Microeconomics Solutions Assignment

Questions: 1. Explain the following statements, the use of tables, diagrams and graphs will greatly enhance the assignment. a. When bad weather ruins a crop of bananas in Queensland the price of bananas rises in grocery outlets around the country. b. Accommodation in motels, hotels and caravan parks is cheaper during the off-season. c. If the price of oil rises substantially and remains high the price of used V8 cylinder cars falls. d. Consider the hypothetical demand schedule below. Answers: 1. The quantity demanded of any good is the amount of the good that buyers are willing and able to purchase at a particular level of price. Similarly the quantity supplied of any good or service is the amount that sellers are willing and able to sell at a given level of price. The market equilibrium occurs at the point where the demand and supply curves intersect resulting in the equilibrium output and price when buyers buy the entire amount that sells offer, i.e., at the market clearing price. Now supply and demand changes depend on many factors such as income, input prices, prices of related good, expectations and many other factors. We analyse the problems below based on the shifts in the demand and supply curves due to their dependence on the changes in such other factors and how these shifts changes the equilibrium output and price in the market. (a) As bad weather in Queensland ruins banana crops, a part of the supply of bananas is ruined indicating the fall in supply of bananas from the previous equilibrium point. Now due to the cut down in the supply, producers need to charge higher prices to earn revenue and profits, the higher price also arises out of the free moving market equilibrium. Hence, the supply of bananas in the country falls which leads to a rise in price. Fig 1(a) shows the supply curve shift from S0 to S1 , an upward shift which is due to fall in supply and hence resulting in rise in price from P0 to P1. The equilibrium point moves from E0 to E1 where the equilibrium output is much lower than the previous one and the equilibrium price is higher to bring the demand supply in equilibrium. Fig 1(a): Fall in supply shifting the supply curve upwards from S0 to S1 resulting into rise in price from P0 to P1; demand curve is denoted as D and equilibrium point moves from E0 to E1 with new output at Q1. (b) During the off-season the demand for accommodations in motels, hotels or caravan parks falls, as people tend to travel less at those times. Therefore, there occurs a fall in demand which the hotel owners face by dropping the prices. A fall in demand is shown by the shift of the demand curve downwards. The demand curve shift results in moving the equilibrium output at a lower quantity and a lower equilibrium price. Thus, the fall in demand forces the motel/hotel owners to lower the price to attract more customers. We see in Fig 1(b) demand curve D0 shifts downward to D1 as demand falls and leading to fall in price from P0 to P1. The equilibrium point moves from E0 to the new point E1 indicating fall in output from Q0 to Q1 and a fall in price from P0 to P1. Fig 1(b): Fall in demand for accommodations results the demand curve to shift downwards which in turn leads to fall in price. Shift of demand curve D0 to D1, output falls from Q0 to Q1 and price falls from P0 to P 1 as equilibrium point moves from E0 to E1. (c) Oil and V8 cylinder cars are related goods other words complementary goods. As per the nature of complementary goods, the changes in price of one good affects the quantity demanded of the other good. Similarly here as oil is an input to run V8 cylinder cars both are complementary goods. Hence with rise in oil price, there occurs lower demand for V8 cylinder cars because to run the cars consumers have to face higher prices which they cant afford. Therefore there occurs a downward shift of the demand curve for the car cylinders. A downward shift of the demand curve results into the fall in price of the cars to bring the market at a new equilibrium which occurs at a lower output and a lower price. We see in Fig 1(c), due to rise in price of related good oil, the demand for the cylinder cars fall, and curve D0 shifts downward to D1 leading to fall in price from P0 to P1. We also see the new equilibrium point E1 is at a lower output and price, the previous equilibrium point being E0. The equilibrium output falls from Q0 to Q1. Fig 1 (c): Rise in price of oil leads to fall in demand for V8 cylinder cars; demand shifts downward for cylinder cars leading to fall in price of cylinder cars. Shift of demand curve D0 to D1, output falls from Q0 to Q1 and price falls from P0 to P 1 as equilibrium point moves from E0 to E1. (d) The price elasticity of demand measures how much the quantity demanded responds to the change in price of a particular commodity. The demand for the commodity is said to be elastic if the quantity demanded responds substantially to the change in prices of that commodity. On the other hand demand of a good is said to be inelastic if the quantity demanded responds only slightly to the changes in price of that commodity. Hence, we see that the price elasticity of demand for any particular good measures how willing the consumers are to move away from the good as its price rises or in the reverse case how willing the consumers are to buy the good if its price falls. Below is given the different price levels with the levels of quantity demanded for respective prices. PRICE (Pi) QUANTITY (Qi) 25 20 20 40 15 60 10 80 5 100 Price elasticity of demand is reprented as the following ratio: (Percentage change in quantity demanded/ Percentage change in Price) To calculate the price elasticities of demand we consider the following mid-point method formula: [(Q2-Q1) /{(Q2+Q1)/2}] / [(P2-P1)/{ (P2+P1)/2}] Where Pi is the ith price of the commodity and Qi is the Quantity at the ith price Pi. Here the price elasticities of demand are with negative signs because demand and price have an inverse relationship, i.e., a rise in price indicates a fall in demand. Now higher the absolute value of the price elasticity of demand, it indicates that demand is more elastic and a lower absolute value indicates that demand is inelastic. We consider each calculation as follows: Price elasticity of demand between prices $25 and $20 = [(40-20)/{(40+20)/2}]/[(20-25)/{(20+25)/2}] = (20/60)/(-5/22.5) = -3 Price elasticity of demand between prices $20and $15 = [(60-40)/{(60+40)/2}]/[(15-20)/{(15+20)/2}] =(20/50)/(-5/17.5) = -1.4 Price elasticity of demand between prices $15 and $10 = [(80-60)/{(80+60)/2}]/[(10-15)/{(10+15)/2}] = (20/70)/(-5/12.5) = -0.74 Price elasticity of demand between prices $10 and $5 = [(100-80)/{(100+80)/2}]/[(5-10)/{(5+10)/2}] =(20/90)/(-5/7.5) = -0.33 We see that as the price fall, the demand for the product rises which goes by the normal price demand behaviour. We calculated the elasticities between the successive price levels and we see that as the price fall the absolute value of elasticities of demand falls. This fall in the absolute value indicates that as price falls the consumers are less likely to move away from the commodity. In other words as price falls the consumers will be more willing to buy the commodity and will not move away from it. As we see at the highest price of $25, the amount demanded is just 20 units and then as the price falls to $20 the quantity demanded increases to 40 units. Now the price elasticity of demand between these two prices is calculated by the ratio of the percentage changes in quantity to the percentage change in price. We see that a 20% fall in price leads to a 100% rise in quantity demanded and via mid-point method we get the price elasticity of demand as -3, which show high elasticity in dicating that the consumer responds substantially to the fall in price. As price keeps falls and we calculate the elasticities between the successive prices, the value keeps falling as the consumer can afford the commodity more and more with fall in price and would not move away from it. Similarly for the prices $20 and $15 we get the price elasticity of demand to be lower than the previous one coming to -1.4 indicating that as price fell from $20 to $15, quantity demand substantially increased showing that people substantially responded to the change in price and now with lower price the consumers are less likely to move away from buying the commodity. Next for price level $15 and $10 the elasticity of demand further falls to -0.74, again indicating that consumers become more willing to buy the product and indicate an inelastic demand such that they will respond less to price changes now. In the end for the last pair of price levels, the price elasticity of demand between $ 10 and $ 5 is just -0.33, which indicates that demand is fairly inelastic to changes in price of the commodity as the value is close to zero( price elasticity of 0 implies demand to be perfectly inelastic). At this point consumers are least likely to respond to price changes with a high quantity demanded of 100 units at $5. 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