Microeconomics: GDP and Market Demand

This solved microeconomics assignment explores key concepts such as Gross Domestic Product (GDP), its limitations as a measure of well-being, and the factors driving sustained economic growth. It delves into market demand, analyzing the effects of increased demand on price and quantity, and differentiating between elastic and inelastic demand. Furthermore, it examines short-run market adjustments in response to changes in demand within competitive industries.

Running head: BUSINESS ECONOMICS
Business Economics
Name of the Student
Name of the University
Author note

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Table of Contents
Answer 1a........................................................................................................................................3
Price floors...................................................................................................................................3
Question 2a......................................................................................................................................4
Perfect Competition.....................................................................................................................4
Answer 3a........................................................................................................................................7
Gross Domestic Product and Economic growth..........................................................................7
Short Answer...................................................................................................................................9
Answer 1a....................................................................................................................................9
Answer 2a..................................................................................................................................10

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Answer 1a
Price floors
I. Price floor is a policy where government sets a minimum legal price for the goods sold in the
market. The minimum price is called support price. Examples of such price support policy
include setting of minimum wage or more importantly in agriculture to guarantee a minimum
income for the farmers. The possible impact of price floor set for Wool farmers is explained
below.
Figure 1: Impact of price floor
(Source: as created by the Author)

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In the absence of government regulation the free market price and quantity is P* and Q*
respectively. This is obtained at the point where supply and demand situation in the market
balances as shown by the supply and demand curve SS and DD. Now support government sets
the price floor at Pf. Because of high price buyers in the market now reduce their demand to QD.
In contrast suppliers increase their supplies to QS. As quantity supplied exceed quantity
demanded there will be excess supply of amount (QS – QD)
II. Any type of intervention in free market mechanism is usually inefficient. With price floor
consumer surplus reduced to a APfC from earlier EP*C. If farmers manage to sell all the quantity
produced then their surplus will increase. To make it happen and maintains the high price
government needs to purchase all the excess quantity at the high price. The subsidy given to the
farmers equals to the area of the rectangle AQDQSB. This imposes additional burden on
government and results in a welfare loss to the society. The shaded triangle shows the dead
weight loss or inefficiency of price floor policy.
Question 2a
Perfect Competition
I.Perfectly competitive market is a form o0f market where exchange has been taken place
between several buyers and sellers. Because of the presence of many sellers in the market each
seller has only a small share of market. The share is so small that it is not possible for any single
firm to influence the price. The goods in the market are sold at price determined by free market
mechanism. Firms here are price taker and not a price maker.

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II. Short run economic profit
As the market price is given in a competitive market marginal revenue and average
revenue both equals to price. As a consequence short run equilibrium condition becomes Price =
Marginal cost. In short run the competitive firm can enjoy an economic profit or loss depending
on the position of cost curve.
Figure 2: Short run economic profit in a competitive market
(Source: as created by the Author)
At point E, price equals to the marginal cost. Hence, it is the short run equilibrium point.
Corresponding to this short run price and quantity are obtained as P* and Q* respectively. Total
cost is the rectangle OQ*AB. Total revenue is the rectangle OQ*EP. Profit is the difference
between TR and TC. Profit = OQ*EP- OQ*AB= BAEP*.

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III. Long run equilibrium
Figure 3: Long run equilibrium in competitive market
(Source: as created by the Author)
In short run, a competitive firm can manage to maintain an economic profit. As there are
no barriers to the entry of new firms in the market, more firms will enter in the market. As a
result market supply curve SS will shift rightward and industry output will increase from Q to
Q*. With increased supply in the market, price will be lower. Entry of the new firms continues
unless there is only normal profit left in the industry.

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Answer 3a
Gross Domestic Product and Economic growth
I.Gross Domestic Product expresses total value of final output produced in a country in monetary
terms. Prices used for computing GDP is either current market price or price of a fixed base year.
The most commonly used method for computing GDP is the expenditure method.
GDP= C+ I+ G + (X- M)
C= Consumption expenditure
I= Gross investment
G= Government expenditure
(X-M)= export – import = net export
GDP is considered as a primary measure of national income. Same as personal income
represent standard of living of an individual, national income represents the living standard of
the society as a whole. If GDP is found to be increasing at an increasing rate then the economy is
said to be growing and hence gives a sign of improved standard of living.
II. GDP though is a good measure of well being is not a perfect measure because ofr the
following shortcomings.
 GDP does not include transfer payments taken place in the economy and any income
from unproductive activities like drug production, fraud, theft and other illegal activities
and hence, understate real growth and well-being over time.

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 GDP computation becomes difficult when there are inaccurate data or missing data
regarding any components of GDP.
 GDP is only a accounting. A higher GDP does not always mean a very high standard of
living. There may be unequal distribution of income leading to problems of inequality
and poverty which is not reflected in GDP.
III. Following are the factors that can lead to sustained increases in GDP over time
Human resource: Quality of human resources determines productivity of the nations. If there is
a continuous improvement in skill, education and training for workers then productivity
increases and hence GDP.
Natural resource: Exploration of new source of natural resource or better use of existing
resource increases GDP overtime.
Capital Formation: increasing investment in capital goods like machinery, transportation,
power and building gives a strong capital base for the economy with increasing production
capacity.
Technological development and social and political factors play important role in determining
sustained GDP growth.
IV. Nominal value considered the current market value whereas real value considers value of a
particular base year. Interest rate charges by banks and the ongoing market interest rate is called
nominal interest rate. Real interest rate is inflation-adjusted interest rate.

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Short Answer
Answer 1 a)
i)
Figure 4: Effect of an increased demand
(Source: as created by the Author)
Increase in demand due to increase in population will cause a rightward shift in the
demand curve. As a result price will be increased from P* to P1 and market quantity will be
increased from Q* to Q1.
ii) In case of inelastic demand, quantity change in demand is less than the price change.
Therefore, increase in price will not hurt revenue of the suppliers. If the demand is elastic in
nature then quantity reduction in response to a price increases will be greater and hence will lead
to a reduction in revenue.
iii) Goods for which demand increases with an increase in income are called normal goods.
Example- both necessary and luxury goods are normal goods. Food, clothes are examples of

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normal goods. Goods for which demand decreases with an increase in income are called inferior
goods. Examples – cheaper quality goods are examples of inferior goods. If income elasticity is
positive then the good is identified as a normal good.
Answer 2a
i) A sudden increase in demand in a competitive industry increases price in the short
run. Increase in price in the short run will increase profit and each firm can enjoy a
short run economic profit then and supply more quantity in the market.
ii) Short run economic profit in the market will attract more firms to enter in the
industry. With increase in number of firms in the industry, quantity supplied in the
industry increases and price decreases. This reduces the short run economic profit in
the market. New firms continue to enter in the market as long as there is more than
normal profit in the industry.