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Economics

Question 1

A. Elasticity

Elasticity refers to the degree of change of a variable dependent on the change of another

variable. In economics, elasticity is used to determine the degree of change in the demand of a

variable by consumers and the supply of the goods and services by producers, dependent on the

factors such as price and income.

B. Users of elasticity of demand

The most common beneficiaries of price elasticity of demand is the business firms. The

knowledge on the price elasticity of demand allows them to determine the optimal level for the

prices of their goods and services. They either increase or decrease their price level accordingly

to ensure that they get the optimal revenue from their products. This concept also aids in the

determination of their market strategies.

C. Users of price elasticity of supply

Among the users of this concept is the government. The price elasticity of supply is essential in

the determinating the incidence of taxes imposed by the government. This concept is also critical
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for businesses allowing them to identify the best pricing strategy ensuring that they make

maximum profit.

D. Users of cross elasticity of demand

The firms benefit from this concept in the determination of their pricing level in the event of

products with substitutes in the market. The concept also helps firms in the determination of the

products they should introduce in the different markets.

E. Users of income elasticity of demand

The firms use the concept in determining the level of production of their goods and the

forecasting of future changes in income level of consumers and their respective impact on their

demand.

F.

No. the elasticity of demand can’t determine the exact units that are going to be sold after the

increase of the price. This is because the change in price of different products leads change in the

demand in different degrees. Products such as basic needs may display inelastic elasticity. Also,

there are numerous factors involved in the process.

No. An analyst could not collect the information needed to determine the units sold after price

increase since there are very many factors influencing demand some of which are not

distinctively measurable.

The information could give the producer a forecast of the expected demand for their product if

the price changed depending on the category of the product in the market using the concept of

elasticity and the graphical presentation of the expected changes. The information may help in
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determining the expected revenue from the change of price assuming all other factors are

constant.

G. Price elasticity of demand

The change in the price can lead to a larger change in the quantity demanded for example where

the consumer has alternatives or can do without the product

The change in the price of a product has a smaller change in demand where the alternatives are

limited or the product is a basic need that the consumer requires.

The change of the price of the products results in an equal change in the quantity consumer’s

demand. When the price increases, the demand decreases with an equal margin.

The change in price has no change whatsoever on the demanded quantity where the consumer

has no choice but use the product.

The decrease of price leads to the increase of the demand from zero in the event of a product

launch in the market.

Price elasticity of supply

The degree of change in price leads to equal degree of change in the supply of the product where

the firm has a larger capacity in their plants.

The change of price does not affect the supply quantity of the product where the firm is not

responsive to change in price and has enough time to change their plants.

The supply quantity can’t be changed in time in response to price where the plants can only

produce a certain specific capacity.

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There is a smaller increase of supply with the increase of price where the use of a fixed plant is

intensified.

Cross elasticity of demand

The positive shift in the demand in the consumption of a product is caused by the decrease in the

price of another product for example the instance of supplementary goods.

The increase in the demand of a product is caused by the increament in the price of another

product in the event of complementary goods.

The change of price of one product does not change the price of the other good in a situation

where the two are unrelated.

Income elasticity of demand

The demand of a product increases with the increase in the level of income since the consumer

has more disposable income.

The increase in the income level translates to the decrement of the demand for a product.

Question 2

A. Total revenue test

The concept helps determine the total revenue that can be assumed from the change in price of a

product assuming all factors remain constant. The information helps determine the pricing

strategy of the firm gaining optimal sales.

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B. Determinants of PED

Substitutability: the closer the substitutes of the product the easier the consumers can switch to

the substitute product for example air travel and train services for continental travel and different

bread.

Income proportion: the shift in price of the product in relation to the consumer’s income. For

example, the increase of price of table salt and the increase in the prices of land.

Necessities and luxury: the elasticity of demand is higher for luxury products than for basic

needs. For example, clothes are a basic need while vacation homes are a luxury.

Time: the consumers do not adjust to price changes very fast and require some time to adapt or

change, for example, cooking gas and coal.

C.

The longer the time involved the higher the elasticity of demand. As a result of limited time for

adjustment for products such as perishable goods the demand is almost inelastic.

D.

Cross elasticity involves situations where the price of one product influences the price of the

other. In this case the price of Pepsi being decreased could lead to the increase of demand due to

preference over other substitutes such as Coca Cola.

E.

The cross elasticity helps in the determination of boundaries, classification of products in

industries and developing a pricing strategy.

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Question 3

A.

Implicit cost are the costs used in the calculating economic profit following the opportunity cost

while explicit costs are used in calculation of the accounting the profit following the expenses

from the firm’s tangible assets.

B.

Production function is the relation between the input of the factors of production and the level of

output.

The production function helps the firm determine the quantity of input that can be use do to

produce a specific quantity at the cheapest cost.

The information required for the calculation of the production function includes the different

kinds of costs in production and the total revenue of the products.

C.

Marginal cost and diminishing returns

Marginal cost and marginal product: when the marginal product rises, the marginal cost

increases.

Marginal cost and average variable cost: when the average variable cost decreases, the marginal

cost increases.
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The accountant and manager in a firm would be interested in the short run production

relationships in the effort to reduce the costs of production allowing the maximization of profit.

Question 4

A.

The law of diminishing returns states that the increase in the level of inputs increases the level of

output up to an optimum point where further increase of each input leads to decreased level of

output.

B.

Marginal cost: the extra cost for each extra unit of the product produced.

Total variable cost: the costs that vary with the change of the production level.

Fixed cost: the production cost that does not change with the change in the production level of

the firm.

Average variable cost: the total variable cost for each addition unit of input

Average fixed cost: the costs that don’t vary with change of level of output divided by the

quantity of units produced.

Total cost: the total cost including the total fixed and total variable cost.

C.

The average total cost is the entire cost of producing each unit of production. The ATC is

calculated from the division of the total cost by the total quantity of the units produced.
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D.

Economies of scale refer to the decreased average total cost of production with the increase

of the output of the firm’s plant. Dis-economies of scale refer to the increase in the average

total cost of production with the increase of the level of firms plant and output.

Question 5

A. Characteristics of pure competition:

There is a high population of small firms in the market.

There is presence of identical products with no differentiation in the market

There is ease of entry for new products in the market.

The firms do not control prices and where supply surpasses demand, only firms that adapt

effectively survive

B.

The firm determines whether it should produce, the quantity it should produce and the level of

profit or loss that is acquired.

C.

The maximum profit has to be determined by minimizing the total cost and maximizing the total

revenue.

Question 6
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A. The maximum profit is achieved at the position where the MP and the MC are equal and is

the point at which the firm should produce.

B. The point of profit maximization is the point where the MP and the MC are equal. This is

also the point of production where the loss is minimized. The firm should shutdown if the

average variable costs of producing are higher that the revenue it would get from sales at that

point.

Question 7

A. At the point at which marginal cost and the marginal revenue intersect, it is the break even

where the firm makes the maximum profit or minimum loss. The point under the breakeven

point the firm does not produce in it maximum capacity while the points above this point

means that the firm reduces profit as the quantity supplied is increased.

B. The long run equilibrium makes assumptions that the firms in the market all have identical

cost curves, the firms’ only adjustment is only entry and exit, and the entry or exit has no

effect on the price of resources, or average total cost of the firms.

Question 8

A. Characteristics of pure monopoly:

There are no close substitutes for the products in monopoly.

The monopoly firm controls prices.

There is only one firm in the market that produces the goods unlike many firms in pure

competition.

The increase in sales is achieved by reducing prices.

The products sold by the monopoly are usually standardized.

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Unlike pure competition, the entry into the market is blocked due to factors such as legal

issues, technology and economic factors.

B.

The firms could use differentiation to create more diverse products in the market and also

produce more superior products than those in the market. the firms could also benefit from

opening up new multiple branches of their stores as well as building a stronger brand for their

company. The use of better packaging for the products and use of advanced marketing tools for

their products would also help the firms penetrate the market.

C.

The monopoly market also uses the marginal profit and marginal cost rule where the profit is

maximized when the marginal cost and the marginal profit is equal. The monopoly is also the

price maker in the market. the increase in price reduce the total revenue of the firm.

Question 9

A. The monopolistic market also utilizes the rule where the marginal profit and marginal cost

are equal at the of profit maximization

B. The assumptions applied to a monopoly include the securing of the firm through patents,

economies of scale and the resources of the firm. The monopoly market also assumes that

there is government regulation and the firm issues similar charges for all the units they sell.

C. The dilemma for government in monopoly market includes non regulation which leads to

under allocation of resources and the firms maximize their profit. The other choice is the

setting of a socially optimum price the price will only be equal to the marginal cost. The
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other choice is fair-return price where there would be productive efficiency by equating the

price to the average total cost.

Question 10

A. Monopolistic competition characteristics:

There is a large population of companies in the market similar to pure competition

Also, the firms don’t set the prices like pure competition

The firms do not agree on the pricing of products

There is ease of entry to the market

The requirement of capital are lower and the economies of scale are also fewer unlike monopoly

markets.

There are differentiated products in the market.

B.

The products of the firms are slightly different from each other, the firms have multiple locations

for their stores and the products as well as services differ in quality. Such firms include apple,

Microsoft and IBM

C. The firm’s profit is maximized at the position at which MC and MR are equal which when

exceeded the firm is producing in excess capacity.

Question 11

A. Characteristics of oligopoly:

There are fewer producers than monopolistic market with large market shares
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There are standardized and differentiated products in the market

The producer control the price similar to monopoly

The firms like monopoly are protected by patents.

The capital requirement unlike monopolistic is considerably high even owning the raw materials

Unlike pure competition, the market has significant barriers to entry.

B. Maximum profitability will be reached at the point in the curve where marginal profit is

equal to marginal profit.

C.

The producers have similar or close costs and demand curves allowing them to collude on the

prices of their products. They may limit their output or set a common price for their products.

This may be done through illegal written agreements or just a gentleman’s agreement.

The firms sometimes reduce their price to match the price decrease of other producers, or ignore

price increases by other producers.

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