Analyzing the Important Micro-Economic Concepts - Coursework Example

Topic:  Microeconomics Table of Contents 2 Introduction 3 Cross price elasti in the U.S.A goods 4 Ronald Coase Theorem 7 Reference 9 Abstract This report aims at analyzing two very important micro-economic concepts. First it takes a look at the concept of cross price elasticity of demand. This concept of elasticity measures the degree of responsive of demand for a good as a result of a change in the price of another but related good. Elasticity of demand is analyzed with respect to the US goods market. For the ease of understanding typical goods of consumption are divided into eleven broad groups and thereby the analysis is carried out. The second part of the report provides an overview of the work of Ronald Coase for which he got the Nobel Prize. The property rights and transaction cost theory holds when parties bargain over the ambiguities associated with properties. Introduction Microeconomics is a crucial branch of economics. It deals with the functioning of the individual units of decision making of an economy like the households, firms and the Government. Cross price elasticity is important from the point of view of economic decision making. Right from policy makers to producers, every individual economic player needs to be aware this concept of elasticity in order to make sound decisions. Demand and supply forces comprise the veins of any economy. Under such circumstances cross price elasticity concept gives a vivid idea of how quantity demanded for a commodity changes as a result of changes in the price of another commodity. Thus producers have to keep a watch on the demand and prices of other goods as well before setting any production plan. The very famous Ronald Coase, the British economist got the Nobel Prize for his work on property rights. He showed how with changes in property ownership or in presence of externality the distribution of wealth is affected. Cross price elasticity in the U.S.A goods Elasticity is a concept that measures the sensitivity of demand for a good or a service in response to a change in its own price or change in the income of the consumer or a change in the price of a related good or service. Cross price elasticity in particular measures the sensitivity of demand for a commodity with respect to the prices of other commodities. For example the demand for tea changes as a result of a change in the price of sugar because tea and sugar complementary goods. The demand for tea also changes as result of change in the price of coffee. However in both cases the change is different. While tea and sugar are complementary, tea and coffee are supplementary. Therefore, a change in the price of sugar directly affects the demand for tea while a change in the price of coffee inversely affects the demand for tea. Mathematically cross price elasticity of demand is the ratio of the percentage change in demand for a commodity X and percentage change in the price of a related commodity Y. It is expressed as, e = Percentage change in quantity demanded for X Percentage change in price of Y The sign of this ratio depends on the relationship between the two commodities, X and Y. If X and Y are complementary in nature then a rise in the price of Y will result in a fall in the quantity demanded for X and thus cross price elasticity of demand for X will be negative or the ratio less than zero. If X and Y are substitutes, then a rise in the price of y will result in a rise in the demand for X and thus cross price elasticity of demand will be positive or the ratio will be more than zero. (How Elasticity of Demand Affects Total Revenue, n.d.) The concept of cross price elasticity remains quite the same irrespective of the economy in consideration. To analyze cross price elasticity of demand in the U.S.A. goods and services, the entire market can be divided into eleven broad aggregate commodity groups. The eleven categories of commodities are, 1. Food, 2. Alcohol and tobacco 3. Clothing 4. Housing 5. Utilities 6. Transportation 7. Medical Care 8. Durable goods 9. Other non-durable goods 10. Other services and 11. Other miscellaneous goods All items of consumption have been divided into eleven groups. Any change in the price of a commodity affects the quantity demanded for a related commodity within a group. It is crucial to note that the different groups are mutually exclusive and unrelated. As such elasticity of demand cannot be calculated between commodities from two different groups. Or in other words elasticity of demand can only be obtained between commodities of the same group. For example a durable good like utensil is in no way related to a food and perishable item like meat and thus two are unrelated. A rise or fall in the price of utensils will no way affect the quantity demanded for meat. Once again even within groups there can be unrelated goods. For example in the clothing group change in the price of footwear will not affect the demand for jewelry or garments. In such cases the ratio between the percentage change in price of one good and the percentage change in the demand for another unrelated good will be equal to zero. However in the transportation group rise in the fare of one mode of transportation will certainly lead a rise in the demand for an alternative mode of transport. It is also important to note in this respect that cross price elasticity of demand is not reciprocal. It is important to calculate the cross price elasticity of demand both ways. (Blanciforti L., Green R.D., and King G.A., August 1986) Ronald Coase Theorem The British economist Ronal Coase is well known for his work in property rights. In the year 1991 he also received the prestigious Nobel Prize for his theory of property rights. Through this theory he divulged the significance of property rights for the institutional structure a functioning of an economy. The Coase theorem of property rights focuses on the transaction costs involved in disputes in neighbouring properties. It addresses the negative externalities like factory smokestack or cattle destroying a nearby farmer’s crops. Under such circumstances, Coase states that taking transaction cost as zero, the economic outcome including the distribution of wealth would be the same. However Coase also made it a point mention that transaction costs are seldom. In reality transaction costs can be so high that it become difficult for negotiations and contracts to take place. Thus through property rights and transaction cost theorem, Ronald Coase tried to assess and refine the orthodox economic models. These earlier models assumed that transaction costs are zero and that economic activity takes place in vacuum. That is to say economic activity can take place even without space, time or any energy inputs for production. If transaction costs were zero even in case negative externality the distribution of wealth would be unaffected. If a person needs to compensate a farmer for crops destroyed by his wandering cattle, the amount the rancher would pay for leasing the land would be lower by that same amount, while the farmers lease would then be higher by that amount. He also points out that even in cases when there is a change in the liability law, the distribution of wealth remains unchanged. Coase’s findings are well applicable to cases where there are changes in the basic property rights like rights to ownership of land. In case the law were twisted so as to support some version of land reform or land rent reform, such as Georgist views of rights to land rent then the distribution of wealth would no more be equal even if there were zero transaction costs. (Mike OMara, May 1999) Reference Blanciforti L., Green R.D., and King G.A., (August 1986), U.S. Consumer Behavior Over the Postwar Period: An Almost Ideal Demand System Analysis, retrieved December 3, 2008, from http://giannini.ucop.edu/Monographs/40-Postwar.pdf Mike OMara, (May 1999), Coases Theorum, retrieved December 3, 2008, from http://www.cooperativeindividualism.org/coase_landtheory.html Read More