Assignment Overview:

1. Question 1

The MP3 player is likely to have an economic demand effect known as the Income effect on demand as the MP3 player is a luxury good. The income can measured as the number of goods and services that it can be utilised to buy. As the income increases the demand for normal goods increase. The MP3 player can be defined as a normal good, a good can further be classified as a luxury depending upon the income of the consumers.The luxury goods have income elasticity greater than 1. Therefore, as the income of the consumer increases the demand for the inferior good is likely to fall. Thus, with the rise in the income of the consumers the demand of the players is likely.

(Sherman et al, 2008)

2. Question 2

2.1 Income Effect on the Demand for Goods

The income effect can be defined as with the increase in the income of the consumer, the purchasing power of the consumer increases leading to the increase or decrease in the demand of particular goods. A price change causes the income effect, thus which has an effect on the purchasing power of the consumer. This can be explained with as for instance a consumer a purchased concert tickets for $70 with the increase in the price of the concert tickets to $100, the consumer has to spend additional $30 on the purchase of the tickets. The consumption will now only be possible if there is an increase in the real purchasing power of the consumer, which would lead to purchase of the normal good in this case concert tickets.

(Robert E. et al, 2010)

3. Question 3

I.Demand and Supply Schedule

Figure 1: Demand and Supply Schedules

The wheat market faces a downward sloping demand curve which implies that with the increase in the price of wheat per tonne the quantity demanded of wheat decreases. Similarly, the free market faces an upward sloping supply curve satisfying the law of supply, which implies with the increase in the price in the free market the quantity supplied increases.

II. Equilibrium

The equilibrium in the free market is determined in the when the quantity demanded is equal to the quantity supplied at the corresponding price levels , thus in this case the equilibrium occurs at the price 280, when the quantity demanded and supplied are equal to 600.

III. Government Regulation

The government imposed price up to a certain level in this case 200, is a price ceiling imposed by the government. The price is a maximum ceiling prevents the suppliers charging a higher price than the price determined by the government. The ceiling leads to the creation of excess demand in the free market, this leading to distortion and reducing the surpluses for both the consumer as well as the producer.

In the above figure the excess demand is represented, when the price is fixed at 200 by the government the free market leads to the expansion of demand, thus giving rise to excess demand in the market and ultimately creating distortion in the free market.

(tutor2u.net – accessed on 5/6/2012)

IV. Change in Supply

V. Change in Equilibrium Price and Quantity

With the increase in the supply by 150 tonnes per week for the corresponding price it has led to the expansion of the equilibrium quantity from 600 – 650 tonnes per week. On the other hand the corresponding price levels have decreased from 280- 240.

VI, VII. Change in the Supply

The increase in the supply by 150 units corresponding to each of the price levels has resulted in the increase in the equilibrium quantity from 600 to 650 tonnes per week; however the corresponding equilibrium price has reduced from 280-240 remained the same. The increase in the supply per tonnes has caused the rightward shift of the supply curve resulting in the expansion of the equilibrium quantity in the free market.  Thus there is a situation of excess supply in the market when the demand levels are constant.

4. Features of a Monopolistic Competition

A Monopolistic market can be characterised with the following features

1. Few sellers

An Oligopolistic market structure is characterised by the presence of a few sellers in the market. The firms are close competitors of each other and are dependent upon each other to make the output and pricing decisions.

In a pure competition there are large numbers of sellers , whereas monopoly is a single seller market.

2. Homogenous or Unique Products

A monopolistic firm is characterised with the firms producing homogenous products or a few firms producing unique products. The output can be identical or distinctive from each other.

A pure competition sells homogenous products, whereas monopoly sells highly distinctive products usually characterised by patents or copyrights to protect them as they are developed with high Research and development and are unique.

3. Entry and Exit

A firm cannot enter a monopolistic market structure as there are huge entry costs that exist within the market structure as the market is extremely competitive in nature. Also, Exit costs are high as the firms may be producing unique products which do not have close substitutes in the market. The same is the case with a monopoly, but in pure competition there is free entry and exit.

4. Imperfect Dissemination of Information

The biggest characteristic of the oligopolistic market structure is the presence of imperfect information available to buyers. Buyers do not have complete access to the market information and often are given the information provided by the firms, like the selling price etc. The price given to the buyers may be inclusive of the advertising costs. The same is the case for a monopoly, but in pure competition there is perfect information in the market.

(Hirschey, 2000 Pages 501-519)

5. Monopolistic Competition

(A) Equilibrium Price and Output

The Profit maximization condition in the case of a monopolistic competition can be stated at the point where the marginal costs (MC) is equal to the Marginal Revenues (MR) , Thus MC= MR in this case , this profit maximization output is 4 units sold at a price of 40.

(B) Long Run Equilibrium

As the barriers to entry are limited in the long run, the monopolistic competition attracts new entrants in the market in the long run .Thus making the industry more competitive and driving the industry to zero profits in the long run. Thus, in the long run firms earn zero economic profits. As the entry of new firms in the markets increases in the long run it shifts the demand curve to the left to the point, where the economic profits are 0 in the long run.

Figure: Long Run Equilibrium in Monopolistic Competition (Manikiw , 2008)

6. Oligopoly Characteristics

An Oligopolistic market can be characterised with the following features

1. Few sellers

An Oligopolistic market structure is characterised by the presence of a few sellers in the market. The firms are close competitors of each other and are dependent upon each other to make the output and pricing decisions.

In a pure competition there are large numbers of sellers , whereas monopoly is a single seller market.

2. Homogenous or Unique Products

Aoligopolistic firm is characterised with the firms producing homogenous products or a few firms producing unique products. The output can be identical or distinctive from each other.

A pure competition sells homogenous products, whereas monopoly sells highly distinctive products usually characterised by patents or copyrights to protect them as they are developed with high Research and development and are unique.

3. Entry and Exit

A firm cannot enter a monopolistic market structure as there are huge entry costs that exist within the market structure as the market is extremely competitive in nature. Also, Exit costs are high as the firms may be producing unique products which do not have close substitutes in the market. The same is the case with a monopoly, but in pure competition there is free entry and exit.

4. Imperfect Dissemination of Information

The biggest characteristic of the oligopolistic market structure is the presence of imperfect information available to buyers. Buyers do not have complete access to the market information and often are given the information provided by the firms, like the selling price etc. The price given to the buyers may be inclusive of the advertising costs. The same is the case for a monopoly, but in pure competition there is perfect information in the market.

(Hirschey, 2000 Pages 501-519

7. Pay off Matrix

(A)High Price Strategy

In the case when both the firms in the market agree to practice the high price strategy, this implies that the firm is practicing non price competition and the firms A and B can said to be in Collusive Equilibrium with each other.

(Chauhan, 2010)

(B) High Price for A and Low Price Strategies for B

In the case when A practices a low price strategy and B practices a higher price strategy, it results in higher pay offs of $650 for firm A, while firm B is considerably less at $300. Thus in this case A has a dominant strategy in the market.

(C) High Price Strategy for firm B and low Price for A

In the case when A practices a low price strategy and B practices a higher price strategy, it results in higher pay offs of $650 for firm B, while firm A is considerably less at $300. Thus in this case B has a dominant strategy in the market.

(D) Low Price Strategy for A and B

In the case when both the firms in the market agree to practice the low price strategy, this implies that the firm is practicing non price competition and the firms A and B can said to be in Collusive Equilibrium with each other.

(Chauhan , 2010)

(E) Conclusion

Therefore it can be concluded that if both firms A and B practice a non-price competition or do not indulge in the price wars, both can maximise their pay offs in practicing both high price as well as low price strategies. The price wars lead to distortions in the markets and results the returns and profits for both the firm.

8. References

• Hall, Robert Ernest, and Marc Lieberman. Economics: principles & applications. 5th ed. Mason, OH: South-Western Cengage Learning, 2010. Print.
• Hall, Robert Ernest, and Marc Lieberman. Economics: principles & applications. 5th ed. Mason, OH: South-Western Cengage Learning, 2010. Print.
• “AS Market Failure Maximum Prices.” tutor2u.net. N.p., n.d. Web. 5 June 2012. <tutor2u.net/economics/revision-notes/as-marketfailure-maximum-prices.html>.
• Swann, Michael J., and William A. McEachern. Microeconomics: a contemporary introduction. 2nd ed. South Melbourne: Thomson, 2003. Print.
• Mankiw, N. Gregory. Principles of microeconomics. 3rd ed. Mason, Ohio: Thomson/South-Western, 2004. Print.
• Chauhan, S. P. S.. Microeconomics: an advanced treatise. Eastern economy ed. New Delhi: PHI Learning, 2009. Print.
• Hirschey, Mark. Study guide to accompany managerial economics. Rev ed. Fort Worth, Tex.: Harcourt College Publishers, 2000. Print.

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