eco assignment

ECOM20023Economics For Business

Question 1, Part AThere will be an increase (rightward shift) in the demand curve of coffee due to the expected price rise. The price of coffee is expected to rise next week, therefore people will buy more coffee and would like to stock more which in turn will increase the demand for coffee and compel the consumers to buy more coffee at the given price. The purpose to observe here is that the non-price determinant of the demand that is expectations of the buyers is the key factor which makes them purchase early (Layton, Robison & Tucker, 2002).

In the above figure the market demand curve for coffee shows how much the consumers are willing to buy at several given prices. This demand curve clearly describes that when the price decreases the quantity increases and vice versa. In simple words, the points A, B, C, D and E depicts the demand curve D. X axis shows the quantity of coffee in kilograms and Y axis shows the price of coffee in dollars per kilogram. But when there is a consumer expectation for coffee that the price of coffee is going to rise next week, then the demand for coffee increases all of a sudden and now at the same price consumers are willing to buy more coffee at point F and therefore due to increase in this non-price determinant of demand that is consumer expectation and large number of buyers there is a change (rightward shift) in demand and we get a new curve D1.Market demand schedule for coffee.Point Price in $/g. Quantity demanded in kg.A 1 50B 2 40C 3 30D 4 20E 5 10F 3 50


Question 1, Part BThe diagram illustrates that there is an increase (rightward shift) in the supply, that means additional units or products are provided at every cost. An enhanced supply is depicted by a budge of the supply curve to the right. There are several reasons for such a shift in the supply curve except for price which only causes a movement in the supply curve. The rightward shift in this supply curve is due to the change (increase) in supply due to various non-price determinants of supply (Gillespie 2007).

This kind of rightward shift in the supply curve is possible in countless markets and one example of such market is the Indian two wheeler market where such a large number of two wheelers are supplied that we have a rightward shift in the supply. As people of India are more style oriented and want to be as mobile as possible for their daily chores, that they prefer a two wheeler every time cited in india info line (2003). By eyeing such a large number of consumers and opportunity in the Indian market, hefty number of domestic and international two wheeler manufacturers has entered into this market and supplied two wheelers at each and every price. As this is a rapidly growing challenge for the companies to make their presence felt, they start introducing new and advanced models of two wheelers. (cited in the hindu business line 2003)

The five factors that have caused this right ward shift are-:(a) A change in number of sellers.(b) A change in technology.(c) A change in costs.(d) Expectations of producers.(e) Input or resource prices.The factor that causes a movement along the supply curve is the price. A amend in the price of a manufactured good is the basis for a change in magnitude supplied; this is expressed as a movement along the supply curve. An expansion in cost will more often than not direct to a boost in the capacity supplied. This is recognized as an extension of supply. A reduce in the capacity supplied is described as contraction of supply (Gillespie, 2007).


Question 1, Part C (1)Definition of elasticity – The thought used to appraise the reaction of one variable to changes in another variable is known as elasticity. It computes and articulates that responsiveness in a shorthand mathematical form. Not only does it grant an evaluation of responsiveness, but it also gives us a term that illustrates trade and industry affiliation (Waud et al. 1998). Therefore, elasticity of demand is the degree of responsiveness of quantity demanded to a change in price and the elasticity of supply is the degree of responsiveness of quantity supplied to a change in price.

Question 1, Part C (2)There is a reason for inconsistency in the elasticity coefficients between the identical two points on a demand curve. The disinterested approach is to decide on the preliminary point as a base and then work out change. But price elasticity of demand grips adjustments between two probable base points. Therefore to get to the bottom of this predicament of difference base points we use a midpoint formula between the two possible initial base points. The midpoint formula for the elasticity of demand is-:

Ed = Change in quantity ÷ Sum of quantities _____________________ Change in Price ÷ Sum of Prices

This can be expressed as-:

Ed = %∆Q = Q2 – Q1 Q2 + Q1


_____________________________ P2 – P1 P2 + P1

%∆P

The midpoint formula is also usually called the arc elastic formula because it refers to elasticity over an arc of the demand curve.

To calculate the price elasticity of demand for good X between points E and Z we use the midpoint formula as -:

E = Q2 – Q1 Q2 + Q1

P2 – P1 P2 + P1

Therefore we have Q2 = 350, Q1 = 300, P2 = 20 and P1 = 400.

Therefore E = 350 – 300 350 + 300

200 – 400 200 + 400

E = 50 / 650

200 / 600 = 50 / 600 650 / 200 = 3/13 = 0.23Therefore demand is inelastic.


Question 2, Part AQuantity Total cost Marginal cost 0 $200 - 1 $900 $700 2 $1800 $900 3 $3000 $1200

Solution -:

Marginal cost (MC) = Change in Total cost Change in quantity = 900 – 200 1 – 0

= $700

Marginal cost (MC) = Change in Total cost Change in quantity 900 = X 2 X = 900 × 2 = 1800

Marginal cost (MC) = 3000 – 1800 3 – 2 = 1200

Average fixed cost = Total fixed cost Change in quantity = 200 / 3 = 66.67 Assumption: We have assumed the Fixed cost to be $200Therefore Average fixed cost = 66.67

Question 2, Part B, (1)Assuming that the firm is a perfectly competitive firm we are given with the following -: ATC = $25, AVC = $20, TFC = $500, MR = $35 and MC = $35.

TC = TFC + TVC Q × ATC = 500 + AVC × QQ × 25 = 500 + 20 × Q25 Q = 500 + 20 QQ 25 – 20 = 500Q = 500 / 5Q = 100


Hence, the level of production for his firm should be 100 units.

Now the profit-:

Profit = Total revenue – Total cost = (Marginal revenue × Q) – (Average total cost × Q) = (35 ×100) – (25 × 100) = 3500 – 2500Profit = $1000

Therefore profit = $1000, as this company is at the level of maximum profit and production because Marginal revenue is equal to Marginal cost, that is $35. This is so because this firm follows a guideline called the MR = MC rule which states that the firm enhances its earnings to a optimum level where Marginal revenue = Marginal cost (Layton et al. 2002)

Question 2, Part B, (2)In the perfect competition a company has no control over price, so in order to maximize profits, the company makes only one decision that what quantity of output to produce to. The following are the two approaches for finding the profit maximization-:

(a) The total revenue – total cost method: As per Layton et al. (2002) this approach is one of the very easy and efficient ways to find a profit maximizing level for a firm in a short run. The main determinants for this approach are output, total revenue, total cost and profit. Taking a hypothetical example of an Indian Bicycle manufacturer, that is HERO cycles and plotting it on the column and graphs, we can learn this approach in detail. Our assumption here is that the market equilibrium is $20 as this firm is a price take. As we see that total cost at zero output due to total fixed cost is $15, total revenue is calculated as the product price times quantity. Therefore subtracting total cost from total revenue gives us the final profit that HERO bicycles earn at each level of output. From 0-1 unit, the company is in a loss and then break-even point at 2 units. If they produce 6 units per hour, they get maximum profit of $70. As quantity enhances 7-10 units the profit decreases. The following graph shows that maximum profit appears when the vertical distance between total revenue and total cost is greatest.


(b) The marginal analysis method – Brue and Mcconnell (2007) states that this approach uses marginal analysis to determine the profit maximization level of output for a firm in short run. The main determinants for this approach are marginal revenue which is change in total revenue decided by change in quantity, marginal cost, average total cost and average variable cost. Again by taking a hypothetical example of an Indian Bicycle manufacturer, that is HERO cycles and plotting it on the column and graphs, we can learn this approach in detail. Our assumption here is that, since HERO bicycles is under perfect competition it has a perfectly elastic demand curve as it’s a price taker and every unit of sale adds to total revenue. In this example HERO bicycles adds $20 to its total revenue when it sells one unit. Therefore $20 is the marginal revenue for every additional unit. Columns of total revenue and total cost shows that, as output increases they both also rise, comparing marginal revenue and marginal cost tells us that marginal revenue is equal to price but marginal cost follows a ‘U’ shape pattern. After plotting the figures in the column, we get the following graph, where profit is maximized when marginal revenue=marginal cost at $20 per unit. The intersection of marginal revenue and marginal cost curves establishes the profit maximizing output at 6 units per hour. Therefore marginal revenue=marginal cost rule states that the firm maximizes profit or minimizes loss by producing the output where marginal revenue equals marginal cost.

Conclusion: In perfect competition, the company’s marginal revenue equals the price that determines the position of the firm’s horizontal demand curve (Layton et al. 2002, p. 180).

Question 2, Part CThe curve that shows the quantities supplied by the industry at different equilibrium prices after firms complete their entry and exit is the long run supply curve. To explain the


adjustment sequence between points in the following figure we use the constant cost industry case, where the expansion of industry output by the entry of new firms has no effect on the firm’s cost curves. This graph shows that the industry is in equilibrium at point A, producing 1500 units per week and selling units at $15 per unit. Then industry demand increases from D1 to D2 and the equilibrium price rises to $2 at point B. Due to this for a short while industry output rises to 20000 units per week. Therefore firms are now earning economic profit as they are now selling product at a higher price, which in turn attracts new firms to enter the industry. Then once the new firm enters the industry, it causes the short run supply curve to shift rightward from S1 to S2, which reestablishes the price at $15 and this brings a new industry equilibrium point at C. At point C, industry output rises to 25000 units per week and the company’s output slash back to $15 per unit. Now the distinctive firm earns standard revenue and fresh firms stop entering the business. We finally connect the points A, B and C which produces the long run supply curve. (Layton et al. 2007, pg194) very strongly concludes that under perfect competitive constant cost industry the long run supply curve of a company is perfectly elastic.

Final learning: A favorable shift in demand (D1 to D2) might be due to change in consumers tastes and preferences which upsets the original equilibrium and produce economic profit. But those profits will cause new firms to enter the industry, increasing supply (S1 to S2) and lowering product price until economic profit are once again zero (Brue and Mcconnell, 2007).

Question 3, Part A, (1)If the prices for new homes have risen and the sales of the new homes have also risen then this is a sheer case of change in demand due to non price determinants, as they affect the demand and causes a shift in the demand curve. The law of demand states that there is an inverse relationship between price and quantity, ceteris paribus (Layton et al. 2002). When as distinction between changes in quantity demanded and changes in demand states that


change in quantity demanded will cause only a movement in the demad curve, where as change in demand will cause a shift in the demand curve. In other words prise increase or decrease will cause a movement along the demand curve and non-price determinant will cause a shift in demand curve. Figure 1 shows that how this situation might occur and following are the non-price determinants of demad which affected the demand-:

(a) A change in the number of buyers – Over a period of time more people may move into an area or a country, creating more potential buyers (Gillespie 2007). For example more and more students, migrants and workers are coming into Australia from all parts of the world, which is thus creating more and more demand for homes in the housing markets. Also there is a geographic shift in population which causes people to move between states and buy new homes (Kotler et al. 2006).

(b) A change in tastes and preferences of the buyers – Even with the importance of consumer sovereignty, we know that fashion and lifestyle can influence consumer preferences and demand curve relies completely on the consumers individual preferences (Png and Lehman, 2007). For example people living in shared accommodation, small town houses or in rural areas are now willing to move into cities and want to have personal and own furnished homes, which in turn creates more demand for new homes in the housing market (Kotler et al. 2006).

Thus in Figure 1 the demand curve shifted from D1 to D2 and there was an upward movement along the supply curve due to the law of supply, that higher he price higher will be the quantity supplied.

Mccarthy and peach (2004) states that, if we take real life examples of supply and demand forces in the housing market “over the long term” in Australia then we get a similar curve like we got one above, but in Australia the non-price determinants of supply play a major role in conjunction with the non-price determinants of demand. Therefore instead of movement along the supply curve, we get a shift in the supply curve. Figure 2 shows how


this situation occurs and following are the non-price determinants of demand and supply which affect or causes a shift in the demand and the supply curve in the long run.

According to Tollner (n.d) non-price determinants of Demand-:(a) A change in the number of buyers – Over a period of time more people may move

into an area or a country, creating more potential buyers (Gillespie, 2007).(b) A change in the Income of buyers – If consumers have an increase in their income

then their demand for property is likely to shift (Gillespie, 2007).

According to Tollner (n.d) non-price determinants of Supply-:(a) Suppliers expectations – This refers to the fact that supplier first thinks what could

be the aspect that might affect his economic situation (Waud et al. 1998). This in other words mean that the supplier uses a far sighted approach and if he determines that he might be in profit if he supplies more then definitely he will start producing more homes as he will have a profit motive behind it.

(b) An increase in number of sellers – If there is an increase in the number of producers in an industry then this should lead to an increase in supply (Gillespie, 2007). More producers may try to enter into an industry because they are attracted by the prospects ofhigh returns. Similar is the case with Australia, by eyeing large demand in future and rising prices, more domestic and international players are willing to move into the construction market.

Thus in figure 2, the demand curve shifts from D1 to D2, and the supply curve shifts from S1 to S2, due to change demand and change in supply in the long term.

Question 3, Part A, (2)


According to Lexis Nexis (2007) the tax Accountants are one of the best paid in the accounting industry and has got very high value attached to them. This can be seen in the present high demand accounting markets such as the Middle East, Australia and some European countries which require accountants in large numbers. The reason for this high demand is due to the complex tasks they undertake and help a firm in maximizing profits and variour other important jobs. They are also paid good wages for the tasks they perform.

But in the market for tax accountants, if there is a decrease in their wages, then that will be a different aspect altogether. If for example we take the present scenario of Australia where accountants are paid handsome amount and if their wages are decreased, then that will directly affect the demand for these accountants, as they there will be less number of people doing accounting studies and due to that there will be a fall in the demand. This can be shown in the figure below, that when the wages move or decreased from W1 to W2, then the quantity of accountants also moved or decreased from Q1 to Q2. The impact of this decrease or this change in their wages has caused a negative shift in the demand curve from D1 to D2. There can be several other reasons for this negative shift in demand but some of the important ones are:

(a) Technological environment – This can be one of the prime reasons for decreasing demand of tax accountants, as new technology forces creates new product and manual work can now also be done online sitting on a laptop. For example videoconferencing is hurting the Airline industry very badly as now very less number of business travellers travel and company’s save their travel expenses (Kotler et al. 2007).


(b) Government encouragement – This is another reason why the demand for tax accountants might fell. Now a days with the help of new softwares government is encouraging people to do all of their tax calculations on the readymade softwares online on government websites. Due to this people are now aware and might require less accountants. Therefore demand is shrinking for professionals such as lawyers, doctors and accountants due to information age and the admission to knowledge provided by internet services (Kotler et al. 2007).

Now considering other industries that may require similar skills of these accountants, such as banking services, company financial advisors, government civil services and finance department etc. might have an increased supply of these tax accountants in their industry. (Here we are assuming that they will be paid slightly lower or equilant to what they got in their Industry) Therefore, if their wages are less or decreased they will shift to other industries. So now we get a new curve below of other industries which shows that as per our assumptions and free market conditions of demand and supply where our assumption of low wage rate will pravail as we are using the standard tools of demand and supply, the supply of tax accountants will rise in their industry from S1 to S2, where as wages fell from W1 to W2.

Question 3, Part B (1, 2 and 3)According to College cram (n.d) in most markets, prices are free to rise and fall with changes in supply and demand, no matter how high or low those prices might be. However, government concludes that sometimes prices are high and low to consumers and sellers which are very unjustified. Therefore government then interferes in the market and place legal boundaries on how low or high prices can be. In the following case the price ceiling has been imposed by the government in a competitive market. By price ceiling we mean a


legally established maximum price for a product a seller can charge (Brue and Mcconnell 2007). The figure below explains the price ceiling. In free market when price was $500 per air ticket, there were 50,000 air tickets sold. But when the government imposed price ceiling at $350 per ticket it caused a shortage and there were only 40,000 tickets now available for purchase. Thus there was a shortage of 20,000 tickets after price ceiling.

The maple syrup market is used with a diagram as a case study to show where a price ceiling has been used and why it was thought to be necessary. The following are the maple syrup market conditions-:

(a) At equilibrium $3 and 50,000 bottles.(b) Consider complaints from buyers: price is too high.(c) Government set a price at $2 per bottle.(d) Therefore quantity supplied: 40,000, quantity demanded: 60,000.(e) Shortage is caused due to excess demand.(f) Incentive for individuals to buy maple syrup at $2 and sell it to other individuals at

higher price, which creates black market.(Hall and Lieberman, cited in Google)


In the figure above when price of maple syrup was $3 per bottle, people were buying 50,000 bottles at point E. But after consumers complaints government imposed price ceiling because with rising income people purchased more cakes, French toast, wafers and ice creams and due to that demand for maple syrup rose. Therefore government imposed ceiling of price at $2 per bottle, but this affected the market and due to this, there is a shortage of 20,000 bottles of maple syrup and only 40,000 available. This is denoted by points R and V.

The following are the results of government intervention-:(a) Shortage in supply – as shown in the figure now there is a shortage of 20,000 bottles

and not all the consumers are getting the maple syrup, because $2 ceiling price is below $3 market clearing price (Brue and Mcconnell 2007).

(b) Wasted resources – people will spend their valuable time and money finding the maple syrup in the market (Krugman and Wells 2004).

(c) Black marketing – As shown in the figure even at low quantity available of 40,000 and low price at $2, sellers might sell same quantity at $4 per bottle (Krugman and Wells 2004).

The better way to deal with this issue is that the government should use rationing method. Government should provide printed coupons with limit to quantity to every household so that they cannot buy more of that in a given period and that every level of society whether rich or poor should receive similar amount (Krugman and Wells 2004).

Question 3, Part C (1, 2 and 3)A negative externality is a charge forced on people other than consumers and producers of a good or service. In simple words it can be called spillover production or consumption costs imposed on third parties without compensating to them (Layton et al. 2002). For example if USA wants any of its old, outdated and rusty ships to be scrapped in Taiwan, then negative externalities arise when Taiwan destroy that ship in its bay and its marine life, sea food and fishing industry is affected badly. USA is only paying Taiwan for scrapping the ship but instead Taiwan has lost more natural resources due to that. This is a negative externality which is explained in the figure below. Therefore is such case the government intervention is very necessary as because as per government of Taiwan it’s creating pollution and external costs are being bearded by Taiwan. Government intervention in such case may include-:

(a) Legislation and regulation – Government of Taiwan may pass certain laws to control certain type of behavior by the externality causing body. Laws affect a number of business behaviors such as health, safety and consumer protection (Gillespie 2007).


(b) Subsidies and taxes – These can be used to encourage or deter certain types of behavior. Government of Taiwan may tax more the USA ship firms so that free market position move to more social optimal level (Gillespie 2007).

To sum up government intervention, we saw that it is required to gain economic efficiency when negative externality is going to affect huge amount of people or when a particular area, industry or domestic business is at risk (Brue and Mcconnell 2007).

Reference: Foundations of Economicsby Andrew Gillespie

McConnell A 2007 'Book Review: Local Government in the United Kingdom

Therefore in the figure above we see that before government intervention the USA ship firms were getting their work done at point A(free market) and were paying just $1000 per ton for breakage of ships. But after government intervention when they were taxed they started paying $2000 per ton and curved moved from point A to B. Therefore the net gain to Taiwan is when we combine the points A, B and C and also it brought down the quantity of ship breakage from 5000 tonnes (quantity free market) to 3500 tonnes (quantity optimum). The following are the ways and options to correct negative externality-:

(a) Environmental standards – They can make a rule to protect their environment by specifying actions by producers (Krugman & Wells 2004).

(b) Emmissions tax – It is that tax which relies on the quantity of pollution an activity has produced (Krugman & Wells 2004).

(c) Tradable emmissions permits – It is a kind of license to emit limited amount of pollutants that can be brought or sold (Krugman & Wells 2004).

The case study choosen here is from the capital city New Delhi of India, where it is shown that how the industrial sector pollutes the main river Yamuna by the industrial waste. Due to rapid globalization, expansion, high investment by foreign firms, rising population, rising


income, urbanization, large scale improvement in infrastructure and improvement in lifestyle huge number of industries are set up at the banks of the Yamuna river and pollutes it to such an extent that the government intervaention has now beconme mandatory and the government therefore has taken serious measures and effective steps to improve the situation. The graphical demonstration below will help us understand where the problem of deadweight loss is and how it can be resolved. (CPCD 2001)

In the figure above resources are over allocated at inefficient equilibrium point A and S(Private) is the industries supply curve. If the industries are required to pay tax on the pollution they do, the economy can move towards the efficient equilibrium point B. Therefore point A, B and C denotes the net benefit to society after taxing the industries. It can be clearly seen that when the government intervened and levied regulation and taxes, these industries moved the their production from 65000 tonnes (quantity free market) per year to 40000 tonnes (quantity optimim) per year and this also affected their price per unit which went up from INR700 per unit (price free market) to INR1200 per unit (price optimum). The government addressed the situation in a very straightforward and stringent manner stating that minimum desired water quality of class-C should be achieved, water standard should be maintained, gave directions to the administration to set time limit till pollution levels come down, no industrial constructions along the river and taxing the polluting industries. (CPCD 2002)

The better way of dealing with the issue should be, that the government should follow an environmental based approach to find solutions for negative externalities. Worthington et al. (2005) p. 450 claims that human action alone is not responsible for causing all the environmental problems faced by the society. Natural processes are also a contributory


factor. Therefore environmental problems resulting from various sources vary along a number of dimensions in the follwing ways-:

(a) Geographical scale – Local, national, regional and global.(b) Duration – Short term, long term and permanent.(c) Source – Individual, firm and industry.

However, Layton et al. (2002) suggests that, the government should be more inclined towards tax based solution in this case, as it not only provides a higher efficiency but it also allows a higher amount of flexibility to both the polluter and the government. Under this system the polluting industries can have a choice between paying tax or installing pollution control equipment and the government can easily vary the tax rates.

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