Vijay Shakya 2 Semester

Exam 2012 Fall

Microeconomics

NEPAL COLLEGE OF INFORMATION TECHNOLOGY

ASSIGNMENT (MICRO ECONOMICS)

SUBMITTED BY:

SUBMITTED TO:

VIJAY SHAKYA

TAK BADHADUR THAPA

DAYANIDHI TIMILSINA SURAJ DEO

LECTURER, ECONOMICS NCIT COLLEGE

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Exam 2012 Fall

Microeconomics

Assignment On

OLD IS GOLD EXAM 2012 FALL QUESTIONS

Submitted as per requirement of college assignment for BBA 2nd semester

Submitted By: VIJAY SHAKYA DAYANIDHI TIMILSINA SURAJ DEO

Under Supervision Of TAK BADHADUR THAPA

Date: 27 DEC 2015

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Exam 2012 Fall

Microeconomics

TABLE OF CONTENTS

 SCARCITY “BEGINNING OF ECONOMIC ACTIVITIES”………....

4

 SOLVED EQUATION FOR ELASTICITY OF DEMAND…………....

4

 SOLVED EQUATION FOR EQUILIBRIUM PRICE AND OUPUT...

6

 DIFFERENCE BETWEEN TOTAL AND MARGINAL UTILITY….

7

 RELATIONSHIP OF TU AND MU WITH DIAGRAM……………....

8

 INCOME AND SUBSITUITION EFFECTS FOR A NORMAL GOODS WHEN PRICE FALLS ………………………………………..

9

 SHORT RUN PRODUCTION FUNCTION WITH DIAGRAM OF TP, AP AND MP……………………………………………………..

10

 PRODUCTION MAXIMIZATION…………………………………….

11

 SOLVED EQUATION OF TOTAL COST FUNCTION……………..

12

 RELATIONSHIP OF AR AND MR IN PERFECTLY COMPETITIVE AND MONOPOLY MARKET…………………………………………

14

 PRICE AND OUTPUT DETERMINATION UNDER MONOPOLY..

16

 SHORT NOTES ON IC AND CROSS ELASTICITY OF DEMAND..

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 REFERENCE………………………………………………………...

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1. a. Scarcity is not only problem but also the beginning of economic activities. Explain ďƒ˜ The starting point of economic analysis is the existence of human wants. Human beings have unlimited wants. That is to say that there is never such a time that a human being is satisfied and not in need of anything. On the other hand, resources available in nature, which should be used to meet those human wants, are limited. The available resources can never be enough to satisfy all human needs. This phenomenon, where there are unlimited human wants which are to be met by very limited resources, is essentially what economists call scarcity. Scarcity is referred to as the fundamental economic problem, and all economic activities revolve around trying to solve this problem.

Economics is basically born with scarcity of resources which leads to development of other economic concepts, principles, theory and practice, since the scarcity makes the people to act with rationality, scarcity (of resources) is a natural state that leads to explore alternative.

Without Scarcity, the science of economic would not exit, economics is the study of production, distribution and consumption of goods and services. If society did not have to make choices about what to produce, distribute and consume, the study of those actions would be relatively baring. Society would produced distribute and consume an infinite amount of everything to satisfy the unlimited wants and needs of humans. Everyone would get everything they wanted and it would all be free. But we all know that is not the case. The decision and trade off society makes due to scarcity is what economics study.

b. Define the price elasticity of demand and measure it by are method when price changes from Rs 20 to Rs 10 in the given example.

Price (Rs.)

20

10

Demand (units)

40

80

ďƒ˜ Other things being equal, price elasticity is the ratio of the percentage in the quantity demanded with the percentage change in price. In other words, it is a measure of relative change in the quantity demanded of goods in response to a relative change in the price.

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According to Ferguson, “price elasticity is the proportionate change in quantity demanded divided by the proportionate change in price.”

Thus, % change in quantity demanded ep = % change in price

In symbolic term, Q ep =

-

p1 *

p

q1 Q= Q2– Q1, Q1= initial quantity demanded, Q2= new quantity demanded

where

P= P2 – P1, P1= initial price, P2= new price.

Here, P1= 20, P2 = 10, Q1= 40, Q2=8 Q= Q2– Q1= 80- 40 = 40 P= P2– P1 = 10 – 20 = -10

We know that,

q ep =

-

p1 *

p

q1

40 ep =

-

20 *

-10

40

=2>1

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Exam 2012 Fall

Microeconomics

2. A market consists of three consumers, A, B, and C, whose individual demand equations are as follows: QdA = 30 – 1.00P, QdB = 22.5 – 0.75P, QdC= 37.5 – 1.25P, and the industry supply equation is given by Qs = 40 + 3.5P a. Find out the market demand function and derive the market demand curve. b. Determine the equilibrium price and quality mathematically. c. Determine the amount that will be purchased by each individual.

Market demand function = QdA +QdB+ QdC = 30 – 1.00P + 22.5 – 0.75P + 37.5 – 1.25P = 90 – 3P Market demand schedule Market demand( 90 – 3P)

Price ( rs) 5

75

10

60

15

45

20

30

25

15

Market demand curve y 25 20 15

Price

10 5

O

D

15

30

45

60

75

x

Quantity demanded 6

Exam 2012 Fall

Microeconomics

 b.

For market equilibrium price, Qd = Qs Or, 90 – 3P = 40 + 3.5P Or, 50 = 6.5P Or, P= 7.7 When p= 7.7 Qs = 40 + 3.5*7.7= 66.95 and Qd= 90 – 3*7.7 = 66.95 So, equilibrium price = Rs 7.7 and equilibrium quantity = 7.7  c. when p = 7.7 QdA = 30 – 1.00* 7.7 = 22.3 QdB = 22.5 – 0.75*7.7= 16.725 QdC= 37.5 – 1.25* 7.7= 27.875

3. a. Distinguish between total utility and marginal utility. Show the relationship between total utility and marginal utility.  Difference between total utility and marginal utility TOTAL UTILITY

MARGINAL UTILITY

1. It refers to the total satisfaction derived by the

1. It is defined as the addition made to the total

consumer from the consumption of a given

utility by consuming one more unit of a

quantity of goods.

commodity.

2. It is the aggregate of marginal utilities

2. It is the ratio of change in the total utility with the change in the total consummation of units of a commodity

3. Mathematically, TU = MU1 + MU2 + …………. + MUN

3. Mathematically TU MU= Q

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Exam 2012 Fall

4. It has no types.

Microeconomics

4. It has got 3 types. i). Positive Utility ii). Zero Utility iii). Negative Utility

5.For example, a person consumes eggs and

5, For example, when a person increases the

gains 50 utils of total utility. This total utility is

consumption of eggs from one egg to two eggs,

the sum of utilities from the successive units (30

the total utility increases from 30 utils to 45 utils.

utils from the first egg, 15 utils from the second

The marginal utility here would be the15 utils of

and 5 utils from the third egg)

the 2nd egg consumed.

Relationship between total utility and marginal utility in diagram

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1. In figure (2), MU curve moves downward having negative slope while in figure (1) TC curve, having negative positive slope moves upward but tendency to move is towards xaxis, which shows decreasing rate.

2. A point F´ in figure (2) MU curve cuts the s-axis at the 6th unit and TU curve has its maximum point F which is saturation point.

3.

At 7th unit MU curve is below x-axis as in figure (2) and TU curve declines from point 'F' to 'G' as in figure (1).

b. Measure diagrammatically, Income and Substitution effects for a normal good when its price falls. ďƒ˜

If X is an normal good, the income effect of a fall in the price of X will be positive because as the real income of the consumer increases, less quantity of X will be demanded. This is so because price and quantity demanded move in the same direction On the other hand, the negative substitution effect will increase the quantity demanded of X. The negative substitution effect is stronger than the positive income effect in the case of normal goods so that the total price effect is negative. It means that when the price of the normal good falls, the consumer purchases more of it due to compensating variation in income. Initially, the consumer is in equilibrium at point R where the budget line PQ is tangent to the curve I1. With the fall in the price of X, he moves to point T on the budget line PQ1, at the higher indifference curve His movement from R to Tor from Đ’ to E on the horizontal axis is the price effect. By compensating variation in income, he is in equilibrium at point H on the new budget line MN along the original curve I1.

The movements from R to H on the I1 curve are the substitution effect measured horizontally by BD of X. To isolate the income effect, return the increased real income to the consumer which 9

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Microeconomics

was taken from him so that he is again at point T of the tangency of PQ; line and the curve l2.

The movement from H to T is the income effect of the fall in the price of X and is measured by DE. This income effect is positive because the fall in the price of the normal good X leads, via compensating variation in income, to the decrease in its quantity demanded by DE. When the relation between price and quantity demanded is direct via compensating variation in income, the income

effect

is

always

positive.

In the case of an normal good, the negative substitution effect is greater than the positive income effect so that the total price effect is negative. Thus the price effect (-) BE = (-) BD (substitution effect) + DE (income effect). In other words, the overall price move from R to T which comprises both the income and substitution effects has led to the increase in the quantity demanded by BE after the fall in the price of X. This establishes the downward sloping demand curve even in the case of an normal good.

4.a What is the short run production function? Explain this with the help of a total product curve, AP and MP curves. ďƒ˜ Short run production function refers to the functional relationship between the units of variable factors and the output. In short run production function, we study the effect of change in the quantity of one variable input on the output, by keeping all other inputs constant. It is also called single variable production function or production function with one variable input.

Algebraically, it is written as: Q=f (Nvf) K Where Q= output, f= Function ,Nvf = Quantity of variable factors, K= constant units of fixed inputs.

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With the help of the diagram we can generate the three stages: Stage I: Increasing Returns: In this stage the total product increases throughout, but it increases at increasing rate initially and both MP and AP increases and MP gets its maximum point and starts decreasing.

Stage II: Decreasing Returns: In this stage, The TP increases at the decreasing rate and reaches its maximum point. Both AP and MP starts to decrease and MP cuts the x-axis.

Stage III: Negative Returns: In this stage TP starts to decline and TP curves slopes downward. The MP of a variable factor is negative and MP curve goes below the x-axis. The AP decrease continuously and slopes downward. b. How can the producer maximize the production at the given total cost and input prices.

Explain ďƒ˜ The producer can maximize the production at the given total cost and input prices from two approaches: A) Total revenue-Total cost approach b) Marginal revenue- Marginal cost approach

A. Total Revenue- Total cost approach

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To obtain the profit maximizing output quantity, we start by recognizing that profit is equal to total revenue (TR) minus total cost (TC). Given a table of costs and revenues at each quantity, we can either compute equations or plot the data directly on a graph. The profit-maximizing output is the one at which this difference reaches its maximum.

In the accompanying diagram, the linear total revenue curve represents the case in which the firm is a perfect competitor in the goods market, and thus cannot set its own selling price. The profitmaximizing output level is represented as the one at which total revenue is the height of C and total cost is the height of B; the maximal profit is measured as CB. This output level is also the one at which the total profit curve is at its maximum.

If, contrary to what is assumed in the graph, the firm is not a perfect competitor in the output market, the price to sell the product at can be read off the demand curve at the firm's optimal quantity of output.

B. Marginal Revenue-Marginal Cost Approach

An equivalent perspective relies on the relationship that, for each unit sold, marginal profit (MĎ€) equals marginal revenue (MR) minus marginal cost (MC). Then, if marginal revenue is greater than marginal cost at some level of output, marginal profit is positive and thus a greater quantity should be produced, and if marginal revenue is less than marginal cost, marginal profit is negative and a lesser quantity should be produced. At the output level at which marginal revenue equals marginal cost, marginal profit is zero and this quantity is the one that maximizes profit.[2] Since total profit increases when marginal profit is positive and total profit decreases when marginal profit is negative, it must reach a maximum where marginal profit is zero - or 12

Exam 2012 Fall

Microeconomics

where marginal cost equals marginal revenue - and where lower or higher output levels give lower profit levels.[2] In calculus terms, the correct intersection of MC and MR will occur when:[2]

The intersection of MR and MC is shown in the next diagram as point A. If the industry is perfectly competitive (as is assumed in the diagram), the firm faces a demand curve (D) that is identical to its marginal revenue curve (MR), and this is a horizontal line at a price determined by industry supply and demand. Average total costs are represented by curve ATC. Total economic profit is represented by the area of the rectangle PABC. The optimum quantity (Q) is the same as the optimum quantity in the first diagram.

5.a. Total cost function of a producer is given by TC= 1000 + 10Q – 0.9Q + 0.004Q3. Find TFC, TVC, TC, AFC, and MC to produce 5 units.  Here, TFC = 1000 TVC =10Q+ 0.004Q3- 0.9Q when q=5 TVC=10*5+ 0.004*(5)3-0.9*5 = 46 TC= TFC + TVC = 1000+46 = 1046 AFC= TFC/Q = 1000/5 = 200 AVC = TVC/Q = 46/5 = 9.2 MC = derivative of TC = 10 – 0.9Q + 0.012Q2 When q=5 = 10 – 0.9*5 + 0.012 * 52 = 5.8

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b. Show the relationship between average and marginal revenue curves in perfectly competitive and monopoly market.  Under perfect competition.

The average revenue curve is a horizontal straight line parallel to the A-axis and the marginal revenue curve coincides with it. This is because under pure (or perfect) competition the number of firms selling an identical product is very large.

The price is determined by the market forces of supply and demand so that only one price tends to prevail for the whole industry, as shown in Table 1.

It is OP as shown in panel (A) of Figure 1. Each firm can sell as much as it wishes at the market price OP. Thus the demand for the firm’s product becomes infinitely elastic. Since the demand curve is the firm’s average revenue curve, the shape of the AR curve is horizontal to the А-axis at price OP, as shown in panel (B) and the MR curve coincides with it. This is also shown in Table 1 where AR and MR remain constant at Rs 20 at every level of output. Any change in the demand and supply conditions will change the market price of the product, and consequently the horizontal AR curve of the firm.

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Under Monopoly The average revenue curve is the downward sloping industry demand curve and its corresponding marginal revenue curve lies below it. The relation between the average revenue and the marginal revenue under monopoly can be understood with the help of Table 2. The marginal revenue is lower than the average revenue.

Given the demand for his product, the monopolist can increase his sales by lowering the price, the marginal revenue also falls but the rate of fall in marginal revenue is greater than that in average revenue. In Table 2, AR falls by Rs. 2 at a time whereas MR falls by Rs. 4. This is shown in Figure 2, in which the MR curve is below the AR curve and lies half way on the perpendicular drawn from AR to the T-axis. This relation will always exist between straight line downward sloping AR and MR curves.

In order to prove it, draw perpendiculars CA and CM to the У-axis and X-axis respectively from point С on the AR curve. CA cuts MR at В and CM at D. We have to prove that AB = BC. In Figure 2, the rectangle ACMO is the TR of OM output at CM price and the area. PDMO also represents total revenue in terms of aggregate marginal revenue (

MR) at OM output.

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6.a Define Monopoly. How price and output is determined in the short run of the firm under monopoly? ďƒ˜ Monopoly is said to exist when one firm is the sole producer or seller of a product which has no close substitutes. The following three condition are necessary to exist monopoly:

i. There is a single producer or seller of a product. ii. There are no close substitutes for the product. iii. Strong barriers to the entry of new firms in the industry exist.

Price and Output determination Under Monopoly

Y

YY

MC

MC

AC

E

MR OUTPUT

X

Fig (i)

O

AR MR OUTPUT Fig (ii)

Y

PRICE

AR

E

O

MC AC

H

PRICE

F H

PRICE

P G

P

F G AC P

O

E

MR OUT PUT

X

Fig (iii)

In Monopoly, Price is determined by the firm itself by the help of AR because AR is equals to price and output is determined by firm when MC is equal to MR. In the above figure, there is a firm which has got 3 situation: i) Abnormal Profit (AR>AC) ii) Normal Profit (AR=AC) iii) Loss (AR<AC)

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i) Abnormal Profit Abnormal profit is that condition where AR is greater than AC which we can see in Fig i. In fig I PFGH is the super normal profit where AR is greater than AC. ii) Normal Profil Normal profit is that stage where AR is equal to AC which we can see in fig ii. Though AC=AR we say it normal profit because AC includes both AFC and AVC. In fig ii the point E is normal Profit. iii) Loss Loss is that condition where AC is greater than AR. In the fig iii GFPH is the loss where AC is greater than AR

7. Write short notes on any two: a. Properties of indifference curve i) IC convex to the origin Indifference curves is usually convex to the origin. In other words, the indifference curve is relatively flatter in its right-hand portion and relatively steeper in its left-hand portion.

Due

to

diminishing

MRS,

IC

is

always

convex

to

the

origin

as

we can see in the figure.

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Microeconomics

ii) Higher Indifference curve yields Higher level of satisfaction than lower It

is

because

or

more

units

that of

the at

least

higher

IC3

one

good

contains than

IC2

more and

units so

on.

of So

both

goods

IC3

has

more level of satisfaction than the IC2 .

iii) IC do not intersect each other If two indifference curves intersect each other, it would imply that an indifference curve indicates two different levels of satisfaction or that two different combinations â&#x20AC;&#x201C; one being larger than the other yield same level of satisfaction.

iv) Indifference Curve always slopes downward to right This property follows the assumptions of non-satiety, i.e. the consumer prefers more goods to less of it. The negative slope of an indifference curve shows that the two goods are substitutes for one another. This must be so if the level of satisfaction is to remain the same on an indifference curve. v) Indifference Curve never touches x-axis If IC touches the x-axis then we canâ&#x20AC;&#x2122;t take x good i.e x good will be 0 which is against our assumption. So, IC never touches x axis. b. Cross elasticity of demand Cross elasticity of demand (XED) measures the percentage change in quantity demand for a good after the change in price of another.

XED = % change in Q.D. good A % change in P good B

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Cross elasticity of demand for Coffee / Tea For example: if there is an increase in the price of tea by 10%. and Q.D of coffee increases by 2%, then XED = +0.2 Substitute goods For goods which are substitutes, we expect to see a positive cross elasticity of demand. If the price of Asda bread increases, people will buy more of an alternative, such as Mother’s Pride bread. 

Weak substitutes like tea and coffee will have a low cross elasticity of demand



Alternative brands of chocolate, e.g. Dairy Milk vsWispa are quite similar, so will have a higher cross elasticity of demand.

Complements goods These are goods which are used together, therefore the cross elasticity of demand is negative. If the price of one goes up, you will buy less of both goods.



For example, if the price of DVD players goes down, you will buy more DVD players and also there will be a increase in demand for DVD disks.



If the price of Samsung mobile phones goes down, we will also buy more Samsung related phone apps.

Using knowledge of cross elasticity of demand



When setting prices firms will have to look at what alternatives the consumer has, if there are no close substitutes they will be able to increase the price. For this reason firms spend a lot of money on advertising to differentiate their products and reduce cross elasticity of demand.



A firm may offer a loss leader to attract complementary sales. For example, a firm may offer a printer, at a low price, because it knows this will lead to increased sales for the highly profitable ink cartridges.

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REFERENCE Managerial economics, dr. h.l ahuja Micro economics, gyan ratna adhikari www.wikipedia.com www.2knomics.com

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