Economic Variable Determinants Changes - Assignment Example

Question 1 PART A The given scenario would present a new rush and demand for tea after a short temporary higher demand for the coffee. In real life situations, there would be immediate short increase in the quantity of coffee demanded as precautionary measures to guard against the planned price increase. But more importantly, coffee which has perfectly cross price elasticity of demand with tea would witness an eventual decrease in the quantity demanded. There would be a new rightward shift to a new demand curve for the tea product which is a very close substitute for coffee in satisfying the same beverage needs. This is on the assumption that there is a prevailing competitive price of tea presently and in the event of the planned increase. If say the present price of coffee and tea is $x and $y respectively where x is greater than or equal to y, then given the speculated price increase $(x+2), there would be a shift to a new demand from coffee to tea by consumers which affects the supply of both goods in the short and long runs. Part B The figure describes a complete change in the supply off one commodity to a new one which has close similarities. It highlights a trend change in the supply matrix of two goods with similar utility value probably due to price determinants. This usually occur in a perfectly competitive market A clear example is the international commodity market selling commodities like cement, small crops etcetera. Price differentiation between commodities Change in taste by consumers Favorable opportunity costs to the new commodity supplied New and cheap techniques of production including cheap available resources. Government policies on former commodity including firm shut down. Factors that cause movement along the supply curve are thus: Cost of Production: This is the aggregate total expenditure on the production of goods and services. The total cost TC of producing goods determines the quantity of output available for sale. Pricing conditions: the market determined price assuming a perfect market condition, affects the supply of goods and services. Where the price is less than the marginal cost of production, Profit is not made and the firm might decide to scale down production to induce price increase. Demand matrix: A higher demand might push an increase in the production and supply of commodities while a decreased demand on the same item might lead to the reverse. Part C Elasticity is degree of responsiveness of demand and supply of goods and services to price and other economic variable determinants changes in perfect market conditions. It measures the rate at which the demand and supply of goods and services changes to the significant alteration of some economic variable such as price, income etcetera. It is expressed as a nominal coefficient of the measured economic variable. Let the price and quantity demanded at point E be P2=$400 and Q2=300 units respectively and at point Z P1=$200 and Q1=350 units, so that using the midpoint rule it gives that P2-P1 =# where # is the price elasticity of demand. Q2-Q1 Therefore, $400-$200 = 200 = 4 the price elasticity of demand is 4 a perfectly 350-300 50 competitive product. Question 2 Part A Quantity Total cost Marginal cost 0 $200 $200 1 $900 $700 2 $1800 $900 3 $3000 $1200 The average fixed cost AFC for the 3rd unit of output is calculated by dividing the total cost TC of the 3rd units and assume the marginal cost to be the average variable cost. Thus $3000 = $1000=Average total cost ATC= AFC 3 Part B 1. The production level is such that the AVC + AFC = ATC i.e. $20 + $500 =$25 X it follows that $20x + $500= $25x > $25x-$20x=$500 Thus $5x=$500 > x= $500 = 100 the firm is production at 100 units per hour, an $5 optimum production level. Assuming perfect market, the firm is operating at maximum profit since MR=MC=$35=P. Where P is the normal equilibrium price at a production of 100 units per hour. The normal profit is then P-ATC > $35-$25=$10 2. The TC-TR method: Here firms allocate resources and produce goods at the product number where the total revenue TR is greater than the total cost TC and whose difference gives the profit and would vary that until additional output results in a TR less than the TC. The output at that point becomes the firm’s maximum output per hour. This method gives a general idea on the maximum output target for a firm by taking into consideration best possible means of production to achieve a set quantity of output for profit maximization and loss minimization. Total cost includes the total fixed cost of production such as cost of plant equipment, land and other assets and the total variable cost of production such as labor costs, cost of raw materials etcetera. Total revenue on the other is the aggregate amount of money realize from the sale of the goods and services. This method does not give an idea of cost of producing additional goods and services in the case of expansion thus is less detailed than marginal analysis method. Marginal Analysis: Here empirical emphasis is placed on the production of an additional unit of the commodity. The revenue and cost of production from the item is expressed as margins i.e. Marginal revenue and cost, MR and MC respectively. In perfect markets, the demand statistics on a data chart is usually horizontal such that the marginal revenue is same and one as the price i.e. MR=P. The firm usually produce at points when MR=MC=P. At this point usually gives the firm maximum equilibrium price at a particular output quantity which would give the firm a normal profit. Part C The figure represents a perfectly elastic long-run supply curve in a perfect market. At point A assuming the stated, the movement to B represents an increase in demand which sets a higher equilibrium price with increase in supply probably due to entrance of new firms into the industry but whose expansion of output has no effect on the firm’s cost curve. Then down to C where the initial equilibrium price is restored due to more supply over demand. Finally down to D where there is a decrease in the price due to excess supply over decrease demand which forces the price down and probably causes some firms to shut down which would start the cycle in the short run over again. This is an example of a constant-cost industry. Question 3 Part A 1) This is a case of an imperfect market condition. It occurs to commodities that have some socio-cultural and/or immense economic value to consumers. The demand curve is upward sloping to the right where there is increased demand for more houses despite increase in the general prices of the houses. Imperfect conditions do not obey the basic laws of demand and supply. The demand for certain goods and services that have certain exceptional appeal to the consumers. When producers increase the price of these commodities, consumers continue to demand for such items driven by other perceived values the items possess other than thoughts on their prices. Houses have certain social and cultural values which often induce the price offered for them which is not really put into consideration. Again during disasters or better still their aftermath, there is a resultant scarcity of houses which is a commodity that satisfies a basic human need. Thus in a city like Adelaide, there would be a surge in the price of the available houses where demand far exceeds supply. This enables the real estate dealers to capitalize on that and effect favorable changes on the prices. This trend could reverse in the long run with increase in supply accompanied by a progressive decrease in demand. This category includes items bought for ostentation, such as jewelries, art collections, vintage wines etcetera. During the house market boom in the United States in early 2001, there was a high demand for housing by the population as a result of increase in personal income and the need for house ownership both for ostentatious value and as economic investment. There was a boom in the mortgage sector of the industry where excess liquidity resulted in excess funds by the operators which resulted overconfidence in subscribing potential customers for mortgage financing. Over the five year period, it resulted in an unprecedented oversubscription in mortgage plans by clients without proper scrutiny and follow-up documentation. There were instances where long unemployed clients applied and got approval for house mortgage financing. The high demand was met by short supply of houses due to new developments at new sites. This led to increase in the prices offered for the houses by developers and dealers as well. The imperfect market condition was witnessed by 2004 where the unit price for a semi-detached duplex was selling at incredible high value but the demand for them was still far in excess of demand. The situation gave rise to the demand curve in the figure described above and was largely part of the reason for the present housing crisis in the US market. 2) The scenario would present a perfect income elasticity of demand of the accountants’ skills assuming perfect market conditions. It would result to a complete right ward shift to the demand for new industries by the tax accountants where there is existing favorable wage structure such as the insurance and banking sectors. The long-run effect is a mass exodus of the tax accountants to other sectors with better wage package. There would be a resultant shortage of tax accountants in the long-run. The sought after market would have a new supply of labor whose quantity would be primarily determined by the price offered for the labor. A good example is the trend witnessed in the banking sector of Nigeria. During the recent restructuring witnessed in the sector, there was an increase in efficiency due to new policy enactment guiding the banks’ operations including ones for new start-ups. A new policy ensured that banks maintained a new upwardly reviewed minimum with the apex bank, the Central Bank of Nigeria to be able to retain operating license. This became necessary following the liquidation and shut down crisis that rocked the industry in recent times. The new policy resulted in a lot of mergers and acquisitions which strengthened the industry leading to unprecedented job growth in the industry with attractive competitive salary packages. The effect of this new trend to sister sectors like the insurance sector witnessed a dearth of skilled accountants due to the attraction in the banking industry. A representation of the demand and supply matrix would give similar curves like that in the chart below. Part B 1. Check Monopolistic tendencies: This could occur if there is fierce competition where firms that was able to withstand the market pressures survives, consolidates and takes over the market at the mercy of consumers. The price ceiling protects the consumers from on this situation which could give the firms power to fix prices instead of price determination by market forces. Price discrimination: The situation described above could make the firms to sell goods and services not based on the demand and supply or cost of production but on some arbitrary decisions taken at their discretion. This exempts some consumers from commodities they would have otherwise have access to. Maintaining the power of Fair competition: The price ceiling ensures existence of competition among firms where the forces of demand and supply come into play. 2. The US Federal Reserve sets the price rate for banks’ lending rate. The government put forward the limits on lending rates by banks to their customers and adjusts the going rate based on prevailing market circumstances. The primary reason for this is for maximum efficiency in the banking sector. This allows customers to borrow funds at reasonable interest rates and ensures that the bank firms compete at a level playing field. Thus the price or rate of buying (borrowing) funds from banks is determined by the general economic outlook as calculated by appropriate government representatives. US Federal reserve rates is known to be an important catalyst in boosting the economy especially during economic downturns such as is witnessed in the present US economic crisis such as the Mortgage sub prime, under-performing financial markets and more especially job losses and reduced consumer spending and confidence which had made experts like Alan Greenspan, a former Federal Reserve Chairman to suggest of imminent economic recession, plus a reduction of the lending rates to spur capital liquidity. 3. A practical way of dealing with the mentioned US economic gloom is for the US government to reverse their long running budget deficit but more importantly for the purpose and scope of this essay, try to crunch the bank rates especially the mortgage rates to minimum digit to spur a new consumer spending trend which would increase liquidity ratio i.e. capital in circulation which would in turn boost investment and subsequent job growth. Part C 1. Lender of Last resort: This function of the government makes it possible for it to step into markets going through externalities influence and try to rectify the situation. Government represents the owner of national resources including national (federal) funds which gives it the mandated authority and responsibility to do everything within its disposal to redress market anomalies through its appropriate agencies for optimum market efficiency. The role of government ensures that the effect of the externality is reversed and the industry revamped for better performance. This in the long run ensures the survival and continued existence of the industries. The figure shows the production data of an industry having external influence. The firm has a negative production matrix where the Average variable cost AVC is well above the marginal revenue MR. It shows an industry operating under a loss at a fixed price which under perfect conditions is assumed to be the price per unit commodity. Further more the need for government to mediate in issues of market influence by negative externalities like air and water pollution can be explained from the existing myths about market as explained by Tom G. Palmer(2007).These myths tend to highlight the ‘whys’ of the need for government’s intervention as the mandated corporate citizen in issues affecting the economy. He argued that there exist perceptions that market as a stand alone seem helpless or “selfish” to be able to address the negative externalities. Few of the myths are explained thus: Reliance on Markets Leads to Monopoly Without government intervention, reliance on free markets would lead to a few big firms selling everything. Markets naturally create monopolies, as marginal producers are squeezed out by firms that seek nothing but their own profits, whereas governments are motivated to seek the public interest and will act to restrain monopolies. Governments can – and all too often do – give monopolies to favored individuals or groups; that is, they prohibit others from entering the market and competing for the custom of customers. That’s what a monopoly means. The monopoly may be granted to a government agency itself (as in the monopolized postal services in many countries) or it may be granted to a favored firm, family, or person. Do free markets promote monopolization? There’s little or no good reason to think so and many reasons to think not. Free markets rest on the freedom of persons to enter the market, to exit the market, and to buy from or sell to whomever they please. If firms in markets with freedom of entry make above average profits, those profits attract rivals to compete those profits away. Some of the literature of economics offers descriptions of hypothetical situations in which certain market conditions could lead to persistent “rents,” that is, income in excess of opportunity cost, defined as what the resources could earn in other uses. But concrete examples are extremely hard to find, other than relatively uninteresting cases such as ownership of unique resources (for example, a painting by Rembrandt). In contrast, the historical record is simply full of examples of governments granting special privileges to their supporters. Freedom to enter the market and freedom to choose from whom to buy promote consumer interests by eroding those temporary rents that the first to offer a good or service may enjoy. In contrast, endowing governments with power to determine who may or may not provide goods and services creates the monopolies – the actual, historically observed monopolies – that are harmful to consumers and that restrain the productive forces of mankind on which human betterment rests. If markets routinely led to monopolies, we would not expect to see so many people going to government to grant them monopolies at the expense of their less powerful competitors and customers. They could get their monopolies through the market, instead. It’s always worth remembering that government itself seeks to exercise a monopoly; it’s a classic defining characteristic of a government that it exercises a monopoly on the exercise of force in a given geographic area. Why should we expect such a monopoly to be more friendly to competition than the market itself, which is defined by the freedom to compete? Markets Don’t Work (or Are Inefficient) When There Are Negative or Positive Externalities Markets only work when all of the effects of action are born by those who make the decisions. If people receive benefits without contributing to their production, markets will fail to produce the right amount. Similarly, if people receive “negative benefits,” that is, if they are harmed and those costs are not taken into account in the decision to produce the goods, markets will benefit some at the expense of others, as the benefits of the action go to one set of parties and the costs are borne by another. The mere existence of an externality is no argument for having the state take over some activity or displace private choices. Fashionable clothes and good grooming generate plenty of positive externalities, as others admire those who are well clothed or groomed, but that’s no reason to turn choice of or provision of clothing and grooming over to the state. Gardening, architecture, and many other activities generate positive externalities on others, but people undertake to beautify their gardens and their buildings just the same. In all those cases, the benefits to the producers alone – including the approbation of those on whom the positive externalities are showered – are sufficient to induce them to produce the goods. In other cases, such as the provision of television and radio broadcasts, the public good is “tied” to the provision of other goods, such as advertising for firms; the variety of mechanisms to produce public goods is as great as the ingenuity of the entrepreneurs who produce them. More commonly, however, it’s the existence of negative externalities that leads people to question the efficacy or justice of market mechanisms. Pollution is the most commonly cited example. If a producer can produce products profitably because he imposes the costs of production on others who have not consented to be a part of the production process, say, by throwing huge amounts of smoke into the air or chemicals into a river, he will probably do so. Those who breathe the polluted air or drink the toxic water will bear the costs of producing the product, while the producer will get the benefits from the sale of the product. The problem in such cases, however, is not that markets have failed, but that they are absent. Markets rest on property and cannot function when property rights are not defined or enforced. Cases of pollution are precisely cases, not of market failure, but of government failure to define and defend the property rights of others, such as those who breathe polluted air or drink polluted water. When people downwind or downstream have the right to defend their rights, they can assert their rights and stop the polluters from polluting. The producer can install at his own expense equipment or technology to eliminate the pollution (or reduce it to tolerable and non-harmful levels), or offer to pay the people downwind or downstream for the rights to use their resources (perhaps offering them a better place to live), or he must stop producing the product, because he is harming the rights of others who will not accept his offers, showing that the total costs exceed the benefits. It’s property rights that make such calculations possible and that induce people to take into account the effects of their actions on others. And it’s markets, that is, the opportunity to engage in free exchange of rights, that allow all of the various parties to calculate the costs of actions. Negative externalities such as air and water pollution are not a sign of market failure, but of government’s failure to define and defend the property rights on which markets rest. The More Complex a Social Order Is, the Less It Can Rely on Markets and the More It Needs Government Direction Reliance on markets worked fine when society was less complicated, but with the tremendous growth of economic and social connections, government is necessary to direct and coordinate the actions of so many people. If anything, the opposite is true. A simple social order, such as a band of hunters or gatherers, might be coordinated effectively by a leader with the power to compel obedience. But as social relations become more complex, reliance on voluntary market exchange becomes more – not less – important. A complex social order requires the coordination of more information than any mind or group of minds could master. Markets have evolved mechanisms to transmit information in a relatively low cost manner; prices encapsulate information about supply and demand in the form of units that are comparable among different goods and services, in ways that voluminous reports by government bureaucracies cannot. Moreover, prices translate across languages, social mores, and ethnic and religious divides and allow people to take advantage of the knowledge possessed by unknown persons thousands of miles away, with whom they will never have any other kind of relationship. The more complex an economy and society, the more important reliance on market mechanisms becomes. Yet government is usually expected to step in to deliberate on issues concerning the influence of negative externalities primarily due to the social contract theory which posits that government is the number one corporate citizen in ‘contract’ with its subjects and given the consensus mandate to effectively allocate national resources to their best use. Different approaches could be employed to address these influences. They include but not limited to industry review through panel of inquiry, survey research etcetera, then policy review on industry, finally market restructuring. Industry review: This is where government tries to evaluate performance to assess the factors responsible for the emergence of such externalities. Policy Review: This is the systematic evaluation of existing guidelines on the affected industry with a view to finding solutions to the impact of the externalities and averts future occurrence. Market restructuring/reconstruction: This is where the recommendations and findings from the entire combination of policy and industry reviews among other solutions are put in place to effect the expected outcome on the revamped industry. 2) The example case study is the house sub-prime mortgage crisis in the United States is a clear case example. The negative externality was the effect of excess foreclosure of applications by clients to the various mortgage firms due to the crippling effect of job losses and low income rates had on the mortgage market. The resulted in a lot of the firms filing for bankruptcy where the US government through the Federal Reserve stepped in to cushion its anticipated ripple effect to other sectors of the economy. They were able to do this by allowing the affected firms to file for bankruptcy to be able to legally accede responsibility of debt payments to the re-financier in this case the US government. Also the government through the Securities exchange commission SEC wrote off large percentage of the money value of the foreclosures allowing for a new repayment structure and plan by the numerous US clients. 3. A further practical suggestion to this is for policy review on the guideline for mortgage application .This is because the boom in the mortgage stocks market influenced the over confidence that led to reckless subscription and lending to the large number of clients without proper documentation and monitoring. There should be a complete overhaul of the policies on mortgage and house re-financing loans to check a situation where an unemployed individual for quite some time would apply and easily get a house mortgage plan. REFERENCES Tom G. Palmer, Twenty myths about markets: Delivered at Conference on The Institutional Framework for Freedom in Africa 2007 Regional Meeting. Mont Pelerin Society Nairobi, Kenya 26. February. 2007 Read More