Applications of Economic Theory

Running head: APPLICATIONS OF ECONOMIC THEORY
Applications of Economic Theory
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1APPLICATIONS OF ECONOMIC THEORY
Table of Contents
Answer 1............................................................................................................................2
Answer 2............................................................................................................................3
Answer 3............................................................................................................................5
Reference..........................................................................................................................8

2APPLICATIONS OF ECONOMIC THEORY
Answer 1
(a) Australia is dependent on Middle East for supply of petrol. All the passenger cars
with large engines in Australia runs on petrol. Thus, an outbreak of hostilities in the
Middle East would hamper the export market of the Middle East and as a result, there
will less export of oil from the region to Australia. Consequently, the supply of petrol
would reduce by significant amount in the country (Becker 2017). The effect of this
reduction of petrol supply would affect the market adversely. The fall in supply will push
the market supply curve from S to S* as shown in figure 1. Owing to this, the equilibrium
quantity would fall from Q to Q* and subsequently the equilibrium price would rise from
P to P* in the figure. Thus, the petrol market in Australia would contract due to the
outbreak of the said hostilities.
Figure 1: Contraction in
Australian petrol market
Source: (Created by the Author)
The impact of the outbreak will not be limited to the petrol market only, it will
affect the market for petrol run cars too. As the rise in price of petrol would increase the
cost of running petrol cars, the demand for petrol cars would fall (Friedman 2017).
Therefore, the market demand curve of the cars would move towards left from D to D2
as shown in figure 2. Given the situation, the equilibrium price and quantity would adjust
accordingly. Therefore, both the equilibrium price and quantity would fall to P2 and Q2
respectively in the figure. Hence, the price and quantity in the car market would

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definitely decline and alike petrol market the car market in Australia contracts. In
addition to that, it can be observed from the figures that revenue of the car market
would decline more than petrol market due to fall in both equilibrium price and quantity.
Figure 2: Contraction in car market in
Australia
Source: (Created by the Author)
(b) The petrol cars causes pollution and is responsible for global warming too as it emits
carbon. Considering, the environmental issue of global warming it is suggested to lower
carbon emission as far as possible to save the environment the earth (Helmers 2016).
However, environment and transportation both are important and addressing both, the
invention of electric car has been made. Previously, electric cars are expensive but now
there are available at affordable prices (Randall 2016). Therefore, keeping the issue of
global warming in mind people would purchase electric cars and gradually reduce the
use of petrol cars. As a result, the demand for petrol cars would decline. Both the
quantity traded and price of the cars would fall. With time, the electric cars would
gradually replace all the petrol cars in the market. Consequently, with gradual
contraction the petrol car market will shut down completely.
Answer 2
(a) Australian government wants to focus on its long term growth and came to decision
that to achieve economic growth in the long run the country requires more number
skilled workers in the workforce. There is a positive relationship between numbers of

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years of education with amount of skill acquired by a worker. Thus, acquiring more
education allows a person to gain more skill. The government of Australia thus
implemented a policy that encourages youth to attend universities and get more
education such that in long run the country might flourish economically. The reason and
concept behind this decision can be explained with the help of production frontier
model. Production frontier model gives the maximum possible attainable productivity
curve given the amount of resources (Guo et al. 2018). The productivity curve is
popularly known as production possibility frontier. Every point on the curve is maximum
attainable productivity that can be achieved from the use of unit resource. For ease of
understanding considering, there is only one resource available to Australia and that is
workers. In figure 3, PPF 1 is the production possibility frontier when youth not attending
universities (Galles, Graves and Sexton 2019). The government of Australia
encouraged youths to attend universities and as a result, the number of workers in the
workforce reduced as all the youth stopped working and started attending universities.
Due to this, there is a fall in productivity. Consequently, productivity declined from PPF1
to PPF2. Thus, PP2 depicts the PPF of the country when youths are attending
universities. On the other hand, with completion of university studies youth joined the
workforce with increased skill than before. Therefore, with more skill youth can produce
more. With increased amount of educated youth in the workforce, the productivity of the
workforce of the country increased gradually and the PPF of the country moved outward
to PPF3. PPF3 is above PPF2 and it means that at PPF3 productivity of Australia is
more than at PPF2. Therefore, it can be inferred that because of youths attending
universities the productivity of the country decreases in present day but increases in
future.

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Figure 3: Change in PPF of Australia with educated youth
Source: (Created by the Author)
(b) In the short run, economic growth can be understood from the study of growth in
gross domestic product (GDP), employment rate and inflation rate. However, in the long
run the determinants of growth are growth of productivity, changes in the demography
and labour force participation (Ong et al. 2017). Productivity growth means the economy
is producing more amount of goods with the same resources available. On the other
hand, change in demography means the improvement in the health and education of
the people of the country and finally labour force participation means employment. A
country is able to attain its maximum amount of output only then when all the workers in
the workforce are employed and working with maximum productivity (Fraumeni 2017).
However, to attain that situation the government of a country needs to implement
policies that would lead the economy to the desired level. The government can
influence economic growth by injecting more capital in the economy, encouraging
innovation and increasing the level of education among people of the country.
Answer 3
(a)
Figure 4: Sales tax on cigarette
Source: (Created by the Author)

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The government is thinking of imposing sales tax on cigarette to discourage
consumption and thereby improve health of the people of the country. The imposition of
sales of cigarette increases the price from P to P* in figure 4. As a result, there is fall in
demand for cigarettes. The demand fell to Q* from Q due to this sales tax. Therefore,
fall in demand for cigarette educed the price received by the producer is given by as P
in the figure. Therefore, the total amount of tax is the difference between and P* and P.
In the figure, the amount of tax revenue is given by the area of both the blue and orange
rectangles. However, orange rectangle depicts the amount of tax paid by the producers
and the blue rectangle is the amount of tax paid by the consumers (DeAngelis 2018). It
is clearly visible that blue rectangle is greater than orange rectangle. It means that tax
paid by the consumers is greater. This happens because cigarette is demerit goods and
the demand of the good is highly inelastic. It means that demand for cigarette falls
proportionately less that the rise in price. Hence, in the case of cigarette major amount
of tax is borne by the consumers. However, in the case of coffee the sales tax is shared
equally by the consumers and the producers (Kim, Paek and Yoo 2019). This happens
because coffee is a normal good and in case of normal good demand is unit elastic that
means demand falls proportionately with the rise in price. Figure 5 depicts the effect of
sales tax on coffee where red and green triangle are the tax burden of consumers and
producers respectively and they are equal.
Figure 5: Sales tax on
coffee

7APPLICATIONS OF ECONOMIC THEORY
Source: (Created by the Author)
(b) Coles and Woolworths operate in the supermarket sector in Australia. They are the
companies that dominate the sector. From the structure of the sector, it is evident that it
is an oligopoly market. In oligopoly market, few firms dominate the market since they
have significant amount of market power (Kim, Lan and Dobson 2019). There are
numerous buyers in the market and the firms act like price setter. The amount of fixed
cost involved in the market is very high and thus there is high barriers to entry and exit.
Therefore, for new firms it is hard to enter and survive in the market. The firms in the
market charge high price and supernormal profit (Su, Liu and Hou 2018). However, if eh
firms cooperate and collude with each other, then the firms will charge price as high as
monopoly and earn supernormal profit equivalent to monopoly. The oligopoly structure
is prevalent in supermarket sector in Australia because establishment of supermarket
demands high fixed cost. Thus, if in these sector perfect competition occurs then firms
would have to charge very high price to sustain otherwise all will shut down. Thus, for
efficiency in the sector it is better to have less number of firms so that they can sustain
and the society gets the benefit.

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Reference
Becker, G.S., 2017. Economic theory. Routledge.
DeAngelis, C.A., 2018. Is Public Schooling a Public Good? An Analysis of Schooling
Externalities. Policy Analysis No. 842. Cato Institute.
Fraumeni, B.M., 2017. Gross domestic product: Are other measures needed?. IZA
World of Labor.
Friedman, M., 2017. Price theory. Routledge.
Galles, G.M., Graves, P.E. and Sexton, R.L., 2019. Leisure and the Production
Possibility Frontier: A Two-Step Pedagogy. The American Economist, 64(1), pp.123-
130.
Guo, X., Li, G.R., McAleer, M. and Wong, W.K., 2018. Specification testing of
production in a stochastic frontier model. Sustainability, 10(9), p.3082.
Helmers, E., 2016. Does the European diesel car boom mitigate global
warming. briefing paper, Green Budget Europe, February.
Kim, H.J., Paek, J.S. and Yoo, S.H., 2019. Price Elasticity of Heat Demand in South
Korean Manufacturing Sector: An Empirical Investigation. Sustainability, 11(21), p.6144.
Kim, S.H., Lan, H. and Dobson, P.W., 2019. Identifying price-leadership structures in
oligopoly. Oxford Economic Papers.
Ong, Rachel, Gavin A. Wood, Stephen Whelan, Melek Cigdem-Bayram, Kadir Atalay,
and Jago Dodson. "Inquiry into housing policies, labour force participation and
economic growth." (2017).
Randall, T., 2016. Here’s how electric cars will cause the next oil crisis. Bloomberg,
New York, accessed Mar, 25, p.2016.
Su, X., Liu, H. and Hou, S., 2018. The trilateral evolutionary game of agri-food quality in
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