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Assignment A – Microeconomics:
(a) If the oil prices rise sharply for years as a result of a war in the Middle East, illustrate the situation with a diagram for the following will be:
(i) Demand for automobiles – in this situation the demand curve will shift to the left. The demand of the oil will decrease due to the increase in the oil prices. As the increase in the price of the oil, the purchasing power of the owners of the automobiles will fall and it will lead to fall in the demand of the oil. When the oil will be expensive then people will reduce the use of the automobiles (Ahmadian, et. al., 2013).
(ii) Demand for home insulation – In this situation the demand curve will shift to the right. With the rise in the oil prices the energy prices will also rise and due to this increase people will prefer measures for reducing the cost. Home insulation reduces the requirement of the heating and cooling appliances as they keeps the home warm in winters and cool in summer.
(iii) Demand for coal –in this situation the demand will shift to the right. Due to rise in the price of oil people will start using substitutes of oil and the demand of coal will increase as it is the substitute of oil.
(iv) Demand for tyres – in this situation, the demand will shift to the left. When the price of oil will increase then the demand of the automobiles will fall. Tyres are used for cars and as a fall in the demand of the cars the demand of the tyres will also fall (Fouquet, 2012).
(v) Demand for bicycles – the demand curve for this situation will shift to the right. Rise in the price of oil will results in fall and in the demand of automobiles and due to this people will look for the substitutes of automobiles and will prefer using bicycle in place of the automobiles.
(b) The impact of external costs and external benefits on resource allocation:
External costs have negative impact over the resource allocation as the market price of the goods increases due to the cost charged by the sellers from the buyers of the goods. In this condition the allocation of the resources will be done on the basis of the private consumptions which will lead to inefficient allocation of the resources in the economy and over allocation of the resources. External benefits the price of the goods charged by the sellers from the buyers is less which leads to under allocation of the resources in the economy (Yohan, et. al., 2012).
(c) The public goods are not produced in sufficient quantities by private markets:
Private markets do not produce public goods as these goods are provided by the government so as to make these goods available to the public in sufficient quantity. Private markets cannot exclude the individuals from consuming the product or service and another reason is the problem of free rider. And if the private markets will produce public goods then this condition will lead to failure of the government.
(a) Explain why scarcity forces individuals and society to incur opportunity costs. Give specific examples.
The resources available are in limited quantity or are scarce. And these scarce resources can be used for the production of limited resources. This problem of scarcity gives rise to the problem of making choice. When the individual need to make choices from the various alternatives then the cost of the alternatives not being selected is opportunity cost (Polley, 2015).
For an example: there are 1000 pieces of woods available and one can produce 40 tables or 70 books from it. For the production of one other need to be foregone and it is referred as opportunity cost.
(b) Suppose a chocolate bar manufacturer promotes its product by advertising an opportunity to win a 'free car'. Is this car free because the winners pays zero for it?
No, the car is not free as the individual winning the price has paid for the chocolate bar and after it won the car it need to pay taxes, license fees and registration fees. So the price of car for the individual will be the price it paid for the chocolate bar, taxes, registration and license. All these costs will be the price of the car for the individual.
(c) Why is production possibility frontier bowed outwards?
The reason behind this shape of the PPC is the law of increasing opportunity cost. When the resources of an economy are devoted more for the production of “A” good then the resources becomes less efficient in the production process of the other good. When the production of one good is increased the opportunity cost of the other good goes on increasing and this is the reason behind the outward shape of the production possibility frontier (Hill, 2014).
Question 4: Suppose electricity prices increase significantly over a two year period as a result of the government introducing a carbon tax that raises the costs for coal-fired stations. Illustrate and explain using diagrams, what happens to:
(a) Demand for domestic gas-Due the increase in the price of the electricity, the demand for the domestic gas will increase as both can be used at each other’s place. In this situation the demand curve for domestic gas will shift to the right (Wood & Alsayegh, 2014).
(b) Demand for solar powered cars- the demand curve will shift in right as when the price of electricity will increase then the consumption of the products running on solar energy will increase as both are substitutes for each other and solar powered cars costs less to the consumers.
(c) Demand for air conditioners-The demand for the air conditioners will decrease and the demand curve for the air conditioners will shift to the left. Due to the increase in the price of electricity people will less prefer air conditioners as they consume more electricity (Wood & Alsayegh, 2014).
(d) Demand for home insulation- the demand curve for the home insulation will shift to left due to the increase in electricity prices.
(e) Demand for outdoor swimming pools- the demand for the outdoor swimming pools will increase as the indoor bathtubs will be used less due to the increased electricity charges. The demand curve will shift in the right (Wood & Alsayegh, 2014).
a) Suppose the income elasticity of demand for pre-recorded music compact discs is 7+ and the income elasticity of demand for a cabinet maker’s work is +0.7. Compare the impact on pre-recorded music compact discs and the cabinet maker’s work of a recession that reduces consumer income by 10%.
In income elasticity, if the income of the consumer is reduced by 10% then in that condition the pre-recorded music compact discs will be 7*10% which will be equal to 70% and the work of the cabinet maker will be 0.7*10% which will be equal to 7%. This shows that the reduction in the income of a consumer will have a greater impact over the pre-recorded music compact discs in comparison to cabinet maker’s work. The fall in the income will have a greater influence over the luxury goods in comparison to the necessity goods. Pre-recorded music compact discs will come under the category of luxury goods as it greater than 1 and cabinet maker’s work will come under the category of necessity goods as it is less than 1 (Sabatelli, 2016).
b) How might you determine whether MP3 music players and the pre-recorded music compact-discs are in competition with each other?
For the purpose of identifying whether the MP3 music player and the pre-recorded music compact discs are in competition with each other or not, there is a need to use cross price elasticity of demand. In case the result from the cross price elasticity of demand is less than zero then they are complimentary and in case the cross price elasticity of demand is greater than zero then they are substitute to each other. In the second case they both will be in competition with each other.
c) Interpret the following income elasticity of demand (YED) values for the following and state if the good is normal or inferior:
YED = +0.8
YED = -2.4
When the value of elasticity of demand is greater than zero than it is a normal good and when the elasticity of demand is less than zero then it is an inferior good. When the YED is +.8 then it is a normal good and its coefficient will be less than 1 due to which it will be inelastic. When the YED is -2.4 then it is an inferior good and its coefficient will be greater than 1 due to which it will be elastic (Sabatelli, 2016).
d) Interpret the following cross-price elasticity of demand (XED) and explain the relationship between these goods.
XED = +0.85
XED = -4.5
When the XED is greater than 0 than in that condition it is a substitute good and its coefficient will be less than 1 due to which it will be inelastic. When the XED is less than 0 then it is a complimentary good and its coefficient will be greater than 1 due to which it will be elastic.
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”.
The above stated statement is having a very little practical value. The features or characteristics of a perfect competition market helps in the better understanding of the reason of the less practical value of the above stated statement. When it comes to a perfect competition market number of sellers and buyers are in huge quantity, the products or goods offered by the sellers in the market are homogeneous and the firms are considered as price taker. But in few industries there is a single seller or few sellers who controls the market and are price makers and the products offered by the sellers are different from each in certain way (Thampapillai, 2010).
b) Illustrate with a diagram and explain the short-run perfectly competitive equilibrium for both (i) individual firm and (ii) the industry.
Individual firm: The short-run perfectly competitive equilibrium for the individual firm can be understood as period when the firm can alter its factors of production for the purpose of maximising the profits or to minimise the loss occurring to the firm. There is a restriction over the entry and exit of the firms from the market which fixes the number of the firms in the market. The firm is said to be at equilibrium at the point where it is earning the maximum profits from its operations. In the short-run perfectly competitive equilibrium the firm’s Marginal cost is equal to the marginal revenue and marginal cost curve cuts the marginal revenue from below and after that it starts rising (Dressler, 2016;2015).
Industry: an industry is said to be in equilibrium in the short-run in the perfectly competitive market where its total production or the output becomes steady and there is no tendency left for increase or decrease in its output quantity. The industry is said to be in equilibrium when all the firms operating in an industry are at equilibrium (Dressler, 2016;2015).
c) Illustrate with a diagram and explain the long-run perfectly competitive equilibrium for the firm.
Long run can be understood as the time period which is adequate for the firm to make changes in the factors of production as per the requirement. All the factors of the production in a long run are variable. New firms can enter the industry and can operate by competing with the existing firms and the firms can leave the industry. Equilibrium output in the long run is determined by the long-run average and marginal cost curve. A firm is said to be operating at equilibrium point in the perfectly competitive market in a long run when the price and marginal cost are equal and the price should be equal to the average cost. In the long run equilibrium of perfectly competitive market for a firm the condition is the price is equal to minimum average cost and to the marginal cost (Dressler, 2016;2015).
Ahmadian, A., Hassan, A. & Regassa, H. 2013, "The impact of oil price fluctuations on the automobile industry", International Journal of Business and Economics Perspectives (IJBEP), vol. 8, no. 2, pp. 35.
Dressler, S. 2016;2015;, "A long-run, short-run, and politico-economic analysis of the welfare costs of inflation", Journal of Macroeconomics, vol. 47, pp. 255-269.
Fouquet, R. 2012, "Trends in income and price elasticities of transport demand (1850-2010)",Energy Policy, vol. 50, pp. 62.
Hill, M.S. 2014, "Production possibility frontiers in phototroph:heterotroph symbioses: trade-offs in allocating fixed carbon pools and the challenges these alternatives present for understanding the acquisition of intracellular habitats", Frontiers in microbiology, vol. 5, pp. 357.
Polley, W.J. 2015, "The rhetoric of opportunity cost", American Economist, vol. 60, no. 1, pp. 9.
Sabatelli, L. 2016, "Relationship between the Uncompensated Price Elasticity and the Income Elasticity of Demand under Conditions of Additive Preferences", PloS one, vol. 11, no. 3, pp. e0151390.
Thampapillai, D.J. 2010, "Perfect competition and sustainability: a brief note", International Journal of Social Economics, vol. 37, no. 5, pp. 384-390.
Wood, M. & Alsayegh, O.A. 2014, "Impact of oil prices, economic diversification policies and energy conservation programs on the electricity and water demands in Kuwait", Energy Policy, vol. 66, pp. 144-156.
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