Principles of Economics: Elasticity, Long-Run Average Cost, Productivity Growth, and Inflation

This document discusses elasticity, long-run average cost, productivity growth, and inflation in economics. It provides solutions to questions related to these topics and explains their relevance in different economies.

Running head: ECONOMICS 1
Principles of Economics
Name
Institution

ECONOMICS 2
Principles of Economics
Question 1 Solution
Elasticity is the percentage change of one economic variable to a change in the other variable,
which is closely related to it, such as demand, price, and income (Fouquet, 2014). Price elasticity
is, therefore, the responsiveness of quantity demanded to a change in price. As a result, if the
elasticity of demand is 1.4; consequently, it shows that the responsiveness of the quantitative of
drugs needed to the change of its price was found to be 1.4. Elasticity, which is greater than one,
is referred to as elastic i.e., the response of demand is greater compared to change in the prices of
the drugs (Gatwood et al., 2014). If the demand for the drug is elastic, then it shows that the
prices of the drugs will lead to a fall in the revenue, while a decrease in the total price leads to an
increase in revenue.
For the company to increase revenue, the price level should be favorable to the customers. As a
result, an elastic of 1.4 shows that the price level is higher than expected thus lowering the firm's
revenue earnings as shown in figure 1.0 below;

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I would, therefore, advise the firm to lower the prices of its product since the output level will
increase to offset the decreased level of price. This is because most firms prefer to attain
marginal revenue, which can offset their daily operations than continue operating at a loss.
However, an elasticity of 0.6 is less than one, thus inelastic. As a result, I would advise the firm
to increase its prices to increase the revenue since there will be a decrease in units sold in the
market. As the volume of output decreases, the increase in marginal revenue will be used to
cover for the diminishing value in sales as the price increases, As a result, the firm will be able to
increase its price in order to be able to maximize the profit and with anticipation of future loss in
revenue to cover for the fixed costs.
Figure 2.0: Inelastic demand
From figure 2.0 above the increase in the price will increase the total revenue even if the total
output will decrease. This is because as the price increases with a decrease in sales, the income
collected will be stable in the long run, thus leading to a stable market revenue earnings
(Oliveira-Castro & Foxall, 2016).

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Additionally, when the proportionate change in the quantity demanded gives the same change in
price for the goods. This type of then the demand is known as unitary elastic demand which is
equal to one as shown in the figure below;
Figure 3.0: Unitary elastic demand
From the figure above, it shows that the firm's revenue is at a maximum; thus, the current price is
favorable to the production. As a result, the production units are proportionately the same in
terms of change to the price. I would, therefore, advise the firm to maintain producing at the
same price without changing the price or production since the unitary elasticity shows that there
is profit maximization (Cavalli & Naimzada, 2015). The primary goal of the firm is to maximize
profit, at the unitary elastic level. It stands a chance to gain terms of revenue but with a
consideration of the changes in the production. This will help to cover the variable costs in the
long run.
Question 2 Solution
The long-run average cost is per unit costs that automobile factories faced when all units are
variable. As the automobile factories increase their scales for the operations through additional
human resources and plants, per unit costs were expected to grow along with the economies of
scale (Dean et al., 2014). The problem of low demand for domestic autos, not more than 2.5

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times the total quantity produced locally was a predicament that faced the United States
Automobile manufacturing industry during the early 1970s. This was due to the financial
recession that hit the country, thus lowering the demand for the locally produced autos (Oh,
2014). As a result, since there was only demand one firm provides, which was equated to the 2.5
firms’ outputs to hit bottom average cost, the other firms were, therefore, making a massive loss.
At the same time, the remaining firm was struggling to sustain its operation in the market.
As the cost of production increases, total revenue will be reduced at the same stead. It, therefore,
leads to a diseconomy of scale where there will be a layoff of workers and a decrease in the wage
rage to sustain the variable costs of operations. However, in the constant return to scale level, if
firms decide to increase their inputs concerning non-changes in the average costs, they will still
experience diseconomies of scale (Dorman, 2014). This is because, in the average long run, each
firm is entitled to produce units that increase as its total output increases. The long run average
cost (LRAC) depicts the lowest cost of providing the autos in the market. When the producers
vary the inputs of productions, including technology, there will be an increase in its production
multiplier in the industry.
The increase in the units produced within the automobile industries led to a decrease in the
average cost for each unit due to increased cost for producing additional products. As a result,
the demand for the autos increased, thus leading to 2.5 times demand at the lower average cost.
The increase I the demand was due to the lower prices for the raw materials in the industry, thus
leading to increment in production. However, in the long run, as the output level will be
increasing, the long-run average cost will be decreasing in the economies of scale due to costs in
production and demand change in the demand for the auto products (Mankiw, 2014).
Question 3 Solution

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The economic rate of productivity growth is directly related to the rate of GDP per Capita
growth, even though the two are unique in their functions (Aghion et al., 2016). Australia is one
of the high-income economies in terms of employment availability, thus showing that as the
percentage of population holding jobs increases, the GDP per capita also increases. It, therefore,
shows that the productivity of an individual worker in a country leads to a GDP per capita
growth since, in Australia; the average worker's productivity is determined by the corresponding
increase in capital creation.
Availability of physical capital, which includes the plant and machinery, infrastructure growth is
also a determinant of GDP per capita growth in Australia (Qu et al., 2016). As the physical
capital enhances, there is an increase in output i.e., the country is stable in terms of technological
growth thus increases the productivity level compared to less developed economies. As a result,
there will be economic growth and development due to enhance human and physical capital,
which are steadily available. Technological progress is described in high-income economies as a
'joker in the deck' because of its combination of innovation and invention capabilities (Kim &
Loayza, 2017). For instance, Australia has ensured that it assembles new technological progress
in the agricultural development, in the manufacturing, and service industries to help its economy
produce quality output in the factories. At the same time, the tertiary institutions are aligned to
the research and development of new ideas that are facilitating the conversion of inputs from the
industries to complete goods and services. As a result, there is an increase in growth of GDP Per
Capita in Australia will increase in the long run compared to middle or low-income countries.
However, in a middle-income earning country like India, this might not be the case because there
might be economic growth without development. India has the availability of physical capital but
lacks the financial superiorly to invest in the nation increased population since there unbalanced

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income distribution among the citizens. For example, the differences in wage distribution are due
to lack of proper education amongst the citizens, thus reduces GDP per capita growth in the
economy (Yeager, 2018). Even though India is one of the middle-income countries who's GDP
per capita increases per year, lack of capital creation with an equitable resource allocation has led
to sluggish economic growth and development in the country.
A low-income country is one that has low capital creation; there is wage gap disparity, and lack
of necessary provisions such as education, health, and meals (Rodrik, 2014). As a result, capital
creation in Afghanistan reduces due to lack of knowledge that promotes human capital growth
and technological progress (Ncube et al., 2014). Productivity rate in Afghanistan is diminishing
with a decrease in human capital creation, thus reduces the rate of GDP Per Capita growth.
Governance and security are also a significant factor in steady GDP Per Capita growth in any
economy therefore, due to insecurity in most of the low-income economies, including
Afghanistan.
Question 4 Solution
Inflation is the persistent change in the basket reasonable prices over some time; thus, a change
in the measurement of the inflation by the government statisticians had significant effects in
terms of quality of goods, prices, and consumers' behavior in terms of substitution biasness
(Tongur, 2019). Consumer Price Index is the commonly used measurement for the inflation
indicator as it measures the purchasing cost of the pre-determined basket goods and services. The
index is more convenient since it takes in to account the nominal cost of the fixed basket prices
of products at a given time.
Government is at liberty to accurately measure and update the prices of the basket goods in order
to help define the nature and type of inflation that a country is anticipating or facing already. If

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the government statistician decides to update the national basket prices of goods and services
after just five years instead of after every ten years, there will be a problem of substitution
biasness which will affect the quality of the new measurement in terms of variability in the time
period for the prices of goods and services (Crayton & Hart, 2015). As a result, there will be a
reduction in the standard measurement, thus leading to a misguidance principle of inflation. This
is because when using the price index as a tool for measuring the inflation rate, the problem of
substitution biasness will be prone to occur. As a result, consumers can substitute goods due to
changes in their prices. For instance, an increase in the amount of apple will force consumers to
replace apple with oranges, thus avoids the increase in price a little bit.
Change in the measurability pattern for the basket goods from ten years to five years will likely
omit the consumers' choice in substituting the increment in the price for one good with the other.
This is because the existence of substitution biasness will neglect the change in the purchasing
choices over ten years to five years (Krugman, 2014). Prices of basket goods change within a
period, thus assuming that within five years, it will remain constant is economically unrealistic.
This is because as the consumer substitutes one good to the other, they forgo a higher price,
which is actively provided in the market for a low price. Changes in consumption patterns due to
change in price will, therefore, result in a difference in the price index (Krugman, 2014).
The changes in prices of goods majorly determine the inflation rate, thus assuming the
substitution effect when consumers switch from a higher-priced commodity to relatively less
expensive products will generally affect the calculation of the inflation rate from ten years to five
years. It will, therefore, lead to an overestimated CPI since the actual changes in prices of basket
goods and services are not included in the measurement (Kaplan & Schulhofer-Wohl, 2017). The
assumption that consumers will always purchase a fixed basket of products over the period

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works against the government statisticians. This is because the national government is obliged to
observe any changes that come to it as a result of the difference in the national consumption
pattern of the individual in an economy.
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