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Purpose of PART 1 - Understanding Fundamental Economic Concepts and Factors Affecting Elasticity

The purpose of PART 1 of this assignment is to enable students to understand fundamental economic concepts such as expected returns, profits and prices; and to apply his / her knowledge on factors affecting elasticity of demand and  elasticity of supply of goods and services.

  1. Two investments have the following expected returns (net present values) and standard deviation of returns.

PROJECT

EXPECTED RETURNS

STANDARD DEVIATION

A

RM50,000

RM40,000

B

RM250,000

RM125,000

Which one has a higher risk? Justify your answer.     

  1. The AIROD Aircraft Company manufacturers small, pleasure–use aircraft. Based on past experience, sales volume appears to be  affected by changes in the price of the planes and by the  state of the economy as measured by consumers’ disposal personal income. The following  data pertaining to AIROD Aircraft Company sales, selling prices and consumers’ personal income were collected:

YEAR

AIRCRAFT SALES (UNITS)

AVERAGE PRICE

(RM MILLIONS)

DISPOSIBLE PERSONAL INCOME (IN CONSTANT 2013 in RM BILLIONS)

2013

8,000

100

650

2014

10,000

89.50

610

2015

8,000

109.5

590

  1. Estimate  the arc price elasticity of demand using the 2013 and 2014 data.
  2. Estimate the arc income elasticity of demand using the 2013 and 2014 data.
  3. Assuming that these estimates are expected to remain stable during 2015. Forecast 2015 levels for AIROD Aircraft Company  assuming  that its  aircraft prices remain constant at 2014 level and that  disposable personal income  will increase by RM40 billion. Also assume that arc income elasticity computed in (b) above is the best available estimate of income elasticity.
  4. Forecast 2015 sales for AIROD Aircraft Company  given that its aircraft prices will increase by RM20 from 2014 levels  and that disposable personal income will increase by RM40 billion. Assume that the price and income affects are independent and  additive and that the arc income and price elasticities computed in parts (a) and (b) are the best available estimates of these elasticities  to be used in making the forecast. 

The purpose of PART 2  of this assignment is to enhance the analytical skill of the students on production functions, cost minimisation, profits maximisation  and to appreciate their usefulness in the real world.

  1. Data on Gross Domestic Product (GDP), Labour and Real Capital for Mexico from 1955-1974 is shown in Table 1 below:

Table 1: Real GDP, Labour and Real Capital for Mexico from 1955-1974

YEAR

GDP (million of 1960 Peso)

Labour

(thousands of people)

CAPITAL (million of 1960 Peso)

1955

114,043

8,310

182,113

1956

120,410

8,529

193,749

1957

129,187

8,738

205,192

1958

134,705

8,952

215,130

1959

139,960

9,171

225,021

1960

150,511

9,569

237,026

1961

157,897

9,527

248,897

1962

165,286

9,662

260,661

1963

178,491

10,334

275,466

1964

199,457

10,981

295,378

1965

212,323

11,746

315,715

1966

226,977

11,521

337,642

1967

241,194

11,540

363,599

1968

260,881

12,066

391,847

1969

277,498

12,297

422,382

1970

296,530

12,955

455,049

1971

306,712

13,338

484,677

1972

329,030

13,738

520,553

1973

354,057

15,924

561,531

1974

374,977

14,154

609,825

  1. Fit a regression equation  using GDP as the dependent  variable and  Labour & Capital as the independent variables. (Use logarithm for all variables)     
  2. Fit a regression equation  using GDP/Labour  as the dependent  variable and  GDP/Capital as the independent variable. (Use logarithm for all variables)
  3. Determine  whether this production function exhibits increasing, decreasing or constant returns to scale and show with suitable diagram.

The purpose of PART 3 of this assignment is to enable students to evaluate levels of competitiveness in various market structures and to introduce the correct strategies in order to obtain competitive edge in a selected market.

  1. Micheal Porter  developed a conceptual  framework for identifying  the competitive advantage from FIVE (5) forces of competition in a relevant market. Using a suitable diagram, critically explain the  Porter’s Five Forces Strategic  Framework.
  1. Alchem (L)is a price leader in the polyglue market. All 10 other manufacturers (follower [F] firms) sell polyglue  at the same price as Alchem. Alchem allows the other  firms to sell as much as they wish at the establised  price and supplies the remainder of the demand itself. Total demand for polyglue is given by the following function ( QT= QL + QF):

P = 10,000 – 10QT

Alchem’s marginal cost function for manufacturing and selling polyglue is:

MCL = 100 + 3QL

The aggregate marginal cost function for the other manufacturers of polyglue is:

∑MCF= 50 + 2QF

  1. To maximise profits, how much polyglue should Alchem produce and what price should it charge
  2. What is the total market demand for polyglue at the price established by Alchem in Part (a) How much of total demand do the follower firms supply

The purpose of PART 4 of this assignment is to ensure that the students are able to apply their knowledge on market theories in assesing current events in the competitive real world.

The world’s top for manufacturers on inexpensive random access memory chips, a key component of all consumer electronic devices, agreed to fines and jail terms for several executive because of 1999-2002 price fixing. The criminal conspiracy raised prices 400 per cent in a six-month period from US$1 to US$4 per 100 megabits and then orchestrated maintaining  the price at US$3.

DRAM chips are generic and easily substitutable between suppliers. As a result, a CARTEL agreement to limit production is necessary to maintain price above competitive levels. SAMSUNG and HYNIX, two KOREA firms that produce  the majority of the chips, paid US$300 million and US$185 million fines, respectively. Infineon Technologies or Germany paid a US$160 million fine, and four executives went to jail for several months and paid individual fines of US$250,000. Micron Technology of Boise, Idaho, received immunity for cooperating with the prosecutors and complainants DELL and HP in making the case. 

Source : Based on `SAMSUNG to pay’, Wall Street Journal (October 14, 2005). pp 43. and `Hynix Pleads Guilty ‘, Wall Street Journal (April 22, 2004). pp.86. 

Please read the article above and answer the following questions

  1. Use a suitable diagram to explain the price-output determination for a TWO (2) -firm Cartel profit maximisation and the allocation of restricted output respectively. 
  1. Suppose TWO (2)KOREA electronics companies, SAMSUNG (firm S) and HYNIX (firm T), jointly hold a patent in a component used on DRAM. Demand for the component is given by the following function:

P = 1,000 – QS – QT

where QS and QT are the quantities sold by the respective firms and P is the (market) selling price. The total cost functions of manufacturing and selling the component for the respective firms are:

TCs  = 70,000 + 5QS+ 0.25Q²S

TCt  = 110,000 + 5QT + 0.15Q²T

  1. Suppose that the TWO (2)firms act independently, determine the optimal output and price with each firm seeking to maximize its own total profit from the sale of the components.
  2. Suppose that the TWO (2)firms decide to form a CARTEL and act as a monopolist to maximise total profits from the production and sales of the components. Determine the optimal output, market share and company total profit when the CARTEL is occurs.  
Purpose of PART 1 - Understanding Fundamental Economic Concepts and Factors Affecting Elasticity
  1. In a market system where producers cooperate in creating individual and aggregate output levels and prices, it is called a cartel. In the case of a perfect cartel type, the output and price of the whole industry as well as each member firm is determined by a common authority which allows the achievement of joint profits for the individual firms. The resultant profit is distributed in a way which is pre-decided. Each firm’s share from the joint profit may not be in proportion to quota of the supply or the cost that would be incurred. The central administrative authority decides the output quota for each firm such that the cost to the outut produced is mininmized. This is found when the marginal costs of the member firms are equal (Pindyck et al, 2009).

To determine price and output of a cartel, we consider a two member firm. The cartel’s industry demand curve would be its aggregate demand curve as shown by DD in the figure given below. Below the demand curve lies the marginal revenue curve of the cartel. The marginal cost curve of the cartel (MCT) is the aggregate or horintal aggregate of the MC curves of both firms A and B (MCA and MCB). Again, the output of each firm is distributed in a way that the marginal costs are equal (Shapiro,1989). The cartel’s profit is maximized where MR is equal to MC which here is shown as point C. The profit maximizing output is here, OQ* and the price is OP*. We see in the figure that when firm A produces OQ1 and firm B produces OQ2 , the marginal costs of the firm is equal. OQ* is the sum of OQ1 and OQ2 with A’s profit PFTK and B’s PEGH, the sum of which is maximum (Hall et al, 2010).

(a) The given demand function is

P=1,000 – QS – QT 

Where QS and QT are the quantities sold by the respective firms and P is the (market) selling price. The total cost functions of manufacturing and selling the component for the respective firms are:

TCs = 70,000 + 5QS+ 0.25Q²S

TCt = 110,000 + 5QT + 0.15Q²T 

Total profit of S is:

ΠS = PQs-TCs= (1000-Qs-Qt)Qs - 70,000 + 5QS+ 0.25Q²S

=-70000+995QS-QsQT-1.25Qs2

Taking partial derivative of the above equation with respect to Qs gives us (Varian, 2010):

dPs/dQs= 995-Qt-2.50Qs………………………………… (1)

Similarly we get firm T’s total profit as:

Π T= PT-TCT= (1000-QS-QT) QT - 110,000 + 5QT + 0.15Q²T

=-110000+995QT-QS QT -1.15QT2 

On taking partial derivatives with respect to Qt we obtain as follows:

dPt/dQT = 995-QS-2.3QT................................................(2)

We see the first equation are functions of QS and QT

Setting both equation 1 and 2 to zero yields:

2.50Qs+Qt=995

Qs+2.30Qt=995

As we solve the two equations we get, QS*=272.32 units and QT*=314.21 units. On substituting these two values in the demand equation we get the equilibrium selling price of P*=$413.47 per unit and the profits obtained are:

Π S=$ 22695 and

Π T=$3536.17.

  1. b) Now if both the firms decide to form a cartel then total industry profits would be:

 π = πs+πt

=PQS-TCS+PQT-TCT

π= (1000-Qs-Qt) Qs - 70,000 + 5QS+ 0.25Q²S + (1000-Qs-Qt) Qt - 110,000 + 5QT + 0.15QT2

= 180000+995Qs-1.25Qs2+995Qt-1.15Q2-2QsQt

To maximize this total profit we take partial derivative with respect Qs and Qt respectively:

dPR/dQs= 995-2.50Qs-2Qt

dPR/dQt=995-2.30Qt-2Qs

Setting these equal to zero we obtain:

995-2.50Qs-2Qt=0

995-2.30Qt-2Qs=0

.On solving we get Qs*=170.57units and Qt*=284.39units. Substituting these in the price functions and profit function gives P*=$545.14 per unit and PR*=$46291.43

The Marginal costs for each firm would be:

MCs= d(TCs)/dQs= 5+0.5Qs

MCt= d(TCt)/dQt= 5+0.3Qt

The marginal cost function as obtained before, on substituting values we get: MCs*=MCt*=$90.29

Reference

Pindyck, R. Rubinfeld, D. & Mehta, P. (2009). Microeconomics. South Asia: Pearson

Hall, R., & Lieberman, M., ( 2010). Economics: Principles and applications, USA: CengagE learning

Shapiro, C. (1989). Theories of Oligopoly behavior. Available at: https://www.sciencedirect.com/science/article/pii/S1573448X89010095 [Accessed 9 March 2017]

Varian, H. (2010). Intermediate microeconomics. New Delhi:Affiliated East-West Press

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