Economics Answer Note #3

Question 1 What is the difference between the term Monopoly and Monopsony? Describe how a monopolistic market would be inefficient. Answer Monopoly and monopsony are both terms used in economics to describe the market structure of a particular industry. A monopoly refers to a market in which there is only one seller of a particular good or service, while a monopsony refers to a market in which there is only one buyer for a certain good or service. In a monopolistic market, the inefficient outcome arises due to the lack of competition. This results in the firm having significant pricing power and the ability to charge higher prices without fear of losing customers to other competitors. The lack of competition also leads to a lack of incentive for the firm to innovate or improve their products and services, resulting in a stagnant market. Additionally, in a monopolistic market, the firm may engage in predatory pricing to drive out potential competitors, leading to higher prices for consumers in the long run. Question 2 Explain the term GDP. What are the limitations of GDP as an indicator of progress? Answer GDP, or Gross Domestic Product, is the total monetary value of all final goods and services produced within a country's borders in a specific time period. It is used as a measure of a country's economic output and growth. However, GDP has its limitations as an indicator of progress. Firstly, it does not take into account non-monetary factors such as environmental impact, quality of life, and income inequality. Additionally, GDP does not account for underground economic activities and the distribution of wealth. It also fails to consider the value of unpaid work and ignores the negative effects of economic growth on well-being. (100 words) Question 3 Elaborate the concept of Demand and Supply in a market and with the help of a diagram explain the 'equilibrium'. Answer Demand and supply are the two pillars of any market economy. Demand refers to the quantity of a product or service that consumers are willing and able to purchase at a given price, while supply is the quantity of a product or service that producers are willing and able to offer at a given price. The intersection of the demand and supply curves on a graph indicates the equilibrium point, where the market clears and the quantity demanded equals the quantity supplied. It is the point where both buyers and sellers are satisfied, as there is neither a surplus nor a shortage of the product. This concept is crucial in understanding and predicting the behavior of markets. To better understand this concept, let's take the example of a simple market of apples. The demand for apples is influenced by several factors, including the price of apples, consumer preferences, and income. If the price of apples is high, the quantity demanded will decrease, as consumers will switch to a substitute or reduce their apple consumption. On the other hand, if the price of apples decreases, the quantity demanded will increase. Similarly, the supply of apples is influenced by the price of apples, production costs, and government regulations. If the price of apples is high, producers will be encouraged to produce more apples as it will generate higher profits. On the other hand, if the price of apples is low, producers might limit their production due to lower profitability. As shown in the diagram, the demand curve slopes downward, while the supply curve slopes upward. The equilibrium point is where the two curves intersect, as it is the point where the quantity demanded equals the quantity supplied. At this point, buyers and sellers are satisfied, as the quantity demanded and supplied are equal. There are various factors that can cause a shift in the demand or supply curve, and consequently, the equilibrium point. This shift can be positive (increase in demand/supply) or negative (decrease in demand/supply), and it can cause the new equilibrium point to be at a higher or lower price and quantity. For example, an increase in the population in an area might result in an increase in the demand for apples, thus shifting the demand curve to the right and increasing the price and quantity of apples in the market. To sum up, the concept of demand and supply is vital in understanding how markets function. The equilibrium point is the point where buyers and sellers are satisfied, and there is no surplus or shortage of the product. Any shift in the demand or supply curve can result in a new equilibrium point, which can have implications for the price and quantity of the product. It is essential to continually monitor and analyze the factors that affect demand and supply to make informed decisions and anticipate market changes. Question 4 What are the factors which determine the growth of a country? Describe the solow model in brief? Answer The growth of a country is determined by various factors, including physical capital, human capital, natural resources, and technology. The Solow model, created by Robert Solow, is an economic growth model that explains the relationship between these factors and the growth of a country. In the Solow model, the level of output (GDP) per worker depends on the amount of physical capital (machines, equipment, etc.) per worker, the level of human capital (education, skills, etc.) per worker, and the level of technology. The model assumes that new technology drives economic growth by increasing productivity. The equation for the Solow model can be written as Y/L = f(K/L, H/L, A), where Y is output, L is labor, K is physical capital, H is human capital, A is technology, and f is a function that shows the relationship between these variables. This equation shows that a country can increase its output per worker by increasing its physical and human capital, and by investing in technological advancements. Question 5 Draw a suitable diagram to explain how a perfectly competitive market makes its supply decision using marginal analysis. Answer In a perfectly competitive market, firms operate under the assumptions of homogenous products, perfect information, and unrestricted entry and exit. As such, firms in this type of market are price takers, meaning they have no control over the price and simply level with the market price. In order to make their supply decision, firms use marginal analysis to determine the optimal quantity to produce. Marginal analysis involves comparing the additional cost and additional revenue of producing one extra unit. To understand how this is applied in a perfectly competitive market, we can look at the marginal revenue (MR) and marginal cost (MC) curves. The MR curve in a perfectly competitive market is horizontal and equal to the market price, while the MC curve is upward sloping to represent the increasing cost of producing additional units. According to the profit maximization rule, a perfectly competitive firm will produce at the quantity where MR equals MC. This is because producing more than this quantity would result in a lower profit, and producing less would also lead to a lower profit. This quantity is represented by the point of intersection between the MR and MC curves. To illustrate this concept, we can use a diagram showing the market demand (D) and supply (S) curves intersecting at the equilibrium price (P*) and quantity (Q*) in a perfectly competitive market. The supply curve, which represents the production decisions of individual firms, will start at the point where the firm's MC curve intersects with the market price (MC = P*). As the market price increases, the MC curve will also shift upwards, indicating that producing more units will result in higher costs for the firm. However, it is important to note that firms in a perfectly competitive market do not consider their fixed costs when making production decisions. This is because fixed costs do not change with the level of output and are therefore irrelevant in marginal analysis.