The Best of Microeconomics - Assignment Example

0 20 108 30 40 25 45 60 Financial Services Credit Crunch Output Suppose that an economy produces the combination of two goods i.e. manufactured goods and financial services. The best or maximum out that this economy can produce is the output indicated on the boundary of Production possibility frontier, However, recession or credit crunch now hits the country and resources were made unemployed. This resulted in the economy moving away from their best or most efficient output. The new output will be somewhere inside in the Production possibility frontier and as represented in the curve by the label "Credit Crunch Output". The reason behind this leftward movement of the output is that many of the resources will be made unemployed or redundant and their output will be lost which means that the total output of the economy will decline. (Rubinfield and Pindyck, 2005) 2) According to Sloman, a perfectly competitive firm is that market structure where all the firms in the industry are producing homogenous goods and selling it a same price. All of these sellers and buyers have perfect information so no firm can sell at a higher price and no consumer can demand to purchase at a lower price because there is competition in the market. On the other hand monopoly is a firm which is a sole supplier or producer of a product service. Since it is the sole supplier it has some market power and therefore can choose to sell the products at a price he wants. However, his price decisions do affect the quantity demanded therefore he has to be wise in make a decision about at what price to sell his products.(2000) If we compare the two firm graphically, we will first see that for a perfectly competitive firm AR or Price curve = MR curve. P = MR = AR is a horizontal line and this represents the constant nature of these curves. This means that any increase in quantity will bring about the same change in marginal revenue curve. This does not happen in a monopoly as in order to increase his revenue in order to increase his revenue, a monopolist has to lower his price as it will increase quantity demand. Due to this AR is always higher than MR (marginal revenue) curve. As a result of this monopolists always determine his quantity demand where MR = MC meet, but he takes a pricing decision on a AR (Average revenue curve) which is higher than MR and yields higher price to the monopolist. But this is not the case in a perfect competitive firm which chooses quantity and price at a place where MR = MC meets and the price is set by the constant or horizontal AR = MR = P curve. As already discussed that a perfectly competitive firm produces a higher output and charges lower price, it is said to be more efficient than a monopolist. Perfectly completive firms in theory enjoy both allocative and productive efficiency, whereas monopolist only achieves allocative efficiency. In the real world also we can apply this model, but the results provided by these models will not be similar as provided by these theoretical models. For example, De Beers is monopoly who owns large diamond reserves and despite of low diamond shoveling costs they can sell it for millions of dollar. This is how a monopolist exploits consumers. Similarly, we all know that Petrol Pump exist in a competitive industry and despite of high costs associated with oil refining , they usually have to sell petrol at a margin of just few cents. In this way, the theoretical model look right, but consider the example of how Wal-Mart existence in the form of a monopoly has provided consumers with lower priced goods as compared to perfectly competitive industry of local general stores. This proves the theoretical model wrong. The other types of market structures that exist are oligopolies, duopolies, monopolistic competitive firms and cartels. These models are much realistic to the model discussed above. 3) The concept of elasticity is the measure of responsiveness of change in quantity demanded, following a change in price. A demand or supply is said to be elastic if the quantity changes by a greater proportion than a change in the price. Similarly, demand or supply is inelastic if the change in quantity following a change in price is lesser in proportion than the price. Price Elasticity is said to be unitary, if the proportion of change in quantity is equal to the change in price. Similarly, the two extreme situation of price elasticity are perfectly elastic or perfectly inelastic. In perfectly elastic curve, the demand changes even when there is no change in price. In perfectly inelastic curve, however, the demand remains the same, no matter whatever is the price. (Lipsey, 2003) Let's now look at the concept of elasticity taking the numerical examples of elasticity and there effects The demand is said to be price elastic when a little change in price causes too much change in quantity demanded. In other word when percentage changes in demand is greater than the percentage change in price. Elasticity = Percentage change in Quantity demanded/ Percentage Change in Price This can be proved by a numerical example also. The answer of the elasticity formula, if greater than 1, then the demand is said to be elastic. Suppose that for a certain product, the company has increased the price by 20%. As a result of this change, the resulting demand has fall by 60%. If we want to check the elasticity of the product we will plug in the above percentage in the formula. Elasticity = 60/20 = 3 Demand is usually elastic when the resulting answer for the formula is more than 1. This is useful for managers and decision makers as they choose to make better pricing decisions. For example, if managers know that the product that they are selling has a elastic demand, they would know that they cannot increase the price of their product in order to maximize revenues and hence profits. For example, any increase in prices in order to increase profit is going to decline the revenues for the company and in turn profits. Suppose that a firm is selling a product at $2. At the current the quantity it is selling is 40 Units. The total revenue that a firm earns is $80, at the current stage. However, the company decides to increase the price of the product to $4. This will result in the decline of quantity demanded to 18 Units. Hence the new revenue that would be earned by the firm is only $72 and hence a decline in the profit. This could be shown in the diagram form. P 4 2 Q 18 40 From the diagram it could easily be seen that at the price $2 and quaintly 40, the area below the curve is greater than at the new situation when price increase to $4 and quantity is 18 units. This area represents the revenue and hence we can conclude that the smaller area means lesser revenue and how an elastic curve makes it unfavorable for the producers to increase prices. If we calculate at the elasticity of the situation we will get the following answer: Elasticity= (18-40/40*100)/ (2-4)/4*100) = 55%/50% = 1.1 And since the elasticity is greater than 1, it is not a good measure for the firm to increase prices as it is going to lose revenue, if it does that, as proved in the above part of discussion how the revenue has decrease from $80 to $72 as the price changes from $2 to $4. Similarly, inelasticity occurs if the responsiveness of Quantity demanded is smaller to the change in price. In other word, when a big change in price bring about a small change in quantity demand. The numerical value of inelasticity is lesser than and equal to zero. (McConnell and Brue, 2005) In this situation, it pays off if the producer increases the prices in order to increase his profit situation. Since, the increase in price is not going to affect the quantity demanded much, the producer is going to benefit from increase revenue and hence larger profit than otherwise he could have earned. For example, let's suppose that a producer again increases the price from $2 to $4. But as a result, the result quantity demanded changes from 40 units to 30 Units. In this case let's assess the revenue situation for the producer: Old Revenue = Price * Quantity = 2 * 40 = $80 New Revenue = Price * Quantity = 4 * 30 = $120 Hence, one can clearly assume that producers benefit from increasing the price of inelastic commodities in term of profits and large revenues. Let's now calculate the elasticity coefficient in this situation to prove our point that in case of inelastic demand, the numerical coefficient is always equal to or less than zero. Elasticity = 25%/50% = 0.5 This is how the producer benefits from an inelastic demand of product by raising prices. This can be shown through a graphical representation of areas under the curve in both old and new situations. Quantity Price 40 30 4 2 The graph clearly indicates that a big change in price has reduced the quantity be only a small amount and how revenue has increased as results. The knowledge of price elasticity is hence essential for producers while making pricing decisions to maximize their revenues and hence profits. References: John Sloman. (2000). Economics. Pearson Richard Lipsey and Alec Chrystal.(2003). Economics. 10th Edition. Oxford University Press. Campbell McConnell and Stanly Brue. (2005). Economics. McGraw-Hill Robert Pindyck and Daniel Rubinfield.(2004) Microeconomics. 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