Microeconomics Assignment: BUECO5903, Semester 2, 2019 Analysis

This assignment solution addresses key microeconomic concepts through a series of questions. It begins by analyzing the impact of various factors on the peanut industry using supply and demand diagrams, including changes in fertilizer prices, consumer preferences, droughts, and health concern...Read More

Running head: Business Economics
Business Economics
Name of the Student
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1Business Economics
Table of Contents
Answer 2..........................................................................................................................................2
Answer 6..........................................................................................................................................3
Answer 7..........................................................................................................................................4
Answer 8..........................................................................................................................................6
Answer 9..........................................................................................................................................8
References........................................................................................................................................9

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Answer 2
(a) An increase in price of fertilizer that is used for growing peanut will increase the cost of
production. Thus, at the same cost the seller can supply less amount of peanuts than before.
Hence the supply for peanut will decrease causing shift of supply curve to the left from S to S1.
Therefore, the equilibrium price of peanuts will increase and quantity will drop. The new
equilibrium quantity and price is shown in figure 1 as Q* and P* respectively.
Figure 1: Decline in supply
Source: (Created by the Author)
(b) Taste of consumers have changes and they are prefer popcorn to peanuts. This will result into
fall in demand for peanuts and owing to this the demand curve shifts leftward causing fall in
quantity demanded and price in the market. The graphical illustration is given below in figure 2.
The demand curve has moved to D1 from D and the new equilibrium price and quantity is given
as P1 and Q1 respectively.

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Figure 2: Decline in demand
Source: (Created by the Author)
(c) The productivity of land that is used for production of peanuts has reduced due to drought
and thus supply of peanuts has decreased causing supply curve to move towards left as shown in
figure 1. Owing to that the quantity supplied fall to Q* and price increases to P*.
(d) The finding by doctors revealed that peanut is bad for health, as a result the consumers
reduced consumption of peanuts. Therefore, the demand for peanuts reduced causing shift of
demand curve to D1 from D as shown in figure 2. New equilibrium quantity and price is thus
given by Q1 and P1 respectively.
Answer 6
Price elasticity of demand is the measure of sensitivity of the demand of a good to its
alteration in price (Miller & Alberini, 2016). It is generally negative because increase in price
decreases demand and vice versa.

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Income elasticity of demand is the measure of sensitivity of a quantity demand of a
product to the alteration in income of the buyer or consumer. It is a positive value because with
increase in income consumer buys more of a good.
Therefore, from the above definition the difference between price elasticity of demand
and income elasticity of demand can be observed that price elasticity shows the effect of
alteration in the price whereas income elasticity illustrate the influence of change in the income.
The cross price elasticity measures the sensitivity of the demand of a good due to the
alteration in price of its substitute good.
It is necessary for a firm to know the difference between each of the three concepts
discussed above because it will help the firm to make price and supply and decisions. Suppose
for some reason price of the good that the firm produces increase, then by the notion of price
elasticity of demand the firm can predict that the demand of the product will fall and it will
reduce the supply responding to the situation. Furthermore, income elasticity of demand helps a
firm to understand the change in income of the buyers and thereby future demand of the market
(Havranek & Kokes, 2015). Using this a firm could change its output decision. Similarly, cross
price elasticity of demand also helps a firm to anticipate the alteration in the price of the
substitute of the good it produces and thereby guide a fir to make its price and output decisions.
Answer 7
(a) Market with a single seller means the market is a monopoly one. In monopoly, seller has
complete market power and thus it can charge price as per its wish. The buyers have no other
alternative to buy from and thus completely depend on the single seller (Niyato et al., 2016).
Therefore, taking the advantage of the market power the single seller charges price P* which is

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above free market price Pc and supplies Q* which is lower than the free market quantity Qc and
earns supernormal profit.. Hence, under this market consumer pays more price and receives less
amount of good and thereby lose consumer surplus. There, is also social welfare loss in this
market. Thus, single seller market is bad and allocates resources inefficiently.
Figure 3: Market with single seller
Source: (Created by the Author)
(b) In perfect competition equilibrium quantity and price is derived by the free market forces. In
this market there is unlimited buyers and sellers and thus no participant in the market enjoys
market power. Hence, the consumers receive the amount of goods they are willing to pay for.
Therefore, the resources are efficiently allocated in this market and no surplus is lost be it
consumer surplus or producer surplus. Hence, perfectly competitive market is used for
benchmark allocative efficiency. The equilibrium quantity and price in this market is given in
figure 4 as P* and Q* at this equilibrium allocation is efficient.

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Figure 4: Allocative efficiency
Source: (Created by the Author)
Answer 8
Pollution is a negative externality that is caused due to consumption or production of
certain products. To control this negative externality two market mechanisms are used, one
addresses consumption generated pollution and the other addresses production generated
pollution. In case of consumption generated pollution tax is imposed on the product, due to
which the product price increase and the consumers decreases consumption of such goods and
thereby demand falls (Lee, Meier & Lee, 2018). Hence, with reduced consumption pollution
generated also reduces. This mechanism is shown in figure 5. Alternatively, in case of
production generated pollution, production ceiling or license fee is imposed on the production of
the good due to which manufacturers cannot produce beyond the ceiling or the number of
producers reduces in the market due to license fee. Therefore, the pollution generated from
production of goods reduces. This mechanism is shown in figure 6

7Business Economics
Figure 5: Consumption
tax
Source: (Created by the Author)
Figure 6: Production ceiling and
license on production
Source: (Created by the Author)

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Answer 9
(a) 70 units of the good will be produced by the firm to meet the objective of profit
maximization at price $8.
(b) Average cost of the firm is $6 at the given value of output.
(c) $6 is average cost and price is $8 and 70 units of the good is produced. Therefore, cost for 70
units is $(6x70) or $420 and revenue gained from selling all units is $(8x70) or $560. Therefore,
$140 is the supernormal profit that the firm earned.
(d) At price $5, the firm will manufacture 50 units of the product to meet the objective of profit
maximization.
(e) At price $5, the firm is in perfectly competitive equilibrium because price equals the average
cost and marginal cost at the point of operation and thus the firm does not earn supernormal
profit.
(f) Price $4 is below average cost and thus there is no profit earned by the firm at this point.
However, the firm produces 40 units to minimize loss.
(g) The price is below average cost and thus the firm not even able to cover its entire cost.
Therefore, at the give price the firm is making loss.
(h) The firm will shut down in the short run if price of product is lower than average variable
cost.
(i) The firm will shut down in the long run if price is below average cost.

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References
Havranek, T., & Kokes, O. (2015). Income elasticity of gasoline demand: A meta-
analysis. Energy Economics, 47, 77-86.
Lee, S., Meier, H. H., & Lee, P. J. (2018). Tackling environmental pollution in Seoul, South
Korea through tax incentives and related strategies. Innovation Addressing Climate
Change Challenges, 20, 127.
Miller, M., & Alberini, A. (2016). Sensitivity of price elasticity of demand to aggregation,
unobserved heterogeneity, price trends, and price endogeneity: Evidence from US
Data. Energy Policy, 97, 235-249.
Niyato, D., Lu, X., Wang, P., Kim, D. I., & Han, Z. (2016). Economics of Internet of Things: An
information market approach. IEEE Wireless Communications, 23(4), 136-145.