Economics: Competitive Market and Price Elasticity of Supply

This document discusses the characteristics of a competitive market, such as product homogeneity and perfect information, and explains the concept of price elasticity of supply. It also provides a table and a figure showing the trend in the elasticity of supply of coarse grain. Additionally, it explores the negative externalities of the paint manufacturing business and proposes a demand side policy to internalize the externality. References are included for further reading.

Running head: ECONOMICS
Economics
Name of the Student
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Table of Contents
Question 1..................................................................................................................................................2
Question 2..................................................................................................................................................2
Question 3..................................................................................................................................................4
Question i...............................................................................................................................................4
Question ii..............................................................................................................................................4
Question iii.............................................................................................................................................5
Question iv.............................................................................................................................................6
References..................................................................................................................................................7

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Question 1
Example of a competitive market that in daily life is wheat market. Generally, wheat market is
competitive market with various characteristics similar competitive market. One of them is
homogeneity of products that means produce of all the sellers are similar to each other with no
significant difference among the products that may share customers to different categories and there by
divide the market into different group of markets. Thus, to survive in the market every seller just
produces similar products with no innovation and investment for differentiation (Cowell, 2018). Only
producing the same good will be sufficient to meet product homogeneity. Secondly, the competitive
market has no barrier to entry and exit that means any firm wants to enter the market can enter without
worrying about entry and exit cost. Thus, the wheat sellers just need to produce wheat and sell the
products at market-determined prices and need to maximize profit where marginal cost equals marginal
revenue. On the other hand, if a seller not meeting the breakeven not even in the long run then it can
exit the market without having significant loss as the fixed costs are transferable. However, the market
would not be affected with such exits, as the number of sellers are numerous and remain in the
equilibrium (McKenzie & Lee, 2016) Thirdly, in perfectly competitive market both the sellers and
buyers have perfect information about price, quality, production process and utility. As there are
numerous players in the markets maintaining secret is impossible from both the sellers and buyers side.
Thus, every information is openly available and anyone can get it whenever it wants and thereby
keeping the balance of the competitive market. Fourthly, in the long run every seller or firm in the
competitive market earns zero economic profit. This happens because if there is positive profit in the
market then entry of the new firm continues until it reaches at the point where marginal cost equals
average total cost or zero economic profit level (Friedman, 2017). More is the number of new firm
more is the resource shortage that drives the cost of factors upwards, decreases profit, and thus reaches
zero economic profit.
Question 2
Table 1: Price elasticity of supply of coarse grain
Year
Productio
n Price
Elasticit
y
2000 10914.388
1951.89
4
2001 13047.895 2583.18 0.60
2002 6923.369
1650.32
3 1.30

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2003 15630.134
2561.79
9 2.28
2004 12062.63
1848.79
3 0.82
2005 14293.904
2131.70
5 1.21
2006 6727.463
1596.98
4 2.11
2007 13289.431
3857.17
9 0.69
2008 12586.806
2852.73
5 0.20
2009 11406.864
2044.96
8 0.33
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009
0.00
0.50
1.00
1.50
2.00
2.50
Elasticity
Elasticity
Year
Elasticity
Figure 1: Trend in elasticity of supply of coarse grain
(agriculture.gov.au., 2019)
In economics, price elasticity of supply refers to the percentage change in quantity supplied of a
good for a given percentage change in price. In the context of coarse grain, price elasticity of supply
measures the proportionate change in supply of coarse grain due to change in price (Baumol & Blinder,
2015). The elasticity is computed using the following formula.
Elasticity of supply= Percentage change∈quantity supplied
Percentage change∈ price

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¿
dQ
Q ×100
dP
P ×100
¿ dQ
dP × P
Q
The measured elasticity of coarse grain helps to understand how the production of coarse grain
changes due to change in price. The estimate of supply elasticity is positive implying production of
coarse grain increase due to an increase in price. In most of the years, the price elasticity estimate is
less than 1. Measured elasticity less than 1 implies, proportionate change in supply is less than
associated change in price. Coarse grains are cereal grains excluding rice and wheat and are mostly
used for feeding animals or brewing (Ruiz et al., 2019). These are not much profitable for production
and usually face an inelastic demand from poultry or cattle firm. As there is not much incentive to
increase production in response to price, production does not increase much for a given increase in
price making demand relatively inelastic in nature.
The sample period considered for elasticity estimates ranged from 2000 to 2009. The estimated
supply elasticity in 2001 was 0.60. Elasticity increases to 1.30 in 2002 followed by an increase in
coarse measured elasticity to 2.38. During these two consecutive years, production of coarse grains
increased rapidly mainly due to an increase in export demand. Estimated elasticity though declined to
0.82 in 2004 but still greater than the elasticity in 2001. Since 2007, measured elasticity started to
decline and became relatively inelastic. The measured elasticity during 2007, 2008 and 2009 are
estimated to 0.69, 0.20 and 0.33 respectively.
Question 3
Question i
Paint manufacturing business is a kind of business that directly affects the society by producing
chemical and smoke effluent. Chemical waste is dumped into water and smoke is emitted in the
atmosphere and thus causes water and air pollution. Hence, contamination of water and air poses
negative effect on the society. The business owners however do not take into consideration the external
cost in the form of air and water pollution. Therefore, the industry does have negative externalities.
Question ii

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Figure 2: Negative externality of paint business
The above figure depicts the market of paint production. As the business generates negative
externality, the social marginal cost is larger than private marginal cost (Cowen & Tabarrok, 2015).
The free market equilibrium is at E with price and quantity being P1 and Q1 respectively. At this point
consumer surplus is equivalent to the area a+b+c+d while producer surplus is the area equivalent to the
area f+g+h. Because of negative externality the society suffers a deadweight loss given by the area e.
The total surplus thus is a+b+c+d+f+g+h-e.
Question iii
A demand side policy to internalize the externality is to impose a tax on buyers equivalent to
the external cost. An imposition of tax equivalent to external cost shifts the demand curve from D to D1.
The price that buyers pay equals to P2. After tax, price received by sellers equal to P3. The quantity
produced in the market lowers to Q2. The dead weight loss generated due to negative externality has
been reduced by imposing tax on purchase (Mochrie, 2015). This is illustrated in the following figure.

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Figure 3: Effect of imposition of tax on buyers
Question iv
Because of the proposed policy, surplus to consumer reduces to area ‘a’. The surplus to
producers reduce to area ‘h’. Government now earns a revenue of b+c+d+e+f. The total surplus now
equals a+b+c+d+e+f+h.

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References
agriculture.gov.au. (2019). ABARES Agricultural commodities and trade data. Retrieved from
http://www.agriculture.gov.au/abares/research-topics/agricultural-commodities/agricultural-
commodities-trade-data#2018
Baumol, W. J., & Blinder, A. S. (2015). Microeconomics: Principles and policy. Nelson Education.
Cowell, F. (2018). Microeconomics: principles and analysis. Oxford University Press.
Cowen, T., & Tabarrok, A. (2015). Modern principles of microeconomics. Macmillan International
Higher Education.
Friedman, L. S. (2017). The microeconomics of public policy analysis. Princeton University Press.
McKenzie, R. B., & Lee, D. R. (2016). Microeconomics for MBAs: The economic way of thinking for
managers. Cambridge University Press.
Mochrie, R. (2015). Intermediate microeconomics. Macmillan International Higher Education.
Ruiz, L., Xia, W., Meng, Z., & Keten, S. (2015). A coarse-grained model for the mechanical behavior
of multi-layer graphene. Carbon, 82, 103-115.