Macro and Microeconomics - Assignment Example

Macro & Micro Economics Question a) Change in people’s consumption as a result of a significant change in the purchasing power of an individual is what is referred to as income effect. When income increases, your consumption goes up. On the other hand, significant changes in the consumption patterns as a result of significant changes in the good’s price are what are termed as substitution effects. If we look at two goods that are substitutes such as margarine and butter, an increase in the butter’s price will lead to an increase in the demand for margarine. In the context of labor supply, when wages increase, the demand for leisure increases as you work less hours and this is the income effect. The increase in income will also increase the price of leisure, which means you have to work more and this is the substitution effect. The backward bending labor supply curve indicates that as wages increase, people earn more and their demand for leisure increases. They substitute work for labor. The wages will increase to a point where the labor offered in the market is less, causing the backward bending labor supply curve (Starr 20). b) When the women do not work, they only receive benefit b. However, they receive the government subsidy (s) plus their wages (w) when they work. The women will be motivated to take up employment because they will be receiving a subsidy that takes care of their children plus a wage. They will get into the labor market if the total of the subsidy and the wages is more than the benefit. W1 is the wage rate for working mothers without the subsidy and the labor supply is at E1. W2 is the wage rate for working mothers after the subsidy. W2 = W1 + S that is the wage plus the subsidy. This will lead to a shift in the labor supply curve to the right from LS1 to LS2. W3 = b which is the benefit the women receive when they do not work as depicted in the diagrams below. The first diagram shows an increase in the demand for the women to work shifting from D1 to D2. The second diagrams show a shift in the supply of labor to the right due to the introduction of the subsidy from LS1 to LS2. Figure 1 Labor Supply for women willing and able to work at the different wage levels and Figure 2 is the Labor Supply Curve working women. c) More women will enter into the labor market. The supply of labor will increase. In a perfectly competitive market, where the labor’s marginal product will be equal to the marginal product of labor (MPL=MPL). Question 2 a) A partial equilibrium only looks at one part of an economy say one sector and general equilibrium looks at the economy as a whole. A general equilibrium is more appropriate than a partial equilibrium as it deals with more than one variable in the economy. Different sectors in the economy are interdependent; a change in one sector say the transport sector will have a change in the production of goods and their distribution. Prices of goods are determined mutually meaning that if the price of fuel goes up, this will affect the price of transport and production of goods. So, while determining the price of the fuel, consideration must be made on the effect it will have on the prices of other goods and services. b) An increase in VAT by the Spanish government will lead to an increase in price of hotel accommodation from P1 to P2, which will make holidays in Spain more expensive. The increase in the tax will decrease the demand for holidays in Spain. As the demand for holidays decreases, there will be less holiday makers traveling to Spain and this will increase the price of airline tickets to Spain. Holiday makers will choose other destinations for their holidays and the demand for these destinations will increase leading to a fall in airline ticket’s price to alternative destinations. E1 is the equilibrium before the tax increase and E2 is the equilibrium after the tax increase. P1 is the price of hotel accommodation. P2 is the price of hotel accommodation after the increase in VAT. The arrows indicate the shift in the demand and supply for Spanish holidays. The limitations of a partial equilibrium regarding complimentary and substitute goods is that it is restricted to a particular sector of the economy and does not take into account the economy as a whole. Hotel accommodation and airline tickets for holiday makers are complimentary goods. A partial equilibrium on the price of accommodation only did not take into account the effect on airline tickets. Partial equilibrium does not take into account the interrelationships of different parts of the economy. It does not explain how the whole economy is affected due to market changes in demand and supply. Question 3 a) In an exchange economy, there is no production of goods. The issue in search and economy is how the goods will be distributed and consumed. Efficiency in exchange is achieved when all goods have been distributed. Input efficiency means that there is production using inputs and efficiency is achieved through the maximization of resources which produces the most profitable level of production. An economy is more efficient than another if it’s capable of producing more services and goods without using more resources. An economy cannot satisfy the conditions of exchange efficiency without the conditions for input efficiency. The goods that are distributed under the exchange economy must be produced somewhere. As they are produced, they must then meet the conditions of input efficiency. b) The two fundamental theorems of welfare economics are the Walrasian equilibrium that states that in any competitive market, the markets will do their work with no interventions in the allocation of resources, and this will lead to a Pareto efficient. The second theorem states the opposite of the first, meaning that efficient allocation of resources will be sustained in a competitive market. The Pareto efficiency means the allocation of resources will lead to an individual being made better off without another being made worse off. In an ideal situation, when one is better off, there is someone who is made worse off (Starr 10). The above Edgeworth box explains a simple economy of two people and with two goods A and B. The total amount for good A is 10 and the total amount for good B is 6. The point of the middle of the box indicates how much of each good each of the two people can have. One person can have (4, 3) that is 4 of good A and 3 of good B, then the other person can only have (6, 3) that is 6 of A and 3 of B. This is the Pareto optimal allocation of goods A and B (Pareto efficient). c) Two people in a pure exchange economy with identical preferences will not trade with each other. There will be no difference in the types of goods that they trade in. Trade between them will have no benefit to either of them. Works Cited Starr, Ross. Why Is There Money? Walrasian General Equilibrium Foundations of Monetary Theory. London: Edward Elgar Publishing, 2012. Print. Read More