The Price Level and Output Level of the Cars QUESTION 1 A There are three factors of production, namely land, labor and capital (Manwich, 2008). For a car manufacturing firm, land includes the area where factory is built, labor includes the workforce working in the factories, and capital includes the machinery that improves the efficiency of the workforce. QUESTION 1 B Fixed costs are those that are independent of the firm’s output level. E.g. electricity bills of the car manufacturing plants. (Manwich, 2008) Variable costs are those that depend on the firm’s output level. E.g.
the costs of doors, panels, and seats that increase with every unit produced. (Manwich, 2008) QUESTION 2 A QUESTION 2 B As shows in the graph, the Scrappage Scheme would increase the output level from Q0 to Q1 and increase the price of cars from P0 to p1. The shift from D0 to D1 shows that the demand of new car has increased due the Scrappage Scheme. Because of this higher demand, Q1, the firms increase prices to maximize revenues. This decreases the demand until Q* is reached at price P1, which is the equilibrium price and output level.
QUESTION 2 C The price level and output level of the cars would decrease. This is because the discounted price of new cars would cause the consumers to switch from buying old cars to new cars. The lower demand for used cars would cause firms to decrease the prices to increase sales. However, as the market for used cars would reach equilibrium, the price and output levels of used cars would be lower than before Scrappage Scheme was implemented. QUESTION 2 D The following non-price determinants could increase the demand for new cars 1.
A reduction in taxes. This would increase the disposable income of consumers and as we know that income is directly proportional to demand, the demand for new cars would increase. 2. Reduction in interest rates. This would cause consumers to save less and spend more because the opportunity cost of saving would become higher. This in turn would increase the demand for new cars. QUESTION 3 In making a choice between different alternatives, the next best alternative that we forgo is known as opportunity cost.
(Case & Fair, 2007) The opportunity cost for financing the scheme would be the option to invest in improving public transportation and creating more job opportunities there. QUESTION 4 A The reason for a relatively more elastic PED in larger cities like London is that there is a stable infrastructure for public transport present which the consumers could easily use instead of owning a car. Also, because the over-crowded traffic conditions of cities like London, the consumers are already more prone to using public transport or other means of transport. Therefore, increasing the price of cars, results in a greater decrease in quantity demanded by consumers.
(wisegeek, n.d. ) QUESTION 4 B I If hybrid car manufacturers could convince the consumers that the savings in petrol could be recovered very quickly and that the higher price paid is extremely beneficial in the long run, both for the consumer and the environment, then hybrid cars could be made less price elastic. QUESTION 4 B ii Lower price elasticity gives the firm liberty to increase prices without reducing the demand by the same proportion. This means that firm could increase its total revenue through lower price elasticity.
(Seager, 2006) QUESTION 4 C The higher the income level of the consumers, the higher is the demand for normal and luxury goods. Therefore, an increase in real income would increase the demand for hybrid cars. QUESTION 4 D The main determinant of PES is time. Firms cannot change the supply of products instantly. This means that in the short run, firms would face a more inelastic PES as compared to in the long run. QUESTION 5 A The phenomenon of increasing efficiency of production and as scale of production is increased is known as economies of scale.
Economies of scale results in a lower average cost per unit produced. (Amadeo, n.d. ) QUESTION 5 B When a car manufacturer increases production, it can experience economies of scale through standardizing production techniques. This was first done be Henry Ford. (Case & Fair, 2007) The firm also saves costs through purchasing raw material and components from suppliers in bulk and availing discounts. QUESTION 6 A The four questions to ask are as follows: 1. How many buyers and sellers are present in the industry and what is their strength? 2.
What is the prevailing level of competition between the manufacturers in the industry? 3. How differentiated are the products? 4. With reference to barriers of entry, how easy is entry or exit into the market? (Helpman & krugman, 1985) QUESTION 6 B Following are answers to questions 1, 2 and 3: 1. A large number of buyers and only a few firms are present in the industry. These firms, such as GM, Toyota, Honda, Ford etc. are responsible for most of the car production in the world and hence, they have the ability to influence prices to a great deal. 2.
There is a high level of competition between firms. 3. The products are differentiated in terms of their style, features, performance, and many more ways. QUESTION 7 A Following are the sources of market failure as observed in ‘Greening the Car’: 1. With increasing demand for cars, firms would have to produce more cars to satisfy the demand. This extra production would result in increased levels of carbon dioxide emissions from factories that would increase pollution and harm the citizens. 2. The car manufacturing industry is an oligopoly.
When just a few suppliers dominate the industry without government intervention, they do not work to the public’s benefits. This can be observed through the high prices set for hybrid cars. QUESTION 7 B 1. The government could intervene and limit carbon dioxide emissions for every firm’s factories. If firms exceed that limit, they would have to pay fines. This would cause the firm’s to invest in research and development and find new, innovative techniques to curb the CO2 emissions from their factories. (Frank, 2008) 2. The government could intervene and set a price limit on hybrid cars.
(Frank, 2008) BIBLIOGRAPHY Good, A. & Kahn, R. (n. d.) Economies of Scale. Wiki Invest. Available from http: //www. wikinvest. com/wiki/Economies_of_scale [Accessed April 14, 2010] Case, K, Fair, R. (2007) Principles of Economics. Eighth Edition. Pearson Education Inc. What is the price elasticity of demand (n. d.) wise geek. Available from http: //www. wisegeek. com/what-is-price-elasticity-of-demand. htm [Accessed April 14, 2010] Frank, R. & Bernanke, B. (2008). Principles of Economics. Fourth Edition. McGraw-Hill Companies. Helpman, E. & Krugman, P.(1985). Market Structure and Foreign Trade. Asco Trade Typesetting Limited Seager, H.(2006). Principles of Economics. Elibron Classics Series. Adamant Media Corporation Manwick, G.(2008).
Principles of Economics. Fifth Edition. Cengage Learning. Amadeo, K.(n. d.) Economy of Scale. About. com. Available from http: //useconomy. about. com/od/glossary/g/economy_scale. htm [Accessed April 14, 2010]