Economic Principles

This document discusses various economic principles including the effects of price changes, adoption of new technology, and changes in demand and supply. It also explores the concepts of elasticity and the entry of new firms in the industry.

Running head: ECONOMIC PRINCPLES
Economic Princples
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1ECONOMIC PRINCPLES
Table of Contents
Question 1..........................................................................................................................2
Question a......................................................................................................................2
Question b......................................................................................................................2
Question c......................................................................................................................3
Question 2..........................................................................................................................4
Question 3..........................................................................................................................5
Question 4..........................................................................................................................7
Question 5..........................................................................................................................9
References.......................................................................................................................11

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Question 1
Question a
When price of a substitute good decrease, there is a decline in demand for the
certain good. A decrease in price of leather jackets encourages people to use more
leather jackets in place of woollen jumpers. As demand for woollen jumpers decreases,
the demand curve for woollen jumpers shifts to the leftward direction (Sloman and
Jones 2017). As demand for woollen jumpers decreases, the equilibrium price and
quantity of woollen jumpers decreases as well.
Figure 1: Effect a decrease in price of leather jackets
The demand and supply of woollen jumpers are presented by the curve DD and
SS respectively. When price of leather jackets, a substitute of woollen jumpers’
decreases, this reduces demand for woollen jumpers. As the demand curve shifts
inward to D1D1, equilibrium shifts from E to E1. Equilibrium price reduces to P1 while
equilibrium quantity for woollen jumpers decreases to Q1.
Question b
Adoption of new machine, which increases productivity within the knitting industry
increases supply of woollen jumpers. The increase in supply increases makes more

3ECONOMIC PRINCPLES
woollen jackets available at every price (Hill and Schiller 2015). The new machines thus
affect supply curve of woollen jumpers, which shifts to rightwards direction. The
increase in available supply increases equilibrium quantity while equilibrium price of
woollen jumpers falls as shown below.
Figure 2: Effect of adoption of new technology in the woollen industry
Adoption of efficient productive technology in the woollen industry increase
supply of wollen jumpers shifting the supply curve to the right. Corresponding to the new
equilibrium, price of wollen jumpers fall while equilibrium quantity of woollen jumpers
increases.
Question c
For a normal good, an increase in income increases demand for the good. Given
that, woollen jumpers are normal goods, an increase in income increases demand for
woollen jumpers. Increase in demand, shifts the demand curve to the right increasing
both equilibrium price and quantity as explained in the figure below.

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Figure 3: Effect of an increase in income on woollen jumpers
With the given increase in income, demand for woollen jumpers increase and
demand curve moves to the right. The equilibrium price of woollen jumpers raises to P2
and the equilibrium quantity expands to Q2.
Question 2
Following the health study showing that eating clove of garlic helps to prevent
heart disease induces people to increase their demand of garlic. The increase in
demand for garlic shifts the demand cure rightward from DD to D’D’. The expansion of
demand leads to an increase in equilibrium price and quantity (Cowen and Tabarrok
2015). The new equilibrium moves up along the supply curve. The statement that
“Consumers, seeing that the price of garlic has gone up, reduce their demand for garlic resulting
in a fall in the price of garlic. Therefore, the ultimate effect of the study on the price of garlic is
uncertain” is wrong. This is because it state resulted increase in price causes demand
to decline and shifts the demand curve to the left. However, increase in price through a
movement along the supply curve does not shift the demand curve further leftward.
Increase in price causes a decline in quantity demanded not demand.

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Figure 4: Change in demand and change in quantity demand
Question 3
Because of bird flu, people reduces demand for live chickens in Sweden. The
decline in demand shifts the demand curve to left. Associated with the declining
demand, government’s precautionary measures and culling of live chicken stock
reduces supply of live chicken as well. The fall in supply shifts the supply curve inward.
As both demand and supply changes simultaneously, there are two opposing effect on
equilibrium price. The fall in demand has a tendency to decrease price while a fall in
supply has a tendency to increase equilibrium price (Maurice and Thomas 2015). The
net effect on equilibrium price depends on magnitude of simultaneous change in
demand and supply. If demand falls by a larger proportion compared to supply, then
equilibrium price declines. On the contrary, if fall in supply is larger than fall in demand
then equilibrium price increases. There is on effect on price in case where demand and
supply change by same proportion. In all the three cases, equilibrium quantity declines
certainly.

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Figure 5: Demand falls more than supply
Figure 6: Supply falls more than demand

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Figure 7: Demand and supply changes by the same proportion
Question 4
Demand is inelastic when proportionate change in demand is less than that of
the resulting change in price. In this case, demand curve is relatively steeper. Demand
is elastic in case where proportionate change in demand is larger than proportionate
change in price (Mochrie 2015). In this case, demand curve is relatively flatter.

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Figure 8: Effect of a decrease in supply with inelastic demand curve
The above figure illustrates impact of a decrease in demand along with an
inelastic demand curve. The inelastic demand curve is shown by the steeper curve DD.
The supply curve is of usual shape. A decrease in supply is shown by the leftward shift
of the supply curve from SS to S1S1. The decrease in supply causes equilibrium price to
increase from P1 to P2. Because of relatively inelastic demand curve, equilibrium
quantity declines by a smaller proportion from Q1 to Q2. As proportionate increase in
price is relatively less than proportionate decrease in equilibrium quantity, total revenue
increase at the new price – output combination (Baumol and Blinder 2015). The new
revenue shown by the rectangular area OP2E1Q2 is larger than the earlier revenue area
of OP1EQ1.

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Figure 9: Effect of a decrease in supply with elastic demand curve
The effect of a decrease in supply with an elastic demand curve is different from
that with inelastic demand curve. In this case, due to relatively elastic nature of demand
proportionate decrease in equilibrium quantity is larger than the proportionate increase
in equilibrium price. At the new equilibrium, total revenue thus declines. At the new
equilibrium, total revenue is given as OP2E2Q2. This is smaller than the revenue earlier
shown by the area OP1E1Q1.
Question 5
The presence of prospective economic profit attracts new firms to enter the
industry. As the creation of internet platform has broken down all the entry barriers new
firms are now free to enter the market. As firms continue to enter the market, there is an
increase in market supply. Resulted increase in supply leads to excess supply in the
industry causing equilibrium price to fall in the market (Ashwin, Taylor and Mankiw
2016). New firms continue to enter the market unless price falls to the level where all
the economic profits are eliminated from the industry. The figure below explain this
using demand and supply analysis.

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Figure 10: Effect of entry of new firms in the industry
Initially firms in the industry face a price of P*. Corresponding to this price,
market price is above the average cost generating economic profits for these firms.
Being attracted by economic profit in the industry as new firms enter the industry market
supply increases shifting the supply curve to the right (Jain and Ohri 2015). The new
equilibrium, price goes down lowering profit for firms in the industry. The new firms enter
unless all the economic profits are erased.

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References
Ashwin, A., Taylor, M.P. and Mankiw, N.G., 2016. Business economics. Nelson
Education.
Baumol, W.J. and Blinder, A.S., 2015. Microeconomics: Principles and policy. Nelson
Education.
Cowen, T. and Tabarrok, A., 2015. Modern principles of microeconomics. Macmillan
International Higher Education.
Hill, C. and Schiller, B., 2015. The Micro Economy Today. McGraw-Hill Higher
Education.
Jain, T.R. and Ohri, V.K., 2015. Principal of Microeconomics. FK Publications.
Maurice, S.C. and Thomas, C., 2015. Managerial Economics. McGraw-Hill Higher
Education.
Mochrie, R., 2015. Intermediate microeconomics. Macmillan International Higher
Education.
Sloman, J. and Jones, E., 2017. Essential Economics for Business. Pearson.