Microeconomics and Macroeconomics Assignment for Economics Students

This document presents a comprehensive solution to a Microeconomics and Macroeconomics assignment. The assignment addresses four key economic questions. The first question examines the optimal pricing strategy for a pharmaceutical company's new hair growth drug, considering different price elasticities of demand. The second question analyzes the automobile industry, discussing economies of scale and the number of firms sustainable in the long run. The third question explores economic growth, comparing GDP per capita across high, middle, and low-income countries, highlighting the roles of human capital, physical capital, and technology. Finally, the fourth question evaluates the impact of changing the frequency of inflation rate calculation on various biases, including substitution and quality bias. The solution utilizes economic theories and graphical illustrations to provide clear explanations and justifications for the answers.

Running head: MICROECONOMICS AND MACROECNOMICS
Microeconomics and Macroeconomics
Name of the Student
Name of the University
Student ID

1MICROECONOMICS AND MACROECNOMICS
Table of Contents
Answer 1..........................................................................................................................................2
Answer 2..........................................................................................................................................4
Answer 3..........................................................................................................................................5
Answer 4..........................................................................................................................................7
Bibliography....................................................................................................................................9

2MICROECONOMICS AND MACROECNOMICS
Answer 1
The company has invented a drug that helps to grow new hairs and thus it is helpful for
bald men. The objective of the company is to make as much profit as possible by selling these
products. It should be noted that the profit of the company will increase only in the scenario
when the company will be able to sell as many product at high prices. However, it is known as
per the theory of demand that price and demand shares an inversely proportional relationship1. It
means that with rise in price demand of a product falls and alternatively with fall in price
demand rises. There, if the company increase the price of the newly developed product then the
demand of the product might fall. The main parameter for the firm to understand whether to
increase price of the product to gain more profit is to find whether the revenue has increased
after increasing the price or not. This can also be understood from the price elasticity of demand
for the product. It is given that the price elasticity of demand for the product is 1.4 at the present
price. Therefore, it can be inferred from the value that with 1% increase in product price the
demand for the product will decline by 1.4%. The demand for the new product of the company is
thus relatively price elastic. Thus, it is clearly visible that with rise in price the demand for the
product falls more than the proportion of price increase2. Hence, it can be said that revenue of the
company from selling this product falls as the price increases. This phenomenon can be
explained by graphical illustration too. Figure 1 is drawn to explain this phenomenon. In figure
1, P is the current price and Q is the current demand for the new product of the company. Thus,
if the price increase from P to P1 then the quantity demand for the product will fall from Q to Q3.
1 Miller, Mark, and Anna Alberini. "Sensitivity of price elasticity of demand to aggregation,
unobserved heterogeneity, price trends, and price endogeneity: Evidence from US Data." Energy
Policy 97 (2016): 235-249.
2 Zetina, Carlos Armando, Ivan Contreras, and Jean-François Cordeau. "Profit-oriented fixed-
charge network design with elastic demand." Transportation Research Part B:
Methodological 127 (2019): 1-19.
3 Loomis, John B., and Michael H. Thomas. "Pricing and Revenue Capture: Converting
Willingness to Pay into." Object Relations and Intersubjective Theories in the Practice of
Psychotherapy (2019): 255.

3MICROECONOMICS AND MACROECNOMICS
However, it can be noticed from the figure that the fall in demand is greater than the rise in price
and thus it can be concluded that the revenue PQ earned at previous price is greater than the
revenue P1Q1 earned from the current price. Thus, it is suggested that given the price elasticity
of demand the company should not increase its current price.
Figure 1: Elastic demand
Source: (Created by the Author)
In a new scenario if price elasticity of demand for the product is 0.6, then it can be said
that the demand for the product is price inelastic4. It means that the proportion of fall in demand
is lower than the proportion of rise is price of product. That means if the in figure 2 the change in
price from P1 to P2 is greater than the fall in demand from Q1 to Q2. Thus, in this case rising
price will increase revenue and thereby profit.
Figure 2: Demand inelastic
4 Geerolf, François. A Theory of Demand Side Secular Stagnation. UCLA Working Paper.
https://fgeerolf. com/hansen. pdf, 2019.

4MICROECONOMICS AND MACROECNOMICS
Source: (Created by the Author)
. Alternatively, if the price elasticity of demand for the product is 1then it means that the
rise demand is proportionate with the rise in price and thus it is called unit elastic too. In this
case, even with rise or fall in price the revenue stays the same.
Answer 2
The given automobile industry in the question has very high amount of economies of
scale. It means that with if the firms in the industry keep on producing then the average cost for
the automobile will decrease until the lowest point of long run average cost (LRAC) curve is
reached, which is given by Q1 in figure 35. It should be noted that the downward sloping part of
the LRAC depicts the existence of economies of scale. Apart from that, it is given in the question
that there are 4 firms in the industry but the domestic demand for the autos are 2.5 times the total
amount of automobile produced at the minimum point of LRAC6. It has been given that there are
four firms in the industry but it is clearly visible that domestic market demand for autos can be
supplied by three out of four firms in the industry. From this, it can be inferred that there are two
firms in the industry that can produce at their full capacity and one firm with half its capacity due
to lack of demand. On the other hand, the fourth firm would face no demand from the domestic
market and thus shut down and make an exit from the market7. The third firm would keep on
producing an the other two firms would not wage a price war with it because to do so the two
well to do firms have to produce beyond Q1 and they enter into the condition where there is
diseconomies of scale. By diseconomies of scale, it means that more the number of automobile
produced by the firms of the industry more will be the average cost for per unit of the product.
5 Ertan, Aytekin, Stefan Lewellen, and Jacob K. Thomas. "The long-run average cost
puzzle." Available at SSRN 3178202 (2018).
6 Badorf, Florian, et al. "How Supplier Economies of Scale Drive Supplier Selection
Decisions." Journal of Supply Chain Management 55.3 (2019): 45-67.
7 Greenlaw, Steven A., and David Shapiro. "7.5 Costs in the Long Run." Principles of Econ
2e (2017).

5MICROECONOMICS AND MACROECNOMICS
Thus, it is not viable for the successful two firm to push the third from out of the industry8. It is
thus evident that in the long run, there will be three firms in total in the industry, out of which
two will be the firms that are in dominating position and the third one is the struggling one.
Figure 3: Long run average cost
of the automobile industry
Source: (Created by the Author)
Answer 3
The economic growth is
among one of the most important factors that estimates the development status of countries
present in the world. One of the key indicator of economic growth of country is GDP per capita
and every country tries to grow the said factor. Gross domestic product of a country is the total
amount of output produced in the geographical area of the country in a specified period of time.
On the other hand, the GDP per capita can be obtained by dividing the total GDP of a country by
its total population9. Thus, GDP per capita reflects the amount of income generated by each
individual present in the country. It should be noted that growth in GDP per capita depends on
the growth factors of the GDP. The factors are human capital, physical capital and technology.
The factors are also known as factors of aggregate production function. Human capital is the
8 Andrews, Matthew, Spyridon Antonakopoulos, and Lisa Zhang. "Minimum-cost network
design with (dis) economies of scale." SIAM Journal on Computing 45.1 (2016): 49-66.
9 Zambelli, Stefano. "The aggregate production function is NOT neoclassical." Cambridge
Journal of Economics 42.2 (2018): 383-426.

6MICROECONOMICS AND MACROECNOMICS
level of education or skill acquired by the labour force of a country10. The physical capital is the
amount of pure capital that is the capital found in in the form of raw material and machineries
that is available in a country. Finally, the most vital factor is technology on which the industrial,
agricultural or any other sector present in the country. Therefore, it can be inferred that the
country which has more amount of all these three factors will be able to achieve to higher GDP
and thereby higher GDP per capita. However, the importance of these factors vary with different
types of countries11. Countries can be categorized into three types and they are high income
country, middle income country and low income country. In the question, Australia is the high
income country, India is the middle income country and Afghanistan is the low income country.
Figure 4: Aggregate production function
for low, medium and high income
countries
Source: (Created by the Author)
In figure 4, the aggregate production
function of the concerned three categories of countries have been given. APF1 shows the
aggregate production function of high income country Australia. On the other hand, APF2
depicts the aggregate production function for middle income country India and low income
country Afghanistan. APF1 is higher than APF2 because of the technology gap between
Australia and the other two countries. Now, in case of Australia output per capita and capital
(both physical and human capital) has reached the steady state and thus to increase the GDP per
10 Munro, Colin W. Clarkand Gordon R. "The Economics of Fishing and Modern Capital Theory:
A Simplified Approach1." Fisheries Economics, Volume I: Collected Essays (2019): 46
11 Harris, Matthew, et al. "Explicit bias toward high-income-country research: a randomized,
blinded, crossover experiment of English clinicians." Health Affairs 36.11 (2017): 1997-2004

7MICROECONOMICS AND MACROECNOMICS
capita the country requires new technology12. Thus, the aggregate production function factor
important for increasing GDP per capita of Australia is technology. In the case of India and
Afghanistan both of the physical and human capital has not reached the steady state stock. Thus,
in order to bring about the growth in GDP per capita of both the countries development of all the
factors are required that is physical capital, human capital and technology.
Answer 4
The calculation of inflation rate in country is done by the government statisticians. The
inflation rate is derived based on a basic basket of goods13. This basic basket of goods is revised
every 10 years. However, the government statisticians has decided to revise the basic basket
every 5 years from now. It can be said that there will be change in inflation rate reflection due to
change of this basket revising decision14. The statisticians if calculate the inflation rate based on
the 10 years basket revision policy then it can be found that the reflection of inflation rate for
many product will be very high for certain products in comparison to the revision policy of
basket every 5 years. This would definitely impact the substitution bias of consumers. It has been
seen that customers tend to switch to substitute products which depicts high inflation in price15.
Therefore, if shorter period considered then it is possible that the inflation of price of the
substituted product is lower than the product with which the substitution is made. Therefore, it
can be said that if the basic basket of goods is revised every 5 years then it will impact the
substitution bias and as a result, the bias will reduce. Additionally, considering the quality bias
12 Thompson, Jamal Alexander. "Information Communication Technology Management as a
GDP Growth Contributor Within Arab League Nations." (2017).
13 Ball, Robert James. Inflation and the Theory of Money. Routledge, 2017.
14 Gooding, Philip. "Consumer price inflation: the 2016 basket of goods and services." Office for
National Statistics (2016).
15 Diewert, W. Erwin, and Kevin J. Fox. "Substitution bias in multilateral methods for CPI
construction using scanner data." UNSW Business School Research Paper 2018-13 (2018).

8MICROECONOMICS AND MACROECNOMICS
factor it can be said as per that current context that quality factor is not included in the inflation
rate calculation. It means that if the price of a good increases due to its qualitative improvement
then the customer will not be able to understand the cause of price increase which indicates that
quality bias remains unaffected by inflation rate of the product16. Hence, it can be said that
quality bias in this context is ambiguous to find as there is no provision in the calculation of
inflation rate to include quality bias. Thus, due to change in revision policy of calculation of
inflation rate by the government statisticians from every 10 years to every 5 years does not affect
the quality bias.
16 Blaum, Joaquin, Claire Lelarge, and Michael Peters. "Firm size, quality bias and import
demand." Journal of International Economics 120 (2019): 59-83.

9MICROECONOMICS AND MACROECNOMICS
Bibliography
Andrews, Matthew, Spyridon Antonakopoulos, and Lisa Zhang. "Minimum-cost network design
with (dis) economies of scale." SIAM Journal on Computing 45.1 (2016): 49-66.
Badorf, Florian, et al. "How Supplier Economies of Scale Drive Supplier Selection
Decisions." Journal of Supply Chain Management 55.3 (2019): 45-67.
Ball, Robert James. Inflation and the Theory of Money. Routledge, 2017.
Blaum, Joaquin, Claire Lelarge, and Michael Peters. "Firm size, quality bias and import
demand." Journal of International Economics 120 (2019): 59-83.
Diewert, W. Erwin, and Kevin J. Fox. "Substitution bias in multilateral methods for CPI
construction using scanner data." UNSW Business School Research Paper 2018-13 (2018).
Ertan, Aytekin, Stefan Lewellen, and Jacob K. Thomas. "The long-run average cost
puzzle." Available at SSRN 3178202 (2018).
Geerolf, François. A Theory of Demand Side Secular Stagnation. UCLA Working Paper.
https://fgeerolf. com/hansen. pdf, 2019.
Gooding, Philip. "Consumer price inflation: the 2016 basket of goods and services." Office for
National Statistics (2016).
Greenlaw, Steven A., and David Shapiro. "7.5 Costs in the Long Run." Principles of Econ
2e (2017).
Harris, Matthew, et al. "Explicit bias toward high-income-country research: a randomized,
blinded, crossover experiment of English clinicians." Health Affairs 36.11 (2017): 1997-2004.
Loomis, John B., and Michael H. Thomas. "Pricing and Revenue Capture: Converting
Willingness to Pay into." Object Relations and Intersubjective Theories in the Practice of
Psychotherapy (2019): 255.
Miller, Mark, and Anna Alberini. "Sensitivity of price elasticity of demand to aggregation,
unobserved heterogeneity, price trends, and price endogeneity: Evidence from US Data." Energy
Policy 97 (2016): 235-249.

10MICROECONOMICS AND MACROECNOMICS
Munro, Colin W. Clarkand Gordon R. "The Economics of Fishing and Modern Capital Theory:
A Simplified Approach1." Fisheries Economics, Volume I: Collected Essays (2019): 46.
Thompson, Jamal Alexander. "Information Communication Technology Management as a GDP
Growth Contributor Within Arab League Nations." (2017).
Zambelli, Stefano. "The aggregate production function is NOT neoclassical." Cambridge Journal
of Economics 42.2 (2018): 383-426.
Zetina, Carlos Armando, Ivan Contreras, and Jean-François Cordeau. "Profit-oriented fixed-
charge network design with elastic demand." Transportation Research Part B:
Methodological 127 (2019): 1-19.