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The current
price is given as $185.
Competitors
Fixed:
Demanded
20
30
40
50
60
70
(i)
Price
Quantity
Price($)
Competitors
Demanded
200
195
190
185
180
175
35
40
45
50
55
60
follow:
Quantity
What would the demand curve be under the kinked demand curve
hypothesis? Illustrate and explain.
300
250
P
r
i
c
e
250
200
200
190
200
185
165
150
Fixed Price
175
175
Follow Price
140
115
100
MR2
Follow MC
70
60
50
Price
35
20
0
10
20
30
40
0
50
Fixed MC
60
70
80
Quantity
Fig.1
The above demand graph plots the two demand scenarios.
1) PQ- represents the demand curve when the competitors follow price
2) AB- represents the demand curve when the competitors price is fixed. The
point at which the two curves intersect is O.
The equation of PQ demand curve is- P+Q=235
The equation of AB demand curve is -2P+Q=420
Hence, the kink demand curve is AOQ which has a kink at the point O. Since it is
assumed that price decrease by a firm will be matched by a price reduction by
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the competitors but an increase in the price is not matched by the competitors,
the relevant demand curve is AOQ, which has a kink at O.
(ii) Plot the marginal revenue curve corresponding to the kinked demand curve
and explain.
The Demand Curve for AB has the equation P+Q=235
Total Revenue=P*Q= (235-Q)*Q
Also we know, Marginal Revenue=Change in Revenue/Change in Quantity=
dt(R)/ dt(Q)
Therefore by differentiation we get the AB marginal revenue curve as
MRab=235-2Q
Similarly we get the PQ marginal revenue curve as
MRpq=210-Q
The following has been plotted by AB and PQ in Fig.1
. (iii) Given that Marginal Cost is $150 at every level of output.
Copy the above table and calculate TR and MR. Determine the profit- maximising
level of output and plot on the graph.
From the above table we get the following:
Q1
20
30
40
50
60
70
P($)
200
195
190
185
180
175
TR1($)
4000
5850
7600
9250
10800
12250
MR1($
)
190
180
170
160
150
140
Q2
35
40
45
50
55
60
TR2($)
7000
7800
8550
9250
9900
10500
MR2($
)
165
155
145
135
125
115
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(i)Inflation:
-It leads to higher pay loads as workers try to maintain their real standard of
living.
-Higher salaries cause a surge in unit labor costs. Businesses increase prices to
maintain their profit boundaries.
-It is can also have an effect on the real value of savings
-The real value of borrowers debt is lessened. Inflation decreases the real value
of income year on year.
-It also causes a disturbance of business planning insecurity about the future
makes planning hard, planning becomes a problem as firms become unsure
about what will happen to their expenses.
-This leads to firms projects to be cancelled or suspended.
-Lower rate of capital investment damages long-run financial growth.
(ii)Unemployment:
Some of the affects are:
-Lost output of goods and services
-Reduction in the long run growth potential of the economy.
-Direct impact on government expenditure, the level of government borrowing
and taxation
-An increase in it results in lower tax revenues.
-Government needs to shell out higher benefit payments
-Burden loss of investment in human capital
-It wastes some of the rare resources used in training workers. Besides, labors
who are jobless for long periods become de-skilled as their skills become
gradually dated in a quickly changing business.
-It is also linked to social and economic scarcity - there is some association
between growing unemployment and growing crime and waning social
displacement.
(b) Illustrate and explain what effect the following will have on the expenditure
line:
(i) An increase in the proportion of peoples income that is saved.
(ii) A fall in exports.
The slope of expenditure line
=Marginal propensity to consume (MPC)
+Marginal propensity to invest(MPI)
+Marginal propensity for government
purchases(MPG-Marginal propensity to import(MPM)
(i)
(ii)
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(ii)
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