Economic Principles: Demand and Supply Dynamics, Elasticity, and Monopolistic Competition

This article discusses the concepts of demand and supply dynamics, elasticity, and monopolistic competition. It explains the relationship between price and quantity demanded, the effect of poor wine harvest on French and Australian wine markets, the market dynamics of orange juice, and the short run equilibrium of a monopolistically competitive firm. The article also includes a reference list of relevant sources.

Running Head: ECONOMIC PRINCIPLES
Economic Principles
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Table of Contents
Question 1........................................................................................................................................2
Question 2........................................................................................................................................2
Question a....................................................................................................................................2
Question b....................................................................................................................................3
Question 3........................................................................................................................................4
Question 4........................................................................................................................................7
Question a....................................................................................................................................7
Question b....................................................................................................................................7
Question 5........................................................................................................................................8
Question a....................................................................................................................................8
Question b....................................................................................................................................9
Reference list.................................................................................................................................10

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Question 1
The theory of demand suggests an inverse relation between price and quantity demanded
of a commodity. This implies if other demand determinant factors remain constant then rise in
price of a good is associated with a decline in demand. Following this law of demand, a
downward sloping demand curve is obtained. An upward sloping demand curve on the other
hand indicates rise in demand along with a rise in price. In the give scenario, it has observed that
sales of beef increases despite increase in price (Carlton and Perloff 2015). However, only from
this observation it cannot be said that the demand curve slopes upward. This is because apart
from price there are several other factors that influence demand and sales. The sales of beef
might be increased because of a much greater increase in price of substitutes like chicken, lamb
or such others. If price increase of beef is relatively lower than that of its substitutes then beef
demand increases. With a relatively lower price, beef seems to be cheaper alternative. Therefore,
with knowing condition of other factors influencing demand, it is not possible to derive demand
relation with price.
Question 2
Question a
Supply of a good depends on the available supply of inputs. The main input in wine
production is wine grapes. The poor harvest of wine grape in France affects supply of wine
grapes in the wine industry. The reduced supply of wine grapes thus hampers the production of
wine French wine. The reduced production of French wine shifts he supply curve upward
(Varian 2014). The shortage of wine supply in French market increases equilibrium price while
reducing equilibrium supply of French wine.

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Figure 1: Effect of poor wine harvest on French wine
(Source: as created by Author)
The poor harvest thus reduces supply of French wines, which leads to an increase in wine price
to P1 and reduces available supply to Q1.
Question b
Australian wine is a substitute to French wine. The supply shortage of French wine
increases price French wine. Faced with a higher price, consumers of wine in France now try to
find an alternative cheaper substitute (Baumol and Blinder 2015). High price of French wine
thus make Australian wine relatively cheaper. People now tend to consume more Australian
wine. As demand for Australian wine increase, market of Australia wine expands with an
increase in both equilibrium price and quantity.

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Figure 2: Effect on Australian wine market
(Source: as created by Author)
Increased demand of Australian wine as a substitute of French wine us shown from the outward
shift of the demand curve to D1D1. The Australian wine market expands, with an increase in price
to P2 and rise in equilibrium quantity to Q2.
Question 3
The market dynamics of orange juice depends on both demand and supply condition.
Change in either demand or supply or both bring a change orange juice market with a change in
both equilibrium price and quantity. A substitute of orange juice is apple juice. If the price of
apple juice decreases then demand for apple juice increase depressing the demand for orange
juice. Increase in wage paid to orange grove workers led to an increase in production cost of
orange juice (Nicholson and Snyder 2014). This reduces supply of orange juice. Market for

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orange juice thus faces a decline in both demand and supply. The effect on equilibrium quantity
is clear. Contraction of both supply and demand causes equilibrium quantity to fall. The impact
on equilibrium price however is uncertain. Supply shortage resulted from an increase in
production cost creates an upward pressure on price. Increase in orange juice demand on the
other hand push price down. The impact on equilibrium price is thus depend of relative strength
of demand and supply. If increase in demand dominates decrease in supply then price will
decrease in new equilibrium (Hildenbrand 2014). Price will increase if the supply shortage
dominates demand declines. Price remained unchanged if demand and supply changes by the
same magnitude.
Figure 3: Demand change exceeds supply
(Source: as created by Author)

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Figure 4: Supply change exceeds demand
(Source: as created by Author)
Figure 5: Demand change equals supply
(Source: as created by Author)

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Question 4
Question a
Revenue of firms depend in both price and quantity of goods sold. Changes in price
causes a change in quantity and hence, changes revenue. Firms often raise price to increase
revenue. Increase in revenue however depends on magnitude of change in both price quantity.
Similarly, taxi owners’ revenue depend on demand of taxi rides and taxi fares. If demand for taxi
rides is relatively inelastic in nature, then rides will not reduce even when fare increases. This
therefore leads to an increase in revue of taxi owners/drivers. The policy of raising fares will not
be an effective policy in case of elastic demand for taxi rides (Azevedo and Leshno 2016). In this
situation, increase in fares will reduce demand for taxi rides largely leading to a decline in
revenue. The confidence on part of the taxi drivers regarding the fact that increase in fare
increases revenue thus indicate assumption of a relatively inelastic demand.
Question b
A number factor influence the price elasticity of demand. The main factor responsible for
making demand for taxi rides inelastic is the flexibility of services. People can avail their own
rides irrespective of time and place. Other available transportation service like private or public
transportation are imperfect substitute of taxi rides. The preference for tax rides is increasing
following the easy availability and flexibility of taxi services (Taylor et al. 2014). This provides
support to the assumption of taxi owners/driver regarding relatively inelastic demand for taxi
rides.

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Question 5
Question a
Given that, short run output (Q) of the monopolistically competitive firm is 50. The output is
sold at a price (P) of $4.50.
From this, revenue of the firm is obtained as
Total Revenue= ( Price× Ouput )
¿ ( $ 4.50∗50 )
¿ $ 225
Average cost of the firm is $5.00. From this, total cost is estimated as
Total Cost = ( Average total cost × Output )
¿ ( $ 5.00× 50 )
¿ $ 250
Profit is the difference between total revenue and total cost.
Profit=Total Revenue−Total Cost
¿ $ 225−$ 250
¿−$ 25
As total cost exceeds total revenue, the firm in the short run is making loss of $25
The figure below describes short run situation of the monopolistically competitive firm.

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Figure 6: Short run equilibrium of monopolistically company
(Source: as created by Author)
Question b
Profit maximizing condition of firm requires marginal revenue should be matched with
marginal cost. However, the firm is making a loss but still short run equilibrium satisfies profit
maximization condition. Loss is incurred, as price charged by the firm is lower than average total
cost of $5(Frank 2015). The firm is making a loss of $25. The firm however should continue
operation at existing level of output price is excess of average variable cost. If the loss continues
in the long-run then the firm should close down its operation.

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Reference list
Azevedo, E.M. and Leshno, J.D., 2016. A supply and demand framework for two-sided
matching markets. Journal of Political Economy, 124(5), pp.1235-1268.
Baumol, W.J. and Blinder, A.S., 2015. Microeconomics: Principles and policy. Cengage
Learning.
Carlton, D.W. and Perloff, J.M., 2015. Modern industrial organization. Pearson Higher Ed.
Frank, R.H., 2015. Principles of microeconomics, brief edition. Mcgraw-Hill.
Hildenbrand, W., 2014. Market demand: Theory and empirical evidence. Princeton University
Press.
Nicholson, W. and Snyder, C.M., 2014. Intermediate microeconomics and its application.
Cengage Learning.
Taylor, T., Greenlaw, S.A., Dodge, E.R., Gamez, C., Jauregui, A., Keenan, D., MacDonald, D.,
Moledina, A., Richardson, C., Shapiro, D. and Sonenshine, R., 2014. Principles of
microeconomics. OpenStax College, Rice University.
Varian, H.R., 2014. Intermediate Microeconomics: A Modern Approach: Ninth International
Student Edition. WW Norton & Company.