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ECON11026 Principles Of Economics1

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  • Course Code: ECON11026
  • University: Central Queensland University
  • Country: Australia

Question:

(i) How much will the firm produce if it seeks to maximise profits?
 
(ii) What is the socially efficient level of output?

(iii) How much is the marginal external cost at this level of output?

(iv) What size of tax would be necessary for the firm to reduce its output to the socially efficient level?

(v) Why is tax less than the marginal externality? Explain.
 

Answer:

Some real life examples of monopolistic competitive market are restaurants, hairdressers, designing clothes, different petrol stations and different television programmes. They operate under this market structure because there are large numbers of similar organisations and every one operates independently (Parenti, Ushchev & Thisse, 2017). Though they are selling same types of products, all products are not exactly same. They are closely substituted with each other. Hence, product differentiation can be seen here. Moreover, each firm can easily enter or exit from this market.  

Under monopolistic competitive market, profit maximising condition of each firm under short-run can be described. Firstly, marginal cost (MC) and marginal revenue (MR) a firm will be equal to each other, that is, MR=MC. Secondly, product differentiation will help each organiser to increase their profit level in the short-run (Nikaido, 2015). Moreover, the demand curve or average revenue (AR) curve and marginal revenue (MR) curve will be elastic.

Fig 1: Short-run profit maximising condition: Monopolistic Competitive Market

Source: (created by author)

In the above figure, average revenue curve or demand curve and marginal revenue curve are drawn by a negatively sloped line. In the vertical axis, marginal cost (MC), average total cost (ATC) and average variable cost (AVC) of short-run monopolistic competitive market are drawn. Moreover, average revenue (AR), marginal revenue (MR) and price are also measured in this axis (Nikaido, 2015). In the horizontal axis, total output is measured. ABCD area indicates short-run profit of a monopolistic competitive firm.

 


Some examples oligopoly market in Australia is motor vehicle industry (Holden and Ford), supermarket industry (Woolworths and Coles) and banking industry (National Australian Bank, Commonwealth Bank, Australia and New Zealand Banking Group) and so on.

Under dominant firm price leadership concept, a dominant firm set prices for its products. Other follower firms only follow this same price level (Ibrahim, Saaban & Zaibidi, 2017). Dominant firm enjoys maximum shares of the market. Leader firms set its price when marginal costs and marginal revenues equate with each other, that is, MC=MR.  Here, the demand curve of both leader and follower firms are negatively sloped.

Fig2: Dominant firm price-leadership model

Source: (created by author)

In this above figure, average revenue, marginal revenue and marginal cost curve of a leader firm is drawn (Cabral, 2017). The leader firm set its equilibrium price at Po. Hence, this price is the equilibrium price level, which other follower firms will follow.

Under monopolistic market, a pricing strategy can be applied by each producer. This pricing strategy is known as price discrimination (Gavious & Segev, 2017). By applying this process, a producer or organiser can charge different prices for a same product under different market situation.

i) Under an airlines industry, a company can charge different prices from different customers for the same airline. When a passenger will buy a ticket long time ago before the scheduled date, then he or she will pay fewer prices for this ticket. However, if the passenger will buy a ticket two or three days before the scheduled flight, then he or she will pay higher price for the same ticket (Borenstein & Rose,2014). Hence, the chief factor of price discrimination is time. Moreover, age is also an important factor to discriminate price. For senior citizens, airlines can offer lower prices. On the other hand, an airline company can offer some discounts on ticket prices to its customers. This discount will be charged for those customers, who frequently buy tickets from this airline (Escobari & Jindapon, 2014). For choosing preferable seats, an airline company can charge higher prices. Sometimes, airlines industry offer coupons to its selected customers.

ii) In a cinema industry, two types of price discrimination strategy can be seen. These are the puzzle related to movie and the puzzle related to show-time. Under this industry, different cinema halls of Australia charge different ticket prices for a particular cinema (Foutz, 2017). This ticket prices may vary from age to age. For adult citizens, cinema halls reduce ticket prices by 40 %, for students 25% and for children 20%. Moreover, almost every cinema halls offer tickets with discount prices for every Tuesday. On the other hand, ticket prices may vary with show times. For a particular cinema, a cinema hall company can charge different prices for different show-time (Beirne, 2015). During peak time, halls charge higher prices for a particular movie. In this context, salary of a film actor can also be discussed. For different movies, actors can charge different salaries.

 

i) The firm will maximise its profit when its marginal cost (MC) equals with its marginal revenue (MR). From table 1, it can be seen that the firm will produce 5 units of output to maximise its profit level. In this output level, MC of this firm is 27 and MR is also 27.
 
ii) Social efficient level of an output occurs when marginal social benefit (MSB) and marginal social cost (MSC) equates with each other. Here, marginal social benefit equates with marginal benefits (Keohane & Olmstead,2016). Moreover, marginal benefits equates with average revenue. That implies MSB= MB = AR.  From table 1 it can be seen that a firm will produce 4 unit of output to achieve socially efficient level of output.

iii) Marginal external cost is the difference between marginal social costs (MSC) and marginal private costs (MPC). Here MSC at output level 4 is 42. Moreover, the marginal private cost or MC is 25. Hence, MEC= (42-25) = 17.

iv) To reduce the output level at a socially efficient level, the firm will charge less tax. Here, the firm’s socially efficient level of output is 4. However, this firm obtains its profit maximising level of output at 5. However, marginal cost and marginal social cost are lower at output level 4 compare to output level 5.

v) Tax will be less than marginal externality. This is because higher level of tax will increase the marginal social cost of a firm. As a result, the firm will produce lower level of output than before. 

b) The reason behind less tax compare to marginal externality is explained. If tax becomes higher than marginal externality, then marginal social cost will be increased.

i) Public Good: Public goods are generally offered by the government of any country. Three chief points of any public goods are non-excludability, non-rivalry and free-rider problem. Non-excludability means the government cannot exclude anyone from consuming any products. Each person will equally consume this product without owning it (Schelling & Monroe, 2015). Non-rivalry means a person cannot prevent other person from consuming a particular product. Free-rider problem indicates that there is no possibility to exclude someone from enjoying any particular goods when other person is consuming this. Some examples of public goods are government hospital, roads and light houses.

ii) Private Goods: Private goods, on the other hand, follow opposite characteristics of public good. Hence, any private good follows rivalry and excludability. When a person owns a private good, other person cannot enjoy this good (Etzioni, 2014). Moreover, they become excluded from consuming this good. Only one person or a group of person can enjoy a private good at a time.

i) Net injection implies differences between overall injections and overall withdrawals of a country. When Australian investors earn higher dividends, it increases the gross domestic income of this country. Hence, it will be the net injection for this country.
 
ii) Net savings decrease the circular flow of income of a country. When Australian people are saving money for holiday, they are acutely withdrawn their money from the economy. Hence, net withdrawal will be increased here.

Nominal GDP for the year 2015 indicates total price of all products that are produced in this year (Barnett, Chauvet & Leiva-Leon, 2016). In 2015, price of 40 units of computers were $800. For 80 cans coke, price was $2.

  1. i) Hence, Nominal GDP2015= $ (40*800+80*2)
  • Nominal GDP2015 = $ (32000+160)
  • Nominal GDP2015 = $ 32,160
  1. ii) Nominal GDP2016= $ (50*1000+240*3)
  • Nominal GDP2016 = $ (50,000+720)
  • Nominal GDP2016 = $ 50,720

iii) Here real GDP in 2016 is measured by the 2015 price level(Laubach & Williams, 2016).

        Real GDP2016 = $ (50*800+240*2)

  • Real GDP2016 = $ (40,000+480)
  • Real GDP2016 = $ 40,480
  1. i)       Gross domestic product (GDP) is calculated below (Laubach & Williams, 2016).

          GDP = C+I+G+NX

  • GDP = $( 4204+ 900+ 270+ 735+ 780- 675)
  • GDP = $ 6,214
  1. ii) Gross National Expenditure (GNE) is calculated below (Kim, Jung, Norrving, Ovbiagele & Saposnik, 2017).

           GNE = C+I+G

  • GNE = $ (4204+735+900+270)
  • GNE= $ 6109

Answer 4:

  1. i) The level of injection (J) and Withdrawal (W) for Dream-Zealand is calculated below (McClure & Thomas, 2017).

Injections (J) = investment (I) + government expenditure (G) + export expenditure (X)

  • J= $ ( 900+ 735+  270+ 780)
  • J= $ 2,685

Withdrawals (W) = net saving (S) + net taxes (T) + import expenditure (M)

  • W = $ (350+600+675)
  • W = $ 1,625
  1. ii) The GDP level of Dream-Zealand will be increased as the level of injection is greater than level of withdrawal (Bocken, de Pauw, Bakker & van der Grinten, 2016). More money will be included in the circular flow of income. Hence, the country will produce more and as a result, GDP will be increased further. It will be good for this country’s economy.
  2. b) Deflationary-gap= Deflationary gap occur when an economy reaches to its equilibrium level before attaining full employment (Kinoshita, 2016). Here, aggregate demand can be increased further to attain full employment level.

Fig3: Deflationary gap

Source: (created by author)

In the above figure, equilibrium level of output occurs at point NE. However, full level of employment can be reached at point Nf (Burdekin & Hu, 2017). Hence, the gap between aggregate expenditure and aggregate demand is called deflationary gap.

 


Inflationary-gap= the concept of inflationary gap is given by Keynes. At full employment level, aggregate demand of a country may exceed the aggregate level of output. This situation is called inflationary gap. In this situation, the country cannot produce more output as full employment level is reached (Levrero, 2015). On the other hand, people demand more output. Hence, excess demand will be occur in the economy. As a result, product prices will be increased. This will further create inflation.

Fig 4: Inflationary Gap

Source: (created by author)

In the above figure, an aggregate demand curve and increased aggregate demand curve are drawn. Moreover, a 45 degree line is also drawn from the origin. This line represents the total expenditure of this country (Goga, Papadimitriou, Matthaiou & Chrysanthidou, 2015).  The country will reach to its equilibrium level of output when total expenditure and total output equate with each other. However, before reaching that point, full employment occur. Hence a gap between total demand and total expenditure is created. This gap is indicated as inflationary gap.

 


In an economy, full employment occurs when all available workers are fully employed. Every skilled and unskilled worker, who is willing to work, can get job. In other words, no involuntary unemployment can be seen in this situation. Those workers can work with the existing wage level (Beveridge, 2014). The economy can fully and efficiently utilise its entire labour force. Every economy tries to achieve this full employment level. However, full employment cannot be seen in real world. It is only a theoretical concept.

Each worker wants to do a job for a minimum wage level. By this minimum wage level, the worker can spend his or her life normally (Meer & West, 2015). On the other hand, if the worker is offered some amount of wage, which is below this minimum level, then he or she will not work. Hence, by offering this minimum wage level, a firm can hire maximum amount of workers. Under full employment situation, each worker is getting this minimum wage level.

 

References:

Barnett, W. A., Chauvet, M., & Leiva-Leon, D. (2016). Real-time nowcasting of nominal GDP with structural breaks. Journal of Econometrics, 191(2), 312-324.

Beirne, R. (2015). Piracy, geoblocking, and Australian access to niche independent cinema. Popular Communication, 13(1), 18-31.

Beveridge, W. H. (2014). Full Employment in a Free Society (Works of William H. Beveridge): A Report (Vol. 6). Routledge.

Bocken, N. M., de Pauw, I., Bakker, C., & van der Grinten, B. (2016). Product design and business model strategies for a circular economy. Journal of Industrial and Production Engineering, 33(5), 308-320.

Borenstein, S., & Rose, N. L. (2014). How airline markets work… or do they? Regulatory reform in the airline industry. In Economic Regulation and Its Reform: What Have We Learned? (pp. 63-135). University of Chicago Press.

Burdekin, R., & Hu, X. (2017). Deflationary Pressures Today: The Chinese, Japanese and Spanish Cases Compared. Robert Day School of Economics and Finance, Students.

Cabral, L. (2017). We’re Number 1: Price Wars for Market Share Leadership. Management Science.

Escobari, D., & Jindapon, P. (2014). Price discrimination through refund contracts in airlines. International Journal of Industrial Organization, 34, 1-8.

Etzioni, A. (2014). Common Good. John Wiley & Sons, Ltd.

Foutz, N. Z. (2017). Entertainment Marketing. Foundations and Trends® in Marketing, 10(4), 215-333.

Gavious, A., & Segev, E. (2017). Price Discrimination Based on Buyers’ Purchase History. Dynamic Games and Applications, 7(2), 229-265.

Gogas, P., Papadimitriou, T., Matthaiou, M., & Chrysanthidou, E. (2015). Yield curve and recession forecasting in a machine learning framework. Computational Economics, 45(4), 635-645.

Ibrahim, A., Saaban, A., & Zaibidi, N. Z. (2017, November). Local stability condition of the equilibrium of an oligopoly market with bounded rationality adjustment. In AIP Conference Proceedings (Vol. 1905, No. 1, p. 030015). AIP Publishing.

Keohane, N. O., & Olmstead, S. M. (2016). Introduction. In Markets and the Environment (pp. 1-10). Island Press, Washington, DC.

Kim, Y. D., Jung, Y. H., Norrving, B., Ovbiagele, B., & Saposnik, G. (2017). Does national expenditure on research and development influence stroke outcomes?. International Journal of Stroke, 1747493017702667.

Kinoshita, E. (2016). Proposition of Thetical and Antithetical Economic Line. European Scientific Journal, ESJ, 12(31).

Laubach, T., & Williams, J. C. (2016). Measuring the natural rate of interest redux. Business Economics, 51(2), 57-67.

Levrero, E. S. (2015). An initial'Keynesian illness'? Friedman on taxation and the inflationary gap.

McClure, J., & Thomas, D. C. (2017). Schumpeterian Leakages and Injections: The Impact of New Product R&D on the Circular Flow.

Meer, J., & West, J. (2015). Effects of the minimum wage on employment dynamics. Journal of Human Resources.

Nikaido, H. (2015). Monopolistic Competition and Effective Demand.(PSME-6). Princeton University Press.

Parenti, M., Ushchev, P., & Thisse, J. F. (2017). Toward a theory of monopolistic competition. Journal of Economic Theory, 167, 86-115.

Schelling, T., & Monroe, K. R. (2015). Economics, Policy, and the Public Good. Science, Ethics, and Politics: Conversations and Investigations, 135.

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