Eco 162
Eco 162
Eco 162
ECO162 MICROECONOMICS
JULY – NOV 2009
Instructions:
1. Form a group of 4 or 5 members.
2. On the cover of the assignment, please write:
a. Names and matrix no. of ALL group members.
b. Programme/part/group.
3. The assignment must be submitted NO LATER than 15th October 2009.
1. Explain how Socialism and Capitalism solve the three basic economic problems.
2. Explain 4 differences between Islamic and conventional economic systems.
3. Explain the concept of scarcity, choice and opportunity cost.
4. Draw all diagrams (with labels) as stated below:
a. Chapter 1: The concave PPC with points showing efficient production, inefficient production and
scarcity problem.
b. Chapter 2: i) The consumer’s equilibrium.
ii) The changes in Qd and changes in Dd curve.
c. Chapter 3: Market equilibrium with a floor price.
d. Chapter 4: i) The production curves (TP, MP, AP) in one diagram.
ii) The cost curves (TC, TVC and TFC) in one diagram.
e. Chapter 5: i) Perfect Competition curve – the 3 short run profits and long run profit.
ii) Monopoly curve – the 3 short run profits and long run profit.
iii) Oligopoly curve – the Sweezy’s model.
5. Write down the formula to calculate cross elasticity of demand. Explain the importance of its
coefficient.
6. Summarize the concept of the Law of Diminishing Marginal Return.
7. Explain 4 determinants of demand.
8. Explain 4 determinants of price elasticity of demand.
9. Using a diagram, explain and distinguish between elastic supply and inelastic supply.
10. Discuss 4 characteristics of monopolistic competition.
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QUESTION 1
Explain how Socialism and Capitalism solve the three basic economic problems.
There are three basic economic problems, there are What to produce?, How to
produce? And For whom to produce?. In different economy systems there are different ways
to overcome or solve this problems
The first basic economic problem is What to produce?. In Capitalism, they use price
mechanism to overcome this problem. The price consumers willing to pay serves as signal
for producer to decide what to produce. Normally they will produce product that are highly
demanded. In Socialism, the decision are made by the goverment. The authority plans what
to be produced based on society need not individual need.
The third basic economic problem is For whom to produce?. In Capitalism, it depends
on consumer purchasing power. If income increase, they will increase their demand. In the
othet hand, in Socialism, goverment fairly divide the goods to the society. The basic needs
will be distributed according to overall society needs.
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QUESTION 2
There are many differences between Islamic and Coventional economic systems. The
differences are, there is no separation between religion and economics in Islam. Everything
is under Allah. The second different between Islamic and conventional economic systems is
in Islamic economic is religiously value loaded. In Islam, we have clear cut between haram
and halal. There are more halal items than haram that can be explore by people.
Other than that, Islam prohibits riba. This is to promote social justice and to uphold
the principle of brotherhood. Islam use equity participation and profit sharing
(mudharabah). Lastly, in Islam the concept utility is for this world and hereafter, not just for
this world satisfaction only. Muslim produce goods and services according to their hierarchy
of needs.
For example in Malaysia, majority people are Muslim so it could prevent people from
doing the bad things. Then, its will decrease the gap between poor people and rich people.
Citizens also would change their mind set, from negative to positive. All people are same
range because all of the human is creation of Allah s.w.t.
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QUESTION 3
Scarcity is the situation in which human wants are forever greater than available
supply of time, goods and resources. It occurs when the society wants exceed the ability of
the economy to meet those wants. This is because human wants are unlimited, whereas the
resources to satisfy these wants limited.
Choice, it occurs when you choose something or when a decision is made on certain
preference that will give maximum satisfaction. Choice will involve a set of alternatives and
decision is made due to cost, benefits and satisfaction.
Opportunity cost is the second best alternatives that a person has to forego.
Anything that consumer has to give up or sacrifice in order to gain somethings. Example, we
have two choice to make, to buy fried chicken or to buy burger. The opportunity cost of buy
fried chicken is we have to forego burger and vice versa.
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Question 4
a. Chapter 1: The concave PPC with points showing efficient production, inefficient
production and scarcity problem.
e. Chapter 5: i) Perfect Competition curve – the 3 short run profits and long run
profit.
ii) Monopoly curve – the 3 short run profits and long run profit.
iii) Oligopoly curve – the Sweezy’s model.
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QUESTION 5
Write down the formula to calculate cross elasticity of demand. Explain the
importance of its coefficient.
∆Qx P₁y
PEDxy = ×
Q₁x ∆Py
Q₂x−Q₁x P₁y
= ×
Q₁x P₂y−P₁y
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QUESTION 6
Summarize the concept of the Law of Diminishing Marginal Return.
Law of Diminshing Marginal Return states that after a certain point, when additional
units of variables input (eg. labor) are added to fixed input (eg. capital or land), the Marginal
Product (MP) of the variable input declines.
The example is, assume that we have a small furniture factory, which has several
machines for cutting, painting and so on. In this situation, we use labour as our variable
input. Many things such as raw materials and utilities can be the variable input in real world.
If we have one or two worker, our production would be very slow. We can solve this
problem by adding more workers in our factory. The marginal product of each succeeding
worker would arise, as the operation become more efficient. The benefit of specialization
could be realized.
But, if we keep adding workers, the problems of overcrowding would arise. Worker has
to wait to use the machines. Now, total output would increase at a diminishing (decrease)
rate. Some machines may be over-utilized. If we add more workers, the marginal product
would become negative- total product (output) would decline instead of increasing, because
the factory become so crowded and congested until no work can be done. Some workers
would sit idling, could not do any work.
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QUESTION 7
First determinant of demand is the price of related goods. A change in the price of
related good may increase the demand for a product, depending on wether the related good
is a substitute or a complementary. Substitute goods is a pair of goods alternatives to each
other. Examples, coffee and tea, magarine and butter. As a price of one good goes up, the
demand for its substitute will also increase. Thus, Dd curve of substitute will shift to right.
Complementary goods is a pair of goods consumed together. Examples, camera and film,
cars and petrol. As price of one good goes up, the demand for its complementary good will
fall. Thus, Dd curve of complements shift to left.
Tastes and preference also is the determinant of demand. The more desirable people
find the good, the more they will demand. Affected by advertising, trend of fashion, by
consideration of health, by the experience from consuming the good on previous occasions
etc. Example, brand-conscious person / comfortable with certain brand, therefore the more
you will demand for that product even thought there is no change in price.
Last but not least, seasons and climate also the determinant of demand. Seasons or
climate can also affect demand. For example, in rainy season, people will use umbrellas or
rain coats. Therefore demand for those products will increase. Different products will also be
demanded at different festive seasons. For example, during Hari Raya, traditional Malay
cookies, baju kurung, raya card will be highly demanded.
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QUESTION 8
First, determinant of price elasticity of demand (PED) is the number and closeness of
substitute goods. The more substitute and the closer they are, the more elastic the demand
will be. For example, automobiles like Toyota, Honda, Ford, Nissan and many others became
perfect substitute for Proton. So the demand curve for Proton must be elastic. For goods
that has no close substitute, the demand is highly inelastic.
Habit forming also is the determinant of the price elasticity of demand (PED). The
more people get used to one product, the more inelastic the demand will be. People don’t
want to switch to other products).
The fourth determinant of price elasticity (PED) is the time period. The longer the
time period after a price of certain goods changed, the more elastic is the demand. Example,
price of a rises by 20%, the consumers may not switch immediately, but as time goes by they
may shift to other brand of shampoo.
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QUESTION 9
Using a diagram, explain and distinguish between elastic supply and inelastic
supply.
ELASTIC
P
Ss
P₂
P₁
0 Q₁ Q₂ Q
Q₂−Q₁ P₁
%∆Qs > %∆P : ×
Q₁ P₂−P₁
The Ss curve is less steep.
The coefficient = 1 < PES < α
Elastic supply means that an increase in price causes a bigger increase in supply. It has a PES
of greater than 1. Supply will be elastic if it is easy for a firm to increase supply e.g. spare
capacity in factory, easy to employ more factors of production.
INELASTIC
P
Ss
P₂
P₁
0 Q₁ Q₂ Q
Q₂−Q₁ P₁
%∆Qs < %∆P : ×
Q₁ P₂−P₁
The Ss curve is steep.
The coefficient = 0 < PES < 1
Inelastic demand. This means that an increase in price causes a smaller increase in supply. It
has a PES of less than 1. Supply is often inelastic in short-term, when it is difficult for firms to
increase their capacit
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QUESTION 10
Lastly, the non-price competition. It has significant role because sellers cannot really
compete in terms of prices. Examples, advertising and packaging. Monopolistic competition
firms advertise their products heavily in effort to inform consumer about their product
differentiation, a strategy to make price less important factor in consumer purchases and
product differences is a greater factor.
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PAST FINAL EXAM QUESTION PAPER - MARCH 2004
PART C (30 MARKS)
Question 1
a) Discuss how a capitalist economy uses market mechanism to solve basic economic
problems.
In this economic system, consumers are very powerful they can influence the
producer decisions. The price they are willing to pay for any goods, serve as signals for
producer and seller to decide what to produce and how much to produce.
Producer will produce goods that are higher demanded which pay the highest price
in order to maximize profits. Price of resources and production factors or inputs, indicate
what production methods to use to minimize production cost. The three basic economic
problems is what goods and services will be produced? Due to limited resources, all
economic must make a choice. They may use different decision making rules and
mechanisms on deciding in what goods to be produce more of one goods, we have to
produce less of another good.
How will goods and services be produced? The economic system must determine
how output is to be produced. Which resources should be used, and how output is to be
produced. Which resources should be used, and how they should be combined to
production, more labor and less capital, etc. m order to maximize production.
For whom will goods and services be produced? Who will consume the goods and
services produced? What is the basis of the distribution? This question is also known as a
distribution question.
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b) With the help of an appropriate diagram, explain the concepts of scarcity, choice and
opportunity cost.
Choice occurs when you choose something or when a decision is made on certain
preference that will give satisfaction. Based on the diagram, the points PPC signifies the
concepts of choice. We have to make a choice among the various combination of rice and
car. To move an alternative A to alternative B, it means that we have made a choice of
producing more rice and less car.
Scarcity occurs when the individual or society wants exceed the ability of the
economy to make those wants. This is because human wants are unlimited, whereas the
resources to satisfy these wants are limited. Based on the diagram above, if we choose to
produce at point Y, it is unattainable due to the problem of scarcity or not enough resources
to produce at that point.
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Question 2
a) Explain why agricultural products are more supply price inelastic compared to that of
industrial products.
Firstly, the time period or adjustment period of agriculture products are responsive
to price. This means that a change in market price during which producer cannot respond
with the change quantity of supplied. For example, a farmer planting tomatoes, he must sell
his current crop at whatever price, his current supply is inelastic because tomatoes cannot
be stored for long time and any change in price can only affect the next growing season. In
short-run, the crops capacity of individual producers is persumed fixed. But they still have
limited way to increase production and supply. Example, a farmer can use more fertilizer to
increase output in response to a presumed increase in demand.
Most of the industrial products that are not perishable compare agricultural
products. The time period to produce the industrial products is short. This is because of the
nature of the industrial products are long lasting and more durable than agricultural
products. So, the supply of the industrial products is elastic. The firm can use any kinds of
materials for its input resulting in supply of its output become elastic.
b) Explain the difference between a change in quantity supplied and a change in supply.
Change in supply and change in quantity supply is the same concept as change in demand
and change in quantity demanded. Change in supply means a change in the entrée schedule
or a shift of the enterer curve. It is caused by a change in one or more of the determinants of
supply such as number of sellers, technology, resource price, taxes and subsidies,
expectation, and price of other goods. But change in supply is a change in any one or more
of these determinants of supply or supply shifters will more the supply curve for a product
either to the right (increase in supply- producers supply larger quantity of the product at
each possible price) or to the left ( decrease in supply). Resource price, the higher resource
(input of the production) price will raise the production cost and reduce the profit. In
technology, improvement in technology enables firms to produce more unit of output at
lower costs; these increases the firms profit and therefore encourage them to increase their
supply. Managerial specialization (managerial economies). Large-scale production also
means better use of, and greater specialization in management.
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Question 3
a) With the use of a diagram, describe the three (3) stages of production in the short-run.
TP/AP/MP
TP
AP
0 Q of L
MP
Stage 1. The firm will start from the source until the intersection of MP and AP.
There is a sharp will increase of TP as we increase the units of variable input, example labor.
It means that each additional will increase in labor units results in greater increase of TP. For
rational producer will continue producing goods at this stage since TP can be increase by
adding more labor.
Stage 2. From the intersection of MP and AP until MP equal 0 and TP at the max. The
values of AP and MP are decreasing but still positive. This is the most efficient stage of
production it because the combination of variable and fixed inputs are used efficiently. The
inputs are fully utilized; no machines are left idle as we have the right number of labors to
operate all machines. A rational producer will produce at this stage. If the firm continues
produce the product after this stage, the TP will start to decline.
Stage 3. Begins when MP=0 and continues to decline thereafter. A rational producer
should not be producing the product at this stage. It because, TP start to decline. There is
overutilization of capital.
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b) Explain four (4) factors that lead to economies of scale experienced by large-scale firms.
The four factors that influence is job specialization, it means one worker with only a few
tasks, repeating the same work, increase the skills, quantity will increase also and the AC will
decrease. Other than that, marketing economies, it means the firms buy inputs in bulk, get
special discounts, decrease the cost and AC will decrease also. Then, financial economies, big
and established firms normally get favorable term when borrow money from banks (lower
interest rate and longer repayment period). The fourth one is managerial economies. This
means that when a manager can manage a bigger output efficiently at the same wage, quantity
increase and AC will decrease.
Question 4.
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b) Explain why firms in a perfectly competitive industry are not able to maintain
supernormal profit in the long-run.
P P S₀
ATC S₁
P₁ P₁
P₀ MR P₀
D₀ D₁
0 Q 0 Q
Single firm Industry
Show the long run equilibrium position of a competitive firm, P= MC= Minimum ATC.
Temporary profit.
P ATC P S₁
S₀
P₀ P₀
P₁ MR P₁
D₀
D₁
0 Q 0 Q
Single firm Industry
Show the long run equilibrium position of a competitive firm, P= MC= Minimum ATC.
Temporary loss.
Entry eliminates economic profit. If P exceeds ATC, the economic profits enjoyed by
the existing firm will attract new firm to the industry. Supply will increase until it force the P
back to minimum ATC.
Exit eliminates losses. If P less than ATC, the firm will incur losses. This will cause the
firm to leave the industry. As they leave, total supply will decline, bringing the P back to
equality with minimum ATC. In the short run, firms may not have sufficient time to liquidate
their assets and go out of the business.
In long run equilibrium. The firm produces at MR=MC and the price is equal to
minimum ATC. Economic profit here is zero, and the industry is in equilibrium. The existing
firms are earning normal profit.
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