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23706 Economics for Management

Answers:

Section A

Question 1   

The given market equilibrium gives the Consumer Surplus (CS) and Producer’s Surplus (PS) as:

CS = area of triangle below the demand curve and above the price line

CS = ½* 40 * (0.80-0.60) = 4 units

PS = area of triangle above the supply curve and below the price line

= ½* 40*(0.60*0.20) = 8 units

With the introduction of the price floor the new equilibrium price is $0.70 per litre. The quantity that is supplied in the market will be 20 litres. The CS and the PS will change to
CS = area of triangle below the demand curve and above the new price line of $0.70

CS* = ½* 20 * (0.80-0.70) = 1 units

PS* = Area of triangle below the price line $0.40 and above the supply curve + the rectangle

PS =  ½*20*(0.40-0.20) + ( 20* (0.70-0.40)

= 2 + 6 = 8 units

The consumers are worse off as the consumer surplus have fallen form 4 units to 1 unit. While the producer surplus have remained same.

After the introduction of the price floor there has been a 20 litres of surplus in the market. The higher price have made the suppliers to produce more and consumers to demand less.

The introduction of the $0.30 per litre subsidy will leads rise in the wholesale market equilibrium quantity as now the suppliers will supply more. The supply curve will shift to the right by the amount of the subsidy. Hence a wedge in the price will be created between the price received by the producers and the price paid by the consumers. The consumers will pay $0.30 ($0.60- $0.30) and the supply will be 50 litres. The equilibrium quantity will be 60 litres. The equilibrium price will be $0.50. The subsidy amount will be (0.30 * 60) = $18.

Question 2

Initial price, P1 = $6 , Trial price, P2 = $4

Initial, Q = 60 pies, Trial, Q2 = 100 pies

Mid-point formula of elasticity =  

Average of price = (6+4)/2 = 5

Change in price = ($6-$4) = $ 2

Percentage change = 2/5*100 = 40%

Average of quantity = (100+60)/2 = 60

Change in quantity = 60-100 = -40

Percentage change = -40/60*100 = -66.66%

Mid-point formula of elasticity = = 40/-66.66 = – 0.60

The results reveal that the pies are inelastic in nature as the absolute value of the elasticity is less than 1.

Revenue and elasticity are related in this way that if the commodity is inelastic in nature the revenue will fall with a decrease in price. Hence it won’t be good to decrease the price to raise the revenues for inelastic goods.
The price should be increased to increase the revenue as the good is inelastic in nature. Hence it should be that price be increased over $6 to raise the revenues. Now the price increased should be stopped when the elasticity would be unitary. There would be no fall or rise in the revenue with increase or decrease or increase in price when the elasticity is unitary in nature.

Question 3

The consumers are expecting that the price will rise in future, they would buy when the price is still lower, this will raise the demand readily when the present price have not actually rise. The demand curve will shift to the right side parallel at the given price. The supply remaining the same will lead to the prices to rise as the demand is now higher. The quantity will be higher in the present, along with a higher price.
The price of the complement good have fallen, meaning that the quantity of complement good will be consumed more. This will also put an upward pressure on the quantity of the good, in question. The price fall of complement good gives rise to a higher price of the as suddenly the good is also consumed more. At the given price of the good in question the demand rise, due to another factor that is complement good. Thus the demand curve of the good will shift to the right. There will a rise in the market price of the good with supply remaining same.
The government subsidy on the suppliers would lead to a higher quantity of the good being supplied at the market. The price received by the supplier wold be higher than what the consumers are paying. The supply curve shifts to the right side parallel, when there is a subsidy given. This decreases the equilibrium price in the market.
The imposition of a price floor will lead to a shortage in the market as now the price is lower than the initial equilibrium. This means there will be higher demand by law of demand and lesser supply b law of supply. There will be a both a lower quantity that will be the equilibrium quantity as, suppliers are supplying less, while the price too is lower than before. The market will have a lot of deadweight loss with loss of total surplus.
The Giffen goods are those inferior goods for which the consumers increase their consumption with increase in price. The income effect of the Giffen goods are higher than the substitution effect. This means that an increase in the income of the consumer will result in less of the Giffen goods consumption. There will be no such effect on the price of the Giffen good

Question 4

The table below is presented

Output per week

Total Costs

AFC

AVC

ATC

MC

VC

$100

–

–

–

–

 

1

150

100

50

150

50

50

2

175

50

37.5

87.5

25

75

3

190

33.33333333

30

63.3333

15

90

4

210

25

27.5

52.5

20

110

5

240

20

28

48

30

140

6

280

16.66666667

30

46.6667

40

180

7

330

14.28571429

32.85714286

47.1429

50

230

8

390

12.5

36.25

48.75

60

290

Taking that the market is competitive in nature and that the normal profit maximizing rules follows, the price of $50 per lamp will mean that the profit is maximised at P = MC = MR, or at quantity 7 or 1. The equilibrium quantity should be at q=7 because the profit is maximised. The quantity 1 would not maximise the profit because the AVC is also $50. In the short run the firm actually shuts down when the AVC is higher or equal to its price. Thus firm can earn profits when the AVC is lower. The profits will be TR-TC = (7*50 – 330) = (350-330) = $20
The given price of laps falls to $30. At this price the lowest AVC is at $30 only. Although at this price the revenues will not be maximised. The quantity can be reduce to $6 to sustain in the market. The firm shuts down when the price is less than the minimum of AVC, such that the firm is not able to cover its variable costs even. This point it would be better to shut down. But Harry should lower the production to q=6 to remain in the market and not shut down.

Question 5

When the inflation moves above the target inflation rate, to lower the inflation the RBS should come up with contractionary monetary policy by reducing the amount of credit in the economy. It can sell the government bonds to reduce the money holding by the public or it can contract the money supply directly. The RBA can also increase the reserve ratios so that the lending capacity of the commercial banks is diminished to some extent and the banks cannot give the ample amount of loans. The RBA can also readily manipulate the interest rate on loans given to the public by the banks, or the lending rate at which the banks borrow form the RBA. With these measures the liquidity in the economy can be readily controlled to not let the money circulation rise above the target level. By the open market operations the RBA sells bonds and let the consumer buy them up to reduce their liquidity.
The open market operations are the best ways to reduce the liquidity in the market. The RBA in behalf of the federal government, sells the bonds which have fixed yield but risk free yields. The RBA lets the consumers buy up these bonds. The demand in the bond market increases, this increases the raises the price of the bonds and the interest rates rises which impacts the rate of interest for loans in the market. This two interventions are possible through OMO. Reduction of money holding by the consumers and the rise of the interest rates of loans by commercial banks.
Yes benefits of the contractionary money policy is for the whole economy with a lower rate of inflation. Inflation generally erodes the value of money that one holds and it also erodes the nominal and disposable income. The income earners do not face a higher price level in general when the CPI inflation is less. This ultimately leads to less quantity consumption and paying more when inflation is high. Inflation also erodes the consumption, when the consumers can reduce their consumption as the price level have increased for almost all goods. This have serious impact on the GDP, output, employment and many other factors.

Question 7

Given

Adult population         = 22 million

Labour force               = 10 million

Unemployment rate    = 5.5%

Unemployed people = 5.5% of the labour force

= 5.5% * 10 million

= (5.5/100)*10 million = 0.55 million people

The labour force participation rate = (Labour force/ adult population )*100

Thus labour force participation rate = (10/22) * 100 = 45.45% of the working age or adult population is part of the labour force.

The reasons why there can be overestimation of unemployment is because many a times there are faults in the reporting the survey personnel about the unemployment. There can be wrong reporting of a person who is seeking for employment yet not being counted as one or the otherwise, as the people do seek employment may not be a regular seeker. While on the other hand the discouraged labours and underemployment can lead to understating of the true unemployment figures.
It is not possible to take unemployment down to 0% as the natural rate of employment at the full employment or potential level can never be 0%. There will be unemployment due to structural changes in the economy which will not end or diminish completely in any economy even at the full employment level. Again the frictional unemployment due to the fact that workers can look for better jobs in the short run span. The always look for better opportunities. The frictional unemployment is very small although can diminish but the structural unemployment due to the structural changes in the economy is a long term phenomenon and is also high. Hence in the long run the natural rate of unemployment will remain persistent even if it is not accelerating. Thus the unemployment can never be 0% in nay economy, be it advanced or developing.

Section B

Answer 9

a) At combination A, the nation could produce 0 Turkeys and 20000 Chickens. In order to produce 8000 Turkeys, the nation need to produce at combination C where its produces 8000 Turkeys and 14000 Chickens. Therefore, it is clear that in order to produce first 8000 Turkeys the nation need to sacrifice (20000 – 14000) or 6000 Chickens. Hence, opportunity cost of producing the first 8000 Turkeys is 6000 Chickens.
b)

Combination

Turkeys (thousands)

Chickens (thousands)

Opportunity cost per thousand Turkeys (

A

20

B

4

18

500 Chickens

C

8

14

1000 Chickens

D

12

8

1500 Chickens

E

16

2000 Chickens

The above table shows the opportunity cost per thousand Turkeys between every consecutive production points. From the table it is evident that opportunity cost per thousand of Turkeys is highest between production points D and E, which 2000 Chickens.

c) Law of increasing opportunity cost states that increasing production of a good increases its opportunity cost at each level. Opportunity cost per thousand Turkeys increases as the nation move from production point A to point E and it is evident from the opportunity cost of producing turkey calculated in table given in (b). Opportunity cost from point A to B is 500 Chickens, from point B to C is 1000 Chickens, from point C to D is 1500 Chickens and from pint D to E is 2000 Chickens. Therefore, the production possibility frontier reflects the law of increasing opportunity cost.
d) The demand for turkeys will fall to zero due to emergence of new strand of bird flu that affects only turkeys, since consumers will not be willing to buy infected turkeys. As a result, the nation will produce chicken since it is the only substitute of turkey in the nation and consumers will definitely buy chicken instead of turkeys in this flu period. Hence, the nation will produce at point A, it means 20000 Chickens will be produced. However, there will be no rise in maximum possible quantity of chicken that can be produced because there is no rise in amount of resources and no new technology has been introduced.
e) Now, if the country produces 14000 turkeys and 2000 chickens, then opportunity cost per thousand turkey between this production point and point D is 3000 chickens. Here opportunity cost greater than the opportunity cost between point D and E. Hence, this production point lies inside the given production possibility frontier and thus the given level of production is inefficient.

Answer 10

a) From the given graph, it is evident that the output quantity (Q) is 1000 units.
b) At output quantity 1000 units, marginal cost is $15.
c) At output quantity 1000 units, average total cost (ATC) is $30.

Now,

Total cost (TC) = ATC × Q

Or, Total cost (TC) = 30 × 1000

Or, Total cost (TC) = 30000

Therefore, total cost is $30000.

d) Average variable cost (AVC) at output quantity 1000 units is $20.

Therefore,

Total variable cost = AVC × Q

Or, Total variable cost = 20 × 1000

Or, Total variable cost = 20000

Hence, total variable cost is $20000.

e)

Total fixed cost = TC – TVC

Or, Total fixed cost = 30000 – 20000

Or, Total fixed cost = 10000

Therefore, total fixed cost is $10000.

Answer 11

a)
i)

Real interest rate = Nominal interest rate – Inflation rate

Or, Real interest rate = 5 – 7

Or, Real interest rate = – 2

Therefore, real interest rate is – 2 per cent.

ii) Real interest rate means the inflation adjusted return the bank need to pay to its depositor after a year. Here, the real interest rate is – 2 per cent means the bank need to pay 2 per cent less than the value of amount deposited by the depositor. It means if the depositor had deposited $100 for a year, then the bank need to pay $98 to the depositor after its maturity.
b) Frictional unemployment is the unemployment that causes due to job search and time of unemployment while switching between jobs. If an economy is characterized by imperfect information and non – zero job search time then the amount of time spent by a worker to find a new job after quitting present job will rise as he or she do not have the sufficient information about the job market and it will take more time to find a new job. Thus, the period of unemployment between switching jobs will rise leading to rise in amount of unemployment hours. This will result in rise in frictional unemployment.
c) For a business two decision are most important and they are investment decision and pricing decision. Investment requires borrowing from banks and for that a business need to pay interest to the bank which is the cost of borrowing. Now, this interest rate in driven by inflation rate. If inflation rate rises, this interest rate would go up and vice versa. Therefore, if inflation rate is going to fall in future then it is better for the bank to borrow in future and vice versa as it will cost the business less and in that way, it can minimize cost. This is one reason why inflation is important to business. Again, when pricing its products a business need to assess the trend of inflation such that it can price its product in future effectively. If the inflation rate increases more than expected then the business would make loss due to pricing its product lower. Thus, it is important for a business to make correct assessment of inflation in order to be profitable and minimize cost of production.

Answer 12

a) Using the same amount of resources Australia produces 2 tomatoes whereas South Africa produces 3 tomatoes. A country said to have absolute advantage in production of a good if it produces the good more efficiently than the other country that is producing more using same resources. In this case, South Africa produces more quantity of tomatoes using same amount of resources and thus it has absolute advantage in producing tomatoes.
b) The country that produces a good at a lower opportunity cost has comparative advantage in producing that good.

Now,

Opportunity cost incurred by Australia in producing 1 ton of corn = 2/3 tonnes of tomatoes

Or, Opportunity cost incurred by Australia in producing 1 ton of corn = 0.67 tonnes of tomatoes

Again,

Opportunity cost incurred by South Africa in producing 1 ton of corn = 3/2 tonnes of tomatoes

Or, Opportunity cost incurred by South Africa in producing 1 ton of corn = 1.5 tonnes of tomatoes

It is found from the calculations that Australia produces corns at lower opportunity cost and thus it has comparative advantage in production of corns.

c) It is already found that opportunity cost of corn production in Australia and South Africa are 0.67 tonnes and 1.5 tonnes of tomatoes respectively.

Now, calculation opportunity cost of tomato production in Australia and South Africa.

Opportunity cost incurred by Australia in producing 1 ton of tomato = 3/2 tonnes of corn

Or, Opportunity cost incurred by Australia in producing 1 ton of tomato = 1.5 tonnes of corn

Again,

Opportunity cost incurred by South Africa in producing 1 ton of tomato = 2/3 tonnes of corn

Or, Opportunity cost incurred by South Africa in producing 1 ton of tomato = 0.67 tonnes of corn

It is found that Australia has comparative advantage in corn production whereas South Africa has comparative advantage in tomato production. Now, if these two countries trade with each other then they could specialize in the product in which they have comparative advantage and export it. On the other hand, import the product in which they do not have comparative advantage. Now, For 1 unit of corn the amount of tomatoes that need to be traded should be greater than 0.67 tonnes but lower than 1.5 tonnes in order to make both the countries better off. In this way, Australia will get tomatoes at lower cost than it could have been produced. On the other hand, South Africa gets corn at lower cost. Thus, from trade both the countries can benefit.

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23706 Economics for Management