Principles of Economics - Assignment Example

Running Header: Principles of Economics Student’s Name: Instructor’s Name: Course Code & Name: Date of Submission: 1a I would build a free-market economy. According to Chand (2005, p. 116) a free market economy is a market in which most of the production takes place in the market sector and it is free from control of the government or the central authorities. In a free market economy the production, purchase decisions and sales taken by households and firms determine the allocation of resources. b. i In a free market economy goods and services are voluntarily exchanged without the intervention of the central government. Under this market the well being of the nation is determined by the interaction of the forces of demand and supply. In free market economy the means of production are owned privately (Hussain 2010, p. 19). On the other hand, a centrally controlled market is one which the prices of goods and services are determined by the government. In the centrally controlled market, the government determines how much the producers are to produce and sell. b. ii According to Hussain (2010 p. 19) a free market is advantageous because it ensures efficient allocation and utilization of resources and at the same time it prevents monopolies from forming. However, the free market economy can create a barrier towards attaining a balanced social welfare because it may lead to the concentration of wealth to a few members of the society. On the other hand, a centrally controlled economy is stable and it ensures all the needs of the public are met. However, it may lead to underutilization of resources, lack of innovation and the public may have few options to choose from. 2 a Demand refers to the quantity of goods that customers are willing and able to purchase at any given period of time. Mankiw (2011, p. 11) notes that the relationship between the price and quantity demanded is explained by the law of demand. The law of demand states that the demand of a product decreases with the increase in its price. On the other hand quantity demanded increases with a decrease in price while holding all the other factors constant. At price P0 the quantity demanded Q0 when the price is increased to P1 quantity demanded decreases to Q2 and when the price is reduced to P2 quantity demanded increases to Q2 2 b The characteristics of the demand curve are determined by the volume of demand. High volumes of demand can cause the demand curve to shift to the right while low volumes of demand can make the demand curve to shift to the left (Simanovsky 2010, p. 454). In addition, the characteristic of the demand curve is determined by the consumption habits. A change in the consumption habits can either shift the demand curve upwards or downwards. Moreover, the aggregate demand also determines the characteristic of the demand curve. A population containing many customers will have a more slighted demand curve as compared to a population with fewer consumers. 3 a According to Forgang and Einolf (2007, p. 122) the percentage change in demand of a product as compared to the percentage change in the price of another commodity is referred to as the cross-price elasticity of demand. It is used to indicate how buyers are ready to substitute one product for another in response to changes in their relative prices. High cross-price elasticity of demand indicates that buyers are readily willing to substitute one product for another relative to their changes in price. Therefore, an organization can use cross-elasticity of demand to determine whether a reduction in price will attract more buyers and at the same time whether an increase in price will make the organization to lose its customers. 3 b Income elasticity of demand refers to the percentage change in quantity demanded of a product due to a relative percentage change in the income of a customer. Taylor and Weerapana (2011, p. 95) notes that there are three types of income elasticity of demand. Positive income elasticity occurs when an increase in the consumer’s income leads to an increase in demand. Furthermore, a negative income elasticity of demand arises when an increase in consumer’s income leads to a reduction in demand. On the other hand, zero price elasticity arises when a change in customer’s income does not change the quantity demanded. Therefore, an organization can utilize income elasticity of demand in order to determine whether an increase in its customers’ income will lead to an increase in demand. This can assist in determining the amount of output to produce. 4 Q P TR TC MR MC TFC TVC AFC AVC AC 0 10 0 8 0 0 8 0 0 0 o 1 10 10 15 10 7 8 7 8 7 15 2 10 20 20 10 5 8 12 4 6 10 3 10 30 26 10 6 8 18 2.67 6 8.67 4 10 40 34 10 8 8 26 2 6.5 8.5 5 10 50 44 10 10 8 36 1.6 7.2 8.8 6 10 60 56 10 12 8 48 1.3 8 9.3 7 10 70 70 10 14 8 62 1.14 8.86 10 8 10 80 85 10 15 8 77 1 9.6 10.6 9 10 90 100 10 15 8 92 0.89 10.2 11.09 GRAPH SHOWING TFC, TVC AND TC A GRAPH SHOWING TC, TFC, TVC, AC, MC AND MR The firm maximizes its profits at an output of 5 units. At this point MC=MR. At this point the firm makes the highest revenues of $6. 5 A perfectly competitive market is characterized by a large number of firms who sell an identical product (Boyes & Melvin 2011, p.221). This is similar to a monopolistic market which is also characterized by many firms. Additionally, in a perfect competition market firms can easily enter or exit the market. Similarly, in a monopolistic market there are no barriers to enter the market and this means that firms can easily enter and exit the market. Furthermore, in the long run, firms in both the perfect competition market and in the monopolistic market make normal profits. On the other hand, firms in both the monopoly and the monopolistic market have a downward sloping demand curve. In addition, marginal cost is less than the price of products in the monopoly and the monopolistic market structures. A monopoly market structure is characterized by a single firm this is different from both the monopolistic and perfect competition markets which are characterized by many firms. Moreover, a monopoly determines the product price and output. This is different from a perfectly competitive market where price and output is determined by the forces of demand and supply. However, in a monopolistic market firms have some control over the market price of their products. Furthermore, in a monopoly there are barriers in entering the market while in both the perfect competition market and in the monopolistic market there are no barriers to entry. Nevertheless, the demand curve in a perfectly competitive market is horizontally slopping while in both the monopoly and the monopolistic market the demand curve is downward sloping. Finally, firms in perfectly competitive market produce identical products while in a monopoly only one product is produced. Firms in a monopolistic market structure produce many products (Taylor and Weerapana 2011, p. 95). 6 According to Tucker (2010, p. 173) a monopoly can only maximize profits by producing at a level of output that is within the elastic range. This is because in the inelastic range of the demand curve a reduction in price leads to lower revenues. It therefore means that when total revenue decreases, marginal revenue becomes negative and this means that the monopolist is unable to maximize profits in the inelastic region of the demand curve. For instance, if the price of the commodity is $4, the monopoly will be forced to increase its price to $ 5 so as to increase revenues. However, in inelastic demand increase in price increases profits hence the monopolist cannot maximize profits. The monopolist would thus prefer to produce within the inelastic part of the demand curve. This is because; at any point within the inelastic range the marginal cost incurred by the monopoly is positive. Therefore, at an output level where marginal cost is equal to the marginal revenue, the marginal revenue is positive. Thus, when marginal revenue is positive the monopoly is able to maximize revenues. 7 McEachern (2011, p. 419) notes that money circulates in the economy in order to facilitate the exchange of goods and services. Money is a medium of exchange and thus it is used to finance transactions in the economy. Circulation of money in the economy enables individuals to exchange resources and products. The Circular Flow of Money Source: O’Connor (2006, p. 54) The inner flow of money is represented by the households and the businesses. The households receive money inform of income while businesses receive money inform of revenues. On the other hand, injections refer to an increase in income which is outside the circular flow. For instance the businesses may borrow funds to make payments to the factors of production hence inject more money in the circular flow. Withdrawals or leakages occur when income received by one sector is not passed on to the other sector. It is that part of income that does not go back to the circular flow in form of expenditure (Jain &Khanna 2009, p. 138). For instance, the household may fail to spend the amount of income received to purchase the goods and services produced hence cause a withdrawal. An equilibrium position is attained when the amount of withdrawals is equal to the amount of injections. 8 According to Mankiw (2011, p. 536) a multiplier effect is a measurement that is used to determine the amount of economic activity that can be created at the national level of the economy by combining investment and purchases. The multiplier is used to indicate the effect of investment on the economy or the ratio of the increase in the total output to the increased amount of investment by the government. Therefore, a renewed demand for mining resources in Brisbane town will make the Australian government to invest money in the town hence this will create employment in the town. The increased income that the workers will have will make them to increase their spending on consumer goods. This means that the amount of purchases made by the consumers will increase as a result of an increase in their incomes. Firms will be forced to produce more output in order to meet the increased aggregate demand. To do this, the firms will be strained to invest more on production. Therefore, the increased investment by the firms will create a positive multiplier effect on the economy. The investment by the government in Brisbane town will lead to increased demand and this will force firms to invest more funds on investment hence create positive multiplier effect on the economy. 9 Money performs three important functions in an economy and they include; a medium of exchange, a store of value and a unit of account (Mankiw 2011, p. 339). Money acts as a medium of exchange when buyers give it to the sellers in exchange of a commodity. It involves transfer of money from the buyer to the seller in order to facilitate the completion of a transaction. Gold and diamond can perform the function of money as a medium of exchange. Sellers can readily accept gold and diamond because of the fact that they are valuable minerals hence this can make them to act as a medium of exchange. Additionally, gold and diamond can be used as a store of value. A person can buy gold or diamond and store it and eventually sell it at a future period. Thus gold and diamond can effectively serve as a store of value. Wheat and strawberries can also act as a store of value. According to Taylor (2006, p. 229) a unit of account is something that allows purchasing power to be carried out from one period to another. Thus, individuals can buy and store wheat and strawberries and then sell them in the proceeding period. The money received can assist them to make their purchases. Moreover, millers and processors can accept the two products as a means of payment. Buyers can use wheat and strawberry to purchase processed products which use both commodities as inputs. On the other hand, a time deposit can effectively act as a store of value whereby it can be used to purchase products in a future period. 10 Fiscal balance refers to the balance of the government in relation to its actual revenues and its expenditures from both the budget and the non-budget allocations. It is the difference between the total revenues and the total expenditures which is calculated as a percentage of the gross domestic product. According to United Nations (2007, p. 186) the fiscal balance assists the government in determining changes in its financial position on an annual basis. The fiscal balance plays an important role in preventing balance of payment disequilibrium and inflation. In addition, it can be used by the government to increase economic efficiency by limiting the size of the public sector. The business cycle refers to the fluctuations in the economic activities which occur around the long term growth path of a country (Chand 2005, p. 117). A business cycle is characterized by periods of stagnation, above the trend growth periods and below the trend growth periods. They are oscillations in the aggregate economic activities and they particularly affect output, employment, profits and prices. Unlike fiscal policy which is considered annually, business cycles are considered over the long term growth in the economy. 11 According to Chand (2005, p.139) a free trade area refers to a free grouping of countries whereby tariffs and other barriers to trade have been eliminated. The countries that form the free trade area remove all the barriers that may restrict trade among themselves but each country maintains the trade barriers to the third countries. The removal of barriers and tariffs facilitates free movement of goods and services among the member countries. The governments that form the member countries are allowed to choose the way to treat the goods and services that may originate outside the non-members. Countries that are members of a free trade area are not restricted from joining other regional organizations. On the other hand, a common market refers to an agreement among a group of countries with an aim of creating a free trade area. According to Lipsey and Chrystal (2007, p. 637) the agreement sets common barriers to non-trade members and free movement of capital and labour among themselves. Therefore, unlike the free trade area, countries that form a common market adopt common tariffs and barriers to non-members. The governments in the common market are required to treat goods that originate from non members in a uniform set way. 12 The depreciation in the exchanges rates of a country can reduce the national income hence reduce the aggregate demand. Mirzaie and Kandil (2007, p. 3) note that the depreciation of the currency stimulates exports and reduces imports. The reduction in value of the currency reduces the prices of the exports and increases the prices of the imports. However, if imports exceed the amount of exports an imbalance or disequilibrium in trade occurs and this has the effect of reducing the real income that is within the economy of the country. Appreciation of the exchange rates lowers the price of the imports and at the same time it increases the prices of the exports. This can create imbalance in trade due to high number of imports as compared to the country exports. According to Lipsey and Chrystal (2007, p. 754) the low cost of imports reduces the demand for locally produced products because the consumers may prefer the cheap imports. This can in turn discourage investments and hence affect the country’s economic growth. References Boyes, W & Melvin, M 2011, Microeconomics, Cengage Learning, Mason Chand, S 2005, Dictionary of Economics, Atlantic Publishers, London. Forgang, W & Einolf, K 2007, Management Economics, M.E Sharpe, New York. Hussain, T 2010, Economics, Laxmi Publications, New Delhi. Jain, T & Khanna, O 2009, Economics Concepts and Methods, FK Publications, New Delhi. Lipsey, R & Chrystal, A 2007, Economics, Oxford University Press, Melbourne. Markiw, G 2011, Principles of Economics, Cengage Learning, Mason. McEachern, W 2011, Economics, Cengage Learning, Mason. Mirzaie, I & Kandil, M 2009, The Effects of Exchange Rate Fluctuations, International Monetary Fund, London. O’Connor, E 2006, The Basics of Economics, Greenwood Publishing Group. London. Simanovsky, S 2010, Microeconomics for Beginners, Global Publishers, New York. Taylor, J & Weerapana, A 2011, Principles of Microeconomics, Cengage Learning, Mason. Tucker, I 2010, Survey of Economics, Cengage Learning Mason. United Nations 2007, Economic and Social Survey, United Nations, Geneva. Read More