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Question 1

Assume ceteris paribus, use demand and supply graphs to illustrate and explain the effectof the following events on the market for woollen jumpers in Australia. In your answer, mention the market equilibrium adjustment process.

(a) The price of leather jackets, a substitute of woollen jumpers, decreases.

(b) Adoption of new machines, which has increased the productivity of the knitting industry.

(c) A rise in income, assuming woollen jumpers are a normal good.

Question 2

Find the flaws in the reasoning in the statement below, paying particular attention to the distinction between shifts of and movements along the demand and supply curves. Draw a diagram to illustrate what actually happens.

Question 3

“A study shows that eating a clove of garlic a day can help prevent heart disease, causing consumers to demand more garlic. This increase in demand results in a rise in the price of garlic. Consumers, seeing that the price of garlic has gone up, reduce their demand for garlic resulting in a fall in the price of garlic. Therefore, the ultimate effect of the study on the price of garlic is uncertain.”

Question 4

Recently in Sweden, due to the discovery of bird flu the demand for live chicken decreased. This was, at the same time, followed by the Swedish government taking precautionary measures and culling 50 percent of the live chicken stock in the country. Using demand and supply graphs illustrate and explain the impact on price and quantity in  the market for live chickens?

1. a) Assume the price of a good decrease from \$10 to \$8, leading to a rise in quantity demanded from 475 to 500 units. Using the midpoint elasticity formula, calculate the price elasticity of demand for the good at this price range.
2. b) How would you use the concept of price elasticity of demand to maximise the total revenue of your business?

Question 5

Assume, in an industry where firms are making an economic profit, the creation of an internet platform has broken down all entry barriers and resulted in a huge increase in the number of firms entering the industry. What will be the implication on profit to the existing firms in this industry? Use graphical demand and supply analysis to support your explanation.

## The Impact of Substitutes on Market Equilibrium

1. The decrease of the price of leather jackets

Economic theory has it that, a change in the price of a substitute of good causes a change in the demand of the substitute in the same direction. That, if the price of leather jumpers decreases as it is in this example, the demand for woolen jumpers will decrease, see. Therefore, the decrease in the price of leather jumpers will attract more consumers hence leading to a shift in the demand curve of the leather jumpers to the right as the equilibrium goes higher from E1 to E2 as shown in Fig. 1.1. Conversely, the demand curve for the woolen jumpers shifts leftwards because their demand decreases and consequently .

1. Adoption of new machines increasing the productivity of the industry

Technological improvement in production of cotton jumpers in the industry affects the supply of the cotton jumpers. It makes production cheaper because the producers spend less on inputs yet producing the same output and thus increasing the number of cotton jumpers produced at any given price see. As such the supply curve shifts to the right as shown in fig. 2.3 below. As it can be seen from the panel for fig. 1.3: at price Pf, the quantity produced after introduction of technology is higher than the initial quantity supplied at the same price. Notably, the equilibrium price also declined from E1 to E 2 after the introduction of advanced production technology.

1. The rise in income of the consumers

Assuming that the nature of woolen jumpers is normal goods, an increase in income of the consumers will mean they will end up demanding more of the jackets and thus shifting the demand curve to the right, generally see. The increase in the demand leads to a fall higher equilibrium price assuming that the supply remained constant as shown in the fig 1.4 below.

1. Question 2

Flaw in Reasoning of the Comment on the Shift of and Movement Along the Demand Curve

Analysis of the statement shows that it confuses the concepts of shift in the demand curve for movement along the supply curve.  The revelation of the study to which the consumers refer results in an increase in demand for the garlic cloves that is seen through a rightward shift in demand from D1 to D2, generally see. This can only be shown using a shift in the demand curve as shown on Fig. 2.1 below. Therefore, the price ambiguously increases as illustrated in the diagram below.

From panel of figures above, it can be seen that a shift in the demand curve leads to an increase in the equilibrium price and quantity to P1and Q1 respectively.  However, an examination of the supply curve shows that there was a movement along the supply curve caused by the increase in the demand. That is illustrated in fig 2.2 as shown by movement from equilibrium E1 to E2.   Therefore, the statement that ‘consumers, seeing that the price of garlic has gone up, reduce their demand for garlic’, is wrong, contra. Such a movement along the supply curve is not responsible for a leftward shift in the demand curve. It is not consistent to the knowledge that: it is only changes in other factors that affect demand other than price that can cause a shift in the demand curve and only changes in price that can cause movement along the supply curve, generally see also.

1. Question 3

## Technological Advancements and their Effects on Supply

The Impact of Bird Flu on the Price and Quantity on The Market of Live Chicken

The reports on bird flu scared customers from purchasing live chicken. At this time, the demand curve for live chicken in the market shifted leftwards as shown in fig. 3.1. At the same time the government’s policy of culling 50% of the chicken considerably cut the supply of chicken in the market thus lowering raising the equilibrium price and lowering the equilibrium quantity as shown in fig. 3.1. Given that the demand and supply of decreased simultaneously, the effect of the decrease in demand is unambiguous but that of supply is almost certain since it is cut by half. The overall effect is an increase of the equilibrium price due to the artificial shortage caused by culling from Pe to P1 and a decrease in the supply from Qe to Q1.

• Question 4
1. Price elasticity of demand using the midpoint elasticity formula

Ignoring the negative sign, the elasticity is 0.4737

1. Price elasticity of demand and revenue maximization

Generally, see, the change in revenue is roughly equal to the product of the quantity of good sold and the change in price added to the product of the original price and the change in quantity. From the foregoing, it is crucial for a firm to consider the elasticity of the good they are dealing with-determine whether it is unit elastic, perfectly elastic or relatively elastic, perfectly inelastic or relatively inelastic. Considering the elasticity of goods, along the demand curve as shown in the panel for fig. 4.1 below;

It is concluded that at point A, the elasticity of goods is elastic. Here, a small change in price causes a large change in the quantity of the good demanded. In such a position, a firm can make more revenue if it lowers its price. The result is so because the increase in demand more than compensates the fall in price. Assuming that the fir originally operates at point C, it can be demonstrated that a revenue moves in the same direction as price. Therefore, an increase in price more than compensates the inelastic changes in quantity demanded. However, maximum revenue is obtained when the demand is unitary elastic that is at point B. Illustratively, assuming that a hypothetical firm using the demand curve in the fig 4.1 sets prices P1, Pe and P2 at 50, 100 and 150 respectively; quantities Q2, Qe and Q1 as 200,400 and 600 respectively, maximum revenue will be obtained at point B. The revenue at point A will be 30,000, that at 40,000 and point will be 30,000.  It can be explained that at this point, the marginal cost is zero. That is one necessary condition for revenue maximization. Samuelson and Marks conclude that; that “Revenue is maximized at the point of unitary elasticity. If demand were inelastic or elastic, revenue could be increased by raising or lowering price, respectively”.

1. Question 5

Profits in an Industry of Firms Making Economic Profits

The internet and online commerce reduces barriers moving markets closer to the ideal perfectly competitive markets.  In such a scenario, the technology lowers existing technical impediments to entry.  At the beginning, firms will have an incentive to enter the market because of the signal of positive economic profits at price P. That is so because at that point, the price is higher than their average total costs. Generally stated, entry of new firms leads to an increase in the supply of the industry because the total supply is a summation of individual supply of the firms including the new entrants. In other words, it leads to a shift of the supply curve to the right as exhibited in fig 5.1 below. As a consequence of increased supply, the prices are driven downwards as can be seen in fig 5.1. The price reduces from P1 to a new equilibrium price Pe. Analyzed together with the costs as can be seen in fig 5.2, it can be seen that the new price Pe equals the average total cost of an individual firm in the long run. As such, the economic profits that initially served as an incentive of entry reduces to zero {from Marginal Revenue 1(MR1 to MR2)} as shown the fig 5.2 panel. As a result of zero economic profits experienced in the long run, entry of firms ceases.

References

Acemoglu Daron, David Laibson and John A List, Microeconomics (Pearson, Global ed, 2016)

Krugman Paul and Robin Wells, Economics (Worth Publishers, 3rdf ed, 2013)

Mankiw N Gregory, Principles of Economics (Cengage Learning, 7th ed, 2015)

Miller Rodger, Economics Today the Micro View (Addison-Wesley, 16th ed, 2012)

Samuelson F William and Stephen G Marks, Managerial Economics (John Wiley & Sons, 7th ed, 2012)

Varian R Hal, Intermediate Microeconomics a Modern Approach (W W Norton &Company, 8th ed, 2010)

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