A2 Unit 3 Diagrams
All essential diagrams for Pearson Edexcel IAL A2 Economics Unit 3 (WEC13/01) — profit maximisation, cost curves, market structures and labour markets.
3.1 — Revenue, Costs & Profit Maximisation
3.1Profit Maximisation — MC = MR Rule
Profit maximisation rule: MC = MR
- If MR > MC: firm gains more from next unit → increase output
- If MR < MC: next unit costs more than it earns → reduce output
- At MC = MR (Q*): profit is maximised
- Price P*: read off the demand (AR) curve at Q*
- Supernormal profit = (P* − AC*) × Q* — shaded rectangle above AC
- If AC > AR at Q*: firm makes a loss (rectangle below AC)
Always find Q* first (where MC=MR), then go up to AR to find P*. Never read price off the MR curve. The profit/loss rectangle goes from AC to AR at Q* — shade it and clearly label it.
3.2Short-Run Cost Curves (MC, AVC, AFC, ATC)
MC cuts both AVC and ATC at their minimum points — this is a mathematical rule, not a coincidence.
- AFC: Fixed costs spread over more units → always falling
- AVC: Variable cost per unit — U-shaped due to law of diminishing returns
- ATC = AVC + AFC: U-shaped, minimum at higher Q than AVC min (AFC still falling)
- When MC < AVC → AVC falling. When MC > AVC → AVC rising
- Vertical gap between ATC and AVC = AFC at any Q
The most tested rule: MC always passes through the minimum of AVC and ATC. If MC is below AC, AC is still falling. If MC is above AC, AC is rising. This is the same logic as a batting average.
3.2 — Perfect Competition
3.3Perfect Competition — Short Run, Long Run & Industry
Short run (middle panel): SR supernormal profits attract new firms (free entry). Long run (right panel): New firms enter → supply increases → price falls back to minimum AC → only normal profit remains. AR=MR is tangent to AC at its minimum.
Key features of perfect competition: many buyers/sellers, homogeneous product, perfect information, free entry/exit, price takers (AR=MR=P).
Key features of perfect competition: many buyers/sellers, homogeneous product, perfect information, free entry/exit, price takers (AR=MR=P).
- LR equilibrium: P = min AC → productively efficient
- LR equilibrium: P = MC → allocatively efficient
In perfect competition the LR outcome is both allocatively efficient (P=MC) and productively efficient (P=min AC). This is the benchmark for evaluating other market structures. Contrast with monopoly where P>MC and P>min AC.
3.4Monopoly — Profit Max & Welfare Loss
Monopoly profit maximisation: Sets MC = MR → output Qm (less than competitive output Qc). Reads price Pm off AR curve (Pm > Pc = competitive price).
- Supernormal profit: (Pm − ACm) × Qm — can persist in long run due to barriers to entry
- Deadweight welfare loss (DWL): Triangle between Qm and Qc — consumers willing to pay more than MC but not served
- Allocatively inefficient: P > MC
- Productively inefficient: usually P > min AC (not at min AC)
- X-inefficiency: no competitive pressure → costs drift upward
The DWL triangle is the key welfare argument against monopoly. However, dynamic efficiency arguments go the other way — monopoly profits fund R&D that benefits consumers in the long run (Schumpeterian argument). Include both sides in an essay.
3.5Monopolistic Competition — SR & LR
Monopolistic competition: Many firms, differentiated products, free entry/exit. Examples: restaurants, hairdressers.
- Short run (AR_SR): Firms can earn supernormal profit
- Long run (AR_LR): New firms enter → each firm's demand falls → AR_LR is tangent to AC → only normal profit
- Excess capacity: Firms produce at Q_LR which is below min AC — productively inefficient
- P > MC → allocatively inefficient
- Benefit: Product variety and choice for consumers
The key diagram here is the tangency condition in LR: AR just touches AC at the profit-maximising output. This shows normal profit is being made and there is no incentive for further entry or exit.
3.3 — Labour Markets
3.6Labour Market — MRP & Wage Determination
Marginal Revenue Product (MRP): The additional revenue a firm gets from employing one more worker. MRP = MPP × MR. This is the firm's labour demand curve.
- Firm hires where W = MRP (wage = marginal revenue product)
- Equilibrium wage W* and employment N* determined at intersection
- Minimum wage above W*: Employers demand fewer workers (Nd falls), more workers supply labour (Ns rises) → unemployment = Ns − Nd
- MRP shifts right if MPP rises (productivity increase) or MR rises (product price increase)
The labour demand curve IS the MRP curve. The MRP theory is the key theoretical justification for wages — workers are paid their marginal contribution to revenue. Higher-skilled workers have higher MRP → higher wages.
3.7Monopsony in the Labour Market
Monopsony: Single buyer of labour (e.g. NHS as main employer of nurses, Amazon in a one-factory town).
- To hire more workers, must raise wage for ALL workers → MCL > ACL
- Profit maximise where MCL = MRP → hires N_m (less than competitive N_c)
- Pays wage W_m (less than competitive W_c = MRP) → monopsonistic exploitation
- Gap between MRP and W_m = exploitation per worker
- Minimum wage can actually increase employment in a monopsony — it removes the upward-sloping MCL up to the minimum wage level
The minimum wage counterargument is critical here. In a competitive market, minimum wage above W* causes unemployment. But in a monopsony, minimum wage set between W_m and W_c can raise both wages AND employment simultaneously. This is examiners' favourite evaluation point.