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ECON1101 Hand-In Assignment 2 (due Week 7)
Q1a.
Answer:
(c)

The price elasticity of supply for this commodity is greater at A than at B

Q1b.
Working Out
The slope of D1 is smaller than D2 and since at the point considered, P = Q = 5, elasticity of D1 is
greater than D2. (Elasticity of demand at D1 is 1 while elasticity of demand of D2 is less than 1 since
its slope is greater than 1)
Answer:
(b)

D2 is more inelastic than D1

Q2.
a) Increasing marginal costs are observed as a reflection of the law of diminishing returns. As
additional labour is used, the efficiency of production decreases causing marginal cost to
increase. This means each unit of labour brings generates less units of production. Thus marginal
cost, which is defined as the change in total cost over the change in quantity produced, increases.
Since labour is a variable factor of production, increasing labour increases the total variable cost.
Assuming that capital is a fixed factor of production, total fixed costs remain constant. Initially as
additional labour increases total variable cost but at the same time increases the total units
produced, the total average cost begins to decrease. However, as marginal cost increases, the
changes in additional quantity from additional labour becomes small enough which causes the
total average cost to increase

b) To maximise profits in a perfectly competitive market, a firm will produce such that its marginal
revenue equals the marginal cost. If marginal revenue is greater than the marginal cost, the firm
will be able to maximise its profits by increasing its output thus increasing marginal cost. If the
marginal revenue is less than the marginal cost, the firm is losing money thus decreases its
output to decrease the marginal cost.
In the short-term where there is a distinction between variable and fixed costs, a firm will continue
its operations and thus their productions if their profit is greater than the fixed costs, in other
words, its total revenue less total costs must be greater than the fixed costs. This is because in
consideration of its shutdown, the fixed costs must be paid, making the fixed costs a sunk cost
which will not have any bearing on whether the firm shuts down or not. Therefore the weight on
shutting down is dependent on the average variable cost, which incorporates the variable cost
and the number of units produced. Thus the firm will continue its operations if its marginal revenue
which is equal to the marginal cost is greater than the average variable cost (marginal revenue =
marginal cost > AVC) i.e. the supply curve in the short-run is represented by the marginal cost
curve that is above the AVC curve.
The supply curve will not be represented by the marginal cost curve if price does not equal to the
marginal revenue and thus the marginal cost. This occurs in reality, as perfectly competitive
markets do not exist. This can be due to varying market powers of firms and many other factors.

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Q3.
a) Elasticity of demand is the percentage change in the quantity demanded resulting from a change
in price. It measures the responsiveness of the quantity demanded to changes in price. In other
words, if a small price change causes a large change in quantity demanded, the product is said to
be highly elastic. If a large price change causes a small change in quantity demanded, it is
considered highly inelastic. If the quantity changes even with no change in price, it is perfectly
elastic while if the quantity does not change with changes in price, it is perfectly inelastic.
Elasticity at point A is given by either of the two formulae:

P
1
Priceat A
1

=
A
slope Quantity at A slope Q A

i.

EA=

ii.

Q
Percentage ChangeQ Q A
EA=
=
Percentage ChangeP P
PA

b) The elasticity of demand decreases as you move from left to right along the demand curve since
the demand curve is a downward sloping curve.
Using the formula (i) in part a), as the slope is constant for a linear demand curve, the elasticity is
dependent on the ratio of the price to the corresponding quantity demanded. Since it is downward
sloping, the left of the curve has larger values of price and smaller quantity values than on the
right of the demand curve, which has smaller values of price and larger quantity values. This
means that

PA
QA

is larger on the left than the right, thus elasticity is decreases from left to right

of the demand curve.

Using formula (ii), this can be seen as the percentage change in Q is greater and the percentage
change in P is smaller along the left of the linear demand curve while the percentage change in Q
is smaller and the percentage change in P is greater along the right of the demand curve. Thus
the elasticity of demand is declining as you move left to right along the demand curve.

Q4.

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Q5.