Microeconomics Study Material with Solved Assignments and Essays - Desklib

The article discusses various topics related to Microeconomics including proportion of spending on soft drinks, energy drinks and cordials, effect of tax in drinks market, tax burden, tax revenue, budget constraint, household demand function, and utility. It also provides solutions to various problems related to these topics.

Running Head: MICROECONOMICS
Microeconomics
Name of the Student
Name of the University
Author note

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Table of Contents
Answer 1....................................................................................................................................2
Answer a.................................................................................................................................2
Answer b................................................................................................................................3
Answer c.................................................................................................................................4
Answer d................................................................................................................................4
Answer e.................................................................................................................................4
Answer f.................................................................................................................................5
Answer g................................................................................................................................5
Answer 2....................................................................................................................................5
Answer a.................................................................................................................................5
Answer b................................................................................................................................6
Answer 3....................................................................................................................................6
Answer a.................................................................................................................................7
Answer b................................................................................................................................8
Answer c...............................................................................................................................11
Answer d..............................................................................................................................11
Answer e...............................................................................................................................11
Answer f...............................................................................................................................11
Answer 4..................................................................................................................................12
Answer a...............................................................................................................................12
Answer b..............................................................................................................................15
Answer c...............................................................................................................................16
Answer 5..................................................................................................................................17
Answer a...............................................................................................................................17
Answer b..............................................................................................................................17
References................................................................................................................................21

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Answer 1
Total spent on energy drinks, soft drinks and cordials
Net worth Lowest Second Third Fourth Highest
All
Household
Soft drinks 2.77 3.85 3.62 4.11 3.59 3.58
Energy drinks 0.77 0.72 0.39 0.39 0.45 0.52
Cordials 0.30 0.36 0.34 0.40 0.40 0.36
Total Spent 3.84 4.93 4.35 4.90 4.44 4.46
Proportion of soft drinks, energy drinks and cordials spending
Net worth Lowest Second Third Fourth Highest
All
Household
Soft drinks 0.00291674 0.002082 0.002163 0.001863 0.001327 0.001943819
Energy drinks 0.00081079 0.000579 0.000601 0.000518 0.000369 0.00054034
Cordials 0.00031589 0.000225 0.000234 0.000202 0.000144 0.000210522
Answer a
Lowest Second Third Fourth Highest All Household
0
0.0005
0.001
0.0015
0.002
0.0025
0.003
0.0035
Proportion of Soft Drinks, Energy drinks and
Cordial
Soft drinks Energy drinks Cordials
Figure 1: Proportion of spending on soft drinks, energy drinks and cordials

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Lowest Second Third Fourth Highest
0.00
1.00
2.00
3.00
4.00
5.00
6.00
Total Spent
Figure 2: Total spent on soft drinks, energy drinks and cordials
Answer b
Figure 3: Effect on tax in drinks market
The figure above depicts the effect of the tax on the retail market of soft drinks,
energy drinks and cordials. The supply curve of these items on the retail level is perfectly
elastic. A perfectly elastic supply is one where a negligible change in price is associated with
a very large change in supply. The supply curve is parallel to the horizontal axis. The
perfectly elastic supply curve for these items are shown as SS. The initial demand of the

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household is perfectly inelastic. Household facing perfectly inelastic demand curve cannot
change their demand even when price changes (Fine 2016). In this the demand curve is
parallel to the price axis. The perfectly inelastic demand curve is shown as DD. The
equilibrium is obtained at point E. Corresponding equilibrium price is P* and equilibrium
quantity is Q*. Now, imposition of ad valorem tax collected on retailers will shift the supply
curve upwards from SS to S1S1 by the tax rate. The new equilibrium is at E1. Price paid by the
buyers, increases to P1. This is the tax inclusive price.
Answer c
The division of tax burden depends on the elasticity of supply and demand. Higher the
elasticity lower is the tax burden and vice versa. The seller of these items have a perfectly
elastic supply curve meaning supply can change infinitely in response to price (Katz 2016).
Buyers because of inelastic nature of demand cannot reduce their demand. Therefore, sellers
bypass the entire tax burden to buyers.
Answer d
Tax paid by average household of each five quintile
Net worth Lowest Second Third Fourth Highest Average
Soft drinks 0.554 0.77 0.724 0.822 0.718 0.7176
Energy drinks 0.154 0.144 0.078 0.078 0.09 0.1088
Cordials 0.06 0.072 0.068 0.08 0.08 0.072
Total tax 0.768 0.986 0.87 0.98 0.888 0.8984
Answer e
Tax paid by average household per week and per year
Net worth All Households (Per week) All Households (Per Year)
Soft drinks 0.716 37.35909
Energy drinks 0.104 5.42646
Cordials 0.072 3.75678
Total 0.892 46.54233
If there were 9.6 million households in Australia during 2017-18, then the tax would raise a
total of (46.54233*9600000) = $ 446806368.
A progressive tax is one where tax rate increases along with taxable amount. In case
of regressive tax the tax rate decreases with increase in taxable amount. In the given scenario,

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the tax rate does not alter depending on the level of spending. The rate remains same
irrespective of the taxable amount. Therefore, the tax is proportional.
Answer f
The own price elasticity is given as -0.90. Therefore, in response to a price increase
by 0.20 demand for soft drinks, energy drinks and cordials will decrease by (0.20 *0.90) =
0.18 that is 18% point.
Net
worth
All
Househ
old
Spending after demand
reduction
Tax payment per
week
Spending
with tax
Tax per
year
Soft
drinks 3.58 2.9356 0.58712 3.52272 30.63445
Energy
drinks 0.52 0.4264 0.08528 0.51168 4.44970
Cordials 0.36 0.2952 0.05904 0.35424 3.08056
Total 4.46 3.66 0.73 4.39 38.16471
The average household will reduce their spending on soft drinks in a week by 3.58-
(3.58*0.18) = 2.9356
The spending inclusive of tax is = 2.9356 + (2.9356*0.20) = 2.9356 + 0.58712 = 3.52272.
The spending in a year = (3.52272 *52.1775) = $30.63445
Answer g
New tax revenue with price elasticity of -0.90 = (38.16471 *9600000) = $366381222
In 2017-8, the tax would raise a revenue of $366381222
Answer 2
Answer a
SSB Price
Price per
lt
Price per
gram
2 litre bottles of soft drink, with 200 grams of sugar $1.00 $0.50 $0.50
2 litre bottles of soft drink, with 200 grams of sugar $3.00 $1.50 $1.50
333⅓ ml cans of soft drink, with 40 grams of sugar $0.50 $1.50 $1.25
333⅓ ml cans of soft drink, with 40 grams of sugar $2.00 $6.00 $5.00
250ml cans of energy drinks, with 25 grams of sugar $2.00 $8.00 $8.00

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250ml cans of energy drinks, with 25 grams of sugar $4.00 $16.00 $16.00
2 litre bottles of fruit juice, with 150 grams of sugar $3.00 $1.50 $2.00
2 litre bottles of fruit juice, with 150 grams of sugar $6.00 $3.00 $4.00
Percentage increse in Price
SSB
Ad
valorem
(A)
Volumetric
(B)
Content
( C)
2 litre bottles of soft drink, with 200 grams of sugar 0.2 0.3 0.4
2 litre bottles of soft drink, with 200 grams of sugar 0.6 0.9 1.2
333⅓ ml cans of soft drink, with 40 grams of sugar 0.1 0.15 0.2
333⅓ ml cans of soft drink, with 40 grams of sugar 0.4 0.6 0.8
250ml cans of energy drinks, with 25 grams of sugar 0.4 0.6 0.8
250ml cans of energy drinks, with 25 grams of sugar 0.8 1.2 1.6
2 litre bottles of fruit juice, with 150 grams of sugar 0.6 0.9 1.2
2 litre bottles of fruit juice, with 150 grams of sugar 1.2 1.8 2.4
Answer b
As all the taxes can be fully passed to the consumers, the entire tax burden is borne by
the buyers. The ad valorem tax (A) is placed on retail price of SSBs, volumetric tax is
imposed on per lit of SSBs and content tax (C) is imposed on per 100 gram of SSB. As
obtained from the table, for first SSB price under ad valorem tax increases by 0.2.under
volumetric price increase is 0.3 and for Content tax it is 0.4. Therefore, those who pay
content tax will reduce their demand at most followed by those under volumetric and ad
valorem. The same pattern is observed for all the SSBs. Price increases the most under tax C.
Price increase is higher for tax B than for tax A. As own price elasticity is same for all the
SSBs, change in demand solely depends on proportionate increase in price. Sales and
consumption will be reduced comparatively less for tax A than those for tax B and C.
In general, price impact is the highest for content tax. Consequently, the possible
demand reduction in this group will be highest based on the own price elasticity. Tax revenue
depends on the extent of price increase and that of the change in demand. The difference in
demand adjustments in turn compensated by the difference in proportionate price increase
yielding same tax revenue for all the group.
Answer 3

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Answer a
Budget constraint
Public school
M ≥ { PY Y for X =12000
PX X + PY Y for X >12000
Figure 4: Budget constraint for public school education
Private school
M ≥ PX X + PY Y

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Figure 5: Budget constraint with private school education
Answer b
Household demand function for private education (X) and other goods (Y)

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Answer c
Demand for private education and other goods for each type of household
Household
Type
Income
(M) a b a+b
a/
(a+
b)
b/
(a+
b) M/Px
Private
Education
(X)
Other
goods (Y)
Utility
(U)
I 80,000 0.1 0.9 1 0.1 0.9 100000 10000 72000 59102
II
120,00
0 0.1 0.9 1 0.1 0.9 150000 15000 108000 88652
III
120,00
0 0.2 0.8 1 0.2 0.8 150000 30000 96000 76075
IV
180,00
0 0.2 0.8 1 0.2 0.8 225000 45000 144000 114112
Answer d
Utility if child household sent their child to free public school
Household
Type
Income
(M) a b
a+
b
a/
(a+b
)
b/
(a+b)
Public
School(X)
Other goods
(Y)
Utility
(U)
I 80,000 0.1 0.9 1 0.1 0.9 12000 72000 60189
II 120,000 0.1 0.9 1 0.1 0.9 12000 108000 86696
III 120,000 0.2 0.8 1 0.2 0.8 12000 96000 63336
IV 180,000 0.2 0.8 1 0.2 0.8 12000 144000 87604
Answer e
Comparing utilities obtained from private and public education, it has been observed that
only household type I will send their child to public school as by doing so it receives a higher
utility
(60189 > 59102). Rest of the three household will send their child for a private education.
Answer f
The schemes suggest to provide government assistance in forms of a voucher where
price for every unit of education is $1. In order to understand whether households are better
off with this new schemes with a higher affordability of education, the demand for education
and corresponding utility level of utility is compared under the three system- free public
education, private education and that under new voucher system.
Comparison of education demand
Household Type Public Education(X) Private Education (X) Education (new schemes)
I 12000 10000 8000

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II 12000 15000 12000
III 12000 30000 24000
IV 12000 45000 36000
As shown from the above table, when household wants completely free education
then they demand 12000 unit of education. For private education with a subsidized price of
$0.80, the education demand for all the four type of household is higher than that under new
voucher schemes. For first household education demand under new schemes is 8000. This is
still lower than free public school education unit
Comparison of utility
Household
Type Utility (Public education) Utility (Private education) Utility (New schemes)
I 60189 59102 57797
II 86696 88652 86696
III 63336 76075 72754
IV 87604 114112 109132
When the utility level is compared it is observed that, the utility level under the new either
same or greater for II, III, IV type of household. However, for type I, utility level is lower
under new schemes because of a lower education demand. So far as private education is
concerned the utility level is no better under new schemes for all the four household types.
The analysis of demand and utility suggests that the new system is though better than
free and restricted amount of education demand for some household but in general the
existing system is more effective in terms of education demand.
Answer 4
Answer a
The consumption leisure model is a microeconomics model for choice between
consumption and leisure. In the model it is assumed that consumers derive utility from two
goods- leisure and consumption good. Both are assumed to be normal good. The choice
between consumption and leisure is limited by the budget constraint (Baumol and Blinder
2015). Change in the effective wage rate has an impact on both choice of work hours and
leisure. Given fixed number of hours in a day, an increase in work hours implies a decrease in
leisure time and vice-versa. In response to a cut in tax rate, the effective wage changes as

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well. The wage effect can be further divided into income and substitution effect. The ultimate
impact on tax cut on work hours depend on the magnitude of income and substitution effect.
The two figures below describe the two possible case for the effect of a cut in top
marginal tax rate. wage line or income constraint is given as WT. The initial utility level is
given by the indifference curve I1. The initial equilibrium is at E1. Corresponding to the
equilibrium, the leisure hour is given as OL1 and work hours is TL1. Now suppose, there is a
reduction in to marginal tax rate. This will shift wage line from WT to W1T. The new
equilibrium is at E2. With a reduction in the tax rate, for every unit of work hours’ workers
now earn a higher wage (Mahanty 2014). This increases the cost of leisure. As the price of
leisure increases, workers now substitute leisure with more work hours. This is the
substitution effect of tax cut. However, with an increase in effect income worker now can get
their needed consumption good at less work effort. This encourages them to take more
leisure. This is the income effect of a cut in tax rate. Income effect thus tends to reduce labor
supply while substitution effect tends increase labor supply (Goodwin et al. 2015). Workers
for whom substitution effect is larger than income effect, labor supply increases while
workers for them income effect is larger than substitution effect the labor supply reduces.
In order to decompose wage effect into income and substitution effect, the money
income is first reduced by compensating variation in income (Young and Hickman 2015). For
this, the additional income is taken back so that the individual can reach to the original
indifference curve I1. The wage line obtained after compensating income variation is W’T’.
This is tangent to I1 at E3. For both figures, movement from E1 to E3 is associated with higher
work hours. This shows the substitution effect. The movement from E3 to E2 is the income
effect. In figure 2. Income effect dominates and hence, work hours reduces from TL1 to TL2.
In figure 3 however substitution effect dominates causing an increase in work hours from TL1
to TL2.
Case 1: Income effect dominates

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Figure 6: Consumption-Leisure model with dominance of income effect
Case 2: Substitution effect dominates

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Figure 7: Consumption-Leisure model with dominance of substitution effect
Answer b
If workers cannot alter their work hours then after the tax cut, then their choice of
work hours and leisure remain same even after the change in tax rate. As worker continue to
out same work effort they will enjoy a higher effective income and hence will be better off by
their increased affordability (Friedman 2017). This is shown in the figure below.

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Figure 6: Consumption-Leisure model with fixed labor income
WT is the initial wage line. The initial indifference curve is I1. The equilibrium is at E1. At the
equilibrium workers supply TL1 work hours and enjoys OL1 leisure hours. Now when there is
a tax cut then wage line shifts pivotally to W1T. With fixed hours of labor TL1, workers will
now reach to a higher indifference curve I2. The new equilibrium point is E2.
If the workers are able to change work hours then some workers might decide to increase
their work hours and hence earn a higher income. The higher income might enable them to
enjoy more consumption goods and hence, enjoy a higher utility (Cowen and Tabarrok 2015).
However, this comes at the cost of reduced leisure. The other might chose to derive
additional utility from increased leisure. The flexibility thus enable workers to derive higher
utility either by increasing work hours or by increasing leisure time and hence, workers
would be better off.
Answer c
i) Real wage is the inflation adjusted wage rate. It is obtained by dividing nominal wage by
the price level (Nicholson and Snyder 2014). An increase in real wage means a higher
affordability for consumers. The increases wage actually increases price of leisure increases.
An increased real wage encourages workers to put greater work effort. With a higher income

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they can increase their standard of living. The substitution effect is stronger than income. The
desire to increase their living standard can be a possible cause of increasing full time work
hours.
ii) Income taxes are compulsory payment made to the government based on the level of
income. Income tax reduces the effective return from work effort. A reduction in income tax
rate thus increases effective income. Workers when get higher return from the work effort
might encouraged to put more work effort.
iii) In economics, consumerism is defined as a situation increasing consumption of goods is
appeared as economically desirable. Increased consumerism therefore means people’s
willingness towards consumer goods increases (Ashwin, Taylor and Mankiw 2016). In order
to increase consumption, income needs to be increased. The desire to consumer more in turn
encourage workers to increase their work hours and earn a higher income.
Answer 5
Answer a
The decision whether to purchase insurance or not that depends on the individual’s
perception of risk and resulted expected utility from participating in an activity. Suppose an
individual has wealth W. Utility is the function of wealth. Now, the individual will be
identified as risk averse if expected utility of the wealth is less than utility derived from
expected wealth. Reverse is the case for a risk lover individual (Mankiw 2016). A risk neutral
individual is indifferent between the two situations. A risk averse individual always wants to
purchase full insurance.
The house of Fei Hong and Saanv faces the risk of bush fires. The expected utility
however is different depending on their wealth level. The expected utility of the house to Fei
Hong may be lower than utility of the expected wealth (Moulin 2014). Therefore, Feig Hong
wants insurance. For Saanvi however the expected utility from the house might be greater
than that derived from wealth derived after payment of insurance premium.
Answer b
i) Farooq’s expected annual income
0.90 × $ 6400+0.1 × 0=$ 5760
ii) Farooq’s expected utility

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0.90 × √6400+0.1 × √0
¿ 0.90 ×80
¿ 72
iv)
The minimum insurance premium that the company should charge is equivalent to the
expected loss of the company.
Now,
Expected loss= p ( insurance will be claimed ) × ( amount ¿be paid ) + p ( insurance will not be claimed ) × ( amount p
¿ ( 0.10 ×6400 ) + ( 0.10× 0 )
¿ 640
Therefore, the minimum premium that a company offering crop protection to Farooq is 640.
v)
Expected income of Farooq, E (X) = 5760
Expected utility of Farooq is, E (U) = 72
Certainty equivalence is the amount such that a consumer is indifferent between taking a risk
and receiving certainty equivalent amount.
The certainty equivalent (CE) therefore yield a utility equivalent to the expected utility of
Farooq.

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Figure 7: Certainty equivalence and risk Premium
U ( CE )=E ( U ( X ) )
¿ , √ CE=72
¿ , CE= ( 72 ) 2
¿ , CE=5184
Risk Premium=E ( X )−CE
¿ 5760−5184
¿ 576
vi)
Diversification is a strategy by which individual makes exposure to many risky events rather
than only a few or one risky venture. By diversification individual aims at dividing risk at
into smaller amount. This allows risks to be repeated overtime. This smooths out good and
bad outcome such that expected outcome is to be achieved.

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If Farooq can divide his field in two halves A and B
Then, expected utility from field A is
E ( A ) =0.90× √3200+0.10 × √0
¿ 0.90 ×56.57
¿ 50.91
Expected utility from field B is
E ( B )=0.90 × √3200+ 0.10× √0
¿ 0.90 ×56.57
¿ 50.91
Total expected utility after diversification
E ( A+ B ) =E ( A ) + E ( B )
¿ 50.91+50.91
¿ 101.82
Expected utility without diversification is 72.
Expected utility with diversification is 101.82.
As the expected utility is from dividing the potato field into two adjacent halves is greater
than the expected utility from farming the field as a whole, Farooq would definitely divide his
field in two and will minimize the risk of crop failure.
vii)
The correlation between two risky events play an important role in deciding whether to
diversify or not. In case of perfect positive correlation good outcome of one event comes with
good outcome of other and bad outcomes is associated with a bad outcome. Now, of risk or
gain associated with field A and field B are perfectly positively correlated standard deviation
of risk of the potato field is the same as the sum of risk of two fields
SD (A+B) = SD (A) + SD (B)
Therefore, diversification would be worthless.

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References
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Katz, J., 2016. The macro-and microeconomics of natural-resource-based
growth. Neostructuralism and heterodox thinking in Latin America and the Caribbean in the
early twenty-first century. Santiago: ECLAC, 2016. LC/G. 2633-P. p. 223-237.
Baumol, W.J. and Blinder, A.S., 2015. Microeconomics: Principles and policy. Cengage
Learning.
Mahanty, A.K., 2014. Intermediate microeconomics with applications. Academic Press.
Goodwin, N., Harris, J.M., Nelson, J.A., Roach, B. and Torras, M., 2015. Microeconomics in
context. Routledge.
Young, D.R. and Hickman, J., 2015. Microeconomics for Public Policy.
Friedman, L.S., 2017. The microeconomics of public policy analysis. Princeton University
Press.
Cowen, T. and Tabarrok, A., 2015. Modern Principles of Microeconomics. Palgrave
Macmillan.
Nicholson, W. and Snyder, C.M., 2014. Intermediate microeconomics and its application.
Cengage Learning.
Ashwin, A., Taylor, M.P. and Mankiw, N.G., 2016. Business economics. Nelson Education.
Mankiw, N.G., 2016. Economics-Microeconomics-Principles of Microeconomics.
Moulin, H., 2014. Cooperative microeconomics: a game-theoretic introduction. Princeton
University Press.