Assessment Item 1 Part A - Short Answer Questions

Ans.1 Opportunity Cost Opportunity cost refers to the cost which is associated with a task in terms of the substitute that is not chosen. Or you can say its foregone. Concept of opportunity comes from the scarcity of goods which we required because of which we are forced to make choice. For example: If one production company wants to produce more axle of bike then shockers of vehicles, then it will produce less of shockers. Producing axle in excess led to opportunity cost of producing fewer shockers. Definition: The cost of an alternative that must be foregone in order to pursue a certain action. Assumptions: In the case of opportunity cost, our assumption is this that while opting one choice we are sacrificing the alternative option which led to generation of opportunity cost. Original Analysis: In opportunity concept, choice which we have to made must be among two or more options. It can be an easy decision, if we knew the actual end outcome. And the risk for achieving high benefits by sacrificing another option leads to opportunity Cost. Example: Say we are having two securities for investment in shares and another in real estate. From shares we are having return rate of 8% and from real estate it must b around 17 % and investment require in real estate is also high. As we are going for the first option because of less amount of investment, our opportunity cost becomes 17% - 8% = 9%

a. Mary spends 2 hours collecting a basket of berries and 3 hours catching a fish. Fred spends 5 hours collecting a basket of berries and 4 hours catching a fish. Marys opportunity coast of collecting an extra basket of berries is: P y/P x = 5/2 = 2.5 Freds opportunity coast of collecting extra basket of berries is: P y/P x = 2/5 = .4

(b) What is Marys opportunity cost of catching an extra fish? What is Freds opportunity cost of
catching an extra fish? Marys opportunity cost of catching extra fish is: P y/P x = 4/3 = 1.333 Freds opportunity cost of catching an extra fish is: P y/P x = 3/4 = .75

(c) Who has an absolute advantage in food production? Explain why.

Definition of Absolute Advantage: It refers to ability of firm or individual to generate more of output as compared to competitors. Explanation: Here Marys has an absolute advantage because of high opportunity which shows that he is very efficient in doing all the work as compared to Freds. (d) Who has a comparative advantage in food production? Explain why.

Definition of Comparative Advantage: It refers to the production of good among two firms or individuals if they can produce at lower cost than anyone else. Explanation: Freds has the comparative advantage because of less opportunity cost in both activities.

Answer.2 In this answer we are going to draw supply and demand diagram for the various market reactions. While drawing supply and demand diagram led to the formation of stage called equilibrium stage. In this situation we need to focus on equilibrium point how it behaves with the changing scenario or market reactions. Definition: Equilibrium refers to a situation in which the price has reached the level where quantity supplied equals quantity demanded. Equilibrium price is the point in the graph where demand and supply curve intersects. Equilibrium price also referred as the price at which quantity demanded and supply are equal. Equilibrium quantity refers to that point on graph where supply and demand curve intersects. Quantity demanded and quantity supplied is at equilibrium price. Example At Equilibrium
Supply Schedule

Demand Schedule

2.00

2.00

At $2.00, the quantity demanded is equal to the quantity supplied!

Diagram: The Equilibrium of Demand and Supply

Now we answer all the parts of this question and see the effect on the demand and supply line of this graph with different market reactions. Also the corresponding changes in the price and quantity with market reactions. (a) A cyclone destroys banana plantations in north Queensland.
Explanation: A cyclone destroys banana plantation in north Queensland where the maximum production of Banana is being done. Around 80-90% of banana plantation is destroyed with this cyclone. As we know banana plant will reproduce banana in 8 to 9 months. And Australia as such not import banana because of its own production. So, the impact of this cyclone on Supply and Demand is like this: Effect on Demand, Supply, Price and Quantity:

Supply goes on decreasing for around 8 to 9 months Demand increases by small, Prices of banana start rising from earlier situation and Quantity required by the customers is also reduced. Assumption: The assumption we made here is this that before cyclone demand and supply are in equilibrium. And we find changes after the cyclones. Diagram:

(b) The government imposes a new tax on Sydneys rental housing market
Assumption: Again here the assumptions are same that before imposing new taxes the demand and supply are in equilibrium. We need to see impact of imposing taxes on Sydneys rental housing market. Explanation:

As the government imposed new tax on Sydneys rental housing market, which led to the total increase in rent which is not favourable for the customers. After new tax implementation the total value of the rent goes high which leads to effect on demand and supply.

Effects on Demand, Supply, Price and Quantity: Supply becomes surplus in this situation. Demand goes on reducing Prices becomes down Quantity become ambiguous Diagram:

(c) Car drivers hear news of a future petrol price increase.

Assumption: Again here the assumptions are same that before imposing new taxes the demand and supply are in equilibrium. We need to see impact of future rise in petrol prices. Explanation:

As the car drivers hear news of a future price increase, which led to the total increase in demand by the car drivers. Every car drivers would like to have his or her tank full before rise of prices so that he/she can save some money for this time only. In future they have

to pay new prices but for some time they can enjoy the low prices. But the supply remains same from the petrol booth. This led to decrease in supply of petroleum in future. Effects on Demand, Supply, Price and Quantity:
Demand is in excess because of future increase in price.. Supply remain same Prices up because of same supply Quantity also rises because of excess demand Diagram:

(d) Coal producers hear news of a future drop in coal export prices.
Assumption: Again here the assumptions are same that before imposing new taxes the demand and supply are in equilibrium.

Explanation: As the coal producers hear news of future drop in coal export prices, this led to large supply of coal in international market and after the coal export prices reduces, then producer will start exporting less in international market and focusing on domestic

market. But at present situation supply of coal will increases. Demand of coal will increase by small.

Effects on Demand, Supply, Price and Quantity: Supply becomes surplus in this situation. Demand remains same or increase by small Prices becomes down Quantity become ambiguous Diagram:

Answer:3 (a) Explain why governments prefer to increase taxes on goods with inelastic demand.
Definition: When a price changes and has no impact on demand and supply its perfectly inelastic. Example: Life saving drug for which one can pay any amount to buy it.

Explanation: Government prefers to increase taxes on goods with inelastic demand because of very simple reason. In inelastic demand if the prices of goods rise, it will not have any impact on the demand. Inelastic demand is applicable to those goods which are very important in use and one cant survive without that. For example: In case of salt, as it is important ingredient for food so one cant ignore the purchase of this good. So every customer has to buy salt even though its prices may go very high. Only small impact is on consumption which is very less impacted.

(b) Explain how an increase in price can eliminate a shortage in the market.
Definition: Shortage in the marker: Refers to large demand and less supply Assumption: Here in this situation it is assumed that in present market situation there is a scarcity in supply of some goods and people need that product so their demands are very high in this situation where as supply is not good. So to overcome this situation with which the shortage of goods gets reduced is by increasing its prices. Explanation Increases in prices will directly effects on the pocket of customer. Customer try to invest same amount which he earlier invest for buying the same product and satisfy with less quantity as compared to earlier which led to reduced in demand and ultimately shortage of goods can be eliminated. Example: As the cyclone occur in Queensland which led to destruction of banana plantation up to 80-90% which led to decrease in supply and increase in demand. O prices of banana rises from $3 to $15 which led to decrease in demand and ultimately shortage of banana eliminates for the next 8 to 9 months.

(c) Describe the difference between an increase in quantity supplied and an increase in
supply and draw a graph to illustrate the difference. Increase in Quantity supplied: Definition: Amount at a given price refers to quantity supplied. Explanation: Whenever increase in price from P1 to P2 quantity supplied also increases from Q1 to Q2. Change in quantity supplied can be done by changing the price. For example: To increase the quantity supplied paying extra for overtime.

Diagram:

Increase in Supply Definition: It is the entire relationship of quantity with the prices where as it is not so in case of quantity supplied which shows relation at two particular price levels. Diagram

d. Why does the marginal cost of production fall when the marginal product of labor increases? Marginal Cost of Production Definition: Marginal cost is the change in cost which occurs due to unit change in production units. Marginal product of Labor: Definition: Change in the result or output by adding a one unit of labor is called marginal product of labor. It is denoted by MPL. Explanation: When the marginal product of labor increases, then number of units of production rises and which further led to the economies of scale With the economies of scale production cost of per unit of good is reduced and which results into low marginal cost. (Law of Diminishing Marginal Returns)

Ans.4

(a) Why is price equal to the long run average cost of production under conditions of perfect
competition? What happens to economic profit? Definition of Perfect Competition: A structure of market in which following 5 characteristics are present: 1. All firms are price takers 2. Freedom of entry and exit in this industry 3. Buyers are aware of the prices and product they are selling 4. Homogeneous product. 5. Every firm is having small or equal share. Assumption: During the long run this market remains Perfect Competition market and homogeneous product is there . Explanation: In this case of perfect competition where sellers and buyers are large in number so none of the sellers can charge higher prices than other seller in the market for longer term. Because every customer would like to have product at minimum cost. So, seller will loosen its market share if he charges more from the customers. So only thing which a seller can do for long run is to charge at average cost of production and have optimum level of profit. So that it can cover large market share, and minimum profit which led to the price almost equal to the average cost of production of the goods. Economic Profit will not be affected because if seller is selling at almost at average cost of production than he covers the larger market share and the total profit of the seller will almost remain same as earlier.

(b) Describe and explain how a sales tax causes a deadweight loss. What is the impact on
consumer surplus and producer surplus in an industry? Draw a graph to illustrate the problem. Definition of Sales Tax: It is the tax which is paid by the customer on the goods purchase. This sales tax is separate from the base price of the product. And sales tax is charge on the taxable price of the product only and that is decided by the government and varies from product to product. Sales tax causes dead weight loss because sales tax led to increase in the price of the goods purchase which led to increase in expense of the customer. As every person cant afford extra money for the same product So he may go for some other cheaper product to counter balance the total price to him. So, in this way it causes dead weight loss. Definition: Consumer Surplus: It is the measure of benefits that people earn from the exchange of goods. It is also defined as the difference in the price which consumer is ready to pay and actual price paid.

Impact on Consumer Surplus Sales tax led to high price of the goods and which further led to higher value of consumer surplus which is not appreciated by the customer and seller may lose his customer. Producer Surplus: Definition: Difference between the amount producers is willing to receive and minimum amount which he can accept from the customer. The surplus amount is the benefit that the producer receives. Impact on Producer Surplus: As higher prices are not accepted by the customer though it is because of sales tax which is also added in the total price of the good So customer will not ready to pay that amount and try to negotiate with the seller and pay less than the price asked by the seller. Because of less price paid seller profit factor reduces because sales tax should remain constant which he has to pay to the government.

References:

1. Taylor, JB & Frost L 2009, Microeconomics study guide, 4th edition, John Wiley & Sons Australia Ltd, Milton. 2. P.L. Mehta, Managerial Economics, 14th edition, Sultan Chand & Sons Ltd. 3. Managerial Economics International Edition 6th Edition Paul Keat, Philip Young Nov 2008 4. Bruce Allen, Neil Doherty, Keith Weigelt, Edwin Mansfield (2005) Managerial Economics