Cost and Microeconomics - Assignment Example

Question The Surgeons Cost Table If the surgeon was to leave the house unoccupied then he has to payfor mortgage, gardener, insurance, rates, security firm, dog care and also take into consideration depreciation of his house. The total would be $26. If now the house was occupied and his conditions that the one renting the house pays for gas and electricity, takes care of the dogs for free, then we would reduce the cost of being occupied by $20+$6+$26, which includes gas and electricity. Now because the person letting the house will take care of the dogs and that there would be no need for a security firm the cost of leaving the house unoccupied reduces by $8.00 (dog care) plus $10 (security firm) which give us $18 therefore the cost of leaving the house unoccupied versus lenting to someone reduces as follows: Cost when unoccupied $76.00, Minus dog care $8.00, Minus security firm $10.00 the balance is $58.00. We also consider depreciation that occurs in excess when someone is living in the house, the excess depreciation is $5, so we add the balance above which gives us $58 plus $5 equals $63. On the gardener's services, because the person renting the house takes care of the gardening services his cost of leaving his house unoccupied reduces by $10 therefore we get $63 minus $10 we get $53. The surgeon should reduce his tent by both the value of dog care and need for a security firm because this are taken care by the person living in the house so our value will be 53-18=35. Therefore the minimum amount the surgeon should accept to receive, as rent should be $35. Question 2 Complementary goods are also referred to as jointly demanded goods. They can be defined, as goods that are used to satisfy a want jointly a good example is a vehicle cannot function without petrol. Substitute goods are products that are similar in that they satisfy the same want, if one's good is not available one can substitute it with another example butter and margarine that are consumed with bread. Butter and margarine can be substitutes of one another. Perfect competitive market is a theoretical market structures in which there are many buyers and sellers with no individual power to influence market price. Prices are determined by demand and supplies in the market assumptions of a perfect competitive market are: Many buyers and sellers, Perfect mobility of factors of production, perfect knowledge, homogenous products, absence of externalities. (Hardwick, Khan & Langmead, p 91, 1997). The analysis of equilibrium price and quantity was by Alfred Marshall (1842-1924). He analyzed the demand curve and the supply curve and stated that where the two curves intersect, they give us the equilibrium price and quantity in the market. (Hardwick, Khan & Langmead, 1997). Qo is the equilibrium Quantity Po is the equilibrium price a) Equilibrium price of butter has increased and that the equilibrium quantity of bread has increased. Possible explanations are: I. Price of milk has decreased - If the price of milk decreases then we expect the price of butter to go down. This is explained by the fact that in production of butter, milk is the key input in the process. Therefore, a decrease in the price of butter cannot explain an increase in price of butter. II. Price of flour has decreased - If price of flour decreases we expect price of bread to go down because flour is the key input in production of bread. If price of bread decreases we expect an increase in the quantity demanded of bread. Therefore this explains the increase in equilibrium quantity of bread. On butter - as the bread demanded increases and having in mind that bread and butter are complementary goods. We expect the price of butter to go up also due to increased demand. Demand and Supply Curve for Bread Price Po P1 SSo 0 Quantity The decrease in price of flour causes the supply curve of bread to shift downwards from SSo to SS1 . our original equilibrium was at Po and Qo and after the shift our new equilibrium is at P1 and Q1. b) Equilibrium price of butter has increased and that the equilibrium quantity of bread has decreased. Possible explanations are: I. The price of milk has increased - If the price of milk increased we also expect the price of butter to go up. Therefore this explains the increase in equilibrium increase in price of butter. As the price of butter goes up, the less of it is demanded. The less the butter demanded this results to a decrease in quantity of bread demanded. Therefore this explains the decrease in equilibrium quantity of bread. Demand and Supply Curve of Butter Price P1 SS1 SS1 SSo Po SSo 0 Q1 Qo Quantity Po and Qo are the original equilibrium price and quantity. P1 and Q1 are the new equilibrium price and quantity. II. The price of flour has increased - An increase in the price of flour causes the price of bread to go up, less of bread is demanded therefore the new equilibrium quantity of bread decreases. As less of bread is demanded we expect less demand for butter, therefore this does not explain an increase in the equilibrium price of butter. Question 3 Tax is a compulsory transfer of money from taxpayers to the government. They are of two broad categories these are direct and indirect taxes. In our case the tax on cigarettes is on indirect tax. When a tax is imposed on a product, it causes the price of that product to rise; in this case the price of one pack of cigarette is raised by 10%. The diagram below demonstrates the effect of a tax on quantity and price of a product. Po and Qo shows the original equilibrium price and quantity. P1 and Q1 shows the new equilibrium price and quantity after tax. Area A shows the value of the tax that goes to the government. SS1 Price P1 Po Quantity Elasticity of demand is the measure of responsiveness of quantity demanded to a change in price of a good determinants of price elasticity include: Existence of a substitute of a good, the more the substitutes a good has the more elastic the demand is. The proportion of consumers' income spent on the goods. The time taken for the buyers to react to changes in price. I. Perfect Price Inelastic. Demand curve Price 0 Quantity II. Perfect Price Elastic Price Demand Curve 0 Quantity a) Demand of wealthier consumers for cigarettes ad demand for lower income consumers. Disposable income for wealthier consumers is larger than low-income consumers. For wealthier consumers the proportion of income that is spent on cigarettes is negligible therefore having in mind that this same consumer has a large disposable income, a raise in price of cigarettes will not affect his consumption. Therefore we conclude that the demand curve is more inelastic for wealthier consumers and elastic for low-income consumers. I. Wealthier Consumer Demand Curve. Price Demand Curve 0 Quantity 1 II. Low-Income Consumer Demand Curve. Price Demand Curve 0 Quantity b. Long run price elasticity of demand for cigarettes is greater than the short run price elasticity of demand for cigarettes. This is explained by the fact that it takes time for buyers to react to change in price of a good. Therefore the demand for cigarettes will be inelastic in the shortrun and more elastic in the longrun. Shortrun Price 0 Quantity Longrun Price 0 Quantity c. Demand of a particular brand is more price elastic than demand for cigarettes in general. Different brands have different prices; other brands are substitutes to a single brand. A consumer who consumes a certain brand that is more expensive than the others and it happens that there is a price rise, that makes the brand even more expensive, then he will substitute his brand for a cheaper one. Therefore, we expect the expensive brand to be more price elastic than the less expensive brands and also elasticity of demand for cigarettes in general. d. If price of elasticity of demand for cigarettes is inelastic what will happen to price, quantity consumed and spending on cigarettes if a tax is imposed. Inelastic Demand Price P1 S1 So Po S1 So 0 Qo Quantity If a tax is imposed, the price rises from P0 to P1, now due to the inelastic demand the quantity demanded Qo does not change. On spending, consumers spend more on cigarettes because the quantity consumed does not change and our price has increased Question 4 Isoquant curve - it is also called an isoproduct curve. It is a contour line, which joins together the different combinations of the two factors of production, namely capital and labor that are just physically able to produce a given quantity of a particular good. Isocost line - illustrates all the combinations of capital and labor that can be bought for a given monetary outlay. i. A change in cost of labor causes the isocost line to shift. Capital 10 Q0 P0 P1 Q1 I1 Io 4 5 Labor Assuming that the cost of per unit labor on average is 4 dollars and the cost of capital is 2 dollars per unit, and that the labor cost per unit increases to five dollars. If we have a monetary budget of 20 dollars then our curves will be as follows: Our initial equilibrium point was at Po which is the intersection of isoquant line Io, an increase in price of labour causes the isocost line to shift to I1 which is our new equilibrium point is at P1 which is as a result of the intersection of isoquant curve Q1 and isocost I1 ii. Unemployment effect of rising minimum wage - As cost of labor increases, firms substitute labor for capital, therefore a rational profit-maximizing firm will use mo re capital and less labor. This means that the rate of unemployment will rise. iii. Firms profit maximizing output and profit maximizing price when minimum wage rises. Where marginal cost curve and marginal revenue curve intersect we have our equilibrium level of output, which is the profit maximizing level. A Firms Cost Curves MC Cost ATC AVC AFC 0 Output A Firms Profit Maximizing Level Cost and Revenue 0 qo Output iv. Effect of a wage rise on profit maximizing price - When the price of labor increases we expect our cost to shift upwards, we expect the marginal cost curve to shift upwards as follow. Price P1 Po 0 Q1 Quantity An increasing in labor cost will cause the cost curves to shift, therefore we expect the price of the firm to go up from its original price Po to a level say P1. Question 5 a) If the cost of machinery and fertilizers go down, farmers will make more profits because of the reduced cost of production. If the farming industry is highly competitive such that we have free entry and exit into the industry. This incentive of extra profits would attract others to engage in farming. As a result of expansion of the number of firms, there would be increased supply of agricultural products, which would be increased, by supply of agricultural products, which would push prices down. This will eliminate the above normal profits. Therefore in the longrun the firms will not be more profitable in the longrun. b) The reason why firms at higher levels of output charge lower prices is because they are able to spread the fixed costs over a large production. This is referred to as economies of scale, which can be defined as falling longrun, average cost as the scale of output increases. This can be demonstrated in a diagram as follows using long run average cost and short run fixed costs. SRAC1 Cost SRAC2 LRAC 0 q1 q2 Output At the level of output q1, the short run average cost curve (SRAC) is higher than at the level of output q2, where the shortrun average cost curve (SRAC2) is lower. At this point the firm should stop producing because if we exceed this output the cost curve will start rising. The fixed costs are divided among the quantity produced, but at a certain level (q2) if we exceed this point the fixed cost increases because the firm will be forced to expand. Some of the fixed costs could be rent, security and insurance. c) An author has an interest is a book's price lower than the price which maximizes the publishers profits. The author is entitled to a fixed percentage of the books price. While the publisher determines what to charge on a book. This price set by the publisher is one that maximizes his profit. The publisher's price considers all his expenses including materials used, staff. Salaries and wages and also the advertising costs. All this adds up to a high price of a book. The price of the book also includes the percentage of the author's entitlement Reference Hardwick P, Khan B, Langmead J, (1997), An Introduction to Modern Economics, 4 Th Edition, Longman Group UK Limited, New York. Read More