Economics and the Business Environment

Economics and the Business
Environment

TABLE OF CONTENTS
Question 1..................................................................................................................................3
Question 2..................................................................................................................................3
Question 3..................................................................................................................................6
Question 4..................................................................................................................................7
Question 5................................................................................................................................10
REFERENCES.........................................................................................................................12

Question 1
a. In the given case, for calculating the profit, it is better to start from the profit maximising
quantity. For determines its profit-maximizing level of output, it will occur at the point where
MR=MC. In the graph, the MR=MC at 400. For deciding the price to charge, now the firm
will act like a monopoly and will try to charge the maximum price. The graph shows the
vertical line reaching through the profit-maximizing quantity until it hits the firm’s perceived
demand curve. In the given graph, it occurs at a price of 100.
b. Under monopolistic competition, demand (D) is equal to the average revenue. Therefore,
at the quantity of 400, the total revenue will be 40000 (400 * 100) and the total cost is derived
by average total cost multiplied by the quantity. Therefore, total cost at 400 quantity level is
16000 (40*400) where average total cost is 40 and the quantity is 400.
c. In short run, under monopolistic competition, the firm maximizes the profit at the point
where MR=MC. Also, the firm earns economic profit when the average total cost is below
the market price and on the other hand, if the average total cost exceeds the market price, in
that situation the firm will suffer the losses which is equal to the average total cost reduced by
the market price and then multiplied by the number of quantity. In the given diagram, the
firm is incurring economic profit or the supernormal profit. The amount of profit is 24000
((100 – 40)) * 400).
d. In case the firms in the market earns an economic profit and then the new firms enter the
market because of free entry and exit it will lead to reduction in the profit of the other firms
and more and more new firms will continue to enter the industry till the time the firm starts
earning normal profits (Stiglitz, 2017). Also, in case there are too many firms in the market,
then the firms will starts incurring loss which will force them to leave the market. This will
again return to the situation of normal profitability. Therefore, the long run equilibrium under
the monopolistic competition will be achieved when the market price is equal to the average
total cost (ATC) where MR =MC and ATC include normal profits.
Question 2
Policy 1:
The government can probably respond in 2 ways either it can use command and
control regulatory behaviour or it can introduce the taxes and the subsidies to make a change
in the consumer behaviour. In practice, implementing the policy is difficult as it requires in-

depth knowledge and understanding about the industry. If it is not done correctly then it can
introduce inefficiency in the business. If the government is not sure about the implication of
the policy it should use different method for mitigating the externality. The corrective taxes
incentivize is the good factor which can be used for reduction and consumption of the
product which is generating externalities. It is the market-based option which is being
available to the government for the purpose of addressing the externalities. This tax is mainly
known as Pigovian tax which is implemented in the market that is incurring negative
externalities. The tax is basically set equivalent to the negative externality. Under the
situation of negative externalities, the social cost pertaining to the activity is more than the
private cost. Under such situation, the outcome of the market is inefficient and may cause
over production of the product. The taxes will make it much expensive for the firms which is
providing supplies of it at the restaurant, bars, hotels and other public places. Thus, providing
an incentive for producing less will definitely work in favour of the policy.
The below graph depicts tax moves the marginal private cost curve upward and in
response to it, the producer of the same have changed the level of output to the socially-
optimum level. The level in relation to the corrective tax will assist in counterbalance the
externality, however, it is little hard to implement the same in the practice by government in
terms of determining the right taxation level. Also, while introducing the tax level, there are
chances that the government might be under pressure from the different interested parties that
would be benefited from the high or low taxation level. Other than this, by implementing the
corrective tax on account of negative externalities, it will result into increase in the
government efficiency but will also raise revenue. Therefore, in this way, alcohol
consumption banning from the public place can be banned effectively if the impact over the
affected parties are taken into account.