Macroeconomics Assignment: Analyzing Economic Concepts and Theories

This macroeconomics assignment solution addresses key economic concepts, starting with an analysis of demand curves and factors influencing shifts. It then delves into price elasticity of demand, calculating it for a specific scenario and classifying its nature. The assignment further explores different market structures (perfect competition, monopolistic competition, oligopoly, and monopoly), their characteristics, and barriers to entry. It also examines social costs and benefits, externalities (positive and negative), and their impact on economic welfare. The solution then describes the phases of the business cycle, including expansion, peak, recession, trough, and recovery, and differentiates between positive and negative output gaps. Finally, it covers the components of aggregate demand and the determinants of investment in an economy. This assignment offers a comprehensive overview of core macroeconomic principles.

Macroeconomics
Macroeconomics
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Macroeconomics
Q1 (a)
Demand curve for cars will shift towards right side in case of increase in its demand.
Increase in demands is a type of situation when the demand of the product starts increasing at the
given price or the demand of the product remain constant even when its price increases because
of certain changes in factors other than price if the good.( Frank, 2014)
The reasons related to the shift of demand curve for car towards the right side includes
(a) Income of the customer may rise.
(b) The price of the substitute goods may rise.
(c) Prices of complementary goods may reduce.
(d) Taste of the customer regarding the product may increase.
(b) The rightward shift in the demand curve of the price of cars is shown by the following
supply demand diagram
The causes of the rightward shift in the demand curve are as follows:
 Rise in the income of the consumer.
 Substitute’s price may rise. For example, if Tata increases the prices of its car then other
companies manufacturing similar segments of car will find and increase in the demands.
 Prices of complimentary goods may fall. For example, if the price of petrol and diesel
goes down then automatically the demand of car will increase.
Q2 (a)
Price Elasticity of Demand (PED or η) is a technique or a method used in Economics in
order to calculate the responsiveness or the elasticity related to the quantity demanded of the
good or any other service according to change in its price. This technique provides the change in
percentage of the quantity demanded with respect to the change in price.
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Macroeconomics
Price elasticity related to goods other than Giffen goods are negative as Giffen goods has
positive Price elasticity of demand. It is said to be inelastic in case the value of PED is less than
one which represents lesser changes in the quantity of the good that is demanded in comparison
to the changes in price and vice versa in case of elastic goods.
Demand of a group is calculated as:
(b) Percentage rise in the price of ice cream = 40%
Fall in quantity demanded = 20%
Hence, the price elasticity of ice cream is calculated as:
η = %change in quantity/ % change in price
= (-20%)/40%
=0.5
Hence, since the elasticity is less than one it is inelastic in nature.
The negative sign represents that a larger change in the quantity demanded will occur
corresponding to the change in its price.
Q3 (a)
There are four different types of market structure under which a firm operates in the
market and they are:
 Perfect Competition: It the market structure which maximizes the efficiency according
to the total surplus generated. In this type of market Advertising does not exist as
products are identical and the firms produce their goods at minimum average cost.
 Monopolistic competition: It is the market in which in which differentiated products are
available which provides the customer with more choices as compared to perfect
competition. This market has lesser efficiency due to higher pricing and lesser total
output.
 Oligopoly: In this type of market structure small number of firms contains or holds
majority of the market share. This model is similar to monopoly but here in case of one
single firm, two or three firms dominate the market.
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Macroeconomics
 Monopoly: It is the market structure where one company provides the goods or services
to the customers. In this model the company has the rights to control the output, increase
its price and enjoy extra profits. This model is a theoretical concept ( Bowen, W.G. and
Sosa, 2014).
The characteristics of these market structure is defined in the following table :
MARKET
STRUCTUR
E
NUMBE
R OF
FIRMS
TYPE OF
PRODUCT
ENTRY
INTO
INDUSTR
Y
FIRM'S
INFLUENCE
OVER PRICE
EXAMPLES
PERFECT
COMPETITION
MANY IDENTICAL EASY NONE AGRICULTURA
L
CROPS
MONOPOLISTI
C
COMPETITION
MANY DIFFERENTIATED EASY MODERATE
MANY LOCAL
RETAIL
OUTLETS
OLIGOPOLY FEW EITHER
DIFFERENTIATE
D OR IDENTICAL
DIFFICULT BETWEEN MODERATE
AND SUBSTANTIAL
AUTOMAKERS
MONOPOLY ONE UNIQUE IMPOSSIBLE SUBSTANTIAL LOCAL UTILITY
(b) The different types of barriers that may arise for any firm to enter in the market includes:
 Government Regulation: government to sometimes act as a barrier in certain markets by
using restrictive licensing requirements or by limiting the accessibility over the raw
materials.
 Start-Up Costs: higher cost for starting the business can also keep the new firms to enter
the market.
 Technology: technology also acts as a barrier as the technology needed to enter a
particular field may be patented by someone else.
 Product Differentiation: it is one of the methods of barriers as in case of strong brand
recognition or because of network effect or due to great customer services, the customer
start perceiving the product of superior quality resulting in difficulties for new firms
(Case and Fair, 2007).
 Distribution Channels and Access to Suppliers: in case if the firm is not able to gain
access to the raw materials, then this situation also represents as a barrier.
Q4 (a)
Social cost refers to the total cost to that the society has to pay because of the production
or consumption of a particular good. Social cost includes both the external cost as well as the
private cost that arises from the production or consumption of a particular good. For example, if
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Macroeconomics
anyone smokes, the private cost for a packet of cigarettes will be around £6 but the external cost
that the society would pay will include (Mishan and Quah, 2007).
 The risk of passive smoking along with air pollution.
 Litters that are left portion of cigarettes.
 Other health cost.
The social cost related to smoking includes both the private and the external cost.
Social benefits refer to the total benefit gained by the society from the production and
consumption of a particular good or service. Just like social cost, social benefits also include
both the private and the external benefits of production/consumption. For example, if we opt
cycling for going to work, the private benefits include
 Lower cost related to driving.
 Health benefits.
But, the external benefits related to it includes
 Other road users will have lower congestion.
 Lower level of pollution.
 Lower health care cost because of better health.
(b) Externalities refer to the difference between the social and private benefits or the cost.
Externalities can be negative (it includes the external costs) or positive (it includes the external
benefits).
Externalities are mainly of four types, positive and negative externality in case of both
consumption and production.
 Positive Externality in Consumption: it refers to the positive aspects of the consumption
of a particular good or service. For example, vaccinations as the welfare of a person not
only depends on whether the person is vaccinated, but it also depends on its neighbors as
if they are vaccinated in order to avoid contagious diseases to spread (Cordato, 2013).
 Negative Externality in Consumption: it refers to the negative aspects of the consumption
of a particular good or service. For example, the welfare of a person not just only depends
on avoiding a ride of a noisy motor bike but also depends on the people living in its
neighborhood to avoid doing the same thing.
 Positive Externality in Production: it refers to the positive aspects of the production of a
particular good or service. For example, production of honey has the beekeepers try to
keep their beehives close to farms as nectar from the plants helps in increasing the
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Macroeconomics
production of honey while on the other hand bees helps the farmer by pollination of the
plants.
 Negative Externality in Production: it refers to the negative aspects of the production of a
particular good or service. For example, production of paper from paper mills as they
dump the waste in the rivers which affects both the fishes the residents living by the
riverside (Turnovsky and Monteiro, 2007).
Q5 (a)
Business cycle refers to the fluctuations in the economy regarding trade, production and
general economic activities.
The different phases of business cycles are:
The phases in the business cycle are basically of two types which are the prosperity phase and
the depression phase while phases like peak, recovery, trough and expansion are intermediate
phases (Woodford, 2009).
The above diagram represents the different phases of a business cycle in graphical form.
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Macroeconomics
The different phases of a business cycle are:
1. Expansion: in this phase the line of cycle starts moving above the steady growth line. It is
the phase where the firms start producing more goods and services ( Hall, R.E and
Lieberman, 2012).
2. Peak: the process of expansion eventually slows down and reaches its highest position
which is known as peak.
3. Recession: during the peak phase there is some gradual decline in the demand for a
particular product because of increase in the prices. The phase is said to be in recession
when this decline in the products demands become rapid and steady.
4. Trough: all the countries economic activities declines below the normal level in case of
trough as it represents the lowest point in the graph where the economy shrinks
5. Recovery: after the economy has shrined to its lowest level it again starts being positive
which results in reversal of business cycle process and this phase is known as the
recovery phase.
(b)
Negative output gap is said to occur when the level of actual GDP is lower than the potential
GDP. In the above graph the line of curve between the depression section represents the negative
gap as in this phase the demand of the good or services keeps on decreasing and the company
will face a situation of loss (Sherman, 2014).
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Macroeconomics
Positive output gap is said to occur when the level of actual GDP is higher than the potential
GDP. The phase between the prosperity sections represents the positive gap as in this phase the
demand of the product again starts increasing and reaches its peak value.
Q6 (a)
The main components of aggregate demand are :
 Consumption (C): it is mainly the household section and in some cases consumption
accounts the larger part of Aggregate demand.
 Investment (I): it refers to the spending done by the companies on capital rather than
households.
 Government Spending (G): it forms a larger section of aggregate demand, it
incorporates capital spending and transfer payments by the government.
 Net Exports (X-M): it refers to the difference between imported goods and exported
goods.
AD = C + I + G + (X-M)
(b) The major determinants of investment in the economy are:
 Interest Rates: if the interest rates are higher it results in higher investments by the firms,
which shows an inversely proportional relationship between investment and interest rates.
Hence firms tend to reduce investment in case of higher rates. For example: the
investment demand curve of a firm
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Macroeconomics
 Expectations: if the firm finds better returns in the future then the firm increases the
investment and the investment demand curve shifts in the right direction.
 The Level of Economic Activity: any firm requires capital to produce certain goods and
services. If the demand of the of the product or services increases then the firm needs to
increase the level of production resulting in increase in the investment. Thus, the
investment demand curve shifts to its right side when there is increase in the GDP (Harris
and Goodwin, 2009).
 The Cost of Capital Goods: the demand curve for investment shows the amount or the
quantity invested at each level of interest rates. Hence if there is any change in the
variable that is kept constant in order to draw the curve will lead to change in the curve.
 Other important determinants include capacity utilization, the stock of capital,
technological changes, other cost factors, and public policies.
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Macroeconomics
References:
Frank, R., 2014. Microeconomics and behavior. McGraw-Hill Higher Education.
Case, K.E. and Fair, R.C., 2007. Principles of microeconomics. Pearson Education.
Hall, R.E. and Lieberman, M., 2012. Microeconomics: Principles and applications. Cengage
Learning.
Bowen, W.G. and Sosa, J.A., 2014. Prospects for faculty in the arts and sciences: A study of
factors affecting demand and supply, 1987 to 2012. Princeton University Press.
Woodford, M., 2009. Convergence in macroeconomics: elements of the new
synthesis. American economic journal: macroeconomics, 1(1), pp.267-279.
Sherman, H.J., 2014. The business cycle: growth and crisis under capitalism. Princeton
University Press.
Mishan, E.J. and Quah, E., 2007. Cost-benefit analysis. Routledge.
Cordato, R., 2013. Welfare economics and externalities in an open ended universe: A Modern
Austrian Perspective. Springer Science & Business Media.
Turnovsky, S.J. and Monteiro, G., 2007. Consumption externalities, production externalities, and
efficient capital accumulation under time non-separable preferences. European Economic
Review, 51(2), pp.479-504.
Harris, J. and Goodwin, N.R., 2009. Twenty-First Century Macroeconomics. Edward Elgar
Publishing.
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