Download Dr. McGahagan Graphs and microeconomics You will see a

Dr. McGahagan
Graphs and microeconomics
You will see a remarkable number of graphs on the blackboard and in the text in this course.
You will see a fair number on examinations as well, and many exam questions, even when not
requiring you to use a graph, can best be answered by sketching one in your mind (or on the
exam paper -- feel free to use the question sheets as scratch paper in any exam in this course).
In following this handout, sketch appropriate graphs in the space provided.
Graphs have several elements, and you will have to pay more careful attention to the details than
you did in algebra, where the axes were always labeled "X" and "Y" and answers were always
purely numerical.
Axes - in economics, a graph is not complete without a label on each of its axes telling you what
it measures. Production possibility frontier graphs have one possibility on the X-axis (for
example, "Agricultural goods") and another on the Y-axis (e.g., "Industrial goods"). Supply and
demand graphs have the quantity of the good produced on the X-axis and its price on the Y-axis.
Sometimes one axis can stand for several variables at the same time -- the Y-axis can be used to
measure price, cost of production, and the dollar value consumers place on a good, since all three
are measured in dollars.
Points - in economics, as in algebra, any point on the graph shows two things at once -- a single
point on a production possibility graph may show 100 bushels of wheat and 20 automobiles. This
point might be referred to as a production bundle.
[sketch a straight-line production possibility frontier with the above production bundle.
Remember to label your axes.]
A single point on a supply-demand graph can show price and quantity at the same time -- for
example, the fact that 8 million shares of Amazon.com were traded today at an average price of
40 dollars a share. Illustrate that point below.
Areas - Take the point mentioned above, showing that 8 million shares of Amazon.com were
traded at $40 a share. What was the total amount spent on this stock? (8 x $ 40 = $320 million)
How can we show this graphically? In measuring a room, width times length gives area; our
graphical yardsticks (the axes of the supply-demand graph) are price and quantity, and price
times quantity gives the total amount spent -- the revenue of the sellers, which is equal to the
expenditure of the purchasers. We will find that other economically interesting quantities
(including profit) show up as areas on graphs.
[sketch the point showing the price-quantity combination for Amazon stock
and shade in the area showing expenditure on the stock]
Lines - A line on a graph shows the relationship between the variables measured on the axis.
As price goes up, the quantity demanded goes down -- this relation may be shown by a
negatively sloped line on a graph.
Lines show economic relationships in two ways: by their slope (how steep they are) and
by their location.
Slope shows how strongly two variables are located. A steeply sloped demand curve
indicates that a big rise in price will only lead to a small decline in the quantity consumed; with a
flat demand curve, there would be a big decline in the quantity consumed.
Slope is measured by rise over run -- the change in the Y-axis variable divided by the
change in the X-axis variable. It is closely related to the marginal concept previously mentioned
-- if the Y-axis shows the quantity of output and the X-axis the quantity of labor input, then the
slope of the line relating output and labor (the production function) shows the marginal product
of labor.
[draw a graph of the electric car market with P = $ 100,000 and Q = 8 thousand; don’t
add an area, but sketch in a steeply sloped demand curve, and then, with dashed lines, a flatter
demand curve. What would happen to the quantity demanded if the price of the electric car
dropped to $ 50,000 and the demand curve were steep? What if it were flat? Provide numbers so
that you can calculate the exact change in quantity and compare it to the change in price].
Location. The location of lines on economic graphs can -- and very frequently does -change. In fact, one of the main points in drawing graphs in economics is to enable one to think
about the consequences of change.
For example, the demand curve shows a negative relation between price and quantity
demanded. But what happens if the incomes of consumers increase? The $ 100,000 for an
electric automobile which looked prohibitively expensive may now be acceptable -- and in fact,
people may wind up buying more even if the price is higher.
Economists deal with this case by saying that the demand curve has shifted.
Redraw your graph of the electric car market and show what will happen to the demand curve if
incomes increase. (Use a dashed line for the new demand curve) It would even be possible for
people to buy more at a higher price; for example, a price of $ 100,000 could correspond to a
quantity of 10 thousand on the new demand curve.
Intersections. Often in economic graphs, two lines will cross, and the point of the
crossing may be important economically. Supply curves cross demand curves at the point of
equilibrium, where the quantity supplied equals the quantity demanded. Finding the intersection
is just about the hardest bit of algebra we will encounter all term, and it is not really very hard.
Suppose the supply curve is
Qs = - 200 + 2 P This implies:
1. if price were zero, - 200 units would be supplied (at that price, people who were producers
would turn into demanders)
2. the quantity supplied will increase by 2 for every dollar increase in price.
Let the demand curve be Qd = 600 - 3 P, which implies
1. If price were zero, 600 units would be demanded (it might be free, but storage could be a
problem. Would you really take 600 cans of tuna fish even if they were free?)
2. The quantity demanded will decrease by 3 for every dollar increase in price.
Where do the two curves cross? Obviously, at the point at which quantity supplied equals the
quantity demanded:
Qs = Qd at the intersection, so
- 200 + 2 P = 600 - 3 P substituting the right hand side of each equation.
5 P = 800
add 3 P to both sides, and add 200 to both sides.
P = 160
is the equilibrium price
To find the equilibrium quantity, substitute the equilibrium price into either the supply or the
demand equation.
Qs = - 200 + 2 (160) = 120.
Qd = 600 - 3 (160) = 120.
Illustrate this supply-demand system below: