Microeconomics Report: Demand, Supply, and Market Equilibrium

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Business Economics
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Table of Contents
Introduction......................................................................................................................................3
Question 1........................................................................................................................................4
A) Describe the effect on the following variables due to the increase in oil prices.....................4
B) Define the impact of external benefits and external cost on resource allocation?..................5
C) Explain why private markets do not produce public goods in sufficient quantity?................5
Question 2........................................................................................................................................6
A) Define how scarcity forces individual and society to incur the opportunity cost?.................6
B) Explain the value of ‘free car’ which is given by the chocolate bar manufacturer to promote
its product?...................................................................................................................................6
C) Explain the reason why production possibility frontier bowed outwards?.............................6
Question 4........................................................................................................................................7
A) Compute the impact of cabinet maker's work and pre-recorded music compact disk of a
recession which reduces consumer income by 10 percent?.........................................................7
B) How will you evaluate that MP3 music players and pre-recorded music compact are in
competition?.................................................................................................................................7
C) Interpret income elasticity of demand and identify whether goods are inferior or normal?...7
D) Interpret cross-price elasticity of demand and identify the relationship between goods........8
Question 5......................................................................................................................................10
A) Define statement "In the real world there is no industry which conforms the perfect
competition model."?.................................................................................................................10
B) Explain the short-run perfectively competition equilibrium for individual and industry?...10
C) Define the long-run perfectly competition equilibrium for the firm?..................................11
Question 6......................................................................................................................................13
A) Mention some of the fixed and variable inputs which can be used in operation a coffee
shop?..........................................................................................................................................13
B) Calculate the average fixed cost, variable cost and total cost of the total output of the
hammers?...................................................................................................................................13
C) Explain the circumstances where labor will be treated as variable cost as well as fixed cost?
....................................................................................................................................................14
Conclusion.....................................................................................................................................15
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References......................................................................................................................................16
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Introduction
This report contains detail discussion of various concepts of microeconomics. Demand, supply,
opportunity cost, cross-price elasticity of demand etc. are some of the discussion which is
mentioned in the report. Short run and long-run equilibrium level in perfect competition market
is presented graphically and interpretation for the same is also given. It defines the concept of
variable and fixed nature of labour cost and also mentioned the list of the fixed and variable cost
of the coffee shop.
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Question 1
A) Describe the effect on the following variables due to the increase in oil prices.
Complementary goods are those goods which can only be used together. Use of one product is
interrelated with the use of other product. These goods have negative cross elasticity of demand
which defines that there is a negative relationship between the price of one product and quantity
demanded the other product.
Substitute goods are those goods which can be used for the same purpose and consider as the
alternative for one another. The demand for one product is affected by the price of other product.
Substitute goods have positive cross elasticity of demand which shows a positive relationship
between the price of one product and quantity of other product.
(i) The demand for automobiles will reduce as oil and automobiles are perfect complementary
goods and the elasticity of demand between both products is negative.
(ii) Demand for home insulation will increase as it can use as an alternative source of oil based
equipment used for insulation. Oil and home insulations are substitute product and hence higher
prices of oil lead to higher demand for home insulation as customer shift from oil to home
insulation.
(iii) The demand for coal is also increased since oil and coal is also the perfect substitute for each
other. Customers will shift to the coal if the oil price is higher than the prices of coal.
(iv) The demand for tires decrease as tires and oil can be considered as complementary goods.
Though the price of oil and demand for tires is not directly linked higher prices of oil leads to
lower demand for automobiles and which eventually affects the demand for tires.
(v) Demand for bicycles will also increase. Bicycle and oil are not related product however
automobiles and bicycle can be considered a substitute for each other hence higher price of oil
leads to a higher demand for substitute product i.e. bicycle.
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B) Define the impact of external benefits and external cost on resource allocation?
Resources allocation is the process where goods and services are allocated for production use.
Goods and services have the capability to provide satisfaction to the consumer. Resource
allocation is affected by external factors and they can be positive as well as negative.
Externalities are results in cost and benefits for the individual who has no desire to incur any cost
and benefits. Those external factors directly impact on the resource allocation as external cost
leads to over-allocation of resources and external benefits results in under allocation of
resources.
C) Explain why private markets do not produce public goods in sufficient quantity?
The private markets core objective of profit making rather than social welfare. Lower quantity
production of public goods creates artificial demand and leads to hiking in prices and private
markets earn enormous profits.
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Question 2
A) Define how scarcity forces individual and society to incur an opportunity cost?
Resources are scarce in the term to fulfil all desires of the consumers. Society and individuals
can only produce a certain amount of goods with the limited resources hence they have to make
choices between goods need to be produced and resource needs to be used. Opportunity cost is
the cost of the next best alternative use of resources as society and individual cannot produce all
desired goods they have to incur opportunity cost for the selected goods. For example - An
individual has $1500 which he can either invest or buy clothes. If he buys clothes, then the
opportunity cost of buying clothes is earning which may have resulted in investment.
B) Explain the value of ‘free car’ which is given by the chocolate bar manufacturer to
promote its product?
Producer promotes the product by means of advertisement and customer will buy more and more
quantity to increase its chances to win the car. Here all customers pay for the chocolate bars
which give them an opportunity to win a car hence the value of the car for the customer is the
entire sales price paid by the customer and it will not consider a zero.
C) Explain the reason why production possibility frontier bowed outwards?
Production possibility curve shows the maximum possibilities of outcome with the given set of
resources and other inputs. Curve bowed outward due to the law of increasing opportunity cost
as increasing quantity in one product will reduce the resources for other product and results in
opportunity cost for the former product.
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Question 4
A) Compute the impact of cabinet maker's work and pre-recorded music compact disk of a
recession which reduces consumer income by 10 percent?
Income elasticity of demand defines the relationship between the quantity demanded of goods
and income of the consumer.
The formula for income elasticity of demand = (Percentage change in quantity demanded/
Percentage change in income)
Given:
Income elasticity of pre-recorded music disks = + 7
Income elasticity of cabinet maker’s work = + 0.7
Impact on quantity demanded:
Pre-recorded music disk = (7 * 10%) = percentage change in quantity demanded is 70 %.
Cabinet maker’s work = (0.7 * 10%) =Percentage change in demand is 7%.
B) How will you evaluate that MP3 music players and pre-recorded music compact are in
competition?
Competition between MP3 and pre-recorded compact can be identified by evaluating cross-price
elasticity of demand between both products. If there is positive cross elasticity of demand, then
both products are a substitute and in competition to each other.
C) Interpret income elasticity of demand and identify whether goods are inferior or
normal?
Inferior good’s demand will reduce with the increase in income.
Normal goods have a positive relationship between income and demand for goods.
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(i) YED = +0.8 shows that income and quantity demanded has positive relation. These are
normal goods as customer shift from inferior goods to normal goods when income increases.
(ii) YED = -2.4 Shows that income and quantity demanded has a negative relation. These goods
are inferior goods as the customer will reduce the demand for those goods if the income
increases.
D) Interpret cross-price elasticity of demand and identify the relationship between goods.
Cross price elasticity of demand defines the relationship between the price and quantity of
related product. The related product can be substitute goods and complementary goods.
(i) XED = +0.85 this shows that the price of one product and quantity of other product has
positive relation. These goods are substitute goods for each other.
(ii) XED = -4.5 this shows negative relationship between price and quantity of related product.
Since it shows a negative relation hence goods are complementary goods.
Figure (Cross price elasticity of complementary goods)
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Figure (Cross price elasticity of substitute goods)
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Question 5
A) Define statement “In the real world there is no industry which conforms the perfect
competition model."?
Perfect competition is the economic structure where various seller and buyer existed in the
market and an identical product is sold by the seller. Price of the product is associated with the
demand and supply forces of the product.
Properties of perfect competitions market are as follows:
 A large number of seller and buyer of the product.
 No barrier on entry and exit of firms.
 Mobile factors of production.
 All Firms in perfect competition market are a price taker.
 The identical product is traded in the market.
Perfect competition industry is hard to exist as all the important feature of perfect competition is
not available in a single industry. In the real world, the product has some different feature and
they are not identical. In case products have zero differentiation then there is a possibility that
producers form an oligopoly. There are some scenarios were a barrier to the entry and exits from
the industry is exist. Hence the concept of perfect competition has very less practical value.
B) Explain the short-run perfectively competition equilibrium for individual and industry?
Short-run equilibrium defines where firm and industry want to earn a maximum profit or reduce
its losses to its minimum. There are no expansion and reduction of production output.
(i) Short run perfectively competition equilibrium of the industry
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All the firms in the industry will be earning a normal profit when the industry is in an
equilibrium situation. Demand and supply are same at prevailing market price in the equilibrium
state of the industry. In the short run, the industry is the price maker.
Figure (Equilibrium level of the industry)
(ii) Short run equilibrium of the firm
In the equilibrium state firm produces an output which has an equal level of marginal cost and
marginal revenue. In the short run, the firm is making the supernormal profit as there is no entry
and exit of firms in the industry. It produces output equal to the demand of the industry.
Figure (Equilibrium level of a firm)
C) Define the long-run perfectly competition equilibrium for the firm?
In the long run perfectly competitive market there is no barrier of entry and exists resulted in the
adjustment of demand and supply. The firm will make an only normal profit on the equilibrium
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