BUSINESS ECONOMICS.

Running head: BUSINESS ECONOMICS
Business Economics
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Table of Contents
Part A: Microeconomics..................................................................................................................2
Answer 1......................................................................................................................................2
Answer 2......................................................................................................................................5
Answer 4......................................................................................................................................7
Answer 5......................................................................................................................................9
Answer 6....................................................................................................................................12
Part B: Macroeconomics................................................................................................................15
Answer 8....................................................................................................................................15
Answer 9....................................................................................................................................17
Answer 10..................................................................................................................................19
Answer 11..................................................................................................................................21
Answer 14..................................................................................................................................23
References......................................................................................................................................26

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Part A: Microeconomics
Answer 1
Answer a
i)
With increase in oil price, there would be a decline in demand for automobile. As a result,
demand curve of automobile shifts to the leftward direction.
Figure 1: Demand for automobile
ii)
People are more encouraged to install home installation for efficient use of energy. As a result,
demand for home insulation increases, demand curve of home insulation shifts to the rightward
direction.

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Figure 2: Home insulation demand
iii)
A close substitute of oil is coal. As price of oil increase, coal demand increases and demand
curve shifts outward.
Figure 3: Demand for coal
iv)
The resulted decline in automobiles due to increase in oil price causes tyres demand to decline.
Accordingly, the demand curve shifts inward (Baumol & Blinder, 2015).

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Figure 4: Demand of tyres
v)
As oil price increases, demand for bicycle increases because people are willing to substitute
automobiles with bicycles. Accordingly, demand curve shifts outward.
Figure 5: Demand for bicycles

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Answer b
External benefits or costs are the additional benefit or cost associated with either
production or consumption but are not captured by market price. External cost has a negative
external effect on society. The external cost when add to private marginal cost raises the social
marginal cost. In free market, private agents do not consider the external cost and hence,
particular good is overproduced indicating misallocation of resources. In case of economic
activity having external benefits, marginal social benefit far exceeds the private benefits. As the
external benefits do not taken into consideration goods are under produced in the market.
Answer c
One main feature of public good is non-excludability. Once the goods are offered, no one
can be prevented to consume the good. People have a tendency to free ride. Because of the
problem of free riders, people do not reveal preference. Demand curve thus do not show true
willingness of people. Another feature of public good is non-rivalry in consumption. As
consumption of the good does not reduce benefit to others people do not willing to pay additional
dollar for consuming the good (Sloman & Jones, 2017). The market mechanism thus fails to
ensure sufficient production of the good.
Answer 2
Answer a
Scarcity implies limited availability of resource relative to human wants. This in turn
means resources are not sufficient to meet all the demand. The limited resource and unlimited
human wants make scarcity as the central economic problem. Because of scarcity, people face
choice problem. When one chose to satisfy one want, others are left unsatisfied because of

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resource constraint. Opportunity cost is the cost arising from sacrifice of next best alternative.
The concept of opportunity cost can be understood using production possibility frontier.
Suppose, using all the resources an economy can produce two goods X and Y. Increase in
production of one good requires decline in production of other indicating opportunity cost of
production.
Figure 6: Opportunity cost of production
Example: If one chose to pursue higher studies instead of joining a job, the opportunity cost is
the foregone salary from the job. Suppose a company can produce 1200 jars of peanut butter
(includes both smooth and chunky peanut butter). The opportunity cost for one jar of smooth
peanut butter is one jar of smooth butter.
Answer b
Though the winners receive the car without paying anything, it is not free actually. Every
consumers’ buying chocolates contribute for the car. Thus, both winners and non-winners of cars

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contribute to the car. Besides, there is an opportunity cost (Jain & Ohri, 2015). Hoping to win a
car, people tend to purchase more chocolates by sacrificing consumption of some other good.
Figure 7: Opportunity cost of free car
Answer c
The primary reason for production possibility frontier bowed outward is the increasing
opportunity cost of production. This means as production of one good increases more and more,
the larger is the amount of other product that is sacrificed. As slope of the PPF is determined
from the opportunity cost, increasing opportunity cost means concave PPF.
Answer 4
Answer a
The pre-recorded music compact disk has an income elasticity of demand of +7. It is
given that recession reduces consumers’ income by 10 percent. Because of recession, demand for
pre-recorded music compact disc therefore contracts by 70 percent. The demand for a cabinet
maker’s work is relatively less inelastic with respect to income having an elasticity value of 0.7.

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Given a relatively less elastic demand, demand for cabinet maker’s work is less affected by
recession with demand lowered by only 7 percent.
Answer b
The extent of competition between MP3 music player and pre-recoded music compact
disc can be determined from the value of cross price elasticity. Cross price elasticity, is greater
than zero, goods are substitutes and hence, compete against each other (Hill & Schiller, 2015). If
cross price elastic is less than zero then goods are complementary and hence, there is no
competition with each other.
Answer c
YED = 0.8.
The given elasticity value implies, increase in income by 1 percent increases demand by
0.8 percent. The positive relation between income and demand means the good is a normal good.
YED = -2.4
The given elasticity value implies, increase in income by 1 percent reduces demand by
2.4 percent. The negative relation between income and demand means the good is an inferior
good (Cowell, 2018).
Answer d
XED = 0.85.
The given elasticity value indicates that unit increase in price of one good pushes up demand of
the related good by 0.85 unit. The goods are substitutes to each other as obtained from the
positive relation between price of one good and demand of other.

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XED = -4.5.
The given elasticity value indicates that unit increase in price of one good pulls down demand of
the related good by 4.5 unit. The goods are complementary to each other as obtained from the
inverse relation between price of one good and demand of other.
Answer 5
Answer a
In real world, perfect competition exists rarely. Perfectly competitive market represents
an ideal form of market characterized by large group of sellers and buyers, identical product,
perfect set of information, price-taking behavior of firms and such other. Practically, such
characteristics are difficult to exits together. It is a hypothetical market and can only be used as a
benchmark of efficiency.
Answer b
In a perfectly competitive market, firms attain short run equilibrium following two
conditions. The revenue from additional unit of production is same as the additional cost
incurred for producing the additional unit. Another condition is marginal revenue should cut the
marginal cost from below. Firm in the short run can earn either an economic profit or loss or
normal profit.

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Figure 8: short run profit for competitive firm
Figure 9: short run loss for competitive firm

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Figure 10: Short run normal profit for competitive firm
For an industry, short run equilibrium is attained where there is no tendency of industry
output to change (Cowen & Tabarrok, 2015). Equilibrium in the industry occurs market supply
and market demand curve intersects. Corresponding to the market price some firms may enjoy
economic profit while others may incur loss.
Figure 11: Short run competitive industry equilibrium

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Answer c
In the long run perfectly competitive firms earn only normal profit. First order condition
for this is short run marginal cost = long run marginal cost = marginal cost = average revenue =
marginal revenue = price = short run average cost = minimum of long run average cost. Another
condition for equilibrium is long run marginal cost cuts marginal revenue from the below.
Figure 12: Competitive firm long run equilibrium
Answer 6
Answer a
Fixed inputs refer to the input where inputs do not change with change in production.
Variable input on the other hand changes with change in output (Mochrie, 2015).
In the coffee shop, the fixed inputs can be the following
 Coffee machine

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 Land
 Electricity
 Other fixed equipment.
The variable input in the coffee shop are
 Workers
 Containers
 Utensils
 Ingredients used for making coffee such as coffee bean, baked goods, dairy products and
others.
Answer b
Total fixed cost = $4000
Average fixed cost = $4000/100 = $40
Total variable cost = $13000
Average variable cost = $13000/100 = $130
Total cost = $4000 + $13000 = $17000
Average total cost = $17000/100 = $170
Answer c
Conditions under which labor is treated as variable cost are payment made to temporary
staffs or overtime wage (Maurice & Thomas, 2015). These costs generally vary with change in

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output. As far as salaries of high management is concerned such as different levels of
management, labor is treated as fixed cost.

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Part B: Macroeconomics
Answer 8
Household consumption expenditure (C) = $3010
Gross private domestic investment (I) = $725
Government consumption expenditure = $720
Government investment expenditure = $165
Total government expenditure (G) = $720 + $165 = $885
Net Export (NX) = Export – Import = $625 – (-$550) = $625 + $550 = $1175
Answer a
Gross Domestic Product ( GDP )=C+ I +G+ NX
¿ $ 3010+$ 725+$ 885+$ 1175
¿ $ 5795
Gross National Expenditure ( GNE ) =C+ I +G
¿ $ 3010+$ 725+ $ 885
¿ $ 4620
Answer b
Gross National Product ( GNP ) =GDP−net property income pays overseas
¿ $ 5795− (−$ 35 )

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¿ $ 5795+$ 35
¿ $ 5830
Answer c
Net National Product ( NNP ) =GNP−Consumption of ¿ capital
¿ $ 5830−$ 285
¿ $5545
Answer d
Current account balance=Export – Import −factor income paid overseas
¿ $ 625 – ( −$ 550 ) −(−35)
¿ $ 625+$ 550+$ 35
¿ $ 1175+$ 35
¿ $ 1210
Answer e
Gross national saving=Y −C−G
¿ $ 5795−$ 3010−$ 885
¿ $ 1900

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Answer 9
Answer a
A decrease in personal income tax increases disposal income of household. This allows
households to consume more. As consumption expenditure increases, the aggregate demand
curve shifts to the right (Uribe & Schmitt-Grohe, 2017). Given the aggregate supply curve, this
increase GDP, output and employment.
Figure 1: Impact of decline in personal income tax
Answer b
An increase in workforce skills increases efficiency of workers. The same workers can
now produce more output. This increases aggregate supply curve shifting the aggregate supply
curve to the right. As aggregate supply curve shifts outward, given the aggregate demand curve,
output increases increasing economic activity while declining the price level.

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Figure 2: Effect of an increase in workforce skill
Answer c
A decrease in export reduces aggregate demand by reducing export earnings.
Consequently, the aggregate demand curve shifts inward. This causes a contraction in economic
activity. GDP, employment and price level reduce.
Figure 3: Effect of a decrease in export

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Answer d
An increase in economy’s capital stock increases the supply of capital in the economy.
This increase aggregate supply shifting the aggregate supply curve to outward direction. As
aggregate supply, increases given the aggregate demand increase national output and
employment level (Heijdra, 2017). The price level however decreases following the increased
aggregate supply.
Figure 4: Effect of an increase in capital stock
Answer 10
Answer a
Problems of using fiscal policy
The first problem of using fiscal policy to expand output is the associated crowding out
effect. Higher spending fail to increase GDP to the expected level because the spending crowds

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out private sector. The private sector lacks fund for making private investment, as it needs to
lend fund to the government.
Another problem associated with fiscal policy is the time lags. Government need some
time to increase in government spending to the targeted level (Agenor & Montiel, 2015). This
might take too much time that other economic condition changes in the economy making fiscal
policy ineffective.
The problem that most of the developing nations face is the higher burden of borrowing
cost. As public debt increases, this puts a shortage of funds in other necessary sector reducing
economic growth.
Answer b
In an economy characterized by imperfect job information and zero job-searching time,
frictional unemployment is inevitable because of the continuous changing nature of the
economy. In the process, some sectors are expanding while others are contracting. As there is
imperfect information in the economy, workers do not have knowledge about the changing skill
requirement of these jobs they need times to find new jobs during transition from one sector
another. Given zero job searching time, people remain unemployed during this time is called
structural unemployment.
Answer c
Macroeconomic policymakers should be concerned of structural unemployment as it is
long term phenomenon and may keep people unemployed for considerable long period. It might
cause non-availability of jobs for some group of workers lacking specific skills resulting in

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permanent unemployment for them. Policy makers therefore should focus on improving skill
requirement of existing labor force in line with the required skills.
Structural unemployment in an economy resulted from mismatch of required skills and
available skills of labor force in an industry (Mankiw, 2014). Cyclical unemployment on the
other hand resulted from business cycle fluctuation. People become unemployed during
depression because of a lower demand for labor.
Answer 11
Answer a
Different between demand-pull and cost-push inflation
Resulted increase in level of price following an increase in aggregate demand is called
demand-pull inflation (Cohn, 2015). Following an increase in demand, demand fall short of
aggregate supply putting an upward pressure on price.
Figure 5: Demand pull inflation

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In contrast, inflation resulted from an increase in production cost is termed as cost-pull
inflation. Increase in cost reduces aggregate supply. Given the aggregate demand, decline in
aggregate supply increases price level.
Figure 6: Cost-push inflation
Answer b
Causes of demand pull inflation
An increase in economic growth increase average income of people. This in turn increase
aggregate demand resulting in a demand-pull inflation.
Another factor that might cause demand-pull inflation is the increase in money supply in
the economy (De Vroey, 2016). As money supply increases, people have a larger sum of money
to spend. This increase aggregate demand and price level.

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Causes of cost-push inflation
Increase in the cost of input in the overall cost of production. As production cost
increases, aggregate supply decreases causing an increase in price level indicating inflationary
level.
Depreciation of currency is another factor that causes cost-push inflation by increasing
the cost of imported inputs.
Answer 14
Answer a
Residents of Australia and international residents from different foreign countries like
Japan, Germany, United State and other partner countries constitute demand for Australian
dollar. Australian dollar demanded domestically to import goods and service abroad or making
unilateral transfer abroad. Internationally demand for Australian dollar depends on tourism,
export demand for Australian goods, purchase of assets in Foreign and speculation.
Answer b
Reserve Bank of Australia is supplying Australian dollars in the foreign exchange market
to maintain liquidity in the market so that it can used for transaction purpose (Goodwin et al.,
2015).

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Answer c
Figure 7: Equilibrium exchange rate
Equilibrium exchange rate occurs corresponding to the point E. The equilibrium
exchange rate is 80.
Answer d
Figure 8: Effect of an increased demand for dollar and decreased supply

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Increased demand for dollars shifts the demand curve rightward to D1. The decline in
supply of dollars shifts the supply curve inward (Baumol & Blinder, 2016). At the new
equilibrium increases the exchange rate. This implies Japan now has to give yen to purchase one
unit of Australian dollar.
Answer e
The exchange rate between Japan and Australia has depreciated while Australian dollar
has appreciated.

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References
Agenor, P. R., & Montiel, P. J. (2015). Development macroeconomics. Princeton University
Press.
Baumol, W. J., & Blinder, A. S. (2015). Microeconomics: Principles and policy. Nelson
Education.
Baumol, W. J., & Blinder, A. S. (2016). Principles of Macroeconomics. Cengage Learning.
Cohn, S. M. (2015). Reintroducing Macroeconomics: A Critical Approach: A Critical Approach.
Routledge.
Cowell, F. (2018). Microeconomics: principles and analysis. Oxford University Press.
Cowen, T., & Tabarrok, A. (2015). Modern principles of microeconomics. Macmillan
International Higher Education.
De Vroey, M. (2016). A history of macroeconomics from Keynes to Lucas and beyond.
Cambridge University Press.
Goodwin, N., Harris, J. M., Nelson, J. A., Roach, B., & Torras, M. (2015). Macroeconomics in
context. Routledge.
Heijdra, B. J. (2017). Foundations of modern macroeconomics. Oxford university press.
Hill, C., & Schiller, B. (2015). The Micro Economy Today. McGraw-Hill Higher Education.
Jain, T. R., & Ohri, V. K. (2015). Principal of Microeconomics. FK Publications.
Mankiw, N. G. (2014). Principles of macroeconomics. Cengage Learning.
Maurice, S. C., & Thomas, C. (2015). Managerial Economics. McGraw-Hill Higher Education.

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Mochrie, R. (2015). Intermediate microeconomics. Macmillan International Higher Education.
Sloman, J., & Jones, E. (2017). Essential Economics for Business. Pearson.
Uribe, M., & Schmitt-Grohe, S. (2017). Open economy macroeconomics. Princeton University
Press.