## 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.

- 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.

- 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 |

- Estimate the arc price elasticity of demand using the 2013 and 2014 data.
- Estimate the arc income elasticity of demand using the 2013 and 2014 data.
- 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.
- 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.

- 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 |

- Fit a regression equation using GDP as the dependent variable and Labour & Capital as the independent variables. (Use logarithm for all variables)
- Fit a regression equation using GDP/Labour as the dependent variable and GDP/Capital as the independent variable. (Use logarithm for all variables)
- 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.

- 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.

- 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 ( Q
_{T}= Q_{L}+ Q_{F}):

P = 10,000 – 10Q_{T}

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

MCL = 100 + 3Q_{L}

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

∑MCF= 50 + 2Q_{F}

- To maximise profits, how much polyglue should Alchem produce and what price should it charge
- 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

- 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.

- 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 – Q_{S} – Q_{T}

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:

TC_{s} = 70,000 + 5Q_{S}+ 0.25Q²_{S}

TC_{t }= 110,000 + 5Q_{T }+ 0.15Q²_{T}

- 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.
- 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.

- 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 (MC^{T}) is the aggregate or horintal aggregate of the MC curves of both firms A and B (MC^{A} and MC^{B}). 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 OQ^{1} and firm B produces OQ^{2} , the marginal costs of the firm is equal. OQ* is the sum of OQ^{1} and OQ^{2 }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 – Q_{S} – Q_{T}_{ }

Where Q_{S} and Q_{T} 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:

TC_{s} = 70,000 + 5Q_{S}+ 0.25Q²_{S}

TC_{t =} 110,000 + 5Q_{T }+ 0.15Q²_{T}_{ }

Total profit of S is:

Π_{S} = PQs-TCs= (1000-Qs-Qt)Qs - 70,000 + 5Q_{S}+ 0.25Q²_{S}

=-70000+995Q_{S}-QsQ_{T}-1.25Qs^{2}

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}= P_{T}-TC_{T}= (1000-Q_{S}-Q_{T}) Q_{T} - 110,000 + 5Q_{T }+ 0.15Q²_{T}

=-110000+995Q_{T}-Q_{S} Q_{T} -1.15Q_{T}^{2}^{ }

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

dPt/dQ_{T} = 995-Q_{S}-2.3Q_{T}................................................(2)

We see the first equation are functions of Q_{S} and Q_{T}

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, Q_{S}*=272.32 units and Q_{T}*=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.

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

π = πs+πt

=PQ_{S}-TC_{S}+PQ_{T}-TC_{T}

π= (1000-Qs-Qt) Qs - 70,000 + 5Q_{S}+ 0.25Q²_{S} + (1000-Qs-Qt) Qt - 110,000 + 5Q_{T }+ 0.15Q_{T}^{2}

= 180000+995Qs-1.25Qs^{2}+995Qt-1.15Q^{2}-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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