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BEO1105 Economic Principles For Demand, The Supply And Demand Balances

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  • Course Code: BEO1105
  • University: Victoria University
  • Country: Australia
Questions:
 
1. Ceteris paribus, assume a global shortage of petrol has resulted in a doubling of petrol prices. Use graphical demand and supply analysis to support your explanation of the impact on equilibrium price and quantity in the market for:
 
a) High fuel efficient petrol cars.
b) Cars that use liquid gas (a substitute for petrol), where the price has not increased.

2. Use graphical demand and supply analysis to support your explanation of the effect the following events will have on the market for beef. (Assume ceteris paribus for each of the event).
 
a) A sharp rise in average income, assuming beef is a normal good.
b) Farmers have access to high quality cattle feed (food for the cows), which has reduced the time it takes to get cattle ready for the market.
c) Governments in beef producing countries have not only ordered the mass slaughter of cows due to the spread of mad cow disease but they have also warned consumers about the dangers of consuming beef. (HINT: Explain all possible impact on price and quantity)

3. Ceteris paribus, assume the increase in new commercial apartments has at the same time been accompanied by a decrease in the demand for such apartments. Use graphical demand and supply analysis to support your explanation of the impact on equilibrium price and quantity of the market for new commercial apartments. 4 Marks
(HIN: Explain all possible impact on price and quantity)
a. If the price of a good increase from $3.50 to $4.25, leading to a fall in quantity demanded from 25 to 15 units, what is the price elasticity of demand for the good at
this price range?
b. Explain why it is important for the business owner to understand the meaning of the elasticity value. 
 
5. The CEO of HAPPY enterprise has decided to change its business strategy from a sales maximising strategy to a profit maximising strategy. Use graphs to support your explanation of the two methods a firm can use to decide on a profit maximising quantity. 

 

 

Answers: 

1. a) When petrol price increases following a shortage of supply, then people are more willing to use fuel efficient cars as it require less petrol (Krugman et al. 2015). Accordingly, the demand curve will shift to the right to D1D1.  At the old equilibrium price P1, the new demand creates car shortage of the amount (Q3 – Q1). With new demand, the supply and demand balances at E2. This is the new equilibrium point with price P2 and equilibrium quantity Q2. 

b)When petrol price rises then demand for petrol substitute fuels increases. This will increase the demand for cars that use liquid gas. An outward shift of the demand curve to D1D1, reflects this change in demand. At the existing equilibrium price P*, this creates an excess demand or shortage of these cars equals to (Q2 – Q*). The balance between new demand and the existing supply curve SS is indicated by the new equilibrium point E1. At E1, there is a higher price P1 and a larger number of cars Q1 in the market.

2.a)Beef is considered as a normal good. For a normal good, when income increases then demand increases shifting the demand curve rightward from DD to D1D1. At the increased demand there will be a shortage of beef of the amount EF. A new equilibrium E1 is defined where new demand curve D1D1 matches with supply curve SS. The new equilibrium is associated with a high price and high equilibrium quantity of beef.

b) The high quality cattle feed makes more cattle available at the given time. Therefore, the farmers can now supply more cattle. The increase in supply is seen from the outward shift of the supply curve from SS to S1S1. The increased supply causes a surplus in the market as shown as E1G. There is initially no change in the beef demand. Therefore, the new equilibrium is attained by restoring balance between new supply and old demand (Blad and Keiding 2014). E2 defines new equilibrium with price P2 and quantity Q2.

c)When government in beef producing countries ordered for mass slaughter of cows then this reduce supply of beef.  Additionally, the warnings given to consumers regarding harmful effect of beef consumption reduces demand supply. As both demand and supply changes new market equilibrium is obtained incorporating both the direction and magnitude of change in supply and demand (Mahanty 2014). Followings are the three cases for all possible combination of demand and supply change.

Case i

When demand changes at a greater magnitude than supply then both price and quantity of beef reduces at the new equilibrium.

Case ii

When magnitude of supply change is greater than demand change then the supply shortage pushes prices up and quantity reduces as before.

Case iii

When supply and demand change by equal magnitude then there is no change in price while quantity reduces under new equilibrium.

3. As the increase in supply new commercial apartment is accompanied with decline in demand for such apartments there is a change in both demand and supply. Depending on the magnitude of change three possible cases can be formed.

Case i

Suppose increased supply of new apartment exceeds that of decline in demand. As the supply force dominates, there is a surplus of new apartments (Zinn et al. 2016). Under the new equilibrium price declines while equilibrium number of apartments increases.

Case ii

Consider a case where demand declines at a greater proportion than increase in supply. In this situation, both price and equilibrium number of apartments decreases.

Case iii

An extreme situation is where demand and supply changes by the same magnitude. Here price declines as usual leaving number of apartment unchanged in the new equilibrium. 

 

4. a)The price elasticity of demand using mid-point method is given as

Where,

P1: old price

P2: new price

Q1: old quantity

Q2: new quantity

Therefore, price elasticity of demand is computed as

b)Price elasticity of demand captures the responsiveness of quantity demand for a corresponding change in price. The elasticity value is -2.59. This implies 1 percent increase in price causes a decrease quantity demanded by 2.59 percent. As demand changes at a greater proportion than price change demand is relatively elastic in nature. With elastic demand the business owner should never increase the price because it then decreases revenue (Baumol and Blinder 2015). On the other hand, price reduction is profitable for the business as it will then increase sales volume by a greater proportion.

5. The CEO of happy enterprise switches the business strategy from sales maximization to profit maximization. Profit of a firm is obtained as revenue less income. The output choice that leads to profit maximization can be made using two alternative approaches.

Profit maximization with Marginal Revenue –Marginal Cost method

This is the most commonly used method for maximizing profit. This approach requires additional revenue from one additional unit should be equal to additional cost of producing that unit. Under this method, the firm should compare marginal revenue and marginal cost corresponding to every unit and choose that output level where marginal cost equals marginal revenue (Pindyck and Rubinfeld 2015).

In figure 11, E is the profit maximizing equilibrium point. Firm can attain maximize its profit by selling Q* output at price P*.

Profit maximization with Total Revenue –Total Cost method

Under this approach profit maximizing output is chosen from where the difference between total revenue and total revenue is maximized. This corresponds to the point where total revenue is maximum and total cost is minimum.

The vertical distance between total revenue curve and total cost curve measures the profit. The distance is maximized at output level Q0 and hence give profit maximizing output. 

 

References

Baumol, W.J. and Blinder, A.S., 2015. Microeconomics: Principles and policy. Cengage Learning.

Blad, M.C. and Keiding, H., 2014. Microeconomics: institutions, equilibrium and optimality (Vol. 30). Elsevier.

Krugman, P., Wells, R., Au, I. and Parkinson, J., 2015. Microeconomics: Canadian Edition. Macmillan Higher Education.

Mahanty, A.K., 2014. Intermediate microeconomics with applications. Academic Press.

Pindyck, R.S. and Rubinfeld, D.L., 2015. Microeconomics; Eight Edition, Global Edition.

Zinn, J., Arjomand, L., Finlay, N., Kheirandish, R. and Solomon, G., 2016. Principles of Microeconomics.

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