Key Assumptions in Classical Economics and Their Application

This document discusses the key assumption of rational actor paradigm in classical economics and its application in hiring decisions and pricing decisions. It also explores the impact of rent price ceiling in the Brisbane house market. The document further calculates marginal cost, fixed cost, and analyzes hiring decisions based on marginal revenue and marginal product.

ECONOMICS FOR MANAGERS
STUDENT ID:
[Pick the date]

Question 1
A key assumption in classical economics is the rational actor paradigm. According to this,
people would act rationally and aim to maximise their self-interest by making optimal
decisions. This assumption is critical as it leads to pattern of behaviour which can be
predicted by the economists leading to theories (Arnold, 2017).
An example of this is highlighted with regards to hiring decisions of labour. Here the
incremental revenue (also called marginal revenue) that can be derived from the hiring of a
particular labour would be equivalent of the product of unit price and marginal product. This
needs to be compared with the incremental cost (also called marginal cost). The hiring of the
incremental labour makes sense only if the marginal revenue is higher than the marginal cost.
This is based on the assumption that the given individual would be driven by the intent to
maximise profits (Mankiw, 2014). It may be possible that in reality a person may hire an
extra labour owing to inclination towards providing employment rather than aim for profit
maximisation. However, such a possibility is against the rational actor paradigm.
Another example where the use of this paradigm is highlighted relates to pricing decisions
made by firms operating in a given market structure. A central assumption which is pivotal
here is that the buyers and sellers both behave rationally. However, in reality this is rarely the
case. But the economic theory does not consider this as focusing on human behaviour which
is not driven by rationality would make prediction difficult and thereby limit the utility of
economics as a useful social science (Arnold, 2017).
References
Arnold, A.R. (2017) Microeconomics. 9th edn. Sydney: Cengage Learning, pp. 34-35
Mankiw, G. (2014) Microeconomics. 6th edn. London: Worth Publishers, 54-55

Question 2
The scenario in the given case relates to imposition of rent price ceiling in the Brisbane house
market. In order to have an impact, this price ceiling of rent would need to be lower than the
equilibrium price which has been assumed in the given instance. The impact of this price
ceiling on the house market in Brisbane can be exhibited using the following graph.
In the above diagram, the current demand and supply of houses for rent in the Brisbane
market is indicated by D and S respectively. As a result, the equilibrium rent is Pe with the
equilibrium quantity being Qe. However, the price ceiling for rent has been set at a lower
price denoted by PC shown using a green horizontal line. It is evident that at the current price
there is acute shortage of houses for rent with the demand being too much and supply being
limited.
From an allocative efficiency perspective, the imposition of ceiling is not a favourable
position. It tends to benefit the tenants leading to higher consumer surplus. Since the
landlords would be adversely impacted by lower rents, hence the impact is visible in the form
of shrinking producer surplus. However, unlike earlier, there is a deadweight loss indicated
by region in red. This clearly highlights loss of efficiency. Typically in such a situation,
owing to demand supply mismatch, on one hand there would be reluctance on the part of
tenants to rent their house while on the other the tenants would also face difficulty spotting
houses. The houses which have already been rented might not be emptied as there may be
lack of incentive to purchase a house. As a result, there is loss of wealth for the homeowners
who might keep their houses empty. Also, the tenants might end up playing a higher price
than PC.

Question 3
a) Marginal cost of hiring of the second worker = Total cost associated with two workers –
Total cost associated with one worker = $ 14,000 - $ 10,000 = $ 4,000
b) The fixed cost is defined as the cost incurred when the number of workers is zero. Based
on the given data, it is evident that this amounts to $6,000.
c) Marginal product produced by the 4th worker = 50 units
Unit selling price = $ 100
Marginal revenue produced by the 4th worker = 50*100 = $ 5,000
Marginal cost of hiring the 4th worker = Total cost associated with four workers – Total cost
associated with three worker = $ 22,000 - $ 18,000 = $ 4,000
Considering that marginal revenue for the 4th worker exceeds the marginal product, hence the
hiring of 4th worker should be done as it would lead to increase in profit by $ 1,000.
d) Marginal product produced by the 5th worker = 30 units
Unit selling price = $ 100
Marginal revenue produced by the 5th worker = 30*100 = $ 3,000
Marginal cost of hiring the 5th worker = Total cost associated with four workers – Total cost
associated with three worker = $ 26,000 - $ 22,000 = $ 4,000
Considering that marginal revenue for the 5th worker is lower than the marginal product,
hence the hiring of 5th worker should not be done as it would lead to decrease in profit by $
1,000.
e) Total cost associated with 5 workers = $ 26,000
Total output produced by 5 workers = 400 units
Average total cost = (26000/400) = $ 65