Question 1:
(a) Suppose the income elasticity of demand for furniture is 3 and the income elasticity for doctors' services is 0.3. Compare the impact on furniture and doctors services of a recession that reduced consumer incomes by 10 per cent. (2 marks)
Change in income = 10% = 0.1
Income elasticity of demand = change in quantity demanded/ change in income
Therefore: change in quantity demanded = Income elasticity of demand × change in income
Impact of recession on furniture:
Change in quantity demanded = 3 × 0.1= 0.3 = 30%
A change of 10% in consumer income will result in a 30% change in quantity demanded of furniture.
Impact of recession on doctor’s service:
Change in quantity demanded = 0.3 × 0.1 = 0.03 = 3%
A change of 10% in consumer income will result in a 3% change in quantity demanded of doctor’s service.
(b) How might you determine whether compact discs and restaurant meals are in competition with each other? (2 marks)
(c) Interpret the following Income Elasticities of Demand (YED) values for the following and state if the good is normal or inferior; (3 marks total, 1.5 marks per part)
YED= 0.5
This is a normal good because its income elasticity of demand is positive. Normal goods have positive income elasticities of demand.
YED= -2.5
This is an inferior good because it has a negative income elasticity of demand. Inferior goods have negative income elasticities of demand.
(d) Interpret the following Cross-Price Elasticities of Demand (XED) and state if the goods are substitutes or compliments. (3 marks total, 1.5 marks per part)
XED= 0.6
The two goods are substitutes to each other because the cross price elasticity of demand is positive.
XED= -2.2
The cross price elasticity is negative and this means that the two goods are complimentary to each other.
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Question 2:
Explain and illustrate with diagrams the differences between diminishing marginal returns and decreasing economies of scale and cite causes and examples.
Diminishing marginal returns
Diminishing returns to scale
Diminishing marginal returns occurs when the output per variable input decrease with each addition of a variable input while holding all the other factors constant while decreasing economies of scale occurs when the output for a given product increases at a rate lower than the rate of increase. Diminishing marginal returns are caused by an increase in one variable input while holding all other inputs at a constant rate (Sloman 201).
The output per worker decreases per every additional worker in the workforce, and this is an example of decreasing marginal returns. The returns per unit sold by a business will decrease as the sales volume increases. This indicates diminishing returns to scale. Diminishing returns to scale are caused by increase in the sales volume without a corresponding increase in the fixed assets available to support such an increase.
(10 marks: 2.5 marks diagrams, 2.5 marks for explanation, 5 marks for causes / examples)
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Question 3:
(a)Explain and Illustrate using diagrams the difference between price and non-price influences in affected the behaviour of a demand curve (3 marks);
Price influence on the demand curve causes it to shift either leftwards with a reduction in price or rightwards with an increase in price. Non price influence on a demand curve causes movements on the level of price along the demand curve without any shifts of the demand curve (Frank 114).
(b) Explain and Illustrate using diagrams the difference between price and non-price influences in affected the behaviour of a supply curve (3 marks);
Price influence on the supply curve causes it to shift either rightwards with a reduction in price or leftwards with an increase in price. Non price influence on a supply curve causes movements on the level of price along the demand curve without any shifts of the demand curve (Frank 156).
(c) Explain and illustrate with diagrams how and why a marginal cost curve maps out a supply curve (4 marks).
Marginal cost curve replicates a supply curve, only with the price taking the place of marginal cost in the y- axis. This is because the producer of a good will always produces at the points at which he can make a return, which corresponds with the marginal cost required at that point (Frank 154).
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Question 4:
(a) Illustrate using diagrams and explain how the oligopolistic firms determines their collective profit maximising price and output levels when they collude and act like a cartel (monopoly)
(4 marks);
The firms will determine the point at which the industry marginal cost equals the industry marginal revenue and set the equilibrium price and output quantity at this level.
(b) Illustrate and explain with diagrams how a cheating oligopolist would chose its profit maximising output level if attempting to increase its market share at the agreed original price
(3 marks);
The oligopolist will choose an output level at which the industry average revenue equals the industry marginal cost. At this point, the oligopolist will maintain the industry price level while at the same time providing for increased supply (Sloman 132).
(c) Illustrate and explain with diagrams how a cheating oligopolist would chose its profit maximising price and output levels if it attempted to undercut the price charged by the other oligopolistic firms (3 marks).
The cheating oligopolist will choose a price which is below the industry price, lower than the point at which the industry marginal revenue equals the industry marginal cost (Kreps 190).
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Question 5:
What will happen to the equilibrium price and quantity of butter in each of the following cases? You should state whether demand or supply (or both) have shifted and in which direction. (In each case, assume ceteris paribus).
(a) A rise in the price of margarine; (1 mark)
The demand for butter will shift rightwards with the increased demand for butter. The equilibrium price of butter will rise with the increasing demand, and the equilibrium quantity will also rise.
(b) A rise in the demand for yoghurt; (1 mark)
A rise in the demand for yoghurt will result in reduced supply of butter; the supply curve will shift leftwards resulting in an increase in the equilibrium price and a reduction in the equilibrium quantity.
(c) A rise in the price of bread; (1 mark)
The demand curve for butter will shift leftwards as demand for butter reduces. There will be a corresponding reduction in equilibrium price and quantity of butter due to the decreased demand.
(d) A rise in the demand for bread; (1 mark)
Increased demand for bread will result in increased demand for butter; the demand curve for butter will shift rightwards, resulting in a corresponding increase in the equilibrium price.
(e) An expected rise in the price of butter in the near future; (1 mark)
The demand for butter will rise in anticipation of the higher prices; the demand curve will shift rightwards resulting into an increase in the equilibrium price and quantity.
(f) A tax on butter production; (2.5 marks)
The equilibrium price will increase and the supply curve will shift leftwards, resulting in an increase in equilibrium price and a reduction in the equilibrium quantity.
(g) The invention of new, but expensive, process for removing all cholesterol from butter, plus the passing of a law which states that all butter producers must use this process. (2.5 marks)
The supply of butter will reduce; the price of butter will also increase. This will lead to a leftward shift of the supply curve and a rightward shift of the demand curve, resulting in an increase in the equilibrium price and the reduction of the equilibrium quantity.
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Question 6:
(a) Discuss the following statement: "In the real world there is no industry which conforms precisely to the economist's model of perfect competition. This means that the model is of little practical value'. (2.5 marks)
The statement is true because the perfect knowledge by both customers and producers envisioned in the model is practically impossible, the maximum efficiency under this model is also impossible to achieve. However, the model is not of little practical value since in practice, the model provides a standard against which real world markets can be compared (Alhashimi, and Dwyer 103)
(b) Illustrate with a diagram and explain the short-run perfectively competitive equilibrium for both (i) the individual firm and (ii) the industry; (2.5 marks each)
(i) Short run perfectively competitive equilibrium for the individual firm
Since in a perfect competition the firm is a price taker, it adopts the equilibrium price that is set by the market, at the point where the marginal cost equals the marginal revenue (MC = MR). The equilibrium quantity is also at the point where the MC curve cuts the MR curve (Kreps 178).
(ii) Short run perfectly competitive equilibrium for the industry
The long run equilibrium for the industry is at the point of intersection of the marginal cost curve with the average total cost. At this point, the price is equal to the marginal revenue (Kreps 187)
(c) Illustrate with a diagram and explain the long-run perfectly competitive equilibrium for the firm (2.5 marks).
In the long run, the equilibrium price in a perfectly competitive market settles at the point where all firms are only making normal profits. The long run equilibrium is at the point where the marginal revenue = short run marginal cost = short run average total cost =long run average cost. (P = MR = SRMC = SRATC = LRAC)(Kreps 203).
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Question 7:
(a) Why is mutual interdependence important under oligopoly, but not so important under perfect competition, monopoly or monopolistic competition? (5 marks)
Mutual interdependence is important in oligopoly because the number of firms is few and the products that are sold and are not differentiated. This means that a decision by one firm causes a reaction by the other firms. In a perfect competition, a monopoly or a monopolistic competition, this is not possible because the actions of one firm are not dependent on the other firms (Kreps 212).
(b) Are there any advantages in having a market structure that does not conform to perfect competition? If so then list five of these and discuss them. (5 marks)
There are advantages of having a market structure that does not conform to perfect competition.
In the provision of socially important goods such as education and health services, it is not ideal to have a perfectly competitive market since this may result in market practices which are socially harmful.
The provision of sensitive social goods and services such as security and defence cannot be entrusted to many players due to the sensitivity of the service or product provided. This makes it necessary to make the provision of such to be under one or a few providers, thus necessitating a market which is not perfectly competitive (Frank 109).
References
Frank, Robert A. Microeconomics and Behavior. New York: McGraw-Hill/Irwin, 6th Edition: 2006. Print.
Kreps, David M. A Course in Microeconomic Theory. Princeton: Princeton University Press: 1990. Print.
Sloman, J. And Norris, K. Principles of Economics, 2nd edition, Sydney: Pearson Education Australia, 2007. Print.
Alhashimi, Haydir and Dwyer, Dean. Study Guide to Accompany Principles of Economics, Sydney: Pearson Education Australia, 2010. Print.
