Explicit and Implicit Costs, Variable Costs - Assignment Example

Running header: Economics Economics Author’s Name Institutional Affiliation Date of submission PART B 1. Explicit and implicit costs differ in that explicit costs are costs that are actually incurred by the organization during production and they can directly be traced to production while implicit costs are the costs that cannot be directly traced to production but are implied in nature and do not involve a cash payment. Examples of explicit costs are salaries, rent, wages and advertisement while examples of implicit costs are interest on owner’s capital, rent of owner’s building and salary to the owner where cash is not incurred in reality. 2. The difference between short-run and long-run is that the short-run is a period of time when the quantity of at-least one input is fixed and the quantity of the other inputs is variable while the long-run is a period of time when all the quantities of all inputs are varied. The long run and short run have no fixed time and hence different companies have varying long run and short run periods. For example, company A might take five years to have all its costs become variable and hence operate in the long run while another can take twenty years to achieve the same. 3. Total product Total fixed cost Total variable cost Total cost Average fixed cost Average variable cost Average total cost Marginal cost 0 $60 $0 $60 $60 $0 $60 $60 1 $60 $50 $110 $60 $50 $110 $50 2 $60 $88 $148 $30 $44 $74 $19 3 $60 $120 $180 $20 $40 $60 $16 4 $60 $150 $210 $15 $37.5 $52.5 $7.5 5 $60 $182 $242 $12 $36.4 $48.4 $6.4 4. Minimum efficient scale refers to the smallest production amount that a firm can achieve while taking advantage of economies of scale as far as supplies and costs are concerned. If a firm does not reach minimum efficient scale in the long run, it will not operate efficiently and hence it will be operating at losses. Consequently, it will be forced to close down. 5. Variable costs which include the costs of nuclear reactors appear to be the problem when it comes to nuclear energy. It makes the nuclear plants uneconomical since the costs of nuclear reactors are too high making it uneconomical when compared to renewable energy sources. b) A stable demand for electricity affects the viability of new nuclear power plants since there will be no market for the new power produced and hence they will be deemed unnecessary. c) Rising use of solar and wind power reduces the viability of new nuclear power plants since they are cheaper in comparison to nuclear power thus reducing the demand for nuclear power. Task 4 1. Restaurants and corn are perfectly competitive. University education and local radio and television are not since the industries are dominated by few large firms that control pricing although there are other smaller firms which are not viewed as controlling the industry. 2. Allocative efficiency is the state of the economy when there is optimal distribution of goods and services with consumers’ preferences being taken into account. Perfectly competitive firms achieve allocative efficiency by producing at the level where price is equal to marginal cost both in the long run and the short run as shown below; Productive efficiency occurs at production possibility frontier and it means that the firm produces goods and services with the optimal combination of inputs thus producing maximum output at the minimum cost. A perfectly competitive firm achieves productive efficiency by producing where price equals to minimum average total cost. 3. The following diagram shows a perfectly competitive market that is operating at a loss 4. Strong prices traditionally cause expansion in an industry eventually bringing an end to high prices and manufacturer’s prosperity. This is because in the short run, there are only few firms operating in the industry. With the high prices, they are able to earn super normal profits which serve to attract more firms in the industry. When more firms join the industry, there is increased supply and with demand being constant, the prices come down in response. As a result, the firms now enjoy less profits or even losses owing to the reduced prices and hence profitability. This is shown in the graphs below; In the long-run, the profits decline; 5. The long run competitive equilibrium for the gold market and for a representative gold mine An increase in jewellery demand induces a surge in the demand for gold. This would raise the prices of gold in the short run making the few firms operating in the industry to earn a supernormal profit. The short run equilibrium for the industry and for an individual firm would appear as illustrated below; Over time, more and more firms will enter the industry in a bid to take advantage of the supernormal profits. This would increase the supply of gold eventually bringing the price of gold below the short run equilibrium in part a above. With fixed costs increasing over time, the profits in the long run will greatly decline. Part 5 1. Network externality serve as a barrier to entry since owing to network effects, certain goods or services are adopted widely and hence appear to be more attractive to new customers than competing goods or services. The social networks with the largest memberships hence become more attractive to new users since they know their friends are likely to be on these networks. This acts to make it hard for new companies to enter the market and gain market share. This barrier is insurmountable since it becomes very hard for new customers to break away from the networks. 2. Advertising might reduce economic well-being since it is costly, it also manipulates people’s tastes and preferences while impeding competition by making products appear different from what they really are. Advertising may however increase economic wellbeing through provision of useful information to the consumers while fostering competition. 3. The statement is false. This is because a monopolist just like any other firm maximizes profit when marginal cost is equal to marginal revenue. Though they are able to affect the price being charged, they still will sell at the price that will give them the highest profit since the demand and supply law puts a constraint on their ability. 4. I don’t agree with the comment. First, the act of looking at what they are already buying is brand management and market research in itself. We need to do market research in order to establish whether we are meeting customers’ tastes and preferences. Furthermore with the advancement in technology, products and services continue to evolve with new products and services being introduced in the market. If no market research and brand management is carried out, then we risk having our products and services being redundant and hence being faced out of the market by more innovative products and services. Furthermore, if our products are not already being bought in the market, it is only market research and brand management that will help us establish why this is the case. 5. The merger will lead to economies of scales resulting from increased production and reduced average costs which might eventually lead to lower costs for consumers. This is shown in the graph below; The new firm will enjoy technical economies owing to lower average costs compared to the combined costs for the merging firms. Economies of scale will also result from bulk buying hence the merger will enjoy discounts for bulk buying with the firm also enjoying financial economies of scale resulting from better interest rates. There will also be organizational economies since the two firms will have one head as opposed to two. b) If the merger is allowed, the resultant market will be an oligopoly with few large firms controlling the industry. The price is likely to fall if the merger takes advantage of the economies of scale with the quantity sold by the merger increasing owing to the reduced price. The profit for the merger will also increase owing to the increased sales. Part 6 1. An oligopoly is a situation where by a market for a particular good or service is controlled by a small number of firms. In many cases, there are at least two firms controlling the oligopoly market. Examples of oligopolies in Australia include the supermarket industry and the soda industry. This is because the Supermarket industry is majorly controlled by Woolworths and Coles while the Soda industry is controlled by Coca-Cola and Pepsi cola. In other words, only a few firms control these markets although there are smaller firms operating in the Market. 2. Yes. The dominant strategy for Godrickporter is to increase its advertising budget. b) Yes, the dominant strategy for Star Connections is to increase its advertisement budget. c) Yes. There is incentive for each of the firms to increase its advertisement budget since in so doing, Godrickporter will increase its revenue from $6,000 to $16,000 while Star connections will have its revenue increase to $15,000. However, if it fails to increase its advertisement budget while its competitor increases, it will lead to its revenue declining to $10,000. d) This game has no Nash equilibrium since there is no point where the competitors are well-off. For instance, Godrickporter would still gain from Star connections increasing its advertising budget but it seems star Connections would loose from Godrickporter increasing its advertising budget. While Star Connections would like that it increases its advertising budget with Godrickporter failing to increase its, Godrickporter would be better off if both the companies increased their advertisement budgets. 3. Public goods are the products which one can consume without reducing their viability to other individuals and which no one is excluded from consuming. Public goods include sanitation infrastructure since their use by one person does not exclude the others from using them. All people in the town or city consume them equally. On the other hand, quasi-public goods have both characteristics of private and public goods since they have partial excludability, partial diminishability, partial reject-ability and partial rivalry. For instance, roads and bridges are quasi-public goods since they could be provided by both private and public sector. 4. A positive consumption externality (vaccination) leads to market inefficiency. For instance, free market would supply vaccination Q at price P. However, when the government provides it, the external benefit included pushes the vaccination to Q1. When vaccination consumption is at Q, the marginal social benefit is above marginal social cost and there should be more vaccination. At Q, the marginal social cost is A and the private benefit is also A but the marginal social benefit is at C. Thus if the vaccination is only at Q there is an opportunity cost to the society and is represented by A,C,B which is the area of welfare loss meaning the market is inefficient. Negative supply consumption externality (pollution) leads to market inefficiency. This is illustrated in the graph below. In a free market, people are likely to ignore the external costs (such as pollution ) to others such as cost of treatment from pollution related diseases thus the output is at Q1 where the demand equals supply. At this point, the market is socially inefficient since at this point Q1, social cost is greater than social benefit. The red triangle represents the deadweight loss and is an area of overconsumption with marginal social cost being greater than marginal social benefit. 5. Surge pricing occurs when the demand is very high relative to supply in the market as is the case with Uber. During the peak time, the services are priced at a price that is relatively higher than normal hours. This makes the market attractive to suppliers so that more suppliers bring their goods or services to the market. Thus, the suppliers are able to supply the consumers at the high price which eventually brings down the prices as the supply adjusts to the demand level at equilibrium. b) Surge pricing ensures that the market is allocative efficient by attracting more suppliers to the market when the demand is very high. This also serves to discourage some consumers who would not afford the high prices. Eventually, the demand and supply are back to the market equilibrium thus ensuring allocative efficiency. Surge pricing acts to increase the level of potential producer surplus as well as the quantity supplied while the consumer surplus decreases. This is because the market becomes more attractive to the suppliers owing to the increased profits while becoming less attractive to the consumers due to the increased costs. c) The alternative to surge pricing is to allow the forces of demand and supply bring the market back to equilibrium. Alternatively, there can be controlled pricing whenever there is an abnormal demand in the market. References: Gillman, M2010, Advanced modern micro economics, London, Rutledge. Read More