Economics Assignment: Analysis of Economic Concepts and Theories

This economics assignment presents solutions to seven short-answer questions/problems, each worth 5% for a total of 35%. The assignment covers modules 2, 3, 4, and 5, and includes topics such as marginal cost, monopoly, economies of scale and scope, and the Nash equilibrium. The questions cover areas such as cost considerations in production, profitability in different market structures, the impact of economic policies on industries like airlines, and the effects of currency fluctuations on sectors like tourism and higher education. The assignment also includes the application of game theory, specifically the prisoner's dilemma and Pareto optimality, and the impact of asymmetric information in the medical insurance market.

Running head: ECONOMICS ASSIGNMENT
Economics Assignment
Name of the Student
Name of the University
Author note
Course ID

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Answer 1
Answer a
Producers of a good needs to consider the marginal cost of production to take production
decision of additional units. Marginal cost is change in total cost for unit change in output. The
creation of the system involves a trial and error process that costs $30,000. This is considered as
a fixed cost. Labor and raw materials on the other hand are the variable cost of production
(Sloman and Jones 2017). In production of additional units, there is no change in cost. Carl
therefore should consider only the variable cost that is cost of labor and raw material.
Answer b
A loss making firm continues production only when price is though lower than total
average cost but is above the average variable cost. Carl is thus considering average variable cost
and hence, agrees to produce even at the loss. Manager on the other hand might be considering
the total production cost that involves fixed cost that the cost associated with making the system
as well (Cowell 2018). This is the reason why the manger enraged and asks Carl why he wanted
to produce at a loss.
References
Cowell, F., 2018. Microeconomics: principles and analysis. Oxford University Press.
Sloman, J. and Jones, E., 2017. Essential Economics for Business. Pearson.

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Answer 2
Answer a
After approval of patent protection, the patent holder enjoys a monopoly position in the
market. The approved patent prevents close substitute to enter the market. Being the single seller
in the market, the firm then can command over price and quantity in the market. The monopolist
firm can then enjoy a higher profit over a longer time horizon (Cowen and Tabarrok 2015). The
monopolistic market structure prevails till the expiry of patents. The figure below shows
profitability of pharmaceutical firms in US after approval and prior to patent expiration.
Figure 1: Profitability under monopoly
In the above figure, demand or average revenue curve is shown by the downward sloping
line DD. Equilibrium point is at E, corresponds to the intersection of marginal revenue and
marginal cost. The equilibrium point sets price and quantity as P* and Q* respectively. As price

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far exceeds the average cost of production firms earn a considerable higher profit denoted by the
area P*KHN.
Answer b
Prior to patent expiry, patent holding producer enjoys a monopoly position. This enables
the firm to enjoy a supernormal profit even in the long run. However, after expiry approval
suppliers of generic drugs started to enter the market. This eliminates the super normal profits in
the market. With availability of close substitute, the market then becomes a monopolistically
competitive market (Mankiw 2014). These new firms continue to enter the market unless profit
drives to zero. The expiry of patent thus reduces profitability of the industry by allowing entry of
generic drugs.
Figure 2: Industry profitability after patent expiry
References
Cowen, T. and Tabarrok, A., 2015. Modern principles of microeconomics. Macmillan
International Higher Education.
Mankiw, N.G., 2014. Essentials of economics. Cengage learning.

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Answer 3
Answer a
Economies of scale in Airline industries
Figure 3: Economies of Scale
Economies of scale in microeconomics refers to the cost benefits that firms enjoy over
large scale production. In the presence of economies of scale, unit cost of production reduces
with increase in output. Airline industry enjoys considerable opportunities for economies of scale
in different aspect. For example, with the aim of reducing production cost the airline companies
outsource several activities. By outsourcing, companies reduce associated cost of subcontractors.
Today, airlines have employees spread around the world especially in areas where benefits and
salaries are relatively lower. The marketing function of airlines also constitute considerable
economies of scale. Most airlines today design trips that comprise both local and international
courses (Kleymann and Seristo 2017). Alliances between major airlines switched the functions
of regional and international companies. Airlines further enjoy cost advantage by using high end
technologies that minimize cost. An improved technology for engine help to save energy cost.
Better logistic and efficient route planning are other ways of reducing cost.

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Answer b
Economies of scope
Figure 4: Economies of Scope
Economies of scope refers the opportunity of a decline in average cost of a company
when it produces an increasing variety of different goods. It actually gives a company
opportunity to produce complementary goods. Consider for example, a company that is a leading
producer of desktop computer. Suppose, the company decides to expand its product line with
remodeling its manufacturing and produces different electronic devices like phones, tablets and
laptop (Carlton and Perloff 2015). As the operating relating to manufacturing building spread
across variety of products, average cost of production reduces. The cost of manufacturing
electronic items in a separate building is thus larger than producing multiple items in a single
building.
References
Carlton, D.W. and Perloff, J.M., 2015. Modern industrial organization. Pearson Higher Ed.

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Kleymann, B. and Seristö, H., 2017. Managing strategic airline alliances. Routledge.
Answer 4
Source of economic profit of Qantas
This year, Qantas recorded a 15 percent hike in its annual profit. The accounted full year
net profit of Qantas after tax payment has increased to $980 million as compared to $852 million
in the previous year. The resulted profit was based on increase in billion-dollar revenue. Profit
has increased despite an increase in fuel prices. The company has experienced a healthy demand
as generated from key sectors of the economy. The increased demand helped to match capacity
of the company (Janda 2018). This provided a positive sign for the company in future. The
higher oil price though significantly raises Company’s cost this has been tackled by a range of
developments in capacity, company’s revenue and other cost effective measures.
Strategies adapted by Qantas to achieve success
The success of Qantas has been followed from implementation of a number of strategies.
The airline industry has an oligopoly structure that is dominated by a few large firms. In such an
industry, firms need to reduce its cost to maintain competitive position and a higher profit share.
The first step of the company towards achieving a higher profit is a significant reduction in the
cost of operation. The company continued its cost cutting attempt till 2012 by restructuring the
engineering operation. This though left many employees jobless but made considerable
contribution in decreasing remuneration cost. Qantas has rapidly transformed its structure and
appeared as a new Qantas by reallocating resources, lining its infrastructure along with efficient
utilization of resources (Theconversation.com 2018). Qantas has also attempted to increase its

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customers’ base by improving part of its fleet to a wide body and offered various attractive
schemes for frequent flyers.
References
Janda, M., 2018. Qantas profit soars even as fuel costs rise. [online] ABC News. Available at:
http://www.abc.net.au/news/2018-08-23/qantas-profit-soars-even-as-fuel-costs-set-to-rise/
10155252 [Accessed 23 Sep. 2018].
Theconversation.com, 2018. Modest profit jump puts spring in Qantas step. [online] The
Conversation. Available at: https://theconversation.com/modest-profit-jump-puts-spring-in-
qantas-step-17675 [Accessed 23 Sep. 2018].
Answer 5
Weak Aussie dollar and impact on tourism sector
Figure 5: Demand, Supply and exchange rate

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The declining demand for Australian dollar reduces inflow of foreign currency in
Australia. The shortage of foreign currency lowers the price of Australian dollar relative to US or
other currency
Relative price of a currency affects different economic sectors of a nation. Since the
middle of 2015, Australian dollar recorded a sharp fall in its value as against US dollar. The
weak dollar has benefited tourism industry of Australia. With relatively small value of currency,
everyone is trying to visit Australia as trips get cheaper. There is an increasing demand of
Australian vacation among both foreign and local travelers. Number of international tourists visit
in Australia has increased by 2% with the number reaching to 620,000. In contrast, the number
of Australian tourists visit overseas declined by 0.7 percent (Mercer 2018). Australia is
experiencing high number of overseas arrival in the short run. Fewer Australians are now
interested to go outside because of weaker currency. Domestic trip on the other hand become
cheaper for them.
Weak Aussie dollar and impact on higher education sector
The higher education sector of Australia has welcomed weak Aussie dollar. For
international student coming for studying in Australia experienced a significant decline in
studying cost in the country. The international educators have stated that any fall in the exchange
rate significantly influences competitiveness of Australian educators. The chief executive of
universities of Australia suggested that drop in Australian dollar makes studying in a world class
university of Australia more affordable. Studies reveled that previously 51 percent of the
international students are satisfied with the living cost in Australia. Following weak Australian
dollar, the percent of satisfied students increased to 87 with overall experience. There are now 88
percent students who are satisfied with the support service (Cahill and Taft 2017). Lower Aussie

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dollar impacted some specific sector more compared to other. International students of higher
education often ignore fluctuations in relative price of currencies as they considered studying
abroad as a long run investment to achieve a better future and career path.
References
Cahill, D. and Taft, R., 2017. Education of immigrants in Australia. In Educating
immigrants (pp. 16-46). Routledge.
Mercer, P., 2018. Aussie dollar decline boosts tourism. [online] BBC News. Available at:
https://www.bbc.com/news/business-34504003 [Accessed 23 Sep. 2018].
Answer 6
Nash equilibrium
Nash equilibrium is game theoretic concept where optimal outcome in the game is
determined corresponding to the strategies where no players have any incentive to make any
deviation from their chosen strategies. Specifically, the concept of Nash Equilibrium in game
theory is that optimal outcome is achieved at the point where neither of the player has any
incentive to deviate from the chosen strategy given choice of strategy of opponent (Telser 2017).
Individual player here receives no added benefits from changing the action given strategy of
other players remain constant. Every players win from this situation as they receive the desired
outcome.

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Figure 6: Nash equilibrium
The above graph explains the concept of Nash equilibrium. The payoff to player 1 and
player 2 are measured in the horizontal and vertical axis respectively. BR1 and BR2 indicate the
best response function of player 1and player 2 respectively. Nash equilibrium occurs where best
response functions of both the player coincide. Nash equilibrium in occurred corresponding to
point E.
Nash equilibrium in prisoner’s dilemma and Pareto optimality
Pareto optimality refers to a state of resource allocation where it is not possible to
relocate the resources that can make an individual better off without affecting preference
criterion or reducing welfare of any other individual in the economy.

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Figure 7: Pareto optimality
Prisoner’s dilemma is a commonly used example in game theory showing two rational
individual chose to non-cooperation even when it gives them a higher outcome. The game is
designed in such a way that cooperation offers both of them relatively small period of
imprisonment. Fearing betrayal from both chose non-cooperation and end with a longer period of
imprisonment. No state is considered as Pareto optimal if one player can get a higher pay off
without lowering payoff to others (Waldman and Jensen 2016). In case of prisoner’s dilemma, by
choosing cooperation both the player can receive a higher payoff. The obtained Nash
Equilibrium is thus not Pareto efficient.
References
Telser, L.G., 2017. Competition, collusion, and game theory. Routledge.
Waldman, D. and Jensen, E., 2016. Industrial organization: theory and practice. Routledge.
Answer 7

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Answer a
Asymmetric information and medical insurance
In the insurance market asymmetric information occurs as a sick person has more
information regarding the medical needs. Sicker consumers tend to pay more price anticipating
higher medical costs. Insurance providers attempt to screen customer in order to eliminate users
of high medical cares (Billett, Garfinkel and Yu 2017). Based on this, they tend to set the limit
for coverage as well as insurance premium to cover the financial risk. With no transparency in
the distribution of information the insurance market distorted many of the healthy consumers
leave the market because of high insurance premium. One example of information asymmetry in
the health insurance market is the US insurance market. Because of asymmetry information in
health system, US faces huge burden of administrative expense in health care market, large
number of uninsured people and incapability of many US residents to afford the needed health
care.
Answer b
Asymmetric information and market for used car
In the market for used cars, some are of good quality and some are lemons or of bad
quality. In times of selling, sellers know the actual condition of the car. For a prospective buyer,
quality of cars is not known clearly. The only know some cars in the market are good while
others are lemon. This leads to the problem of asymmetric information in the market between
buyers and car sellers in the market. Seller in turn has the inside information which distorts the
market transaction. The goods car cost higher than lemons. The good cars in the market worth
$10,000 while lemons worth exactly half of that. The expected value of a car thus is (10000*0.5)
+ (5000*0.5) = 7500. Buyers would not pay any more than 7500 or rather less. The sellers of

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good cars thus leave the market and only lemons are left (Lotfi et al. 2015). This results in a
market failure as bad cars are sold at the same price as the good one because of asymmetric
information.
References
Billett, M.T., Garfinkel, J.A. and Yu, M., 2017. The effect of asymmetric information on product
market outcomes. Journal of Financial Economics, 123(2), pp.357-376.
Lotfi, F., Gorji, H.A., Mahdavi, G. and Hadian, M., 2015. Asymmetric information in Iranian’s
health insurance market: Testing of adverse selection and moral hazard. Global journal of health
science, 7(6), p.146.