Perfect Competitive Markets and Allocating the Resources Fairly Across Sectors in the Economy - Research Paper Example

Question 1 a) . The relationships of the two variables are described using the graph, verbal statement and the numerical table. There is a positive relationship between the number of umbrellas sold and the number of rainy days experienced. The graph shows the best description because the relation of the two variables is clear and self-explaining. Numerical table of the two variables (rainy days and number of umbrellas) Figure 1 shows a table describing the relationship between the number of umbrellas bough and the number of rainy days. number of rainy days sales of umbrellas 5 10 10 12 15 14 20 16 Figure 2 is a graph showing the relationship between the two variables (rainy days and number of umbrellas) The slope of the curve showing the relationship between rainy days and number of umbrellas is computed by dividend changes in umbrella from changes in the number of rainy days. The slope = change in number of umbrellas ÷ change in number of rainy days =6 ÷15 =0.4 (b). Figure 3 shows a possibility production frontier. ii). The opportunity cost when the production of chocolate increased from 5 to 10 thousand kg. is 13 tractors iii). The opportunity cost per thousand kg of chocolate produced is highest when the chocolate production shift from 20 to 25. iv). Figure 4 illustrate a change from economic inefficiency to economic efficiency The arrows A and B move towards efficiency. Any point along the possibility production frontier is economic efficient. Pont above or below the possibility production frontier is economically inefficient. (c) i). Figure 5 shows the market for mobile phone accessories if the income of households increases. The demand curve shift from the left side (blue) to the right (red) side of the demand and supply curve ii) Figure 6 shows the market for housing if a new immigration law decreases the annual quota for new immigrants moving to the country The demand curve shift from the right side (blue) to the left (red) side of the demand and supply curve iii) Figure 7 shows the market for natural honey as consumers become more aware of its healing properties. The demand curve shift from the left side (blue) to the right (red) side of the demand and supply curve iv) Figure 8 shows the market for hot dog sausages as a supermarket runs a ‘special advertisement’ on hot dog buns. The demand curve shift from the right side (blue) to the left (red) side of the demand and supply curve (a). Figure 9 Completed the table showing various costs   Fixed Variable Total Marginal Average Average Average Revenue if Profit if cost cost cost cost Total Variable Fixed Price = Price =         cost Cost cost $20/unit $20 0 30 0 30   0 0 0 0 -30 1 30 1 31 1 31 1 30 20 -11 2 30 4 34 3 17 2 15 40 6 3 30 8 38 4 12.67 2.67 10 60 22 4 30 15 45 7 11.25 3.75 7.5 80 35 5 30 24 54 9 10.8 4.8 6 100 46 6 30 35 65 11 10.83 5.83 5 120 55 7 30 48 78 13 11.14 6.86 4.29 140 62 8 30 65 95 17 11.88 8.13 3.75 160 65 9 30 86 116 21 12.89 9.56 3.33 180 64 10 30 110 140 24 14 11 3 200 60 11 30 138 168 28 15.27 12.55 2.73 220 52 12 30 170 200 32 16.67 14.17 2.5 240 40 ii) Figure 10 show Marginal Cost, Average Total Cost, Average Variable Cost and Average Fixed Cost curves iii) The shapes of the graphs: Marginal Cost Curve is sloping upwards as the quantity of goods produced increases. Average Total Cost Curve slopes downwards but higher than the average fixed cost as quantity of goods produced increase. After the lowest cost point, it begins to slope upwards with increase in the quantity of goods produced. An average variable Cost curve increase as the quantity of goods increased but is normally lower than the marginal cost curve Average Fixed Cost Curve is a downward sloping curve as the quantity of the goods increases. iv) Figure 11shows profit maximizing output. The profit maximization out put if the price is $11 is 6 units and the mamiximum profit at the level is $15. This is a point where price = total average cost and second derivative is negative. v) Figure 12 shows the analysis profit maximizing output when the price per unit is $17. The profit maximization out put if the price is $41 is 7 units and the mamiximum profit at the level is $17.this is a point where price = total average cost and second derivative is negative. (b) Figure 13 shows similar cost information, but now applies to a monopoly firm.   Fixed Variable Total Marginal Price per Total Marginal   cost cost cost cost unit Revenue Revenue Profit 0 30 0 30 0 0 0 0 0 1 30 1 31 1 25 25 25 -6 2 30 4 34 3 24 48 23 14 3 30 8 38 4 23 69 21 31 4 30 15 45 7 22 88 19 43 5 30 24 54 9 21 105 17 51 6 30 35 65 11 20 120 15 55 7 30 48 78 13 19 133 13 55 8 30 65 95 17 18 144 11 49 9 30 86 116 21 17 153 9 37 10 30 110 140 24 16 160 7 20 11 30 138 168 28 15 165 5 -3 12 30 170 200 32 14 168 3 -32 ii) Figure 14 shows marginal cost and marginal revenues of a monopolist iii) The level of output and price under monopoly structure is are 7 units and price per unit is $19 iv) 1 unit is the level of resource misallocation comparing the outcome under the monopoly situation with the outcome under perfect competition Question 3 (44 marks) (a) (i) Explain what negative externalities are, and why there may be a case for government intervention to address them There are activities of businesses or individuals that affect the lives of people who live around them. It may also affect the natural environment in which the business or individual operates. The environment or people are affected either positively or negatively. Positive and negative effects are called externalities. Positive externalities are realized when the people and the environment gain from the activities of the individuals or firms. However, when they suffer, negative externalities are experienced. According to Callahan (2004), the British economist Pigou played a major role in describing the theory of externalities. Negative externalities are costs or negative effects that spill over to the third parties because of the activities of other people or business entities. The third party is a person or entity that is not part to the activities or processes that goes on when the negative effects are generated. Negative externalities are factory emissions, noise pollutions and dumped wastes. A good example of a negative externality is a factory that dumps untreated wastes into the river or carbon emissions released by fuel engines. People who use the water down stream spend their money in cleaning the polluted water. Therefore, the cost of cleaning the water is a negative externality. (ii) Describe some of the ways to correct the negative externalities and the pros and cons of each method. Give examples. Governments apply various mechanisms to eliminate or reduce negative externalities. They include government taxations, criminalization of the polluting activity, government regulation through quotas and permits. The first mechanism used to reduce the negative externality is taxation. The government or local authority introduce taxes to the business or non-business entities responsible for producing pollutants that harms the environment and the people who live in it. Environmental taxes are the most powerful tool societies for reducing externalities and protecting human and environmental health. There are advantages associated with the use of taxes to reduce or eliminate negative externalities. The first advantage is that tax provides negative incentive in production. Therefore, the firms producing externalities are encourage to reduce the level of their output thus cutting the level of externalities because externalities are directly proportional to the amount of goods produced. Secondly, tax is revenue to the government. The amount collected for the firms that cause negative externalities are used to mitigate the externalities and the remainder is used to finance worthy projects in the country for the benefit of the people. There are disadvantages associated with taxation. The first disadvantage is that it is difficult to measure the level or amount of negative externality in the real world. This is because a problem caused by the externality can trigger many other problems that are not measurable. Measuring externalities requires advanced technology that may not be available. Secondly, if the demand for the product that is produced is inelastic, the increase of taxes would not reduce the externalities as anticipated. This is because firms transfer the taxes to consumers who will buy it even when prices increases due to imposition of tax because the demand is inelastic. Thirdly, taxes cause inequality. This results because the people who are taxed are those who are using the product and those that do not use the product remain untaxed. Fourthly, the cost of collecting taxes is usually high and in some circumstances, it may be higher than the amount of tax collected. This is because an office needs to be created and people employed to collect the taxes. High cost of tax administration is not good for the nation or community because it reduces available finances that could have been used for other productive ventures. The fifth reason why tax is not good way of reducing uncertainties is because tax collectors can be corrupted or the firm that cause externalities may be evade tax. The second method that is used to regulate negative externalities is to criminalize the act. The government through its regulatory agencies bans all the activities that cause extensive negative externalities. This is appropriate when the costs of negative externalities are much more than the benefits derived from it. Therefore, any person who is found contravening the law is prosecuted and punished according to the law. The advantage of criminalization is that it eradicates the production of goods that cause extreme negative externalities and negative externalities would be avoided. The main disadvantage is that it does not apply to the production of essential goods or services. For example, a country producing life saving drugs cannot be asked to stop production because many people will die. The third method of controlling the negative is through imposition of quotas. Business and non-business entities are allowed to products their products or conduct their activities up to a certain level. The method is able to reduce the level of externalities in the short time and essential products or services continued to be produced. However, it is very difficult to compute acceptable level of negative externalities and there may be no transparency and accountability on the sides of firms producing the essential good or services. The fourth method is use of permits and licenses. This is applicable where so many entities would like to engage in producing certain good or a product. The government steps in to reduce the numbers of entities operating to reduce the amount of negative externalities. The method reduces the negative externalities in the short run but they may not be transparency and accountability due to corruptible employees. (iii) Choose a case study from your home country where an externality exists in a current market. Illustrate the situation and the resulting deadweight loss in a diagram and discuss ways that your government has addressed the presence of negative externalities in the market. The governments in the United Kingdom are concerned with environmental sustainability and undertake measure to cut the emission of dangerous fumes into the environment. There are many causes of air pollution. The emissions from factories, vehicles, and other means of transport and green house gasses cause air pollution and contribute to global warming. Aircrafts in the UK have agreed to pay air and noise pollution taxes. Figure 15 is the Diagram Illustrating the resulting deadweight loss when a government imposes tax to curb externalities. The governments in the United Kingdom have made substantial strides too ensure that the negative externality is reduced through use of taxes. Use of taxes to control externalities shifts the supply curve upwards from S1 to S2. Taxes increases the prices and lead to reduction of goods or services demanded by the consumer. Therefore, when tax DC increases prices from C to D, the quantity of goods demanded reduced by AB from B to A. in addition, taxes cause deadweight loss. Dead weight loss is the value that both the consumer and the supplier losses because of introduction of tax. In the above diagram, total dead weight losses are indicated by the triangle EGH. (iv) Suggest other options for dealing with negative externalities in your case studies (relate this back to your answer in part The Transportation sector in the United Kingdom provides essential services that are important for the development of the economy. As a result, it is not possible to put a total ban in the production of the transport service. Criminalization of offering transport services cannot be introduced because transport is an essence for economic growth and development. Therefore, the government should regulate the aircraft emission causing the negative externalities produced by the company by instituting the use of permits. The government lay down procedures to ensure that the aircrafts that are used meet the set specification of rules and guidelines to minimize the emission of the dangerous fumes. Use of licenses is a better way of regulating the negative externalities. However, it should not be depended upon entirely because officials charged to oversee the implementation of the set the guideline may be compromised and not do his or her job as required. (ii). (a) Discuss (with examples) how a monopolist can practice price discrimination. Choose a case study of a market where a monopolist practices price discrimination. There are various ways in which a monopolist can introduce price discrimination on the products they sale. The first way is through perfect price discrimination. This is an approach used by the monopolist to charge its customers the highest price they can afford and willing to pay. The monopolist treats each customer differently. Those with much money to spend are charged more relative to those who have less money to spend. For example, a monopolist may wish to sell the latest Range Rover Models to two customers. The first customer may be charged thousands of dollars above the second customer. Therefore, the monopolist will charge more amount of money to the person with higher income than to the other person with less income. The second way in which the monopolist discriminates is by consumer group based discrimination. The monopolist segments the markets geographically, use time or age. For example, a monopolist may decide that the unit price per product in location A may be one and half times more that those paid by consumers in location B or the monopolist may offer a discount for its goods and services from 6 am to 2pm. However, after 2 pm the discount ends and customers pay higher prices after 2pm to the close of business. However, monopolists should be keen to identify customers that give them the highest price and concentrate on selling to them to earn higher revenues. (b) Discuss conditions that allow the monopolist to practice price discrimination. Various conditions must exist for the monopolist to be able to practice price discrimination. The first condition is that the market should be imperfect. This means that they should be one seller and many buyers. In addition, the firm should be able to influence the price of good and services that it produces. This enables the monopolist to set the prices of its goods and services any time. The second condition is that the monopolist should be able to separate the markets. This is very important because it prevent the customers who buy from low priced markets from selling in higher priced markets segments. An example of successful separation is discriminating between adults and children. Children and adults who wish to watch high-level football match or rugby tournament are charged differently. The adults have different coloured tickets with higher price tags as compared with those. The red coloured tickets help monopolist to differentiate and prevent adults from using the blue coloured tickets for children. This is because adults may be tempted to purchase and use the low priced tickets that belong to children. The third condition that must exist is the willingness of some customers to pay more. There must be consumer groups with different demand elasticities. For example, students with low income will be more price elastic as compared to the working population with higher income. There are various benefits of price discrimination. The first benefit is that the firm is able to increase its revenues. Price discriminations allow the monopolistic firms to attract more income by exploiting high-end markets. Secondly, firms can use increased revenues that resulted form price discrimination to improve their performances and acquire capital goods for the firm. In addition, extra profits earned from price discrimination are used for research and development activities of the firm. Research leads to creativity and creation of better goods and services that will appeal more to consumers. Finally, price discrimination enables people who do not afford high prices to purchase the same products from low priced markets. (c) Compare the market outcomes with the potential outcomes of perfect competition. The perfect and imperfect markets have different outcomes. First, imperfect markets benefit from price discrimination while the competitive market do not benefit from price discrimination. This is because monopolistic markets enable firms to set prices as they wish. However, the many buyers and sellers in a perfect competitive market do not allow for price discrimination because any slight increase in prices chase off the customers. Secondly, monopolistic markets do not promote efficient use of resources. This is because the goods and services produced in the monopolistic market are less than those that are produced in the perfect competitive market. Therefore, monopolistic markets lead to misallocation of the resources of the society. The tight competition in the competitive market will make most firms put in effort to minimize their costs incurred and focus on efficiency in productivity. The firms in the competitive market with cost leadership are likely to increase demand of their good and service as well as revenues. Therefore, firms in a competitive markets are more likely to adopt new technological at faster rate because of the threat of competition. Improved technologies are associated with lower cost of production and improved qualities of goods. Thirdly, monopolistic markets cause high barriers of entry and exit. Therefore, very few firms operate in the monopolistic markets as compared to those operating in a perfect competitive market. In perfect competition market, entry of new firms will be easy if they feel they will make abnormal (economic) profits. Hence, new firms entering the market will bring extra competition and ensures that the prices are maintained low. Fourthly, competitive markets offer lower prices as compared to monopolistic markets. In perfect competition, lower prices arise because of large number of firms are competing. In this type of market, suppliers encounter highly elastic demand curves. If suppliers increase prices, the outcome will be large fall in both demand and total revenue of the firm. In addition, there will be high cross price elasticity of demand for one product with respect to relative price change of another. However, monopolistic markets generate high levels of revenues. High revenue earned by monopolistic firms may be used for research and development spending. Firms enjoying huge profits have the ability to allocate part of their profits on capital investment spending and other research and development projects. The spillover effects of research can be viewed in the development of superior products for consumers and faster pace of innovation The fifth outcome results from the cost of production. Monopolistic markets have higher cost of production as compare to the perfect competitive market. In imperfect competitive markets, firms may use the absence of real competition to bring about increase in production costs and productive efficiency loss. In addition, firms in this kind of market may be inefficient. This comes about, as they believe that they already have a protected market, hence will be reluctant to invest on research and improved management. Wasting of scarce resources can result from these inefficiencies. When there is high competition, firms keep tight control of their costs. This is because they do not want to lose their market share. Finally, most economists believe that perfect competitive markets are better because they help allocate the resources fairly across many sectors in the economy. References Mankiw, G 2008, Principles of Economics 5th ed, Cengage Learning, New York. Callahan, G 2004, Economics for real people: an introduction to the Austrian school, 2nd ed, Ludwig von Mises Institute, Austrian. Baumol, W & Blinder, A 2008, Economics: Principles and Policy, 11th ed, Cengage Learning, New York. Read More