Microeconomics Example

Microeconomics

Using the production possibilities model below, illustrate where each concept is located on the graph and explain the following each economic concepts:

1.

1. opportunity cost

2. increasing costs

3. unemployment

4. scarcity

Opportunity cost

Opportunity cost is a measure of the value of money foregone in order to achieve another good, in the above diagram the opportunity cost at point E that has 80 units health care and 50 units of education, to achieve 70 units of education then the opportunity cost is 80-60 units of health care.

Increasing costs:

As we give up one unit for another there reaches a point where you have to give up more units to get one unit, from point C to B is an example, from point C to B we give up 20 units of health care to get only 10 units of education.

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Unemployment:

Point G shows a point where there are idle resources in the economy. This point shows under utilization of resources and therefore shows unemployment.

Scarcity

Point A shows scarcity of health care because we have 100 units of health care and 0 units of education. Point F shows scarcity of education because it shows the availability of 100 units of education and zero units of health care.

Because beef and chicken are substitutes, when the price of chicken decreases then people demand more chicken and the quantity demanded of beef decreases, this shifts the demand curve down ward bringing the equilibrium price and demand to a lower level for beef.

1.

1. meat cutter wages decrease

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Microeconomics

when the meat cutter wage decreases the cost of production for beef decreases shifting the supply curve down wards

1.

1. incomes decrease

When income decreases the demand by consumers will go down because their disposable income will be lower and therefore they will demand less beef, therefore the demand curve will shift down wards bringing the equilibrium price and quantity downwards.

1.

1. import quotas on foreign beef are increased

When import quotas are increased then the supply of beef goes down and this will result into a shift in the supply curve upwards as follows, the equilibrium price will now be higher.

1. Define price          elasticity of demand.

Price elasticity of demand is the responsiveness of demand to a change in price

Explain what an elasticity coefficient >1 implies.

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Microeconomics

When the coefficient is greater than one then this means that if we increase the price by one unit then the quantity demanded will decrease by more than one unit

What factor or factors might explain why this value is >1.

If the price elasticity of a good is greater than one then it is possible that the good has a close substitute and the good is produced in a free market

Explain what an elasticity coefficient <1 implies.

When the elasticity is less than one then a change in price by one unit will decrease the demand by less than one unit.

What factor or factors might explain why this value is <1.

For a good to have a coefficient of elasticity less than one then it is possible that that good has no close substitute.

Draw a graph illustrating each case.

an elasticity coefficient >1 implies.

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Microeconomics

An elasticity coefficient <1 implies.

4. Returns to scale is a production concept, while an economy of scale is a cost concept. Using an example describe each and explain how they are related.

Economies of scale refer to the cost concept where the cost of producing goods and services reduces as a result of increased production when the fixed costs are divided into many production units. For example if the cost of producing one unit of a good is 500, where of this cost 100 is the fixed costs, and the total fixed costs are 1000, then our production is 10 units, if we increase the production into 100 units then the fixed cost will still be 1000, but for each unit the fixed cost will be 10, therefore the cost of production for one unit is 410.

Returns to scale is a production concept, it means that as we increase production we will experience a reduction in the cost curve until a point when this cost starts to increase again, there is increasing cost to scale, constant costs to scale and decreasing costs to scale, a firm should produce until there is constant returns to scale.

5 Multiple Choice Questions – Extra credit – 1 point each

1. Price elasticity of demand shows how:

1. To compute the slope of the demand curve.

2. Quantity demanded responds to price changes.

3. Quantity demanded responds to changes in the price of other goods

4. Price responds to quantity change

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2. Which of the following influences the price elasticity of demand?

1. Availability          of substitutes

2. Prices relative to budget

3. Length of time

4. All of the above

3. Ceteris paribus means:

1. Holding everything constant except for the variables you are interested in examining.

examining.

4. The equilibrium price in a market is found where:

1. The market          supply curve intersects the market demand curve

2. The market supply curve intersects the y-axis

3. The market demand curve intersects the y-axis

4. The market supply curve intersects the x-axis

5. If consumers expect PC manufactures to offer rebates next month, consumers will:

1. Increase their demand for PCs today

References:

Anthony Samuelson (1964) Economics, McGraw-Hill publishers, New  York

Stratton (1999) Economics: A New Introduction, McGraw Hill Publishers, New  York

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Philip Hardwick (2004) Introduction to Modern Economics, Pearson Education Press, UK