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ECO511 Economics For Business 3

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  • Course Code: ECO511
  • University: Charles Sturt University
  • Country: Australia


Answer the following:


Excise tax rates on tobacco and tobacco products increase in March and September based on average weekly ordinary time earnings. Perform a web-search to determine the amount of excise tax charged (as at 1 January 2018) on a standard 20 packet of cigarettes. If the standard packet is sold for a price of $30, how much is the before tax price?

Illustrate using the demand and supply model, the effects of a tax imposed on sellers of tobacco products. Explain in detail who pays the tax (buyers and/or sellers) and discuss the role the price elasticity of demand plays in determining the impact on prices and quantity of tobacco products sold. Be explicit about any assumptions made in developing predictions. 


a) Assume a perfectly competitive firm’s total cost (TC) for different levels of output Q is given by:

Q   TC
0     50
1    100
2    140
3    170
4    190
5    210
6    230
7    260
8    300
9    350
10  410

In a table format for the range of output (Q) provided determine: average total costs, average fixed costs, average variable costs and marginal costs. At a price of $35 how many units will be produced in the short run? At this price how many units will be produced in the long run?

b) Explain the differences between a monopolistically competitive market and an oligopolistic market? Give examples of industries with these market structures to explain your answer. 


Some State Governments around Australia have pursued policies to merge Local Government Councils. Explain the economic rationale for these policies, use cost curves and related evidence to support your arguments.




There is an excise duty (tax rate) is as follows Australian Taxation Office, (2018)


Tax Rate

Retail Price

Base Price

Upto Jan 2018




Since March 2018





Price Elasticity refers to the degree to which the demand a good is price sensitive. i.e. if a small increase in the price, reduces the demand disproportionately (greater than 1), then the demand for the god is highly price elastic. Similarly, if the demand for the good is relatively unaffected, then the price elasticity is low. (Less than 1) (Mankiw, 2008)

It is measured as:

EDP = Proportionate change in demand/ proportionate change in per unit price.


Figure 1  Price Elasticity of Demand

Source: (Samuelson & Nordhaus, 2006)

In the diagram above, as the price drops from P1 to P2, the demand (and consequently output) moves from Q1 to Q3. The ratio of (P2-P1)/(Q2-Q1) is the elasticity of demand. The reverse effect is seen as price increases from P1 to P3. Output falls fromQ1 and Q2 and hence the (P3- P1/ Q1- Q3) elasticity will be negative.  


Figure 2 Various kinds Price Elasticity of Demand

Source: (Chauhan 2009)

According to international research, generally, the elasticity of demand for cigarettes in Western Countries is less approximately -0.4.  (Tobacco in Australia, 2018)Thus, the Price Elasticity of demand for cigarettes is low (Panel 2 of Figure2). Hence, an increase in the tax would not reduce the demand in the same proportion. (Mankiw, 2008) Tobacco consumption has decreased significantly in Australia and taxation has played a role in this transformation. (Australian Bureau of Statistics, 2013)


Figure 3 The Effect of Taxes on Tobacco Based Products (Example: Cigarettes)

Since, the demand is not expected to reduce to a great extent, if the price changes considerably, the seller can afford to pass it on to the consumer, Thus, the consumer will have to pay a higher price of the cigarette. The implication of this is that the consumer will either be forced to pay more or decrease consumption. The benefit of this is received in the form of greater public health. Additionally, given that the demand for cigarettes is highly inelastic and the demand is not expected to shrink much, there is the possibility of additional revenue to the government. (Mankiw, 2008)



a) Fixed and Variable Costs

  1. Marginal Costs is calculated as the cost of the “last unit produced  i.e Current Total Costs – Previous Total Costs for every level of output.(Chauhan, 2009)
  2. Average Variable Cost, here, is taken as the average of the Marginal Good Produced and the Total Output. (Chauhan, 2009)
  3. Average Total Cost: The Average Total Cost is taken as the Total Cost divided by the output. (Chauhan, 2009)
  4. Variable Costs have been taken as the Marginal Cost divided by the Output.

Table 1 Various Production Costs Associated with cigarettes


Total Costs

Marginal Costs

(Total Costt – Total Costt-1

Average Variable Costs

(Total Costs -50)/ Output

Average Fixed Costs

(50 / Output)

Average Total Costs

(Total Cost/ Output)




































































The price of a product is also, the marginal revenue of the product.

In the short run, the producer will produce up to a point where the Marginal Revenue = Marginal Cost. At production level of 8 units and 2 units, the Marginal Cost is 40 which is slightly higher than the Marginal Revenue. Hence, the production level will be either 3 units or 7 units.


At the production level of 3 units, the Total Revenue of the good will be :

Total revenue = Price X Output

= $(35 X3)

 = $105.

 However, at this level, the total costs are at $170.

Hence, the Profits are

Profits = Total Revenue – Total Costs

= $170- $105

= - $65.

There is a net loss of $ 65 at this level.

At production level  of 7 units, the Total Revenue is

Total revenue = Price X Output

Total revenue = $35 X 7

= $245

At this level , the Profits are

Profits = Total Revenue – Total Costs

= $245- $260

= - $15

Hence, the seller will stop production at 7 units since the seller is trying to minimize losses.

In the long run, the  producer will produce where the average cost (long run average cost) is the lowest. This is at output level 8 and 7. Since, the Marginal costs is lowest at 7, the producer will still produce 7 units.


a)  Differences between Monopolistic and Oligopolistic Market Structures

Monopolistic Competition: a monopolistic competition is an example of an imperfect market structure. It is not a perfect competition because there a few buyers and sellers. However, it is not a perfect monopoly, since there are more than one supplier. (Mankiw, 2008)The industry of web browsers is an example of a monopolistic competition market. Web Browser Google Chrome has a large market share but there are a few other web browsers like Safari, Mozilla Firefox and Opera that also function. (Brown, 2017)

An Oligopolistic market is one wherein there are more than two producers but not many. There a fewer sellers in an oligopoly than in a monopolistic competition. (Samuelson & Nordhaus, 2006)

  • There can be two types of oligopolistic structure. In oligopolistic markets, when firms co-operate to set the output or the price together, it is known as a collusive. Example, oil cartels such a OPEC.
  • In an Oligopolistic structure, when firms compete instead of colluding, it is a normal oligopoly.(Mankiw, 2008)

The characteristics of a Monopolistic Competition and Oligopoly are as follows:

Table 2 Comparisons Between Monopolistic Competition and Oligopoly


Monopolistic competition


Number of sellers

Many  sellers but fewer than that in perfect competition

Few sellers

Type of Product sold

Slightly Differentiated

Differentiated/ standardized

Existence of Entry Barriers to the market

Some barriers but not  blocked completely

Significantly high barriers

Individual Firm’s level of Control over Price

Limited control

In collusive oligopolistic structure, there is joint control which is significantly high; in non-collusive situation little to none.

Non Price competition

In the form of advertising , branding, etc.

Product differentiation through innovation, process differentiation and tactics like loyalty bonuses, discount deals etc.


Large E-commerce platforms like Amazon .com; Web Browsers such as Google Chrome, Mozilla FireFox Etc.

Airline Industry in USa, Australia,

The Computer Operating Systems Market

Resource Allocation

Less than efficient allocation of resources

Less than efficient allocation of resources


Price and Output determination in a Monopolistic Competition

 Short Run Equilibrium

The firm will produce at an output which is the intersection of the  Marginal Revenue and the Marginal Cost below.

  • In Figure A, minimum average cost point is higher than the demand. Hence, the firm will have super normal profits.
  • Figure B, minimum average cost point is lower than the demand. Hence, again super normal profits are realized.

Figure 4 Monopolistic Competition

Source: (McConell, Brue, & Flynn, 2009)


Figure 5 Monopolistic Competition Short Run

Source: (McConell, Brue, & Flynn, 2009)


Figure 6 Short Run Equilibrium in monopolistic Competition

Source: (McConell, Brue, & Flynn, 2009)

Long Run Equilibrium

In the long run, demand for firm’s products will lower as more firms enter the market for profits, which will erode the super normal profits. Thus, in the long run, the firm will only make profits at it’s break even point i.e where average costs equal price. (McConell, Brue, & Flynn, 2009) (Shown in diagram below)

Price and Output Determination in Oligopoly

The  long-run and short run equilibrium of firms in an oligopoly are almost similar. The price and output determination is as follows:

Kinked Demand Curve:  Non Collusive Oligopoly


Figure 7 Kinked Demand Curve

Source(McConell, Brue, & Flynn, 2009)

The “kinked demand curve” is a feature of the non-collusive oligopoly.  There will always be a ruling price. If any of the firms lowers the price than this price, the other firks will follow suit. On the other hand, the other hand, if the firm raises the price to increase it’s Total revenue, then it will be priced out of the market since the competitors will have a lower price. E-commerce firms have price structures that are largely based on such a structure.

An Oligopolists demand curve is shaped by the decisions of his competitors. If the competitors match the demand curve and price which are represented as D2  D2   and MR2 MR2     in the diagram. In all likelihood, the rivals will ignore the price increase if he attempts to raise the price from QP to a higher point but will follow a price cut, if he lowers the price. Thus, the demand curve is kinked i.e  D2 P D1 and the Marginal Revenue is broken at MR2  MR1


Figure 8 Kinked Demand Curve

Source: (McConell, Brue, & Flynn, 2009)

The kinked shape of demand curve DPD and the broken Marginal Revenue Curve MRMR  explain the price inflexibility of an Oligopoly. Any change in Marginal costs between MC1 and MC2 cuts the short dashed vertical segment of the MR curve.

Collusive Oligopoly

In a Collusive Oligopoly, price and output setting process is identical to monopoly output and price determination since all firms are joint together like a single firm.

Figure 9 Collusive Oligopoly

Source: (McConell, Brue, & Flynn, 2009)

Each Oligopolist will charge at QP i.e above the average costs and will produce Output Q . Thus, they will have super normal profits.


Some local authorities in Australia have started merging local councils in order to form a bigger municipal council.  This would imply merging of the operations of two municipal corporations. However, empirical evidence from Australia does not present any evidence to support this theory. (McQuestin, Drew, & Dollery, 2018)

Economic Rationale

This is done so that the local councils can provide shared services and earn shared revenues. It is expected that the economies of scale enjoyed by the merged councils will help improve the services to the citizen and in some cases, may even foster innovation. (Australian Centre of Excellence for Local Government, 2011)

Australia is not a very densely populated country. Hence, the total annual revenues received from a county may not be enough to cover costs. Hence, the merging will bring about economies of scale. (Mankiw, 2008)

The Average Cost Model

The Total Average Costs of running a county will decrease and the services will be share by a greater number of people and the counties will share costs of operation. There will be greater operational efficiency as the Average Factor Costs (payments as rent for land and interest for capital) may decrease. (Chauhan, 2009) Additionally, greater scale will allow counties to purchase materials in bulk. This is illustrated in the diagram below:

Figure 10 Typical Cost Curve

Source: Adapted from (Chauhan, 2009)

A typical cost curve is U shaped. . As the scale of operation increases, the costs of operation of the local government would keep decreasing. However, once there are minimum costs that would be incurred. This is point P. If the scale of operation increases beyond that, then the costs begin to rise. Hence, there might be rationale to merge a few local governments but  these mergers should be limited. Care must be taken to ensure that these mergers do not increase to a scale that the benefits of mergers are lost.


Figure 11 The Average Total Cost Curves Model

A typical U- shaped Marginal cost curve is shown in the picture above. As seen in the diagram above, generally cost curves with greater outputs have lower marginal cost curves i.e they cost of producing the last unit is lower because the total output is larger. (Samuelson & Nordhaus, 2006).



Australian Centre of Excellence for Local Government. (2011). ‘Amalgamations: To Merge or not to Merge?’. Retrieved from Local Government NSW:

Australian Taxation Office. (2018, March 1). Excise rates for tobacco. Retrieved from Australian Government: Australian Taxation Office:

Brown, A. (2017, November 20). Google Chrome Has Some serious NEw Competition, as FireFox launches Quantum Browser. Retrieved from Express:

Chauhan, S. (2009). MICROECONOMICS: Theory and Applications, Part 1. New Delhi: PHI.

Mankiw, G. (2008). Principles of Microeconomics (5th ed.). Mason Ohio: Cengage Learning.

McConell, C. R., Brue, S. L., & Flynn, S. M. (2009). Economics. Irwin: McGraw Hill.

McQuestin, D., Drew, J., & Dollery, B. (2018). Do Municipal Mergers Improve Technical Efficiency? An Empirical Analysis of the 2008 Queensland Municipal Merger Program. Australian Journal of Publi Administration, doi:10.1111/1467-8500.12286 (Online acess only).

Samuelson, P. A., & Nordhaus, W. D. (2006). Economics (18th International Edition). New delhi: Tata McGraw Hill.

Tobacco in Australia. (2018). Price elasticity of demand for tobacco products. Retrieved from

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