QUESTION
Using the same amount of resources, Australia and New Zealand can both produce apples and oranges as shown in the following table, measured in thousands of tonnes.
SOLUTION
|
Australia |
New Zealand |
||
|
Apples |
Oranges |
Apples |
Oranges |
|
12 |
0 |
6 |
0 |
|
3 |
3 |
3 |
3 |
|
0 |
4 |
0 |
6 |
- i. Does either country have an absolute advantage in producing both goods? Explain your answer.
Answer: Yes. Each country has comparative advantage over other in producing at least one good.
|
|
Exchange Rate |
|||
| Situation No. | Australia | New Zealand | Australia | New Zealand |
|
1 |
Apples |
Apples |
Oranges |
Oranges |
|
2 |
2 |
1 |
0 |
0 |
|
3 |
1 |
1 |
1 |
1 |
|
4 |
0 |
0 |
0.67 |
1 |
As the above table of exchange rate shows that in the situation 1 when Australia produces only apples has comparative advantage over New Zealand because exchange rate is 2:1 i.e Australia produces just 2 times more apple than New Zealand.
In situation 2 there is no comparative advantage when both the countries producing both the goods.
In situation 3 when both the countries producing only Oranges ,exchange rate is 0.67:1 that means New Zealand has comparative advantage over Australia.
Thus above table and explanation shows that either of the country is having comparative advantage only when they produce the good of comparative advantages.
- ii. Who has a comparative advantage in producing apples? Who has a comparative advantage in producing oranges? Explain your answer.
Answer : Australia has comparative advantages in producing Apples because for every one unit production of apple in New Zealand ,Australia produces 2 apples.
New Zealand has comparative advantages in producing Oranges because for every 0.67 orange production in Australia, New Zealand produces 1 orange.
iii. Suppose that both countries are currently producing 3000 tonnes of apples and 3000 tonnes of oranges. Show that both can be better off if they specialize in producing one good and then engage in trade. Explain your answer, with the aid of diagrams.
Answer : As the above diagram shows if both the countries produces both the goods then there is no comparative advantage . For 1 apple Australia has to give 1 orange and same happens in New Zealand.
But If both the countries start specializing in producing one good and then engage in trade as below table shows Australia has comparative advantage in producing apples for 1 orange it can give maximum 2 apples to New Zealand.
Similarly ,if New Zealand specializes in producing oranges then it can get 1 apple for less than 1 orange i.e orange >.67
|
Australia |
New Zealand |
Exchange Rate |
|||||
|
Apples |
Oranges |
Apples |
Oranges |
Australia | New Zealand | Australia | New Zealand |
|
|
|
|
|
Apples |
Apples |
Oranges |
Oranges |
|
12 |
0 |
6 |
0 |
2 |
1 |
0 |
0 |
|
3 |
3 |
3 |
3 |
1 |
1 |
1 |
1 |
|
0 |
4 |
0 |
6 |
0 |
0 |
0.67 |
1 |
|
|
Australia specializes in apples
|
|
New Zealand specializes in oranges
|
|
|
|
World Output |
||||||
| Possibility |
Australia |
New Zealand |
World Output |
|||
| – |
Apples |
Oranges |
Apples |
Oranges |
Apples |
Oranges |
| All apples |
12 |
0 |
6 |
0 |
18 |
0 |
| Autarky |
3 |
3 |
3 |
3 |
6 |
6 |
| All oranges |
0 |
4 |
0 |
6 |
0 |
10 |
The above table shows that World output is maximum when both the countries specializing in the good in which they have comparative advantages.
Question 2. (15 marks)
The Olympic legend, Ian Thorpe, decided to retire from swimming to undertake a double degree in linguistics and psychology at Macquarie University. To concentrate on his university studies, he pulled out of lucrative sponsorship work. In 2010, after realising that he might be close to bankruptcy, Thorpe returned to swimming championship training and sponsorship work in the hope that he might be able to slowly rebuild his financial and celebrity status whilst remaining a high grade point average (GPA) at university. He can only dedicate 40 hours a week on either study or sponsorship. If he dedicates the entire 40 hours on study a week, he will maintain a GPA of 4.0. If he dedicates the entire 40 hours on sponsorship a week, he will earn $40,000 weekly. Thorpe’s achievement in terms of GPA and sponsorship money according to the time he dedicates to each are provided below.
|
GPA |
Sponsorship $(000) |
|
0 |
40 |
|
1.0 |
37 |
|
2.0 |
30 |
|
3.0 |
18 |
|
4.0 |
0 |
- i. Construct Thorpe’s production possibility frontier with grades (in terms of GPA) on the horizontal axis and sponsorship (in terms of money earned) on the vertical axis. Explain why his PPF takes this shape.
Answer :
|
|
PPF
|
|||
|
|||
|
|||
|
|
|
|
|||||||||
|
Ian Thorpe’s PPA take this shape due to increasing opportunity cost.
- PPF touches X-axis because he gains maximum GPA when sponsorship money is zero at Y-axis.
- PPF touches Y-axis because he gains maximum sponsorship money when he gets zero GPA at X-axis.
- Between A & B points he has to leave sponsorship money at increasing rate for every GPA point.
- ii. What is Thorpe’s marginal cost of GPA? Show and explain how his MC curve is derived.
Answer :
|
GPA |
Sponsorship $(000) |
Marginal Cost of GPA $(000) |
|
0 |
40 |
– |
|
1 |
37 |
3 |
|
2 |
30 |
7 |
|
3 |
18 |
12 |
|
4 |
0 |
18 |
|
. MC of GPA
|
|
.
|
.
|
.
|
|
|
|
|
|||||||||
|
The above table and graph shows that for every one GPA he has to sacrifice sponsorship money at increasing rate.
For 1st one point of GPA he has to leave $5000 money , for 2nd point he has to leave $7000 ,for 3rd point he has to leave $12000, and for 4th point he has to leave $18000. Thus his sacrifice of money for every GPA is increasing it is called increasing marginal opportunity cost.
- iii. Above is the table of the swimmer’s marginal benefit from an increase in grade. If Thorpe uses his time to achieve allocative efficiency, what is his GPA and how much sponsorship money will he earn?
Answer :
|
GPA |
MB $(000) |
MC of GPA $(000) |
|
0 |
– |
|
|
1.0 |
20 |
3 |
|
2.0 |
13 |
7 |
|
3.0 |
7 |
12 |
|
4.0 |
3 |
18 |
|
. MB of GPA
. MC of GPA
|
|
.
e .
|
. .
|
.
|
.
|
|
|
|
|||||||||
|
Above table and the graph shows that after 2 GPA MC is greater than MB . Therefore he should aim at scoring GPA between 2-2.5 then he can achieve allocative efficiency and maximize the gains.
Allocative efficiency exists where marginal cost is equal to marginal benefits. In the above graph point e shows allocative efficiency.
iv. What would happen if Thorpe wins 2 Gold Medals in the London Olympics in 2012, thereby substantially increasing his sponsorship income? Explain what happens to his PPF, MC curve, MB curve, and efficient time allocation?
Answer :
If Thrope wins 2 Gold Medals in the London Olympics in 2012, thereby substantially increasing his sponsorship income, his PPF will not change. Thrope’s PPF shows the grade he can produce for different hours of swimming and these production possibilities are unaffected by his Gold Medals winning. Hence Thrope’s MC curve will not change. However Thrope’s MB from swimming increases because of winning of Gold Medals MB curve shifts rightward. As a result, his efficient allocation of time now allocates more time to grades which will result in higher grades.
Question 3. (20 Marks)
Calvin Harris is planning a concert in Sydney. Harris’s manager (Mark Gillespie) is considering changing the way the artist’s concert tickets are priced. You are the head economist of the consulting firm, E2C (Economists to Celebs) Gillespie hired to estimate the demand for Harris’s concert tickets. You classified people who go Harris’s concert into two groups, and discovered two different demand: the demand curve for the general public (QP = 500 – 5P) and the demand curve for students (QS = 200 – 4P).
- i. Graph the two demand curves on one diagram. If the current price of tickets is $35, identify the quantity demanded by each group.
Answer:
| Price | Qp | Qs |
|
50 |
250 |
0 |
|
45 |
275 |
20 |
|
40 |
300 |
40 |
|
35 |
325 |
60 |
|
30 |
350 |
80 |
|
25 |
375 |
100 |
|
20 |
400 |
120 |
|
15 |
425 |
140 |
|
10 |
450 |
160 |
|
0 |
500 |
200 |
If the current price is $35 then quantity demanded by general public is 325 and demand by students is 60.
- ii. The manager wants to increase price by $10 a ticket. What is the price elasticity of demand for each group? You must explain the meaning of these elasticity values to Gillespie.
Answer :
Price elasticity for general public
Price(OLD)=35
Price(NEW)=45
QDemand(OLD)=275
QDemand(NEW)=325
% change in price= [Price(NEW) – Price(OLD)] / Price(OLD)
By putting values in the above formula we get :
[45-35]/35 = 0.286
Calculating the Percentage Change in Quantity Demanded
[QDemand(NEW) – QDemand(OLD)] / QDemand(OLD)
By putting values in above formula we get :
=[275-325]/325 =-0.154
Price elasticity of demand = (% Change in Quantity Demanded)/(% Change in Price)
By putting values in above formula we get :
Price elasticity of demand = -0.154/0.286 = -0.54
Price elasticity of demand for public group is -0.54 that means demand is price inelastic . A 1% increase in price will decrease demand by .54%.
Price elasticity for students
Price(OLD)=35
Price(NEW)=45
QDemand(OLD)=60
QDemand(NEW)=20
% change in price= [Price(NEW) – Price(OLD)] / Price(OLD)
By putting values in the above formula we get :
[45-35]/35 = 0.286
Calculating the Percentage Change in Quantity Demanded
[QDemand(NEW) – QDemand(OLD)] / QDemand(OLD)
By putting values in above formula we get :
=[20-60]/60 =-0.67
Price elasticity of demand = (% Change in Quantity Demanded)/(% Change in Price)
By putting values in above formula we get :
Price elasticity of demand = -0.67/0.286 = -2.34
Price elasticity of demand for students is -2.34 that means demand is price elastic. A 1% increase in price will decrease demand by 2.34%.
- iii. You need to explain to the manager that charging a price of $35 for each ticket will not maximise the revenue for the artist from ticket sales. Gillespie understands you better if you use diagrams.
Answer :
| Price | Qp | Qs | TRp | TRs |
|
50 |
250 |
0 |
12500 |
0 |
|
45 |
275 |
20 |
12375 |
900 |
|
40 |
300 |
40 |
12000 |
1600 |
|
35 |
325 |
60 |
11375 |
2100 |
|
30 |
350 |
80 |
10500 |
2400 |
|
25 |
375 |
100 |
9375 |
2500 |
|
20 |
400 |
120 |
8000 |
2400 |
|
15 |
425 |
140 |
6375 |
2100 |
|
10 |
450 |
160 |
4500 |
1600 |
|
0 |
500 |
200 |
0 |
0 |
|
|
||||
| Maximum |
12500 |
2500 |
||
The above table shows that revenue is not maximum when price is $35. Revenue from general public is maximum when the price is $ 50 and from students is maximum when the price is $25.
The above graph shows that revenue is not maximum when the price is $ 35.
Now let’s see the total revenue from both the groups.
| Price ($) | Qp | Qs | TRp | TRs | TRp+TRs |
|
50 |
250 |
0 |
12500 |
0 |
12500 |
|
45 |
275 |
20 |
12375 |
900 |
13275 |
|
40 |
300 |
40 |
12000 |
1600 |
13600 |
|
35 |
325 |
60 |
11375 |
2100 |
13475 |
|
30 |
350 |
80 |
10500 |
2400 |
12900 |
|
25 |
375 |
100 |
9375 |
2500 |
11875 |
|
20 |
400 |
120 |
8000 |
2400 |
10400 |
|
15 |
425 |
140 |
6375 |
2100 |
8475 |
|
10 |
450 |
160 |
4500 |
1600 |
6100 |
|
0 |
500 |
200 |
0 |
0 |
0 |
|
Maximum |
13600 |
||||
The above table and graph shows that revenue from both the groups is maximum $13600 when the price is $ 40 for each ticket.
- iv. Suggest what price the manager should charge if he wants to maximize total revenue collected from ticket sales? The manager will appreciate if you use the same diagram (drawn part iii) to explain. Suppose Mark Gillespie discovers that the group, 30 Seconds to Mars, is selling concert tickets at an adjoining venue. You subsequently find out the general public prefers Calvin Harris while the group is more popular with students. The students’ demand curve for 30 Seconds to Mars is QS = 200 – 2P and there is no demand from the general public.
Answer :
| (I) | (II) | (III) | (IV) | (VI) |
| Price | Qp | Qs | Qs for 30 seconds to Mars |
TRp |
|
50 |
250 |
0 |
100 |
12500 |
|
45 |
275 |
20 |
110 |
12375 |
|
40 |
300 |
40 |
120 |
12000 |
|
35 |
325 |
60 |
130 |
11375 |
|
30 |
350 |
80 |
140 |
10500 |
|
25 |
375 |
100 |
150 |
9375 |
|
20 |
400 |
120 |
160 |
8000 |
|
15 |
425 |
140 |
170 |
6375 |
|
10 |
450 |
160 |
180 |
4500 |
|
0 |
500 |
200 |
200 |
0 |
The above table and the graph shows that if students are buying tickets from 30 seconds to Mars then Calvin Harris can have maximum reveune if he sets price for general public at $ 50 where revenue would be $ 12500.
- v. What quantity is demanded of the group’s concert tickets if the price is set at $35?
Answer : If price is set st $ 35 demand = QP = 500 – 5P
= 500-5*35 = 325
vi. Assume that Gillespie kept ticket prices for Calvin Harris’s concert at $35 a ticket while he considered your earlier findings. You receive a call from the box office that quantity of tickets sold to students fell after the tickets for 30 Seconds to Mars went on sale. You subsequently find out that when the group’s ticket drops from $35 to $30 a ticket, Calvin Harris only sold 40 tickets to students. You must explain Gillespie (using the elasticity concept), how the group’s pricing strategy affected Harris’s revenue from ticket sales.
Answer :
Price is falling from $35 to 30 ,that means price is falling $ 5.In part (ii) we found price elasticity of demand for students’ group is -2.34 1% increase in price will decrease demand by 2.34%.
As per given demand equation demand at price $35 is = 200-4*35 = 60
He could sold only 40 tickets at $35 and now at price of $ 30 he can sell 20+20*(5*2.34%) = 22.34
Revenue at $35 = $35*40 =$1400
Revenue at $30 = $30*22.34 = 670.2
Total Revenue = $2070.2
Without competition he could have earned = $35*60 = 2100
Loss due to group’s pricing strategy = 2100 -2070.2= $29.8
Question 4. (Part A – 15 marks; Part B – 10 marks)
(A) The table provides information on the demand schedules for train travel for Ann, Brian and Mark.Assume they are the only buyers in the market.
|
QUANTITY DEMANDED (KM) |
|||
| PRICE ($ PER KM) |
ANNE |
BRIAN |
MARK |
|
3 |
30 |
25 |
20 |
|
4 |
25 |
20 |
15 |
|
5 |
20 |
15 |
10 |
|
6 |
15 |
10 |
5 |
|
7 |
10 |
5 |
0 |
|
8 |
5 |
0 |
0 |
- i. Show using the appropriate number of diagrams, how the market demand curve is constructed using information about individual demand.
Answer :
|
QUANTITY DEMANDED (KM) |
||||
| PRICE ($ PER KM) |
ANNE |
BRIAN |
MARK |
Market Demand |
|
3 |
30 |
25 |
20 |
75 |
|
4 |
25 |
20 |
15 |
60 |
|
5 |
20 |
15 |
10 |
45 |
|
6 |
15 |
10 |
5 |
30 |
|
7 |
10 |
5 |
0 |
15 |
|
8 |
5 |
0 |
0 |
5 |
Above table and the graphs show that market demand is obtained by adding individual demands.
- ii. What are the maximum prices that Ann, Brian, and Mark are willing to pay to travel 20 kilometres? Explain why?
Answer :
Maximum price that Ann is willing to pay to travel 20 kilometers is $5 per KM that is $ 5* 20 = $ 100
Maximum price that Brian is willing to pay to travel 20 kilometers is $4 per KM that is $ 4* 20 = $ 80
Maximum price that Mark is willing to pay to travel 20 kilometers is $3 per KM that is $ 3* 20 = $ 60
- iii. What is the marginal social benefit when the total distance travelled is 60 kilometres?
Answer :
When total distance travelled is 60 kilometers ,price is $ 4 per KM. In case of individual demand maximum demand at $ per KM is 25 Km. So marginal social benefit = 60*4 – 25* 4 = 240 – 100 = $ 140
- iv. What is the marginal benefit for each person when they travel a total distance of 60 kilometres. How many kilometres does each person travel?
|
QUANTITY DEMANDED (KM) |
||||
| PRICE ($ PER KM) |
ANNE |
BRIAN |
MARK |
Market Demand |
|
3 |
30 |
25 |
20 |
75 |
|
4 |
25 |
20 |
15 |
60 |
|
5 |
20 |
15 |
10 |
45 |
|
6 |
15 |
10 |
5 |
30 |
|
7 |
10 |
5 |
0 |
15 |
|
8 |
5 |
0 |
0 |
5 |
When they travel a total distance of 60 kilometers ,ANNE travels 25 KM ,BRIAN 20 KM and MARK 15 KM.
v. What is each traveler’s consumer surplus when the price is $4 a kilometre? What is the market consumer surplus when the price is $4 a kilometre?
Answer :
ANNE’s consumer surplus = $4 *25 =100/2 = $50
BRIAN’s consumer surplus = $4 *20 = 80/2 = $ 40
MARK’s consumer surplus = $4*15 = 60/2 =$ 30
Market consumer surplus = $4* 60 = 240/2 =$ 120
(B) Chinese power plants have run short of coal, an unintended effect of government mandated price controls — a throwback to communist central planning…To shield the public from rising global energy costs…Beijing has also frozen retail prices of gasoline and diesel…Oil refiners say they are suffering heavy losses and some began cutting production last year, causing fuel shortages in parts of China’s south. CNN, May 20, 2008 (Assume the market for various types of fuel are not affected by global prices or markets.)
i. Are China’s price controls described in the news clip price floors or price ceilings? Explain how China’s price controls have created shortages or surpluses in the Chinese markets for coal, petrol, and diesel, using the supply and demand model to illustrate.
Answer:
China’s price control described in the news clip price is price ceiling .
Price D
D
Demand &Supply
The above graph shows that in China earlier equilibrium was at point E now doe to price ceiling producers are facing losses and hence cutting down the production. Therefore supply curve shift from S to S1 and equilibrium reaches at E1 where price cannot go up and quantity supply is decreasing.
- iii. Show how China’s price controls have changed consumer surplus, producer surplus, total surplus, and the deadweight loss in these markets, using the diagram(s) drawn in part i.
- iv. Answer :
Price s D S1
CS
g t
h k
PS1 i PS
D
j
Demand &Supply
At equilibrium E when there is no price celing
Consumer surplus (CS) is skh area
Producers’ surplus (PS) is hkj area
At equilibrium E1 when there is price ceiling
Consumer surplus is sgt area
Producers’s surplus is gti area
Question 5. (20 marks)
ITunes is rapidly dominating the global market for music sale. Assume that the download price for Dance artist Calvin Harris’s single “Feel So Close” is $1.19 and the number of downloads per day world-wide is 3000. What will happen to the market for this single if the following events occur:
(i) The population of Dance music fans decreases AND productivity in music production increases?
Answer : In this case demand and price for this download will go down.
Price D
D1 S1
P
E1
P1
D1 D
Q1 Q Demand &Supply
Above graph shows that due to decrease in no. of fans for dance music and increased productivity supply curve has shifted from S to S1 ,hence supply has increased due to increased productivity and demand curve has shifted downward that demand has decreased due to decrease in no. of fans for dance music. Because these shifts in demand and supply curves , price has come down from P to P1.
(ii) Dance fans switches away from Dance music to R&B music AND the price of MP3 players increases
Price D
D1 S1
D2
P
E1
P1
P2
D1 D
D2
Q2 Q1 Q Demand &Supply
Answer : Further demand and price will go down .
The above graph shows that demand has come down from D1 to D2 curve and price also has come down from P1 to P2.
(iii) The number of other Dance singles decreases on iTunes AND income increases
Answer : In this case demand will go down and price will not change.
(iv) The artist is rumoured to have died AND the download price of Paul Simon’s “You can call me Al” decreases substantially.
Answer : In this case demand and price for single will go up .
Each event (i, ii, iii and iv) occurs independently (ceteris paribus). For each of the following situations, explain what will happen to the equilibrium price and the equilibrium quantity for the download of “Feel So Close” on iTunes. For each part, you must:
I) draw an appropriately labeled diagram,
II) show the adjustment process from the original to the new equilibrium, and
III) a detailed written explanation of this adjustment process.
Question 6. (Research Question – 15 Marks)
- i. Explain the concept of externality in economics? Give one example of a positive and a negative externality in Australia.
An externality in economics is the effect of the production or consumption, on third party who is neither producing nor consuming that good.
These externalities are categorised as : Positive externalities and Negative Externalities
Positive externalities are like benefits received from a firm opened in rural area where it will have to build infrastructure which will benefit to rural people.
Negative externalities are from air pollution from factories
- ii. Why we need to distinguish between private cost and social cost?
We distinguish between private cost and social cost because both have different implications in accounting. Private cost is the cost incurred in procuring the production resources ,in production process and selling. Private cost is included in every financial decision of business like while determining price, profit, cost etc.
While social cost is private cost plus externalities. Therefore if a firm avoids paying for negative externalities then it should pay for social cost because firm operates in the society and for having socially efficient production rate it has to pay for social cost.
- iii. In regards to air pollution, use a diagram to show and explain how the existence of pollution can make the market equilibrium inefficient.
Social costs
P2
P1
Q2 Q1
Equilibrium will be where private cost curve cuts demand curve that is P1 price and Q1 quantity at this point firm reaps maximum benefit.
But due to negative externality (pollution) equilibrium should be where social costs curve cuts demand curve at P2 price and Q1 quantity.
The above diagram shows that due to social cost caused by pollution has shifted equilibrium results increase in price from P1 to P2
- iv. Show on the same diagram (in part iii), how efficiency can be achieved with pollution tax
Private costs + Tax
P2
P1
Q2 Q1
Thus above diagram shows that due to tax firm has to produce less Q2 and sell it at higher price P1.
- v. Briefly explain using a supply and demand model, how the carbon tax introduced by the Gillard Government will affect the market for a good that relies on products from the mining industry.
If the carbon tax introduced by the Gillard Government will affect the market for a good that relies on products from the mining industry, price for mining raw material will go up and demand for raw material is inelastic therefore any increase in price of raw material will not change the demand and supply for the good.
REFERENCES
- N. Gregory Mankiw.(2005). Principles of MICROECONOMICS, 4th Edition, Thompson Publishers, with Aplia. URL:http://econ.aplia.com
- Bergstrom, T. C. and Miller, J.H. (2000).Experiments with Economic Principles: Microeconomics (2’nd edition,, ISBN:0-07- 226518-X)
- Varian, H: (2000): Microeconomic Analysis, W.W. Norton, New York.
- Koutsoyiannis, A. (1979). Modern Microeconomics (2nd ed), Macmillan Press, London.
- Stonier, A.W and Hague (1972): A Text Book of Economic Theory, ELBS, London.
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