Employed Person in Different Jobs - Case Study Example

PART A: SHORT QUESTIONS ANSWERS Question 1: (a) What is the opportunity cost to an employed person of the following? Explain. By definition, an opportunity cost is the very next alternative foregone in order to pursue a certain priority. (i) Working two hours fewer each week. (1/2 mark) The reward for working is increased revenue. Therefore, the extra work an individual works translates into increased revenues. However, working for reduced hours and for this matter two hours lesser will result to decreased returns. Thus, such a person will forego working, which is associated with increased return for other activities. (ii) Holding £1000 in £100 notes for a year. (1/2 mark) Holding £ 1000 in £100 notes for a year is basically holding liquid cash. This means a person chooses to hold money at the expense of spending. Spending can either be on investment activities or basic consumption. Therefore, holding cash in hand means that such a person foregoes spending thus denying himself good life, which is associated with purchase of items to make life more desirable or investment for increased finances. (iii) Consuming a glass of wine costing £10. (1/2 mark) Wine is considered a luxurious drink. In addition, wine costing £10 a glass is quite expensive and this means such person will have foregone saving just to enjoy a glass of expensive wine. The implication of such spending is reduced level of saving since money which could be saved in spent on luxurious drinks. Further, such spending has far reaching effects on investments since they are largely financed from savings. (b) On separate demand and supply diagrams for bread, sketch the effects of the following: (i) A rise in the price of wheat. (1 mark) Wheat is a raw material used in production of breads. An increase in price of wheat is attributable to decline in supply possibly due to low production causing the demand to rise. Increased demand on the other hand leads to higher prices for wheat. With the new increased price for wheat and assuming that bread manufacturers continue to buy wheat, they will in turn increase the price of bread. The following diagram shows the effect on demand and supply of bread as a result of increased price of wheat. Figure 1: Supply curve Price Quantity of bread supplied The above diagram shows the effect of price increase on quantity of bread supplied. Basically, bread producers are motivated to produce more at increased price. For example, at £5, seven pieces of bread are supplied. However, with increase in price of wheat which at the same time causes rise in price of bread, anew price of £7 is achieved leading to increase in quantity supplied to £12. Figure 2: Demand Curve Price Quantity of bread demanded The above diagram shows the effect of rise in price on quantity of brand demanded. Originally, the price of bread is at £5 and seven pieces are produced. However, with rise in price to £6, the demand curve moves backwards (demand 2). This causes a decrease in quantity demanded to five pieces. (ii) A rise in the price of butter and margarine. (1 mark) Butter and margarine are complements of bread. Complements refer to products which are used together with the item in question. Assuming that some buyers will not consume bread without margarine or butter, then increase in price of complements will affect bread consumption unfavourably. A rise in price of both butter and margarine will lead to decrease in their purchase as many consumers will not afford to buy (Jones, 2008). Assuming that such consumers will not consume bread without either butter or margarine, this will also lead to decreased quantities of bread demanded. Figure 30: supply curve. Price of a butter and margarine Quantity of bread demanded When the price of a complement increases, the producer will be motivated to produce more butter and margarine. Assuming the price of bread remains constant, the increase in price of complements will not lead to increase in bread supply. This is because bread producers are also motivated to increase their level of production by increase in price. Figure 4: Demand curve Price of a butter and margarine Quantity of bread supplied The above diagram indicates the effect of increase in price of butter and margarine on the quantity of bread demanded. Assuming, consumers will not consume bread without butter or margarine, reduced purchase of butter and margarine will equally translate into reduced demand for bread. (iii) A rise in the price of rice, pasta and potatoes. (1 mark) Rice, pasta and potatoes are not related to bread. Therefore, increase in their price may not have an effect on quantities of bread demanded. Figure 5: Demand Curve Price of rice/ Pasta / potatoes Quantity of bread supplied Figure6: Supply curve Price of rice/ Pasta/ Potatoes Quantity of bread supplied Figure 5 and 6 above show no movement in both demand and supply curves. Rice, pasta and potatoes are neither complement nor supplements. Therefore, an increase in their price will not have an effected on both quantity of bread supplied or demanded. Question 2: (a) Which are likely to have the highest cross-elasticity of demand: Two brands of coffee or coffee and tea? Explain. (1.5 mark) Cross elasticity of demand is a measure of responsiveness of demand to change in price of a related good. Such goods can either be complements or substitutes. Two brands of coffee are neither substitutes nor complements. In case of a substitute, an increase in price of coffee will increase demand of tea leading to positive price elasticity. Therefore, the highest cross-elasticity of demand will be experienced between coffee and tea. (b) The following are some costs incurred by a leather shoe manufacturer. Decide whether each one is a fixed cost or a variable cost or has some element of both. Explain. (i) The cost of leather. (1 mark) Fixed costs are those costs that do not change whereas variable costs are costs that vary with level of production. Following this description, the cost of leather can be considered a mixed cost since regardless of the number of leathers produced, the selling price remains constant and in the event it changes such a change cannot be attributed to level of production. (ii) Electricity for heating and lighting. (1 mark) Electricity cost varies on the level of consumption and therefore a variable cost. (iii) Basic minimum wages agreed with the union. (1 mark) The minimum wage agreed with the union is a fixed cost since this is the minimum amount that a company should pay its workers. Question 3: (a) Table 1: profit-maximizing output and the level of maximum profit Quantity (Q) 0 1 2 3 4 5 6 7 Price (P) 12 11 10 9 8 7 6 5 Total cost (TC) 2 6 9 12 16 21 28 38 Profit= PQ-TC -2 5 11 15 16 14 8 -3 Figure 7: profit-maximizing output P/ TC Quantity (Q) Graph 7 above is plotted based on the information given in the above table. According to Graph 7, the profit maximizing output and maximum profit curve intersects at price of £ 10 and level of output of 3 units. This indicates that it is at this point that profit maximizing output and maximum profit is realized. Figure 8: Level of maximum profit Price/ Profit Quantity (Q) From figure 8 above, the points at which total cost (TC) curve intersect profit curve indicates the range at which the firm will be profitable with the firm making the maximum profit 15 units level of output. (b) Under what circumstances would you expect a monopoly to charge the following, explain? Monopoly refers to a situation where there is only one seller of a given product that has no close substitutes. (i) A higher price. (1 mark) A monopoly will charge a higher price when intending to make high profits. In this case, the monopolistic seller takes advantage of market dominance to charge high prices. This is because even if the product is sold at a high price, the buyers will not have other options and will still purchase. (ii) A lower price than if the industry was operating under perfect competition. (1 mark) On the other hand, a monopoly may set a lower price for a commodity or service. This is common where such monopoly is not motivated by high returns but increased sales. Such a case is more common with products or services provided by the government. The objective of the government is to increase product or service accessibility to the people. Similarly, the government may provide commodities or services at a lower price than the cost price by giving subsidies. Question 4: (a) Describe the method of price discrimination that an airline industry uses. Give an example and draw graph. (1 mark for graph and 1.5 for explanation = 2.5 marks) Price discrimination takes place when an organization charges varied prices to different consumers for the same product or service. Figure 6: Price discrimination in the airline industry Fare Quantity of seats offered Airlines use differentiated price by selling similar travel services to different market segments. This is achieved by assigning varied booking capacities that sells at different prices to different classes of commuters. This restriction enables different market segments to purchase tickets within the range set for them. Figure 6 above show three scenarios where passengers are willing to pay different fares for the same service. In this case, passengers can either choose to board a full plane with a capacity of four seats at a cost of £6. However, the other segment is willing to pay a higher fare of £7 to travel in the same plane. The airline manages to discriminate on price since some passengers are willing to wait for the plane get passengers for all seats available while other passengers are willing to fly in a half filled plane for an extra cost. b). Figure 7: Cost and benefits of firm A Marginal benefit/ Cost Output (Units) (i) What is the profit-maximizing level of output for this firm? (1/2 mark) Profit maximizing level of output is attained at the point of intersection of marginal benefit and marginal costs curves. From figure 7 above, marginal benefit and marginal costs curves intersects at 7 units’ level of output. This means that the firm will realize the maximum profits when at production level of 7units. (ii) What is the socially efficient level of output? (1/2 mark) From figure 7 above, the socially efficient level of output is shown at the point of interaction between marginal social benefit and marginal social costs graphs. Marginal social benefit is constant at 100 and intersects the marginal social cost curve at output level of 8units. Therefore, at this level of output, the firm will be producing products at the minimum social costs. (iii) Why might the marginal pollution costs increase in the way illustrated in this example? (1 mark) From figure 7 above, marginal pollution costs increases as the level of output increases. This is attributed to increased level of pollutants output that increases with increased level of production. PART B: CASE STUDY Question 1: What is the significance of the observations made by the author Catherine Hockley in her article regarding market failure and pollution: ‘Be Warned: Pollute and Pay the Price’ about the storm water pollution? Why does the author suggest that polluters should pay the price for polluting? Firstly, Hockley notices that firms are to be held responsible for dumping effluents into the storm water. In this respect, she affirms that firms that dump pollutants should be severely punished. Hockley views the market as the main villain in storm water pollution is a tragedy. The market forces contribute by excluding firms from bearing environmental consequences. To avoid the problem of market failure, the market forces must be completely checked by implementing government decision that market cannot make for itself. The government should contribute in sorting the market failure problem by formulating policy goals and intervening in firm’s production process by imposing fines in form of taxes to those firms that create environmental harm. From Catharine’s observation of storm water pollution, we learn that people who release pollutants should be fined by being taxed. The other point we learn from the article is that it is besides firms that release pollutants, ordinary people also have the capacity to pollute storm water. Therefore, it is rational to also impose fines to individuals who pollute storm water. For instance, people washing cars pollute storm water. This polluted water flows into rivers and ends up in the lakes or sea. Such polluted water causes big damage by making polluted sea and lakes inhabitable for fish and sea grass. Lack of these organisms in the sea contributes to occurrence of strong tides that cause devastating effects to sea and lake users. Therefore, the pollutants inflict damages on people and the society at large. The property of pollutants, according to Hockley (2003), is by their creators. It brings about the question, why should people create and carelessly release pollutants to the environment? According to Catherine, if these pollutants cause damage to the environment, then the creator of such pollutants should compensate the resultant damages. Basically, if people understand environmental harm posed by their activities, then they should do something to stop it. Imposition of taxes leads to high production costs, which many firms try as much to avoid. In this respect, consumers can also use other implicit bargaining to punish firms that fail to comply (Samuelson & Nordhaus, 2007). For instance, they can demand commodities that are environmentally friendly. With consumers willing to pay high prices for such products, the firms that fail to comply would suffer reduced sales despite their low prices. Moreover, community groups must pressure such firms that are not environmentally friendly by mobilizing consumers to boycott their products and denying them most favourable treatment in the community. According to Hockley (2003), prevention of water pollution is critical for every business with the capacity of releasing effluents to the rivers. Failure to prevent water pollution should be made dearer for all businesses. Question 2: Why do people allow pollutants to enter storm water drains when they know they can cause serious environmental damage? Illustrate and explain this negative externality caused by storm water pollution. Every firm seeks to maximize profits and shareholders wealth. To realize this goal, firms have to substantially control their costs. However, many firms are only interested in controlling costs that directly relates to their production activities. Before the advent of green economy where firms are required to be environmentally friendly in their production activities, many firms were less concerned about the impact of the by-products released to the storm water. Even in the presence of regulatory framework, some firms continue to pollute the storm water by evading legal framework put in place by the authorities. Optimal penalty theory assumes that firms’ compliance depends on the chances of being detected and imposition of stiff fines. Firms will, therefore, respond to marginal incentives such as strict monitoring, imposition of higher penalties and strict law enforcement. However, under the optimal penalty theorem, compliance seems irrational since the monetary penalty for noncompliance is usually lesser than the cost of compliance (Coase, 1960). To ensure optimality, the government should impose other costs on polluting firms. These could include putting in place more elaborate compliance mechanisms that seeks long-term relationships and imposition of both governmental and non-governmental fines such as private citizen lawsuit that can damage the reputation of a firm. As argued by Fabel (2004), if property rights are not clearly defined, then this could cause a tragedy of the commons popularly known as the externality. As echoed, by Jensen and William (2006), negative externalities cause social inefficiencies. Notably, for a positive externality, marginal social benefit is more than marginal private benefit when the converse is true for negative externality. Negative externalities cause overconsumption of a product if the government fails to interfere in such a situation. This is because the price will fall below the optimal price. Disappointingly, the market fails to reflect extra benefits provided or costs imposed to the third parties. This is because the negative externality will lead to inefficient and misleading allocation of scarce resources. However, based on the issues highlighted by Catherine, the government must take actions and if none is taken, then it means there will be less fish and the entire environment will be worse. Eventually the storm water pollution impact will affect not only the pollutant creators, but also the entire society. For instance when polluted water finds its way to lakes and seas, fish and other living organisms will be affected. It means fish will be killed while the oceanic grass that helps to control strong tides will be destroyed. However, with reduced number of fish, there will be no sufficient fish in the market. Not only will the pollutant creator lack enough fish for themselves, but the problem of fish shortage will be extended to the entire community. On the part of high tides due to destruction on oceanic grass, such high tides will not only overturn boats and ship carrying the pollutant creators, but also other people hence extending the problem to community at large. Question 3: Apply marginal-cost and marginal-benefit analysis to illustrate and explain how the system of fines and pollution taxes impact on the level of pollution. Figure 8: Private marginal cost and social marginal cost analysis Cost Quantity, Q Figure 8 above explains how pollution taxes and fines impact on the level of pollution. It shows ways and solutions that could be used to overcome inefficiencies caused the negative externalities. According to Epple and Visscher (2009), the most appropriate ways are giving incentives or imposing direct controls to influence companies to correct the problem of externalities. Tax imposed on companies is one of the main ways of correcting this problem. As mentioned above, when the problem of externalities if not corrected, there will be too much pollution in economy. Notably, in a competitive market, firms private marginal cost includes capital, labour and land. Therefore according to entrepreneurs, the cost of environmental pollution should not form part of their budget. This means that a company should factor in marginal cost to the environment in each item produced. With this idea, the social marginal cost is separated from private marginal cost. Under competitive market, it is assumed that marginal cost curve is market demand curve. Based on figure 8 above, if companies fail to factor in marginal cost of pollution in its private marginal cost, this will cause high production due to low prices. This situation is well explained in the figure 8 above by the two equilibrium points of private marginal cost (MCp) and social marginal cost (MCs). Therefore, to prevent market failure, the government should intervene by imposing taxes on pollutants. This is because, if the government imposes taxes on companies, they will in turn internalize the externality. Figure 8 above shows that at a price of £7, 7 units of by-products are released to the environment. However, after the government imposes tax, the price of the commodities rises to £9 leading to reduction of the quantities of by products from 7 units to 5 units. Externalities usually cause misallocation of resources. If the transaction cost is lower, the bargaining power of the affected parties is negatively affected by the externality hence equating both private and social costs. This problem causes the need of creating a cutline between social and private costs. However, one of the challenges faced in formulating efficient environmental policies is proper estimation of benefits derived from pollution control and other related policies. Therefore, some proponents argue that government policy should be based on the economic incentives to the firms and not merely government regulation. The regulatory controls imposed by the government tend to be uniform for all firms in the market. The main standards include performance based and technology standards. Technology standards provide the methods and equipment that firms must use to enhance compliance. In such a case, all firms are required to use the best technology to control water pollution in the market. On the other hand, performance standards set the allowable units of pollutants that a firm should release to the environment per a given time period. Such uniform standard has overtime proved effective in limiting the quantities of pollutants released to the storm water. Question 4: Would the most efficient pollution control regulatory system necessarily ensure that there would be zero pollution? Illustrate and explain your answer. From micro-economic point of view, the most efficient pollution control regulatory system does not necessarily lead to zero pollution. This is because the marginal pollution cost equates the tax marginal cost. Basically, companies have the capacity to regulate waste polluting storm water, air and environment at large. However, if the company chooses to decrease the amount of waste released to the storm water, the product cost would in turn increase. Similarly, when the government imposes tax on companies, the average total cost will only decrease temporarily and then rise. In this scenario, the company is given the optimal point to take advantage of other than stopping all the pollutants. According to Karpoff and Lott (2007), if property rights are not clearly defined, it will cause increased productions of pollutants. Nevertheless, economists continue searching for socially efficient level of pollutants by trying to balance between social benefits and costs. The reason why people cannot successfully turn pollutants to zero level is because if all firms are made to eliminate all pollutants, the cost of such clean up will be to enormous for the companies to afford. This will further decrease the marginal benefits of reducing the units of pollutants released to the environment. Ideally, the fines imposed by the government should be dependent on the amount of pollution released to the environment rather than the activities of firms. The most appropriate pollution charge provides incentives by influencing environmental conservation decisions. Presence of pollution charges makes firms to reduce pollution levels. In this respect, firms will reduce pollution activities to a point in which pollution tax rates equals marginal cost of control. Nevertheless, firms will implement controls at different degrees. For instance, firms with high marginal costs will enforce less control measures while those with low costs enforcing more. At the point of producing the last pollutants, it will be found that the marginal benefits of reducing will be so modest hence not in a position to offset marginal costs. Further, this may not be possible as every firm seeks to realize maximum profits and could easily close down if private marginal benefits are outweighed by marginal costs. This would mean that there would be no firm to produce the last unit of pollutants. In this regard, the socially efficient level of pollution is achieved at the point where marginal social benefits equate marginal social costs. Identifying the most appropriate charge level is very critical. This is because setting to high charges will excessively curtail production. On the other hand, if the charges are set too low, it will lead to insufficient environmental protection. Therefore, finding the efficient charge presents a big challenge to policy makers and thus they should seek to balance costs of controlling negative externalities, associated benefits and equity. References Hockley, C., 2003. Be Warned: Pollute and Pay the Price. The Advertiser Coase, R.H., 1960. The Problem of Social Cost. The Journal of Law and Economics. 3(5), pp. 1- 44. Epple, D. and Visscher, M., 2009.Environmental Pollution: Modelling Occurrence, Detection and Deterrence. Journal of Law and Economics, 27(5), pp. 29-35. Fabel, O., 2004. Entrepreneurial Firms: An O-Ring Approach. Journal of Institutional and Theoretical Economics, 160 (55), pp. 416-438. Jensen, M. C. and William H. M., 2006. Theory of the Firm: Managerial Behaviour, Agency Costs and Ownership Structure. Journal of Financial Economics, 3(5), pp. 305-60. Jones, C., 2007. Input-Output Multipliers, General Purpose Technologies, and Economic Development. Mimeo: University of California-Berkeley. Karpoff, J. M. and Lott, J. R., 2007. The Reputational Penalty Firms Bear from Committing Criminal Fraud. Journal of Law and Economics, 36(12), pp.757-780. Samuelson, P.A. and Nordhaus, W.D., 2007. Microeconomics. McGraw Hill Education, London. Read More