The Classical Theory of Micro Economics - Essay Example

?Micro Economics Table of Contents What Happens When The Government Imposes A Minimum Wage? Explain Using A Graph. 3 2. What Economic Concept Explains Why Most People Specialize In A Specific Profession Rather Than Trying To Make All Of The Things Themselves? 6 3. A Group Of Doctors Discovers That Vegetable Shortening, Relatively, Is Much Worse For You Than Oil Or Even Such Close Substitutes As Butter And Lard. Explain What This Will Do To Supply And Demand Of Shortening And Oil. Explain The Role Of Price At Each Stage. 7 4. How Does The ‘Invisible Hand’ Described By Adam Smith Work? Explain What Smith Meant By The Invisible Hand And How It Works. What Signals Producers And Buyers To Adjust Quantity Supplied/Demanded And Reach Equilibrium? 8 5. According To Economic Theory, How Do Consumers Decide What Goods To Buy? What Does The Final Decision To Buy Something Depend On? 10 1. What Happens When The Government Imposes A Minimum Wage? Explain Using A Graph. Minimum wage laws set rules regarding the minimum wage that can be provided by an employer for obtaining labour. The Fair Labour Standards Act of 1938 was established by the US congress to set down the minimum wages that should be offered to employees to ensure a proper standard of living. The labour market faces the forces of demand and supply. The supply of labour is determined by workers and the demand is determined by the employers. In the absence of the government intervention the wages get adjusted with the labour supply and demand. When the minimum wage is above equilibrium then the supply of labour exceeds the demand. This causes unemployment. Thus, the wages of employees who already have the job increases and the income of employees who do not have the job are lowered. The affect of minimum wage depends on the experience and skills of the employees. The skilled and experienced employees have their equilibrium wages much above the minimum wages. The greatest affect of minimum wages is on the teenage labour based market. Teenagers have low equilibrium wages because they do not have much skills and experience and are willing to work on low pay in exchange for the training they receive on the job. A study reveals that 10% increase in minimum wage reduces teenage employment to 1% - 3%. 10% increase in minimum wage does not increase teenage wages by 10%. The minimum wage also affects the supply quantity of labour. Since the minimum wage of the teenagers increase, the number of teenagers willing to work also increases. Minimum wage increases the income of the poor. Certain opponents of minimum wages consider that it results in unemployment, teenagers dropping out of schools and restricts unskilled workers from obtaining training on their job (Mankiw, 2008). Source: (Encyclopedia of Earth, 2006). The above figure represents the condition in the classical labour market. A legal minimum wage interferes with the free market adjustments and causes true unemployment. The demand and supply model of labour Source: (Encyclopedia of Earth, 2006). The above figure shows conditions in the traditional market. The labour quantity and the equilibrium are determined by market forces. 2. What Economic Concept Explains Why Most People Specialize In A Specific Profession Rather Than Trying To Make All Of The Things Themselves? Specialisation is a concept that relates to most of the modern economies. Modern economies do not produce everything. Rather they produce those things that provide them a ‘comparative cost advantage’. The excess from the production is exported and the items that are not produced within the country are imported. This kind of specialisation ensures greater economic growth. At an individual level, specialisation ensures greater work efficiency and greater productivity. The high levels of productivity and efficiency ensures high income levels (Jain & Ohri, n.d.). Specialisation is based on the law of comparative advantage. According to the law of comparative advantage, the individual who has a lower opportunity cost of production of a definite level of output should specialise in the production of that amount of output. Absolute advantage is said to be possessed by an individual if he is capable of producing with fewer resources. While absolute advantage concerns using fewer sources, comparative advantage concerns what else could be produced with the help of those resources. Specialisation involves exchange of products. This means that neither people consume everything that they produce nor do they produce everything that they consume (McEachern, 2008). 3. A Group Of Doctors Discovers That Vegetable Shortening, Relatively, Is Much Worse For You Than Oil Or Even Such Close Substitutes As Butter And Lard. Explain What This Will Do To Supply And Demand Of Shortening And Oil. Explain The Role Of Price At Each Stage. The fat or lard that is obtained from an animal or vegetable is known as shortening. It is a semisolid fat which is used to produce baked goods and the name ‘short’ has been derived due to the crumbly texture of the product. The fact that doctors had discovered that vegetable shortening has a negative affect on health will reduce the demand for oil. Customers would not akin to purchase a product that has an adverse impact on health. Since demand and price have an inverse relationship, thus with the fall in the demand the price levels would also fall. The customers will not be willing to buy the amount of short oil that is in supply in the market. Thus, the suppliers will reduce the price of short oil to influence people to purchase short oil. The reduction in price will not increase the demand since people would not prefer to compromise on their health. The demand for short oil in this case is inelastic since the price change is not having any affect on the supply and demand. Consequently, suppliers will be forced to reduce their supply of short oil in the market due to the absence for demand of short oil. 4. How Does The ‘Invisible Hand’ Described By Adam Smith Work? Explain What Smith Meant By The Invisible Hand And How It Works. What Signals Producers And Buyers To Adjust Quantity Supplied/Demanded And Reach Equilibrium? Adam Smith believed in the concept of ‘invisible hand’. He believed that while pursuing their personal interests, people often lead to the benefit of the entire society. When individual try to obtain the best for their family and themselves, they indirectly benefit the entire society. For example when there is a scarcity of oil, the rise in the prices of oil motivates people to reduce driving and thus conserve oil. At the same time, suppliers are motivated to discover other oil sources because they can earn profit from the rising oil prices. Thus, the self-interested motives of each entity benefit the society in general (UNCG, n.d.). The concept of invisible hand elaborates that a decentralised capitalistic economy, even in the absence of a central planner, produces effectively the goods and services demanded by the consumers. The theory states that in a free market, alignment occurs of the personal interests on an individual and the society. An individual can earn money by offering valued services and goods to people. The extent to which that individual is motivated to improve his income and standard of living motivates him to provide the service or the good effectively. This in the long run helps in generating wealth for the society (Crowley, 2010). Adam Smith’s concept of ‘invisible hand’ elaborates on the selfish behaviour of consumers and producers. The producer’s intention is to charge the highest price and the consumer’s objective is to obtain desired goods at the lowest price. If producers raise prices considerably then consumers shift to substitutes. The presence of competition between individual suppliers prevents them from charging very high prices. The market’s invisible hand causes price to adjust according to the demand and the supply. If demand increases then market prices rise and the rising market prices make suppliers increase their output to meet demand. The presence of competition ensures that firms provide consumers their desired products at market determined prices. Thus, the supply and demand gets adjusted to reach the state of equilibrium where the quantity demanded is equal to the quantity supplied. 5. According To Economic Theory, How Do Consumers Decide What Goods To Buy? What Does The Final Decision To Buy Something Depend On? The neoclassical theory holds that a negative relation exists between the price of a product and the quantity of the product demanded. The underlying assumption of the neoclassical theory is of a rational individual who tries to maximise his satisfaction. The individuals as rational choosing agents try to get the maximum satisfaction on the criteria of utility. Thus, the value of a good is not based on just its price but also on the amount of utility that is generated from the purchase of the product. Individuals rank their preferences and purchase the good they believe will provide them the maximum utility. Thus, their purchase is guided by their subjective feelings. This is known as utility maximisation (Scarlett, 2009). When the price of the product falls, consumers purchase more of the products and purchase lesser amount of the products when the prices increase. If the demand for a product decreases sharply with the rise in prices then the demand is said to be highly elastic. In contrast if the consumers’ demand does not change with the increase in the price then demand is inelastic. The wants of consumers are unlimited but resources are limited. Therefore, consumers need to balance their wants with their resources (Scarlett, 2009). References Crowley, G. R. & Sobel, R. S., 2010. Introduction. Adam Smith: Managerial Insights from the Father of Economics. [Online] Available at: http://www.be.wvu.edu/divecon/econ/Sobel/All%20Pubs%20PDF/Adam%20Smith%20Managerial%20Insights.pdf [Accessed January 24, 2011]. Encyclopedia of Earth, 2006. The Classical Theory of Unemployment. Theories of Unemployment. [Online] Available at: http://www.eoearth.org/article/Theories_of_unemployment [Accessed January 24, 2011]. Jain, T. R. & Ohri, V. K., No Date. Principal of Microeconomics. FK Publications Mankiw, N. G., 2008. Principles of Microeconomics. Cengage Learning. McEachern, W. A., 2008. Economics: A Contemporary Introduction. Cengage Learning. Scarlett, 2009. Neoclassical Economic Theory. History of Economic Theory and Thought. [Online] Available at: http://www.economictheories.org/2009/10/neoclassical-economic-theory.html [Accessed January 24, 2011]. UNCG, No Date. Adam Smith. BB&T Program on Capitalism, Markets and Morality. [Online] Available at: http://www.uncg.edu/bae/bbt/capitalism/adam_smith.html [Accessed January 25, 2011]. Read More