Micro economic - Assignment Example

Micro economic assignment Part A Your first task is to use models and concepts relating to producer behavior to analyze the effects of increased demand for bio-fuels on the inputs to its production (including crops, such as corn). i. Analyze the impacts of increased demand for biofuels on the demand for and price of crops such as corn. Figure 1: Isoquant Isocost Analysis for the Production of Biofuels From other raw materials and plant matter, liquid fuels referred to as biofuels can be produced. From the Isocost Isoquant analysis graph above, we assume that corn (C) and Oil (O) are utilized in the production of biofuels (B). Therefore, the production function for biofuels will be represented by B= f(C, O). In the graph, the prices of oil and corn have been represented by PO and PC respectively. Figure 2: Equilibrium Price and Quantity in the Market for Corn .High Isocost and Isoquant curves results when the demand of biofuels increases which results in an increase in production levels of biofuels. For the production of biofuels to be effected, corn has to be used. Since, increased biofuels demands imply increased production of biofuels, it is right to say that the demand for corn will also increase significantly. Consequently, the demand that arises from the production of biofuels and that of food consumption would be compromised as depicted in figure 2 with D2 and D1 respectively. The result ripple effect will, therefore, mean that the price of corn will increase thereby leading to a reduction in the consumption of corn as food. Many people will, therefore, opt for alternatives or substitutes since there will be reduced food availability. An isoquant is a curve that combines factors that are employed in production to arrive at the same output level. The isoquant has no effects in the changes of input prices. Every isoquant shows an output level. Isoquants of Higher levels show high output level (Baumol and Blinder 2011). An isocost line on the other line combines various factors, which are same in cost (Baumol and Blinder 2011). That why it is a straight line. The intercepts represent the amount of units of input which can be employed when it is the only purchased factor in a budget. The slope gives the price. The higher the line means that a higher cost is incurred. Therefore, the increase in prices of corns leads to a movement of the isocost line along the x axis towards the origin. Given a constant budget the quantity of corn can only be reduced. This will lead to a change in the isocost lines. This will further lead to a rise of isocost line along conventional axis. ii. Analyze how developments in agricultural and conversion technology might influence the impacts identified in Part A (i). To counter the effects caused by increased demand for biofuels, increased conversion technology and agricultural productivity as well as use of Agricultural biotechnology and second generation biofuels would suffice (Zilberman, et al. 2008). Changes in technology are internal or depend on the economic conditions. An economy that opts to move away from inputs that cost much can always adopt technology changes. It is a mechanism that solves the increased cost of input problems. In the situation of increased costs of corn, there can be an adoption of technology to deal with the problem. Changes in technology will lead to reduction of quantity of input that is needed and, therefore, reduce the costs that are involved. The output level will increase with the same cost constraint. Therefore, the supply will increase hence the demand will fall (Rubinstein 2006). iii. Analyze the effects of increased competition between participants in the oil market on the impacts identified in Part A (i). In case, there is increased competition in the market of oil ceteris paribus; the prices of oil are bound to fall. If the prices of oil fall, it means that the prices of inputs will drop as oil is the input used in production of biofuels. Therefore, using the same cost allocated for production the inputs used will increase meaning that the output level will also increase. The isoquant will, therefore, move further away from the origin. Part B Your second task is to use models and concepts relating to consumer behavior to analyze the effects of changing fuel and crop prices on individuals. i. Analyze the impact of an increase in the price of crops and a (proportionately smaller) decrease in the price of fuel on a low income person who spends most of her income on food (derived from crops) . ii. Repeat the Part B (i) analysis for a high income person who spends a relatively small proportion of her income on food. Comment on the distributional consequences of the changes in the price levels. Discussion What led to the income sizes effect were the levels of consumption. The prices of food rise due to increased demand of food. The increase in the prices of food makes one to be worse off. The fall of fuel prices reinstates the consumer position; it makes it better. The consumer becomes worse off as most of the income is used in food as this is a basic need. The fall in prices of fuels and rise in prices of food given low income will lead to the substitution effect and income effects. From the diagram above, substitution effects in F1E takes place when there is a movement from A to D. Income effect EF2 takes place when there is a movement from D to B which implies that the good that is being dealt with is a normal good. This income effect is what leads the fall in demand as the low income is only left for the purchase of food (Mansfield and Yohe 2004). In summary, the price changes overall effect are divided into two effects, income and substitution effect. In this case, the substitution effects take place when the consumer takes advantage of fall in prices of food keeping the satisfaction derived from it same as before (Baumol and Blinder 2011). Income effect makes a consumer to change the quantity of food purchased as it changes the power of purchasing within the budget constraint. Increase in income levels will increase the purchasing power of an individual. It will lead to a shift in the budget line to the right. This is because the purchase price of this consumer has been elevated. Part C Your final task is to identify and discuss possible government policy responses to the issues raised in Parts A & B. Discussion A decrease in inputs will lead to a subsequent reduction in production hence low supply. The low supplies will lead to a subsequent rise in the prices of the biofuels. Increase in the price of bio-fuels will lead to subsequent rise in the prices of food products. As corn is part of the inputs that are employed in the production of biofuels, prices are bound to shoot because demand for them will rise. To solve the issue that has been raised, the government can come up with various policies to solve the problem. Firstly, there is an increase in demand of biofuels and to solve such as there is an increase in demand of biofuels, production will be compromised due increased cost. Increase in demand of the bio-fuels will lead to an increase in the price of inputs. This in turn, will lead to increased costs as the prices of inputs will rise. If the inputs’ costs increase production will be compromised, there is a certain amount of cost that should be spent on the inputs. The government can subsidize the production cost. The government does this by subsidizing the price of corn that is being purchased by the firm. By doing this, the cost of production will be reinstated to the initial one and the output level will meet the demand of the consumers. This will also reinstate the prices of bio-fuels. Another way of solving this case is by reduction of taxes on the produced bio-fuels. The reduction of taxes will lower their prices to the initial ones. The government can also launch a project on the agricultural sector for increased production of corn. The government can be large producers of corn. From this, the firm that produces bio-fuels will be supplied with the inputs but at subsidized cost. The government can also introduce price controls in this situation. In case, there is increased competition in the market of oil ceteris paribus; the prices of oil are bound to fall. If the prices of oil fall, it means that the prices of inputs will drop as oil is the input used in production of bio-fuels. Therefore, using the same cost allocated for production the inputs used will increase meaning that the output level will also increase. The isoquant will, therefore, move further away from the origin. The price controls will ensure that the increase in prices of bio-fuels is reinstated. The government can advise firms to resort another input that can play the part of corn. The government can also advocate for alternative uses of energy and impose heavy taxes on the production of bio-fuels to discourage its production and reduce the prices of corn. Increased competition amongst the oil producers can be controlled by setting price standards on oil. The government can improve the technology of firms that produce bio-fuels. The improved technology will reduce the production cost hence making the prices of these products affordable. The government can also control the distribution of bio-fuels in the economy. The government should restrict the amount of the products that are sold and encourage the use of other alternative sources of energy. The use of other alternative sources will result to controlled demand of this fuel as there other source of fuel that act as supplementary. The government can also initiate a program of creating awareness on the importance of conserving bio-fuels as energy sources. The government can advise firms to resort another input that can play the part of corn. The government can also advocate for alternative uses of energy and impose heavy taxes on the production of bio-fuels to discourage its production and reduce the prices of corn. Increased competition amongst the oil producers can be controlled by setting price standards on oil. The government can improve the technology of firms that produce bio fuels. Reference 1. Baumol, William J., and Alan S. Blinder. Economics: Principles & Policy. New York: Cengage Learning, 2011. 2. Chiang, Alpha C. Fundamental Methods of Mathematical Economics . New York: McGraw-Hill Inc., 1984. 3. Hirschey, Mark. Managerial Economics. New York: Cengage Learning, 2008. 4. Jehle, Geoffrey A., and Philip J. Reny. Advanced Microeconomic Theory. 2. Amsterdam: Addison-Wesley, 2001. 5. Mansfield, Edwin, and Gary Wynn Yohe. Microeconomics: Theory/Applications. New York: W.W. Norton & Company, 2004. 6. Morishima, Michio. The Economic Theory of Modern Society. CUP Archive , 1976. 7. Rubinstein, Ariel. Lecture Notes in Microeconomic Theory: The Economic Agent. Princeton: Princeton University Press., 2006. 8. Varian, Hal R. Microeconomic Analysis. 2. New York: W. W. Norton & Company, 1992. 9. Zilberman, David, Deepak Rajagopal, Steven Sexton, and Gal Hochman. "Biofuel and the new economics of agriculture." Farm foundation Workshop Berkele. Berkely: Agricultural and Resource Economics, 2008. Read More