Effect of a Fall in Demand on a Firms Price and Profit - Air New Zealand - Assignment Example

Assessment Item 2: Short Answer Questions by Course: Tutor: University: Department: 10th January 2011 Question 1 a) Price discrimination occurs when a firm successfully sells similar products at varied prices in diverse markets where such difference in price is not because of differences in marginal cost. An example to demonstrate price discrimination in airline industry is the case of Air New Zealand and Qantas where Qantas prices airfares at 25% lower in markets monopolized by Air New Zealand. b) The assumptions of monopolistic competition are as follows: Many producers and consumers hence concentration is low There is product differentiation hence consumers are aware of non-price differences among different competitor products. Products have some level of price control thus are classified as price makers. Low barriers to entry and exit c) Monopolistic competition is not efficient in allocation of resources mainly because of the negatively sloping demand curve as well as its ability to determine price in the market. The negative slope of demand curve means that monopolistically competitive firm is able to charge a price that is greater than marginal revenue. The price is also greater than marginal cost at the profit maximizing level. This inequality between price and marginal cost contributes to inefficiency in allocation of resources. d) Adjustment process of a firm in a monopolistically competitive industry is illustrated in figure 1. Figure 1: Effect of a fall in demand on a firm’s price and profit If a firm is currently in the long-run, it means that Average Total Cost Curve is tangent to the demand curve. At the same time, price is equal to Average Total Cost hence; the firm is making zero profits. Given this long-run position, a fall in demand has the effect of shifting demand curve to the left in the short-run. The result is that Average Total cost exceeds the price consequently giving rise to losses indicated by the shaded region. In the long-run, firms that are making losses will exit the industry. Demand in the remaining firms will increase to shift the demand curve rightwards. This returns the firm to a profit situation where price is higher than average total cost. Question 2 a) Costs and benefits of a firm operating under perfectly competitive firm is shown in the table below i. Profit maximizing level of output for a competitive firm occurs where marginal private cost is equal to marginal revenue. From the table above, output of 7 units results in equality between marginal private cost and marginal revenue. ii. Socially efficient level of output is given by the output level where marginal social cost is equal to marginal revenue. The output of 5 units results in equality between marginal social cost and marginal revenue. iii. The reason for the rising marginal pollution costs is that the environment becomes less capable of handling the pollution as additional units of output are produced. b) Trade unions i. Trade union is seen to be an advantage by workers in a union because unions allow workers to negotiate with their employers as a group. There is also job security in a union as opposed to non-unionized job. ii. Trade union is seen to be a disadvantage by workers in non-unionized jobs because of union fees charged on a monthly basis Question 3 a) Circular flow of income is the movement of income and goods between various sectors of the economy. As an example, a firm combines various factors of production during their production activities. Owners of the factors of production in turn receive wage for labour, rent for land and interest for investment funds. Entrepreneur as well receives profit. Households purchase the output from production and the money received by firms is used to pay for the factors of production. This is the circular flow of income. One of the assumptions in circular flow of income is that households spend all income on output from firms. Secondly, firms produce output that is demanded by households. Thirdly, earnings received by firms are distributed as wages, salaries, rent, interest, and profits. Injections and withdraws prevents circular flow of income and money from becoming constant. Savings, taxes, and imports are withdrawals from circular flow. On the other hand, investments, government expenditure, and exports are injections into circular flow. These injections are financed through retained earnings or borrowings and results into additional circular flow of income. b) In circular flow of income, an increase in exports leads to more income in an economy. Households will start to consume more consequently creating output shortage. Firms are then obliged to purchase for more capital goods in order to bridge the shortage. This can be through import of capital goods. In this case, imports will increase. Since consumption has increased, net taxes would also rise because more goods are purchased by households. The GDP will increase because of income flow from foreign nation resulting from exported goods. c) When planned injections are less than withdrawals, national income would decline, which in turn results in lower growth. Unemployment is also high when injections are less than withdrawals. This is because few jobs are created when economic growth is low. Inflation is low when planned injections are less than withdrawals. The reason for this observation is low demand in the economy, which pushes the price downwards. Net export tends to increase when injections are less than withdrawals because domestically, people do not have enough incomes to import goods. A decline in imports means that net exports increases. Question 4 a) The National Minimum Wage Order 2013 is the most recent minimum wage decision, which provides a national minimum wage of $622.20 per week, causal loading of 24 per cent, and various rates of special national minimum wage. In 2012, national minimum wage was at $606.40 per week and causal loading of 23 per cent. The categories of special national minimum wage were also low. This increment in national minimum wage would have a negative impact on unemployment because high wage rate is a burden to an employer. Unemployment rate would therefore increase. b) The concept of multiplier is a theory of income, output, and employment. It gives a relationship between changes in income following a change in investment (Cohn, 2007). Economically, an increase in investment leads to an increase in income. Income in this case does not increase equally to the increase in investment but by several times. This number of times that income increases is called the multiplier. The slope of AE is shown below Since the slope is 0.75, then the multiplier is If full employment is achieved at level of GDP of $200 billion, there will be a deflationary gap of $40 billion. The reason is that output is less than potential of the economy or rather level of full employment. This is illustrated in the figure 2 below. Figure 2: deflationary gap c) In order to close the gap, government expenditure has to change as follows: Reference List Cohn, SM 2007, Reintroducing Macroeconomics: A Critical Approach, London, M.E, Sharpe. Read More