Perfect Competition in Markets with Adverse Selection - Assignment Example

Student’s Name Instructor’s Name Subject Details Due Date Micro-economics Q. 1. According to Pennacchi et al. (p. 37-42), the demand curve can shift due to factors that affect demand of a commodity. Such factors include; Government policies, Population, Distribution of income, Consumer preferences, consumers’ disposable income and prices of other related products. Whereas, the supply curve can shift because of factors that influence supply. Such factors include; cost of production, availability of inputs, prices of related products, natural factors and government policies. Perfect competition creates efficient allocation of resources as it majorly deals with homogeneous products. Buyers and sellers have freedom to sell and buy their commodities since there is no government interference. Additionally, this market structure allows forces of demand and supply to operate uninterrupted. However, a monopolistic market competition may lead to market failure since products involved are differentiated in terms of quality and made to look different through ways of wrapping, branding, packaging and colouring. Moreover, there are many firms and products involved and therefore a firm can carry out restrictive practices thereby forcing others out of the market. Q. 2. A budget line is a downward sloping straight line that is drawn by graphically representing possible combinations of goods with their prices to match with the exact income. It should be ensured that the total cost of all these combinations equate to the consumer’s total income. The slope and position of the budget line is determined by the consumer’s income and prices of commodities in that, a change in either of the factors will cause the budget line to shift in response to this. The consumer’s equilibrium can be identified graphically representing her budget set in a budget line then identifying where various bundles that match her income lie. A budget set is a prescription of all possible combinations regarding the two goods which a consumer can comfortably afford to purchase according to his/her total income and market prices. Every point that lies on the budget line indicates possible bundles applicable to the consumer. Therefore, a consumer can pick any commodity that lies within the budget line since it corresponds to her total income. Q. 3. A perfect competition is a type of product market structure which allows the forces of demand and supply to operate uninterrupted. Some of the features of a perfect competition are; a wide range of sellers and buyers, limited government interference, absence of excess supply or demand, existence of perfect mobility of factors of production and homogeneous products. Profit maximizing output can be identified by cross examining the relationship between total cost and total revenue or marginal cost and market price. Since, Profit= Total Revenue-Total cost and Marginal cost= Market price. A comparison between the total cost and the total revenue is made and the output quantity with the maximum scale of difference is identified. The profits made at each stage of production is quantified and this point provides the optimum level output reached. It is a process that involves five phases; Identifying levels of output produced, determining the total revenue generated, determining the total economic cost, subtracting economic cost totals from their corresponding revenues, and finding the greatest profit margin. If marginal revenue is equal to marginal cost, it simply means that producing more or less output cannot increase a firm’s profits (Azevedo et al. p. 27) A shut-down point occurs when revenue generated from goods and services sold is not covering fixed costs. The shut-down point occurs at the point where the average variable cost is high than the marginal revenue. A firm operating on a loss rather than profits is expected to apply the shut-down rule which requires a firm to temporarily close its operations if the variable costs does not exceed the price. In other words, the total revenue (T) the firm is generating should be more than the corresponding variable cost (VC). That is, R=VC. The firm will not be covering its production costs if the total revenue it generates is less than or equal to the variable cost. Macro-economics Q.4. Gross Domestic Product is the sum of the market value of products (in terms of goods and services) that a country produces in a one year period. Three approaches are used to measure GDP; the expenditure approach, where the total value of net profits (X) is lessened from net imports (M) and added to the total value of personal consumption expenditure (C), gross private fixed investment (I) and government expenditure investment (G); Therefore, GDP = C + I + G+ (X-M). In the income approach, all income earned by firms and households and their total expenditure is added whereas in the expenditure approach, the value of expenditures made on the products are added to determine the GDP. A circular flow diagram illustrates two ways of measuring GDP; Aggregate expenditure and Aggregate income. In the aggregate expenditure approach, expenditure (E) is given as E= C + I + G + (x-m), thus, the value of finished products output equates to the total expenditure. The Aggregate income approach states that the total income earned from final goods and services is equal to the total expenditure given by, Y. Thus, Y = C + I + G + (X-M). Real GDP is not a reliable indicator of the standards of living because; 1. The inflation rate is often overstated since quality improvements are neglected in its calculation. 2. Important factors such as household production, health, leisure time, political freedom, expectancy and social justice are not included. 3. The costs of environmental damage are not deducted from the real GDP. Q. 5. Inflation refers to a situation where the general prices of goods and services are rising. This situation is caused by increase in prices to maintain margin profits or an increase in demand than supply. The purchasing power of currency decreases while the commodities value increases. The consumer price index is measured by first selecting commodities and the base year whose price is expressed as $1, then determining their average prices using either the simple average or the weighted average method. The percentage change or movement in price index is calculated to determine inflation. Since the value of currency is not factored for and that three different definitions of CPI are used, biased numbers can be obtained. Q.6. Economic growth refers to an expansion in the productive scale of a country determined by a comparison between the GNP of one year to that of another. Economic growth is measured using either the Gross Domestic Product or through an increase in the living standards of people. It is measured as the percentage increase in real GDP in per capita income. It is determined by factors such as; availability of natural resources, population growth, technology and capital formation. Since Production Possibility Frontier is associated with economic concepts such as scarcity, opportunity cost, productive efficiency and economies of scale, it can be used to demonstrate economic growth. Scarce resources are allocated depending on the alternative ways that any particular economic agent will chose to follow when the opportunity cost of a given item is increased thus this demonstrates the effects that accompany economic choices which consumers make. It is provided that all possible combinations that can be generated from two commodities or items are often reflected by the Production Possibility Frontier and hence, growth of capital and labour results into the PPF shifting outwards, while a decrease in either of them will shift the PPF inwards (Barro & Robert, p. 121-144). Works Cited Pennacchi, George, and Alexei Tchistyi. "On Equilibrium when Contingent Capital has a Market Trigger: A Correction to Sundaresan and Wang Journal of Finance (2015)." (2016). Barro, Robert J. "Inflation and economic growth." Annals of economics and finance 14.1 (2014): 121-144. Azevedo, Eduardo M., and Daniel Gottlieb. "Perfect competition in markets with adverse selection." (2015). Read More