Intermediate Microeconomics - Assignment Example

Intermediate Microeconomics Answer Pareto-Efficiency Human wants are unlimited but the resources available to satisfy their demands are scarce. Appropriate allocation of resources is the primary issue for any contemporary economic system. An economy attains the stage of pareto-optimality when it allocates its productive resources in the most proficient manner. From the pareto-optimal situation it will not become feasible to make any one better-off, until someone else is made worse-off in the economy (Mankiw and Taylor, 2006). The exact resource allocation framework of an economy that helps to attain pareto-efficiency or optimality is known as the pareto-efficient allocation. Figure 1: Pareto-Efficient Allocation Quantity of Good A A1 Pareto-Efficient Allocation B1 Quantity of Good B (Source: Author’s Creation) The above production possibility frontier shows the pareto-efficient outcome of a hypothetical economy producing only good A and B. The pareto-efficient allocation is A1 and B1. “Yes”, a person can be worse-off in a pareto-efficient outcome, while existing in a better position in the pareto-inefficient state (McAfee, 2009). The statement can be proved with the help of a hypothetical example. Let 10 units of mango be the total resource base of an economy and let there be only 2 agents, namely A and B within it. If A owns 7 units of mango and B owns 1, then theoretically the economy lies in a pareto-inefficient state but A lies is a better position compared to B. Through resource re-distribution of the economy, if A receives 5 units of mangoes and B owns the other 5, then the economy reaches a state of pareto-efficiency. However A becomes worse-off, losing 2 units of mango from the pareto-inefficient stage. Pareto-inefficiency elaborates a state where all the productive resources of an economy are not utilized is the best possible manner. An economy can move from a pareto-suboptimal to a pareto-optimal state, by at least making one of its individual better-off. Thus it is “not” possible to attain a pareto-efficient state by making everyone worse-off, compared to the state where they existed in the pareto-inefficient outcome (Orbach and Einav, 2007). The statement can be proved with the help of a hypothetical example. Let economy possess 20 units of mangoes as its total resource base and four individual’s altogether, namely A, B, C, and D. If all the individuals own 3 mangoes (each), then the economy exists in a pareto-inefficient state. The market will reach a state of pareto-optimality, only if all the resources (20 units of mangoes) are consumed. The economy will be able to reach pareto-efficiency, by at least making one individual better-off with greater number of mangoes. The theory of pareto-efficiency is not related to equity. Thus an economy can attain a state of pareto- inefficiency by distributing resources inequitably (Woodford, 2003). An economy can hence exist or reach a state of pareto-efficiency, by making someone better off. However one individual can be made better-off in a pareto-efficient stage only by making one or others worse-off. Let 20 mangoes be the total resources available in an economy and the total number of agents are four, namely A, B, C and D. The economy will lie in an equitable pareto-efficient state if each individual owns 5 units of mango. However the economy will remain in a state of pareto-efficiency if A is provided 14 mangoes and the others are given 2 mangoes each. Theorem of Welfare Economics First Theorem of Welfare Economics The first theorem of welfare economics is also popularly known as the Invisible Hands Theorem. The theorem leads the market to a social optimum state, where the welfare is maximized subjected to the given resource constrains in the economy. The first theorem of welfare economics states that an economy can achieve the state of social optimality, by strictly following laissez fair policies within its marketplaces. The theorem is hence against government interventionist policies. It states that the net social welfare of an economy declines with public involvement in its resource allocation as well as distributional strategies. However the some researchers claim that an economy cannot attain a social welfare maximizing state, without government guidance (Brian and Vane, 2002). It is perceived that resource allocation process without government participation inequitable or sometimes pareto-inefficient. The first welfare theorem states that the free market outcome is always pareto-optimal. The theorem’s validity is based on some assumptions. These assumptions state that an economy can reach social optimally without government intervention, if the number of buyers and sellers across major industrial segments are infinite and each market agent is rational. Even so, social optimality can be attained according to the Invisible Hands Theorem, only if the buyers and sellers are adequately informed about the market features in detail (Brian and Vane, 2002). Thus first theorem of welfare economics is primarily applicable in the hypothetical market structure of perfect competition. Second Theorem of Welfare Economics The second theorem of welfare economics states that an economy can achieve social optimality in a competitive equilibrium provided; the public sector authorities redistribute the productive resources on basis of equality. Researchers claim that the second welfare theorem is more appropriate as it segregates the matters of efficiency and resource distribution (Joshua, Jurek and Stafford, 2009). According to the first theorem of welfare economics, an economy can attain a state of pareto-efficiency but the resource distribution process of the market might be inequitable. On the other hand, according to second theorem, resources of an economy can be equitably distributed, from the state of pareto-efficiency. Empirical Analysis If an economy is guided by capitalistic policies and experiences least government intervention, then in the competitive equilibrium level the country can maximize its social welfare. However if the resources of the market are not distributed equitably, then the level of its income inequality increases. A country can never improve its socio-economic parameters without the essence of equitable resource distribution (Joshua, Jurek and Stafford, 2009). The countries in the contemporary era are governed by mixed economic principles. Under this regime the public authorities promotes competition across all the major industrial segments but ensures re-distribution of income between the individuals. Hence the second theorem of welfare economics is more realistic than the first theorem. Equitability and social welfare cannot be maximized without active private-public participation (Joshua, Jurek and Stafford, 2009). Answer 2: Price Discrimination Disneyland is Paris was founded in 12th of April 1992 (DisneyLand, 2014). It was originally the Euro Disney Resort in Paris and was converted into Disneyland by Michael Eisner (DisneyLand, 2014). It is a type of amusement part in Paris, France (DisneyLand, 2014). The company provides price discounts to its visitors in France in some special occasions. The prices charged by the company often differ in terms of the age of the visitors, time of visit and their loyalty towards the concern (DisneyLand, 2014). However the price discriminations introduced by the company on its entry ticket prices is a type of third degree price discrimination. Under this regime the organization provides special discounts to its different customers’ groups (DisneyLand, 2014). The ticket prices of Disneyland Paris are lower for juniors and higher for adult visitors. The company changes high during weekends and relatively low during the weekdays (DisneyLand, 2014). Elasticity of Demand Disneyland implements the policy of price discrimination in business because it faces relatively elastic demand for its products and services in the market. Elasticity is the degree of responsiveness between the rate of change of quantity demand for a commodity or service with respect to rate of change of its price (Joshua, Jurek and Stafford, 2009). |ep|= % change in quantity demanded / % change in price Since Disneyland faces relatively elastic demand in the market, percentage change in is quantity demanded is more than percentage change in its price. Figure 2: Relatively Elastic Demand Price P1 Demand Curve P2 Q1 Q2 Quantity Demanded (Source: Author’s Creation) The above graph shows a relatively elastic demand curve. The change in quantity demanded (Q1-Q2) is more than the change in price (P1-P2). Disneyland provides comfort or entertainment products and services in the market. The demand for such products is elastic in nature. A slight rise in the prices of entry tickets of Disneyland significantly lowers the number of visitors. There are other entertainment hubs of Paris, where the consumers prefer to visit under such circumstances. By providing discounts the company lowers the price of its tickets and hence experiences significant rise in the number of its visitors. Thus, price discounts are highly effective when the demand faced by the products and services of a company are relatively elastic in nature. Types of Price Discrimination Price discrimination is the process through which a seller charges different prices for its products or services from separate customers (Corsetti and Dedola, 2003). The policy of price discrimination is adopted by a seller for maximizing profit in business. Price discrimination is primarily segregated in terms of three categories. First Degree Price Discrimination In first degree price discrimination, a seller charges highest possible prices for products and services from the customers (Corsetti and Dedola, 2003). Under such circumstances the industry experiences zero consumer surpluses. First degree price discrimination is primarily practiced by the monopolists in the market. Figure 3: First Degree Price Discrimination Revenue and Cost Demand Curve Quantity (Source: Author’s Creation) The above figure shows that under first degree price discrimination, the revenue earned by the monopoly seller is different for each unit. Empirical Analysis The service provided by a doctor is unique and non imitable in nature. A doctor is often considered as a monopolist in the market. A doctor can charge different fees from each of its patients and hence discriminate prices on first degree basis (Joshua, Jurek and Stafford, 2009). Giant pharmaceutical companies producing rare life saving drugs often implements the first degree price discrimination in business. Second Degree Price Discrimination In second degree price discrimination, the seller charges dissimilar prices for separate quantity of output. The prices established are inversely related to the quantity of output traded (Corsetti and Dedola, 2003). Empirical Analysis Peak and off-peak pricing strategy is a type of second degree price discrimination. This method of pricing is widely practiced in the telecommunications industry. The telephone companies charges different rates during daytime, evening and night (Riley, 2012). The charges vary according to the quantity of usage. Figure 4: Second Degree Price Discrimination (Source: Riley, 2012) The above figure shows second degree price discrimination, where the peak price (P1) is higher than the off-peak price (P2). Third Degree Price Discrimination In third degree price discrimination, a seller charges different prices for separate groups of people. This is the most commonly followed approach in the contemporary business world. Third degree price discrimination is followed by a seller on grounds of customers’ age, income or geographical location (Corsetti and Dedola, 2003). Figure 5: Third Degree Price Discrimination (Source: Riley, 2012) The above figure diagrammatically explains third degree price discrimination. The seller charges higher price (Pb) from market B, compared to the price (Pa) it charges in market A. The selling price in market B is higher because it experiences more inelastic demand compared to the price elasticity of market A (Windsor, 2009). Thus price and elasticity shares an inverse relationship with each other. Conditions for Price Discrimination A company can implement the strategy of price discrimination and enhance profit in business. However there are two primal conditions required for price discrimination. There must be certain differences in the price elasticity levels of different groups of consumers in the market (Ross, 1979). Under such circumstances the company is able to charge higher from the consumers generating inelastic demand and charge lower from the buyers creating elastic demand. This is because, when a buyer’s demand in inelastic in nature, then a massive increase in the price level brings about relatively limited change in the quantity demanded for it. On the other hand, if a consumers’ demand is elastic in nature, then a slight fall in the price will increase demand relatively more for the produce of a firm. The effectiveness of price discrimination strategy of a company also depends on its industrial structure (Courty and Pagliero, 2009). If a company conducts business in a highly competitive market and the threat of new entrants within the industry is high, then it should not discriminate the consumers on basis of price. This is because; the buyers switching costs in the market becomes high in such industries. If the company practices high discriminations then the buyers switch off to other firms (Riley, 2012). Thus price discrimination becomes effective if the industry is less competitive in nature (Riley, 2012). Reference List Brian, S. and Vane, H. R., 2002. An encyclopaedia of macroeconomics. Massachusetts: Edward Elgar Publishing. Corsetti, G. M. and Dedola, L., 2003. Macroeconomics of international price discrimination. London: Centre for Economic Policy Research. Courty, P. and Pagliero, M., 2009. The Impact of price discrimination on revenue: Evidence from the concert industry. [pdf] Carloalberto. Available at: [Accessed 25 July 2014]. DisneyLand, 2014. DisneyLand. [online] Available at: [Accessed 25 July 2014]. Joshua, C., Jurek, J. and Stafford, E., 2009. The economics of structured finance. Journal of Economic Perspectives, 23(1), pp. 3-25. Mankiw, G. N. and Taylor, M. P., 2006. Microeconomics. Connecticut: Cengage Learning EMEA. McAfee, R. P. 2009. Competitive solutions: The strategists toolkit. Princeton: Princeton University Press. Orbach, B. Y. and Einav, L., 2007. Uniform prices for differentiated goods: The case of the movie-theatre industry. International Review of Law and Economics 47(1), pp. 1-26. Riley, G., 2012. Price discrimination. [online] Available at: [Accessed 25 July 2014]. Ross, S. A. 1979. The Economic theory of agency: The principals problem. American Economic Review, 63(1), pp. 134-139. Windsor, C., 2009. The rise of regulatory capitalism and the decline of auditor independence: A critical and experimental examination of auditors’ conflicts of interests. Critical Perspectives on Accounting. 20(2), pp. 267-288. Woodford, M., 2003. Macroeconomics. New Jersey: Princeton University. Read More