Diminishing Returns, Return to Scale and Perfect Competition - Essay Example

Economics Name: Institution: Economics Question 1 From the graph above, Pb = Price buyers pay; Pm = Market price without the taxes = Ps = Price sellers receive. The area of the red rectangle in the graph, is equal to the amount the government receives as tax revenue. Whereas the area of the triangle is equal to the loss of economic welfare that results due to taxation also refered to as the deadweight loss. The loss of economic welfare consist of the buyers that will be not buy the product since the price is higher than what they are willing pay and therefore they resort to go without. On the seller’s side, some sellers will not produce the product since they are not receiving a price that is high enough to cover the economic cost they incur. From the two situation, the benefit that the both the buyer and the seller would have contributed to the society and the economy in general is the deadweight loss and is as a result of the tax imposed by the government. The buyers contribute to part of the tax in an economic point of view by through the reduced consumer surplus that amounts to the difference between the price of the product and their willingness to pay. Sellers on the other hand contribute to part of the tax by the reduction in producer surplus. The loss goes to the government inform of taxes. Diminishing returns, Return to Scale and Perfect competition Diminishing return- Diminishing returns refers to the decrease marginal output in the process of production when a single factor of production added whereas all the other factors of production remain constant. This is at times refered to as the law of diminishing marginal returns. Return to Scale – return to scale refers to what happens as the factors of production are increased in the long run. The return to scale can occur in 3 way. There can be constant return to scale where the amount of output increases in the same proportion as the amount of inputs change. The next one is the decreasing return to scale and this refers to the situation where the output increases less proportionately to the amount of inputs. The final one is the increasing return to scale where the output increases more than the proportional increase in output. In the short run of perfect competition market, not all factors can be varied and in most times the only factor that can be varied is labour and therefore in the scenario, the business tends to experience a constant return to scale. In the long run, all the factors are variables and this means that both capital and labour can be varied. In this case, it will reach a point where the business will experience an increasing return to scale due to a slight increase in labour or capital. The business will enjoy this up to a point where there is diminishing returns to scale where the increase in factors of production doesn’t lead to any increase I output. How The Reserve Bank of Australia control the interest rates in the economy In the modern world, the interest rate is a tool for proper economic management that is used to stimulate the economy. The Reserve Bank of Australia performs this role in Australia and achieves this by manipulating the “overnight money market”. When the Reserve Bank of Australia wants to drive down the interest rate, it supplies additional money. On the other hand if the Reserve Bank of Australia wants to drive the interest rate up it takes the money out of the system. Under normal practices, the Reserve Bank of Australia pre announces its target to the banking sector. The equilibrium interest rate is at the point where the quantity of money demanded equals the quantity of money supplied and is depicted as r*. If the interest rate shifts above the equilibrium, then there will be excess money supply in the market. At high interest rates, individuals are likely to hold financial assets in interest earning securities. There will be more money in the economy than people wish to hold and therefore the Reserve Bank of Australia will take the money form the economy and hence it will drop back to equilibrium. The vice versa is true. Allocative and Productive Efficiency Allocative Efficiency The concept of allocative efficiency is built on the concept of Pareto optimality. This means that one person cannot be made better off without making the other party worse off. The concept of allocative efficiency states that it is good to attain Pareto optimality because at that point, the mix of commodities that are produced, match the needs of the consumer. Frome the graph, allocative efficiency is attained when the consumers pay a market fee that is equal to the private marginal cost of the production. The condition for allocative efficiency for any firm is to create an output whereby the marginal cost (MC) equals the price (P). Productive Efficiency Productive efficiency refers to the situation whereby firms aim to minimize the cost of inputs that are required to produce a target output. Here the firms maximize their outputs given a combination of input. In order for a given industry to achieve productive efficiency, the specific firms must ensure that they have the same marginal costs. Just as it has been stated above, the firms aim at producing output at the lowest possible cost which is the average total cost. The cost will be minimized at the lowest point of the firms short run average total cost curve. This therefore implies that the MC= ATC, this is because the Marginal cost curve always cuts the Average Total Cost curve at the lowest point. Economic Impacts of Imposing tax on public Service The imposition of tax on public Service has numerous effects on the consumers. The new tax will push the tax costs towards consumers. This tax has a multiplier effect even on the disposable income of the consumers. The disposable income of the consumers will reduce and hence affect the welfare of the consumer. This will also lead to formation of orthodox ways of handling garbage. In conclusion, this will lead to the destruction of the net economic surplus and even the government will lose. Tax on Private goods In this case, the situation will have positive impact hence creating net economic surplus. This is because the tax put in place is refered to as externality tax and has the impact of reducing the externalities in the environment. In this case the tax created will make the factories compensate for the noise they produce through tax. The louder the noise the greater the tax. This will make most industries be keen on noise pollution since they are aware that there is a cost for that. In the long run the government will have been able to reduce noise pollution and also collecting revenue which will be used to run the society. Features of Oligopoly Market Oligopoly markets have features such as, small number of firms, Identical or differentiated products, barriers to entry and Interdependence. One of the main characteristics of oligopoly market structures is that it has a small number of large firms. Their sizes give each firm a reasonable size of the firm In most oligopoly market structures, the products tend to be identical or slightly differentiated. There exist numerous barriers to entry unlike the market structures. Some of the main barriers to entry include high start capital, copyrights and patents and also government restrictions. There is also interdependence in oligopoly market structure, in the sense that the firms are so large to an extent that the action of one fir, affects the the set market conditions. Game theory Opponent Focal strategy PA LA PA 10,0 3,0 LA 2,-5 5,5 Dominant strategy refers to as situation where regardless of what the players do, the strategy earns the opponent a larger pay off than any other [Bar13]. From the above it can be inferred that there is no dominant strategy. Nash equilibrium- this refers to the optimal outcome of the game, where none of the players has the chance to deviate from the already chosen strategy after considering the other opponents choice. Unemployment and Inflation According to the Philips curve, inflation and unemployment have an inverse relationship where when variable increases, the other factor decreases. However the Australian Government can put in place policies that prevent further inflation in the economy. Fiscal policy- the government can adopt a deflationary fiscal policy that aims at increasing the taxes and lowering the government expenditure as an attempt to reduce the inflation levels. Monetary policy- the other option is adopting a deflationary monetary policy that seeks to increase the interest rate and reduce the level of money supply in the economy. Supply side policies- these involves policies that seek to improve the supply of goods and services in the economy. Such policies include privatising some of the government institutions. The other way is by increasing the competition in the industries by scraping out the existing trade barriers. Exchange rate policy- The other way in which the government can attempt to deal with the inflation, is by reviewing the country’s exchange rate policies. This involves, the government attempting to increase the value of its currency so as to reduce any form of imported inflation and this will also have the impact of reducing the demand for imports. References Bar13: , (Barron, 2013), Read More