginal cost is greater than the average total cost, and in fact, the same can be applied to average variable cost.

Graph reading continued


This may appear to be a similar graph, but it is entirely different because here the y axis is the quantity Q2 of another good. The top right point involves Q* of good 1 and Q2* of good 2. The point to its left involves half as much of good 1, while the point below it involves half as much of good 2.

This graph is called the a graph of possible production, where shared available resources are used to produce two alternatives at varying quantities. If more of good 1 is produced, less of good 2 is produced. The characteristics of the curve is that:
 * 1) convex quarter shape, from 12pm to 3pm
 * 2) convex shape is explained by suitability of some resources for good 1, and some for good 2, so that more quantity is produced of good 1 and good 2 when Q1 = Q2, because specialised resources are allocated most efficiently.