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ASSIGNMENT ECO162 MICROECONOMICS JULY NOV 2009 Instructions: 1. Form a group of 4 or 5 members. 2.

. On the cover of the assignment, please write: a. Names and matrix no. of ALL group members. b. Programme/part/group. 3. The assignment must be submitted NO LATER than 15th October 2009.

TASK 1 Answer ALL questions. 1. 2. 3. 4. Explain how Socialism and Capitalism solve the three basic economic problems. Explain 4 differences between Islamic and conventional economic systems. Explain the concept of scarcity, choice and opportunity cost. Draw all diagrams (with labels) as stated below: a. Chapter 1: The concave PPC with points showing efficient production, inefficient production and scarcity problem. b. Chapter 2: i) The consumers equilibrium. ii) The changes in Qd and changes in Dd curve. c. Chapter 3: Market equilibrium with a floor price. d. Chapter 4: i) The production curves (TP, MP, AP) in one diagram. ii) The cost curves (TC, TVC and TFC) in one diagram. e. Chapter 5: i) Perfect Competition curve the 3 short run profits and long run profit. ii) Monopoly curve the 3 short run profits and long run profit. iii) Oligopoly curve the Sweezys model. Write down the formula to calculate cross elasticity of demand. Explain the importance of its coefficient. Summarize the concept of the Law of Diminishing Marginal Return. Explain 4 determinants of demand. Explain 4 determinants of price elasticity of demand. Using a diagram, explain and distinguish between elastic supply and inelastic supply. Discuss 4 characteristics of monopolistic competition.

5. 6. 7. 8. 9. 10.

TASK 2 (PAST FINAL EXAMS) Answer PART C ONLY. Each group must select ONE of the past final exam questions as listed below. Please make sure that you dont choose the same question. Attach a copy of the question. 1. 2. 3. 4. 5. 6. 7. APR 2009 OCT 2008 APR 2008 OCT 2007 APR 2007 OCT 2006 APR 2006 8. 9. 10. 11. 12. 13. 14. NOV 2005 MAR 2005 OCT 2004 MAR 2004 OCT 2003 APR 2003 SEP 2002 15. MAR 2002 16. SEPT 2001

QUESTION 1 Explain how Socialism and Capitalism solve the three basic economic problems.
There are three basic economic problems, there are What to produce?, How to produce? And For whom to produce?. In different economy systems there are different ways to overcome or solve this problems The first basic economic problem is What to produce?. In Capitalism, they use price mechanism to overcome this problem. The price consumers willing to pay serves as signal for producer to decide what to produce. Normally they will produce product that are highly demanded. In Socialism, the decision are made by the goverment. The authority plans what to be produced based on society need not indiv idual need. Second basic economic problem is How to produce?. In Capitalism, producers normally choose methods in order to maximize profits. They can either choose labor intensive or capital intensive based on prices of the factors. In Socialism, the methods determined by the government depending on economic purpose. Capital intensive is used to increase economic growth while labor intensive is used to reduced unemployment problem. The third basic economic problem is For whom to produce?. In Capitalism, it depends on consumer purchasing power. If income increase, they will increase their demand. In the othet hand, in Socialism, goverment fairly divide the goods to the society. The basic needs will be distributed according to overall society needs.

QUESTION 2 Explain 4 differences between Islamic and Co nventional Economic S ystems.


There are many differences between Islamic and Coventional economic systems. The differences are, there is no separation between religion and economics in Islam. Everything is under Allah. The second different between Islamic and conventional economic systems is in Islamic economic is religiously value loaded. In Islam, we have clear cut between haram and halal. There are more halal items than haram that can be explore by people. Other than that, Islam prohibits riba. This is to promote social justice and to uphold the principle of brotherhood. Islam use equity participation and profit sharing (mudharabah). Lastly, in Islam the concept utility is for this world and hereafter, not just for this world satisfaction only. Muslim produce goods and services according to their hierarchy of needs. For example in Malaysia, majority people are Muslim so it could prevent people from doing the bad things. Then, its will decrease the gap between poor people and rich people. Citizens also would change their mind set, from negative to positive. All people are same range because all of the human is creation of Allah s.w.t.

QUESTION 3 Explain the concept of scarcity, choice and oppurtunity cost.


Scarcity is the situation in which human wants are forever greater than available supply of time, goods and resources. It occurs when the society wants exceed the ability of the economy to meet those wants. This is because human wants are unlimited, whereas the resources to satisfy these wants limited. Choice, it occurs when you choose something or when a decision is made on certain preference that will give maximum satisfaction. Choice will involve a set of alternatives and decision is made due to cost, benefits and satisfaction. Opportunity cost is the second best alternatives that a person has to forego. Anything that consumer has to give up or sacrifice in order to gain somethings. Example, we have two choice to make, to buy fried chicken or to buy burger. The opportunity cost of buy fried chicken is we have to forego burger and vice versa.

Question 4
Draw all diagrams (with labels) as stated below: a. Chapter 1: The concave PPC with points showing efficient production, inefficient production and scarcity problem. b. Chapter 2: i) The consumer s equilibrium. ii) The changes in Qd and changes in Dd curve.

c. Chapter 3: Market equilibrium with a floor price. d. Chapter 4: i) The production curves (TP, MP, AP) in one diagram. ii) The cost curves (TC, TVC and TFC) in one diagram. i) Perfect Competition curve the 3 short run profits and long run profit. ii) Monopoly curve the 3 short run profits and long run profit. iii) Oligopoly curve the Sweezy s model.

e. Chapter 5:

Note : Answers behind.

QUESTION 5 Write down the formula to calculate cross elasticity of demand. Explain the importance of its coefficient.
FORMULA of Cross Elasticity of demand (PEDxy):

PEDxy =
=

Q x = initial quantity of good X Q x = new quantity of good X P y = initial price of good Y P y = new price of good Y

The importance of coefficient of cross elasticity of demand is how responsive the quantity demanded of one good is to a change in the price of another good. If the cross elasticity of demand is a positive (+), then, the relationships of goods is a substitute goods. When cross elasticity of demand is a negative (-), then, the relationship of goods is a complementary goods. If the cross elasticity of demand is equal to 0, the relationship of goods is a unrelated goods.

QUESTION 6 Summarize the concept of the Law of Diminishing Marginal Return.


Law of Diminshing Marginal Return states that after a certain point, when additiona l units of variables input (eg. labor) are added to fixed input (eg. capital or land), the Marginal Product (MP) of the variable input declines. In other word, additional workers are applied to a constant amount of capital equipment (fixed resources), output will eventually rise by smaller and smaller amounts as more worker are employed. We must assume that the all units of variable input are equal in quantity. The significant of Law of Diminishing Marginal Return is to enable the producers to identify the most economical stage of production, given the fixed and variables factors of production. The example is, assume that we have a small furniture factory, which has several machines for cutting, painting and so on. In this situation, we use labour as our variable input. Many things such as raw materials and utilities can be the variable input in real world. If we have one or two worker, our production would be very slow. We can solve this problem by adding more workers in our factory. The marginal product of each succeeding worker would arise, as the operation become more efficient. The benefit of specialization could be realized. But, if we keep adding workers, the problems of overcrowding would arise. Worker has to wait to use the machines. Now, total output would increase at a diminishing (decrease) rate. Some machines may be over-utilized. If we add more workers, the marginal product would become negative- total product (output) would decline instead of increasing, because the factory become so crowded and congested until no work can be done. Some workers would sit idling, could not do any work.

QUESTION 7 Explain 4 determinants of demand.


First determinant of demand is the price of related goods. A change in the price of related good may increase the demand for a product, depending on wether the related good is a substitute or a complementary. Substitute goods is a pair of goods alternatives to each other. Examples, coffee and tea, magarine and butter. As a price of one good goes up, the demand for its substitute will also increase. Thus, Dd curve of substitute will shift to right. Complementary goods is a pair of goods consumed together. Examples, camera and film, cars and petrol. As price of one good goes up, the demand for its complementary good will fall. Thus, Dd curve of complements shift to left. Second determinant of demand is consumer s income. As income increase, buying power will increase. Therefore, demand for most goods will rise. Th ere are different effects on different goods. If it is a normal/luxury goods, when income increase, demand also increase. If the goods is a inferior goods, when income incr ease, demand will decrease. If the goods is a necessities, when income increase, dem and will be constant. Tastes and preference also is the determinant of demand. The more desirable people find the good, the more they will demand. Affected by advertising, trend of fashion, by consideration of health, by the experience from consuming the good on previous occasions etc. Example, brand-conscious person / comfortable with certain brand, therefore the more you will demand for th at product even thought there is no change in price. Last but not least, seasons and climate also the determinant of demand. Seasons or climate can also affect demand. For example, in rainy season, people will use umbrellas or rain coats. Therefore demand for those products will increase. Different products will also be demanded at different festive seasons. For example, during Hari Raya, traditional Malay cookies, baju kurung, raya card will be highly demanded.

QUESTION 8 Explain 4 determinats of price elasticity of demand.


First, determinant of price elasticity of demand (PED) is the number and closeness of substitute goods. The more substitute and the closer they are, the more elastic the demand will be. For example, automobiles like Toyota, Honda, Ford, Nissan and many others became perfect substitute for Proton. So the demand curve for Proton must be elastic. For good s that has no close substitute, the demand is highly inelastic. Second, determinant of price elasticity of demand is the proportion of income spent on the good. The higher the proportion if income that is spent on a particular good, the more we will be forced to cut consumption when its price increase. Therefore price elasticity of demand will be more elastics. The lower the proportion of income spent on certain good, then the more inelastic the demand will be. Habit forming also is the determinant of the price elasticity of demand (PED). The more people get used to one product, the more inelastic the demand will be. Pe ople don t want to switch to other products). The fourth determinant of price elasticity (PED) is the time period. The longer the time period after a price of certain goods changed, the more elastic is the demand. Example, price of a rises by 20%, the consumers may not switch immediately, but as time goes by they may shift to other brand of shampoo.

QUESTION 9 Using a diagram, explain and distinguish between elastic supply and inelastic supply.
ELASTIC
P

Ss P P

% Qs > % P :

The Ss curve is less steep. The coefficient = 1 < PES < Elastic supply means that an increase in price causes a bigger increase in supply. It has a PES of greater than 1. Supply will be elastic if it is easy for a firm to increase supply e.g. spare capacity in factory, easy to employ more factors of production. INELASTIC
P Ss

P P

% Qs < % P :

The Ss curve is steep. The coefficient = 0 < PES < 1 Inelastic demand. This means that an increase in price causes a smaller increase in supply. It has a PES of less than 1. Supply is often inelastic in short -term, when it is difficult for firms to increase their capacit

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QUESTION 10 Discuss 4 characteristics of monopolistic competition.


First characteristic of monopolistic competition is many sellers. The industry has many sellers but less than in perfect competition industry. The firm only has a small market share. Each firm has a comparatively small percentage of the total market, so each has limited control over the market. There are no collusion, because the presence of large number of firms ensure that collution is very unlikely and there is little interpendence, each firm can determine its own pricing without considering the possible reactions of rival firms. One seller cuts its price and increase in sales, the other firm may not fell it. Differentiated products is also the characteristic of monopolistic competition. Monopolistic competition provide produts slightly different from competing products with regard to product attributes, services to consumers, location and accessibility, or other qualities, real or imagined. In a simple word, differentiated products explain the products are similar in nature but different in terms of packaging, quality, brand names etc. Third characteristic of monopolistic competition is relative easy entry and exit. Anybody can set up firms easy but not as easy in perfect competition. New firms have to come up with new product features and brands to compete or establish their reputations. Lastly, the non-price competition. It has significant role because sellers cannot really compete in terms of prices. Examples, advertising and packaging. Monopolistic competition firms advertise their products heavily in effort to inform consumer about their product differentiation, a strategy to make price less important factor in consumer purchases and product differences is a greater factor.

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PAST FINAL EXAM QUESTION PAPER - MARCH 2004


PART C (30 MARKS)

Question 1
a) Discuss how a capitalist economy uses market mechanism to solve basic economic problems. In this economic system, consumers are very powerful they can influence the producer decisions. The price they are willing to pay for any goods, serve as signals for producer and seller to decide what to produce and how much to produce. Producer will produce goods that are higher demanded which pay the highest price in order to maximize profits. Price of resources and production factors or inputs, indicate what production methods to use to minimize production cost. The three basic economic problems is what goods and services will be produced? Due to limited resources, all economic must make a choice. They may use different decision making rules and mechanisms on deciding in what goods to be produce more of one goods, we have to produce less of another good. How will goods and services be produced? The economic system must determine how output is to be produced. Which resources should be used, and how output is to be produced. Which resources should be used, and how they should be combined to production, more labor and less capital, etc. m order to maximize production. For whom will goods and services be produced? Who will consume the goods and services produced? What is the basis of the distribution? This question is also known as a distribution question.

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b With th h lp of n pp op i t di oppo tunit ost


xpl in th

on pts of s

it

hoi

Choice occ s whe you choose some hing or when a decision is made on certain pre erence that will give satis action. Based on the diagram, the points PPC signifies the concepts of choice. We have to make a choice among the various combination of rice and car. To move an alternative A to alternative B, it means that we have made a choice of producing more rice and less car. Opportunity cost is anything that consumers has to give up or sacrifice in order to gain something. From the PPC, we can say that if we switch from point B to point C we are actually sacrificing the production of the car in order to produce more rice. Scarcity occurs when the individual or society wants e ceed the ability of the economy to make those wants. This is because human wants are unlimited, whereas the resources to satisfy these wants are limited. Based on the diagr m above, if we choose to a produce at point Y, it is unattainable due to the problem of scarcity or not enough resources to produce at that point.
     

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nd

Question 2
a) Explain why agricultural products are more supply price inelastic compared to that of industrial products. Firstly, the time period or adjustment period of agriculture products are responsive to price. This means that a change in market price during which producer cannot respond with the change quantity of supplied. For example, a farmer planting tomatoes, he must sell his current crop at whatever price, his current supply is inelastic because tomatoes cannot be stored for long time and any change in price can only affect the next growing season. In short-run, the crops capacity of individual producers is persumed fixed. But they still have limited way to increase production and supply. Example, a farmer can use more fertilizer to increase output in response to a presumed increase in demand. Agricultural product requires a long period of p roduction, from planting to harvest. That will make the agriculture products is inelastic. The agriculture products also are perishable. If the products are easily perishable, then the supply would be inelastic. Even the price is increase supplier would no t increase their quantity supply in large volume due to perishable problem. Examples of agriculture products that is perishable are tomatoes, carrot, fish etc. Sometimes the agriculture products are too costly to store, it will have a low elasticity of Ss (inelastic). Goods that are too costly to be store is goods that are to be store in large amount. As example, fishes or vegetables that harvests in large quantity. Most of the industrial products that are not perishable compare agricultural products. The time period to produce the industrial products is short. This is because of the nature of the industrial products are long lasting and more durable than agricultural products. So, the supply of the industrial products is elastic. The firm can use any kind s of materials for its input resulting in supply of its output become elastic. b) Explain the difference between a change in quantity supplied and a change in supply. Change in supply and change in quantity supply is the same concept as change in demand and change in quantity demanded. Change in supply means a change in the entre schedule or a shift of the enterer curve. It is caused by a change in one or more of the determinants of supply such as number of sellers, technology, resource price, taxes and subsidies, expectation, and price of other goods. But change in supply is a change in any one or more of these determinants of supply or supply shifters will more the supply curve for a product either to the right (increase in supply- producers supply larger quantity of the product at each possible price) or to the left ( decrease in supply). Resource price, the higher resource (input of the production) price will raise the production cost and reduce the profit. In technology, improvement in technology enabl es firms to produce more unit of output at lower costs; these increases the firms profit and therefore encourage them to increase their supply. Managerial specialization (managerial economies). Large-scale production also means better use of, and greater specialization in management.

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Question 3 a) With the use of a diagram, describe the three (3) stages of production in the short -run.

TP/AP/MP Stage 1 Stage 2 Stage 3

TP

AP 0 MP Q of L

Stage 1 . The firm will start from the source until the intersection of MP and AP.
There is a sharp will increase of TP as we increase the units of variable input, example labor. It means that each additional will increase in labor units results in greater increase of TP. For rational producer will continue producing goods at this stage since TP can be increase by adding more labor.

Stage 2 . From the intersection of MP and AP until MP equal 0 and TP at the max. The
values of AP and MP are decreasing but still positive. This is the most efficient stage of production it because the combination of variable and fixed inputs are used efficiently. The inputs are fully utilized; no machines are left idle as we have the right number of labors to operate all machines. A rational producer will produce at this stage. If the firm continues produce the product after this stage, the TP will start to decline.

Stage 3 . Begins when MP=0 and continues to decline thereafter. A rational producer
should not be producing the product at this stage. It because, TP start to decline. There is overutilization of capital.

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b) Explain four (4) factors that lead to economies of scale experienced by large -scale firms.
The four factors that influence is job specialization, it means one worker with only a few tasks, repeating the same work, increase the skills, quantity will increase also and the AC will decrease. Other than that, marketing economies, it means the firms buy inputs in bulk, get special discounts, decrease the cost and AC will decrease also. Then, financial economies, big and established firms normally get favorable term when borrow money from banks (lower interest rate and longer repayment period). The fourth one is managerial economies. This means that when a manager can manage a bigger output efficiently at the same wage, quantity increase and AC will decrease.

Question 4. a) Compare any four (4) characteristics of perfect competition and monopoly.

Perfect competition Many buyers and sellers. y Neither of them have the influence over the market price. y The sellers are normally the price takers because the output sold is relatively small compared to the market volume. Free entry and exit. y Firms can enter the industry without restrictions from relevant authorities or government. y Firms can also freely exit from the market if incur losses. Role of non-price competitions. y Producers or seller in this market structure don t have to advertise their product. y Even if they do advertise, no guarantee the sales will increase. y The product is sold by many other sellers or a fixed price. Perfect knowledge. y Both buyer and sellers have perfect knowledge of market condition. y If a seller increases the price, the other sellers and the buyers will come to know about it.

Monopoly Sole producer. y There is only one seller with many buyers.

There are barriers to entry. y There are restrictions for a new firm to enter the market. ( government laws and regulations)

Role of non-price competition. y Advertisement is not needed to promote sales. Since the monopolist is the only seller in the market, consumers do not have other choice. If advertising is undertakes, this is to have a good relationship with the consumers.

The monopolist has power to control the market price.

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b) Explain why firms in a perfectly competitive industry are not able to maintain supernormal profit in the long -run. P ATC P P MR P P D 0 Q 0 D Q P S S

Single firm Industry Show the long run equilibrium position of a competitive firm, P= MC= Minimum ATC. Temporary profit.

ATC

S S

P P MR

P P D D

Single firm Industry Show the long run equilibrium position of a competitive firm, P= MC= Minimum ATC. Temporary loss.

Entry eliminates economic profit. If P exceeds ATC, the economic profits enjoyed by the existing firm will attract new firm to the industry. Supply will increase unti l it force the P back to minimum ATC. Exit eliminates losses. If P less than ATC, the firm will incur losses. This will cause the firm to leave the industry. As they leave, total supply will decline, bringing the P back to equality with minimum ATC. In the short run, firms may not have sufficient time to liquidate their assets and go out of the business. In long run equilibrium. The firm produces at MR=MC and the price is equal to minimum ATC. Economic profit here is zero, and the industry is in equilibrium . The existing firms are earning normal profit.

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