Economics Answer Note #69

Question 1 Look at the demand curve in Figure 4.5.1. What is the maximum someone is willing to pay for the first unit of the product? Question 4Answer a. $9 b. $8 c. $4 d. $10 e. $5 Answer Based on the demand curve in Figure 4.5.1, the maximum price that someone is willing to pay for the first unit of the product would be $10. This can be determined by looking at the point on the curve where the quantity demanded is at its highest, which is at the point where the price is $10. At this price, consumers are willing to buy the first unit of the product, and any increase in price would result in a decrease in demand. The demand curve in economics represents the relationship between the price of a product and the quantity that consumers are willing and able to buy at that price. As shown in the demand curve, as the price of a product decreases, the quantity demanded increases and vice versa. This is known as the law of demand, which states that there is an inverse relationship between price and quantity demanded. The concept of consumer surplus also plays a role in determining the maximum price someone is willing to pay for the first unit of a product. Consumer surplus is the difference between the maximum price that a consumer is willing to pay for a product and the actual price they pay. In this case, the maximum price a consumer is willing to pay for the first unit is $10, but if the product is priced at $9, the consumer will experience a surplus of $1. This indicates that the consumer values the first unit of the product at a higher price than what they actually pay for it. Question 2 If all variables remain unchanged except the price of screen size and quality (Psc), which decreases by $20, then the demand for Grapple tablets will: The multivariate demand function below will be needed for questions 12-18. Setting: Grapple, Inc. is a leading seller of laptop personal computers. However, they want to become a leading tablet seller, too. Your marketing department, aided by your economics staff, has estimated a function to help you in the quest for market leader in tablets. The variables are defined after the function. Qg=10000-25Pg+20Ph+30Pr-15Pdv-35Psc-10Pmm+0.05Ag+0.03A25C+0.1Y Qg = the number of Grapple tablet computers demanded per week. Pg = the price of each new Grapple tablet (in $). Ph = the price of each Hewpaq tablet (in $). Pr = the price of each Ronova tablet. Pdv = the price to equip a tablet with Holographic digital video (in $, this is an upgrade option that enables three dimensional graphics on a tablet. Two dimensional graphics is standard equipment). Psc = the price of various screen sizes (in $, a 8 inch is standard, but upgrade options are 10 inch extra sharp, 12 inch, 12 inch extra sharp, Each also has a touch-screen option. The upgrades get progressively more expensive as the size and capability increases). Pmm = the price of memory chip upgrades (in $). More 2 Gigabyte (Gb) chips can be added. Of course each added 2 Gb chip costs more. One 2 Gb chip is standard. Y = average annual disposable income of a typical tablet purchaser (in $). Ag = average age of a tablet purchaser (in years). A = average annual Grapple advertising expenditure (in $). C = number of computer systems the average tablet purchaser already owns. possible answers a. increases by 200 b. decreases by 200 c. increases by 450 d. decreases by 450 e. increases by 700 f. decreases by 700 Answer Based on the given demand function, a decrease in Psc would result in a decrease in the demand for Grapple tablets, which is option d: decreases by 450. Explanation: According to the law of demand, there is an inverse relationship between price and quantity demanded. This means that as the price increases, the demand decreases, and vice versa. In this case, the variable Psc represents the price of screen size and quality, which is a crucial factor for buyers when purchasing a tablet. As Psc decreases by $20, the overall price of Grapple tablets would decrease for different screen size and quality upgrades. This would make the tablets more affordable for potential buyers, potentially attracting more demand. However, this decrease in price may not be substantial enough to significantly increase the demand. Furthermore, the other factors in the demand function, such as price of other tablets, price for equipping Grapple tablets with holographic digital video, and the price for memory chip upgrades, are either constant or decreasing. This would further contribute to a decrease in demand for Grapple tablets. Question 3 As shown in Exhibit 17-2, if people behave according to adaptive expectations theory, an increase in the aggregate demand curve from AD1 to AD2 will cause the price level to move: a. directly from 100 to 110 and then remain at 110. b. from 100 to 105 initially and then eventually move to 110. c. from 100 to 105 initially and then eventually move back to 100. d. directly from 100 to 105 and then remain at 105. Answer In order to answer this question, we must first understand the basic concept of adaptive expectations theory. According to this theory, individuals base their expectations of future outcomes on their past experiences. Therefore, if an individual expects prices to rise in the future, they will adjust their behavior to match this expectation. Now, let's refer to Exhibit 17-2 which shows the effects of an increase in aggregate demand on the price level. As the aggregate demand curve shifts from AD1 to AD2, it signifies an increase in the overall demand for goods and services in the economy. This can be due to factors such as government policies, changes in consumer behavior, or an increase in exports. Based on adaptive expectations theory, individuals will adjust their expectations of prices to match this increase in demand. Therefore, we can eliminate options c and d as they suggest a decrease in the price level, which goes against the theory. Moving on to options a and b, both suggest an initial increase in the price level from 100 to either 110 or 105. However, according to adaptive expectations theory, individuals will only adjust their expectations gradually rather than all at once. This means that option b, where the price level moves to 105 initially and then eventually to 110, is the more accurate answer. To provide a more comprehensive answer, it is important to also consider the concept of rational expectations. This theory states that individuals will base their expectations not just on past experiences, but also on all available information and data. Therefore, if individuals have access to information that suggests the increase in aggregate demand is temporary, they may not adjust their expectations as much, leading to a smaller increase in the price level. In conclusion, based on adaptive expectations theory and considering the concept of rational expectations, an increase in the aggregate demand curve from AD1 to AD2 will cause the price level to initially move from 100 to 105 and then eventually move to 110. However, the extent of this increase may vary depending on individual expectations and available information. Question 4 “Oligopoly occurs when just a few firms share a large proportion of the industry.” In terms of the above statement provide an evaluation of firms that operate as an oligopoly industry. Answer According to the statement, an oligopoly occurs when just a few firms dominate a large portion of a particular industry. This type of market structure can have both positive and negative implications for the firms involved and for the overall economy. One potential benefit of an oligopoly is that it can lead to higher levels of efficiency and innovation. This is because in an oligopoly, firms are often competing against a small number of rivals for market share. This competition can incentivize firms to constantly improve and differentiate their products in order to gain an advantage and attract customers. As a result, consumers can have access to a wider range of high-quality products at competitive prices. On the other hand, the concentration of power in a few firms can also result in higher prices and reduced consumer choice. In an oligopoly, firms have the ability to control supply and manipulate prices, leading to potential harm for consumers. Additionally, the dominance of a few firms can also limit market entry for new competitors, creating barriers for smaller firms to compete in the industry. Moreover, the behavior of firms operating in an oligopoly is often interdependent. This means that the actions of one firm can have a significant impact on the others in the market. As a result, there is a high likelihood of collusion and anti-competitive practices among oligopolistic firms in order to maintain their market dominance. In terms of sources, economist Paul Samuelson argues that an oligopoly can be considered as a "market structure of intermediate grade between perfect competition and monopoly" (Samuelson & Nordhaus, 2004). This concept is elaborated further by economist Joan Robinson who suggests that a key characteristic of oligopoly is the existence of a few dominant firms with significant market power (Robinson, 1951). In conclusion, while an oligopoly can lead to efficiency and innovation, it can also result in negative consequences for consumers. Firms operating in an oligopoly have significant market power and their behavior is often interdependent, which can lead to collusive and anti-competitive practices. As such, governments and regulators must carefully monitor and intervene in these markets to ensure fair competition and protect consumer welfare. Question 5 “In the long-term time frames, companies have more flexibility to change their operations.” In terms of the above statement, fully discuss, with the aid of a diagram, the ONE most relevant cost curve that is applicable to a firm. Answer The statement above suggests that companies have more flexibility to change their operations in the long-term. This raises the question of how firms make decisions about their operations, specifically in terms of costs. In order to fully discuss this, we will look at the Long-Run Average Cost (LRAC) curve, which is the most relevant cost curve applicable to a firm. Firstly, it is important to define the LRAC curve. The LRAC curve shows the relationship between the average cost of production (AC) and the level of output (Q) in the long-run. It is derived from a number of short-run average cost curves (SRAC) where each SRAC curve represents a specific level of fixed costs. Typically, the LRAC curve is U-shaped, because of the concept of economies and diseconomies of scale. In the long-run, firms have more flexibility to make changes to their operations, such as increasing or decreasing their production capacity, as there are no fixed factors of production. This allows them to adjust their costs to achieve the most efficient level of production. In the short-run, firms have to make decisions based on their initial level of fixed costs, which may result in suboptimal efficiency levels. It is important to note that the LRAC curve has three distinct sections. The first section represents economies of scale, where a firm experiences decreasing average costs as its output increases. This is due to spreading fixed costs over a larger output, as well as other efficiencies of scale. The flat section represents constant economies of scale, where the firm is operating at its most efficient level of production. The third and final section represents diseconomies of scale, where a firm experiences increasing average costs as its output increases, due to issues such as coordination problems and managerial inefficiencies. A diagram of the LRAC curve can be seen below: [Insert Diagram] In terms of the statement, the LRAC curve demonstrates the flexibility that companies have in the long-term. As firms have the ability to change their operations, they can move along the LRAC curve to find their most efficient level of production. This may involve expanding or shrinking their production capacity to take advantage of economies of scale or avoid diseconomies of scale. However, it is important to note that the LRAC curve is not a fixed curve. As the market conditions change, firms may experience shifts in their LRAC curve, resulting in changes to their optimal level of production. For example, if there is an increase in the price of a key input, this may result in a rightward shift of the LRAC curve, making it more expensive for firms to operate at their previous level of output. Furthermore, companies must consider their long-term costs in order to make informed decisions about their operations. This includes considering not only the direct cost of production, but also any associated opportunity costs. For example, if a firm chooses to expand its production capacity, it may involve additional costs such as hiring and training, as well as potential lost opportunities in other areas of the business. In conclusion, the Long-Run Average Cost (LRAC) curve is the most relevant cost curve applicable to firms in terms of their flexibility to change their operations in the long-term. The LRAC curve allows companies to determine their most efficient level of production by taking into account economies of scale and diseconomies of scale. However, firms must also consider their long-term costs and the potential shifts in their LRAC curve in order to make informed decisions about their operations.