Principles of Economics - Assignment Example

Name: Course: Tutor: Date: Principles of Economics Graph 1 Price The above-plotted demand curve slopes downward from left to right thus having a negative slope because the two main variables, which are price and quantity, work in the opposite direction. As the price of the commodity decreases from 80 cents to 20 cents, the quantity demanded of apples increases over the period of time and the vice versa is very true, with all factors remaining constant. There are exist fundamental reasons as to why the demand curve slopes downward from left to right, they include; law of diminishing marginal utility, income effect substitution effect and the entry of new buyers [Fra04]. The law of demand is founded on the law of diminishing returns in that. The cardinal utility approach states that when a consumer purchases more units of a given product or good, the marginal utility of the good declines. Thus, the consumer will purchase more units of the commodity if and only if the price falls [Mar131]. Income Effect- When the price of a good decrease, the purchasing power or the real income of the household increases. Because of this, the consumer is in a position to purchase a greater number of commodities with the same amount of income. This has the effect of increasing the demand of the commodity not only for the existing buyer but also for the new buyers in the market. When at the lower price, the demand for the commodity is high thus; the demand curve is likely to slope downwards from left to right. Substitution effect – The substitution effect also causes the demand curve to slope downwards from left to right. A good example is that when the price of meat drops and the price of the other substitutes such as beef and poultry remain constant, it is most likely that the consumers are likely to prefer to purchase the meat because the price will be relatively cheaper [Got13]. In this case, the increase in the demand for meat is most likely to move the demand curve downwards, from left to right. Entry of new buyers- In most cases when the price of commodity drops, the demand of the good not only increases among the old buyers but also new buyers tend to enter the market [Car14]. The combined effect of both the substitution and income effect results to the demand extending, ceteris paribus, as its price falls. This therefore leads to the demand curve sloping down wards from left to right. Elasticity of Demand At 80 cents, the quantity demanded is 14,000 whereas at 40 cents the demand is 26,000. Price Quantity Demanded 80 14,000 40 26,000 Change in Price 80-40 = 40 40/80 * 100 = 50% Change in Quantity demanded 14,000 – 26,000 = -12,000 -12,000/26,000 = 46.15% Elasticity of demand = change in quantity demanded / change in price of the commodity -46.15 / 50 = 0.92 Elasticity of demand = -0.92 The elasticity of demand = -0.92 In most cases when the elasticity of a good is less than 1.0, this implies that the demand is not very sensitive to the price change. However, good that have an elasticity value of 1.0 are said to be unitary elastic. In our case, the good is not unitary elastic since the value is less than 1.0. Question 2 For us to understand effectively the value of the coefficient stated above one has to understand what the Price Elasticity of demand is and its main functions. Price Elasticity of Demand measures the responsiveness of the demand to the changes in the price of a specific good [Fra04]. However, the responsiveness of a good is determined by the value of the price elasticity of demand. In simple terms, it is always the ratio of the change in percentage of the quantity demanded and the greater change in price. It is important to note that the value of the Price Elasticity of Demand is always negative due to the downward sloping of the demand curve [Arn14]. However, during analysis people only refer to the absolute value of the price elasticity of demand. In the case above, the value of the Price Elasticity of Demand has been identified as -0.92 and that in this case we will use the absolute value 0.92. Four parameters help us determine the responsiveness of demand [Arn14]. When the value of the Price elasticity of demand is greater than 1.0, this implies that the demand of the good is elastic. In this case, the consumers of the good are very sensitive to any price change. If the value of the Price Elasticity of demand is equal to 1.0, this therefore implies that the demand of the commodity is unitary elastic [Kum04]. This therefore shows that the price change and the consumer response is the same. If the price elasticity demand of the product is less than 1.0, this implies that the demand of the commodity is inelastic and that the consumers are unresponsive to the price changes. Finally, if the Price elasticity demand for a good is close to zero, this implies that the demand of the good is perfectly inelastic thus implying that the consumers are very insensitive to the price change [Sob09]. Question 3 In this situation, a 6 per cent decrease in the price of Peanut butter causes the total revenue derived from peanut butter to increase. The first implication is that when the price of the peanut butter dropped by 6 per cent, the demand for the commodity in turn increased thus causing the increase in the sales of peanut butter. Thus, the first thing that we know about the demand of the peanut butter is that it increased. However, this is not enough, it is important to classify the elasticity of the demand. As discussed above, the elasticity of demand mainly refers to how sensitive the demand of a good or service is to the changes in the other economic variables [Got13]. A good example is the price elasticity of demand, which determines how the quantity demanded of good changes, with the changes in price of the same commodity. When the price elasticity of demand of a commodity is unit elastic, then this means that changing the price of the commodity will not change in any way the total revenue derived from the product. When the price elasticity of demand of the product is inelastic, this means that a decrease or an increase in the price of the commodity will not have a significant effect on the quantity demanded, hence minor changes in the quantity demanded of the good [Sob09]. Whereas when the price elasticity of demand of the good elastic, a slight decrease in the price of the commodity is likely to lead to an increase in the demand of the good hence a significant increase in the sale of the commodity. From this analysis, we can infer that the price elasticity of demand of the peanut butter is elastic and that is why it resulted to an increase in demand of the quantity demanded and hence and increase in value of the total sales. Question 4 These types of goods are referred to as complementary goods. This refers to the type of goods that go together [Lev13]. The change in the price of one commodity, affects the complement good. Thus, it is right to say that the price of one good affects the demand of the other good. In our case, the mayonnaise complements the French fries and that is why the increase in price from 2.50 to 3.00 dollars not only affects the demand of French fries but also affects the demand of mayonnaise. Complementary goods do have negative cross elasticity of demand [Got13]. Cross elasticity demand, determines the responsiveness of the quantity demanded of a good in relations to a change in price of another good. However, most consumers tend to consider such factors before buying a commodity since they consider the cost of the complementary good [Sob09]. Another example when individuals buy cars, they tend to consider the price of fuel and long run maintenance of the car. If the price of fuel continues to increase over time, most individuals might shy away from buying cars since the maintenance cost is also likely to be high in future. In the case of French fries and mayonnaise, since the demand mayonnaise is linked to French fries, this therefore means that the higher the demand for French fries, the higher the demand for mayonnaise and the lower the demand for French fries, the lower the demand for mayonnaise. It must be noted that the price of complementary goods are related thus if the price one good increases, so will the price of the other commodity increase. Question 5 It is important to understand type of market structure in which the supermarket in Australia falls. This type of market structure is referred to as an oligopoly market structure. Oligopoly market structure refers to a market structure that is dominated by few sellers commonly referred to as oligopolists [Hil14]. Because of the presence of few sellers, every oligopolist is aware of the actions of the other seller. Therefore, entrance of a new supermarket in the Australian is likely to be identified by the competitors and thus will do everything to try to prevent the success of the new entrant. In most cases the oligopolistic firms end to collude which in turn reduces the competition and the customers benefit even more. Graph 2 The graph above shows the market structure of the oligopolistic market structure and the entrance of anew supermarket in the industry. The model further shows that the prices in the market are stable and that there is very little incentive for the sellers to change their price [Car14]. The firm in this market tend to compete using the non-price competition methods. An increase in price by a seller would mean losing a large percentage of the market share since they will be considered uncompetitive unlike the other seller because the demand is elastic for a price increase. On the other hand, if the firms reduce their prices, they are likely to gain a significant market share. To prevent this, the other firms will follow suit and reduce their prices as well. Therefore, the demand in this case is inelastic for a price reduction. Income has significant effects on the demand of a product. The amount of income one receives influences the purchasing power of the specific population. Income fluctuations can be considered in two ways and the income can fluctuate either upwards or downwards [Mar131]. In case the income fluctuates upwards, this means that the household will have a larger disposable income. Disposable income refers to the income an individual remains with after tax. Thus, the higher the income, the larger the disposable income. In most cases when the disposable income is high, the household tend to consume more and thus pushing up the demand for goods and services in the economy. Upward fluctuation of income will therefore lead to a higher demand for goods and services and will in turn lead to a greater income for the supermarkets. However, in oligopoly, the market players will not be in a position to increase their rice considering the fact that demand is elastic for a price increase and thus the seller can be easily swiped out of the market with any slight increase in price [Kum04]. In the event that there is downward shift in the fluctuations of income, which in economics it is only feasible in the occurrence an increase in taxation since in labour economics, the level of wages and income, cannot be reduced in the economy [Kum04]. In this case, the disposable income is likely to reduce and thus the demand for goods and services provided by the supermarkets will reduce. This will have the effect of reducing the revenue of the supermarkets in the industry. The supermarkets in the industry cannot reduce their prices because the demand is inelastic for a price decrease in the industry. Population trends play a significant role in determining the demand of the goods [Fra04]. One of the main factors that affect demand is demographic factors. Thus, the size of population of an area determines the size of demand expected. In areas where the population is high, there is high demand of household goods, compared to the areas where the population is low. It is therefore right to say that the population trends will significantly affect the performance of the supermarket, both in the short run and in the long run [Hil14]. The new supermarket should also consider the consumer expectation and tastes of the Australian population thus stock products that meet their needs. This is always a vital factor and determines greatly whether a business will prosper or not. Business that consider the consumers’ tastes, are more likely to develop compared to the businesses that do not meet the need of their consumers. So to enter the market with ease, the supermarket should also consider the investing in advertisement, as this help in reaching a greater market and naming the brand of the supermarket known to individuals. Graph 3 (Shift in Demand and Supply) P1 represents the product price of the oligopoly market and Q1 is the quantity demanded. If the firm raises the price (D1) whereas others do not increase in the same manner, then its revenue is likely to decrease despite the price increase. On the other hand, if the firm reduces its price (D2), this will see the other firms reducing their price, to avoid a loss of the market share [Car14]. The kink in the demand curve explains the reason as to why the firms in the oligopoly market structure tend to resist changes in the price. Question 6 Game theory involves the study of the strategic decision making process [Zam13]. Thus, we are going to us game theory, to be able to arrive at the solution, in this specific situation. In this decision making process, there are two players involved, this includes the politician and the businessperson. The politician strategy in this case is very crucial and that the businessperson understands how important the politician is to him and his business. Thus, the businessperson counts on the politician to assign him monopoly in a specific industry so as to benefit significantly and in turn fund the politician’s campaign. The politician is thus in a dilemma as to whether to assign him the tender or not. This helps us to identify the type of game theory that we are dealing with in this specific scenario. This is similar to what is referred to as the prisoner’s dilemma The prisoner’s dilemma refers to a game where two rational individuals are likely not to cooperate even when chances seem it is of the best interest for both of them to cooperate [Owe13]. There exist certain assumptions that are made in such a game. Some of the assumptions made are that both players, understand the specific nature of the game and that despite being on the same side, no one has loyalty to the other. Nash Equilibrium refers to the situation where the outcome of the game is where none of the player has an incentive to move away from the strategy he or she has chosen after considering the opponents choice and strategy. In this situation, the players are in equilibrium such that a change in strategy by one of them would lead to the other party earning less compared if he or she remained with the present strategy. In this specific situation, betraying people’s offer has a greater reward than cooperating among themselves. Only the person with self-interest is likely to betray the other and thus the only possible outcome is for both of them to betray the other in that the politician to fail to provide the tender and that the prisoner not to finance the campaign in return. The fact that they cannot write a contract makes the opportunity cost of the game to be zero. The probability of re-election is also 0.5 if the politician does not cooperate and if she cooperates, the probability of re-election reduces by 0.5. Give Don’t Give Bribe *,0.5 *,1 Don’t Bribe *,0 0,0.5 The one in red represents the businessperson’s deal and that the one in black represents the politician’s deal. Thus from the game it is vivid that whichever strategy, the person that is likely to benefit is the politician. From this analysis, the Nash equilibrium can be easily arrived at. The Nash Equilibrium is = (0, 1) This therefore shows that the politician is likely to benefit from the deal. Thus, the politician should get into a deal with the businessperson and offer him a deal since this will increase the chances of her retaining the sit. Works Cited Fra04: , (Frank and Bernanke), Mar131: , (Marshall), Got13: , (Gottheil), Car14: , (Cartwright), Arn14: , (Arnold), Kum04: , (Kumar), Sob09: , (Sobel), Lev13: , (Levine), Hil14: , (Hillman), Zam13: , (Zamir, Maschler and Solan), Owe13: , ( Owen), Read More