AC4UK40O Introduction to Economics: Elasticity, Revenue & Profit

This economics assignment delves into various concepts, starting with the calculation and interpretation of price elasticity of demand for different consumer groups and its impact on total revenue. It further explores cross-price elasticity, identifying substitute and complementary goods, and quantifying the effect of price changes on related products. The assignment also examines the impact of supply shocks, such as an earthquake affecting semiconductor chip production, on market prices and firm revenues under varying demand elasticities. Finally, it discusses profit maximization conditions for firms in competitive and monopolistic markets, the unsustainability of abnormal profits in perfectly competitive markets, and strategic pricing choices using game theory concepts like maximin and maximax strategies, within the context of a prisoner's dilemma.

ASSESSMENT BRIEF
INTRODUCTION TO
ECONOMICS

Question 1
a. Ped for Group A & B
For Group A = Percentage Δ in Q demanded in Group A / Percentage change in price
Q0 = Sales prior to discount
Q1 = Sales after allowing for discount
% Δ in Q demanded by Group A = Q1 - Q0 / [Q1 + Q0 / 2]
Q1 = 1.70 million
Q0 = 1.60 million
% Δ in quantity demanded = 1.70 – 1.60 / [1.70 + 1.60 / 2] = 0.1 / 1.65 = 6.06%
% Δ in price = 10% discount
Ped for Group A = 6.06% / 10% = 0.60.
Similarly, Ped for Group B = % Δ in quantity demanded by Group B / % Δ in price
Percentage change in quantity demanded by Group B = Q1 - Q0 / [Q1 + Q0 / 2]
Q1 = 1.75 million
Q0 = 1.55 million
% change in quantity demanded = 1.75 – 1.55 / [1.75 + 1.55 / 2] = 0.2 / 1.65 = 12.12%
% Δ in price = 10% (given)
Ped for group B = 12.12% / 10% = 1.21.
b. Effect of discount over total revenue resulting from each group
In case of group A, as the Ped is 0.6 that is, less than 1 which indicates that the demand is
inelastic. Therefore, with the provision of 10% discount on the sales of book will lead to the
decrease in the total revenue derived by Bookworm.com. On the other hand, in case of Group
B, as the Ped comes out as 1.21 that is, greater than 1 which shows that the demand in elastic.
Accordingly, with the provision of 10% discount on the book sold by Bookworm.com will
result in the increase in total revenue derived by the seller.

c. Bookworm.com on knowing that from which group the customer is belonging to and have
an option to offer or not to offer 10% discount and it is given that the book seller wants to
enhance its total revenue, then definitely it would provide discount to Group B & not A. This
is because with the provision of discount to group A, total revenue would decrease while in
case of group B, total revenue would increase.
Question 2
a. Cross Ped refers to the % change in Qd of one good as a result of % Δ in price of another
good. With regards to sign of cross Ped, a positive sign indicates that the two goods for which
the elasticities have been determined are substitute goods where a rise or fall in price of one
good resulted in rise or fall in quantity demanded of its close substitute. It implies that there is
a direct relationship between the goods that are substitutes. On the other hand, a negative sign
indicates that the two goods for which the elasticity of demand has been determined are
complementary goods where a rise or fall in price of one good leads to the fall or rise in the
quantity demanded of its complements. It implies that there is an inverse relationship between
the two goods that complements.
From the table given in question, Airconditioning units & Kilowatts of electricity and
high fuel consuming SUVs & gasoline are complementary goods as the cross- Ped in their
case is negative. On the other hand, Coke & Pepsi, McDonald’s burger & Burger king’s
burger and Butter & margarine are substitute goods because the cross - Ped in their case is
positive.
b. The cross - Ped being larger (and positive as well) indicates that two goods under
consideration are very close substitute of each other. For instance, the cross - Ped of butter and
margarine is higher than the cross - Ped of McDonald’s burger & burger King’s burger (Curtis
Jr, 2018). This indicates that the former are closer substitutes of each other as compared to
the substitutability of the latter. Again, the cross Ped being greater (and negative as well)
indicates that the two goods under consideration are strong complements of each other. For
instance, the cross – Ped of Airconditioning units & kilowatts of electricity is greater than the
cross – Ped of SUVs & gasoline. This shows that the former are strong complements of each
other than the latter.
c. On the basis of information given in the table, it has been implied that the cross – Ped
between Coke & Pepsi is 0.68 which implies that when there would be 1% rise in the price of
Pepsi, the Qd of Coke would get increased by 0.68%. Accordingly, if the price of Pepsi

would rise by 10%, then there would be 10 times increase in the quantity demanded of Coke
which can be determined as follows:
Increase in Qd of Coke with 10% increase in the price of Pepsi = 0.68% * 10 = 6.8%.
d. The information in the table indicate that the cross – Ped between SUVs and gasoline is -
0.33 which implies that a 1% fall in the price of gasoline would result in increase in the Qd of
SUVs by 0.33%. Accordingly, with the fall in the price of gasoline by 5%, the Qd of SUVs
would get increase to the extent of 5 times of the cross – Ped which can be determined as
follows:
Increase in the Qd of SUVs with 5% fall in the price of Gasoline = 0.33% * 5 = 1.65%.
Question 3
a. With the occurrence of earthquake, the supply would get significantly reduced because
Taiwan was considered as the major supplier of semiconductor chips in the world market.
This would create a gap between supply and demand where supply being less than the
demand in the market leading to increase in the prices of semiconductor chips (Newbery,
2019). With the rise in price, the total revenue would increase for the non – Taiwanese firms.
Accordingly, the price effect would exceed the quantity effect which means that the demand
must be inelastic in this case. The following diagram shows how the shift in supply curve to
the leftward has resulted in reduction in the total revenue as a result of quantity effect
depicted through area A. Also, it has been shown that how the gain in TR resulting from the
price effect has (depicted through area B) outweigh the quantity effect.
Figure 1: Price effect and quantity effect on total revenue for a semiconductor chips market

b. In the condition where the supply has reduced due to the occurrence of earthquake in the
region who is considered as the major supplier of semiconductor chips that is Taiwan. The
reduction is supply keeping the demand unchanged means the supply being less than the
demand resulted in competition among the buyers which would lead to increase in the prices
of semiconductor chips for Non – Taiwanese firms (Kamionka, 2021). However, with the
increase in the prices of semi conductor chips, the total revenue of these firms is falling
indicates that the quantity effect must be outweighing the price effect. This indicates that the
demand for semi conductor chip must be elastic. Price effects are resulted in rise in total
revenue while quantity effects are resulted in fall in total revenue. In the diagram below, it
can be seen that with the leftward shift of supply curve, it leads to reduction in the TR to the
extent of the amount of quantity effect along with rising to the extent of the amount of price
effect. However, quantity effect being higher than price effect leads to reduction in TR.
Figure 2: Price effect and quantity effect on total revenue for a semiconductor chips market
Question 4
a. Profit maximizing condition
As per the rule of profit maximization, a firm attempt to choose to produce that quantity
where the MC equates the MR and after that point, MCC seems to be rising. In other words,
firms attempt to maximise its profit by opting to produce the level of output at which the MC
& MR are equal (Aditia, 2019). This is true in case of both perfectly competitive firm and
monopolistic firm. If lower quantity of output is being produced because the MR is greater
than MC leading to higher profits, then the firm would not be able to expand its output by
fully utilising the available capacity. A condition of MR > MC implies that firm can expand
its output for getting higher profits.

Figure 3: Profit maximizing condition of perfectly competitive firm
In the above figure, Q indicates profit maximizing output level because at this point MR is
equal to the MC and after that MCC is rising.
Figure 4: Profit maximizing condition of monopolistic firm
In the above figure, Q2 is the profit maximizing output level because at this point the MC is
equal to the MR & MCC is rising after this point. Also, Q1 indicates that the MC & MR is
equal, but firm in an attempt of get higher profits would operate at Q2 because it would
allows it to produce greater quantity than Q1.
b. In economic, abnormal profits refers to the excess or supernormal profit obtained by a firm
which over & above of what the owner has expected in terms of normal return to capital.

They are deemed as unsustainable because they create stimulation for new supply which in
turn leads to forceful reduction in prices and accordingly, the abnormal profit swiped off the
market. Existence of abnormal profit is possible in the long run only in case of imperfectly
competitive market where have successfully choked the entry of new firms in the market.
Below figure shows the supernormal profit opportunities for the firms in perfectly
competitive market.
In the above figure, the AR – AC * Q2 is equivalent to the abnormal profit. This could
become possible because of rise in demand leading to rise in prices and accordingly, a firm is
able to make supernormal profit in the short run which means excess profit than what is
minimum return required to keep business functioning.
It is known that there are no barriers to enter the perfectly competitive market and other firms
on getting aware of the fact of abnormal profits would definitely get encouraged to enter this
market leading to rise in supply and forceful reduction in the prices (Kurniawati, 2019). In
the above figure, the price would shift back to P1 with the rise in supply keeping the demand
constant. Accordingly, the abnormal profit would be swiped off from the market leading to
all firms making normal profits in the long run where the equilibrium between demand and
supply curve would set in at P1 price level and Q1 quantity. In this way, adjustment process
took place from short run supernormal profit to long run equilibrium in a market that is
considered to be perfectly competitive.

Figure 5: long run equilibrium in a perfectly competitive market
c. Being the pricing manager at Firm A, the strategic choices would be as follows:
1. Maximin strategy
Lower payoff while going for price £2 = £22000
Lower payoff while going for price £1 = £12000
Maximum of the above two is £22000, which is the required payoff for the maximin strategy.
2. Maximax strategy
Higher payoff while going for price £2 = £26000
Higher payoff while going for price £1 = £14000
Maximum of the above two is £26000, which is the required payoff for the Maximax
strategy.
3. Within the given prisoner’s dilemma, no dominant strategy exists for any of the two firms
as the optimal choice for both the firm is to go for lower price of £1 to enhance their
respective payoffs.

REFERENCES
Kurniawati, T., 2019. Improving students’ higher order-thinking skills through problem-
based learning in introduction to microeconomics course. KnE Social Sciences, pp.9-
20.
Aditia, R., 2019, November. The Development of Learning Material of Hybrid Learnings
Based to Improve Students Learning Outcomes of Introduction to Microeconomics.
In Journal of Physics: Conference Series (Vol. 1387, No. 1, p. 012148). IOP
Publishing.
Kamionka, T., 2021. Applied microeconomics. Recent advances. Introduction
[Microéconomie Appliquée. Avancées récentes. Introduction] (No. hal-03290104).
Newbery, D., 2019. Imperfect Markets and Imperfect Regulation. An Introduction to the
Microeconomics and Political Economy of Power Markets. Economics of Energy &
Environmental Policy, 8(2), pp.204-208.
Curtis Jr, J., 2018. Economics: A Student Textbook and Professor Manual for University
Instruction of Microeconomics Courses. Scholars' Press.