Microeconomics assignment

1.Advantages of Price Control

Government- Certain control regulations ensure necessary goods such
as food remain affordable to most citizens. This can be seen in luxury
markets such as in football games where a ticket is set at a maximum
price and not the market price so that the supporter can attend the
game.
Suppliers- Price control ensures suppliers receive enough revenue
allowing them to adjust to the market climate and limit the possibility
of a shortage. It is extremely important in the commodities market due
to the frequent fluctuations in price.
Consumers- Price control prevents suppliers from overcharging
consumers. An example is in the housing market. Use of a rent ceiling
put a limit on the amount landlords charged their tenants when the
market would allow for detrimental price gouging.
2.Challenges faced by the government in a Planned Economy
The needs of the society are often ignored for the betterment of
the economy. Workers are not given options on where they can
be employed or where they can move.
The black market explodes in a command economy. Due to the
governmental restrictions, good and services that are not offered
in the command economy begin being offered on the black
market.
The amounts of goods being produced are not balanced. One item
will be mass produced whereas another will not have enough to
support the economic needs. The government entity that controls
the economy has difficulty obtaining up-to-date information
about the needs of the consumers. Many times, rationing
becomes a way of life within a command economy.
Exporting goods becomes problematic because it is difficult for
the controlling entity to determine which products and prices will
be most successful within the global market
In a Planned Economy, the cost of gathering information for
planning is very high.
3. Five different levels of price elasticity
Perfectly Elastic Demand
Perfectly elastic demand is said to happen when a little change in price
leads to an infinite change in quantity demanded. A small rise in price
on the part of the seller reduces the demand to zero. In such a case the
shape of the demand curve will be horizontal straight line as shown in
the figure.

The figure 1 shows that at the ruling price OP, the demand is infinite. A
slight rise in price will contract the demand to zero. A slight fall in price
will attract more consumers but the elasticity of demand will remain
infinite (ed=). But in real world, the cases of perfectly elastic demand
are exceedingly rare and are not of any practical interest.
Perfectly Inelastic Demand
Perfectly inelastic demand is opposite to perfectly elastic demand.
Under the perfectly inelastic demand, irrespective of any rise or fall in
price of a commodity, the quantity demanded remains the same. The
elasticity of demand in this case will be equal to zero (ed = 0).
Unitary Elastic Demand
The demand is said to be unitary elastic when a given proportionate
change in the price level brings about an equal proportionate change in
quantity demanded. The numerical value of unitary elastic demand is
exactly one i.e. Marshall calls it unit elastic.

Relatively Elastic Demand

Relatively elastic demand refers to a situation in which a small change
in price leads to a big change in quantity demanded. In such a case
elasticity of demand is said to be more than one (ed > 1). This has been
shown in figure 4.
Relatively Inelastic Demand
Under the relatively inelastic demand, a given percentage change in
price produces a relatively less percentage change in quantity
demanded. In such a case elasticity of demand is said to be less than
one (ed < 1). It has been shown in figure 5.

All the five degrees of elasticity of demand have been shown in figure 6.
On OX axis, quantity demanded and on OY axis price is given.

It shows:
1. AB Perfectly Inelastic Demand
2. CD Perfectly Elastic Demand
3. EG Less than Unitary Elastic Demand
4. EF Greater Than Unitary Elastic Demand
5. MN Unitary Elastic Demand
4. Features of markets
The Perfect Competition Market

Perfect Competition is a theoretical market structure. It is primarily

used as a benchmark against which other, real-life market
structures are compared.

Perfect competition is the opposite of a monopoly, in which only a

single firm supplies a good or service, and that firm can charge
whatever price it wants because consumers have no alternatives
and it is difficult for would-be competitors to enter the
marketplace. Under perfect competition, there are many buyers
and sellers, and prices reflect supply and demand. Also,
consumers have many substitutes if the good or service they wish
to buy becomes too expensive or its quality begins to fall short.
New firms can easily enter the market, generating additional
competition. Companies earn just enough profit to stay in
business and no more, because if they were to earn excess
profits, other companies would enter the market and drive profits
back down to the bare minimum.
Monopoly Market
The Monopoly is a market structure characterized by a
single seller, selling the unique product with the
restriction for a new firm to enter the market.
Features of a monopoly market

Under monopoly, the firm has full control over the supply of a
product. The elasticity of demand is zero for the products.
There is a single seller or a producer of a product, and there is no
difference between the firm and the industry. The firm is itself an
industry.
The firms can influence the price of a product and hence, these
are price makers, not the price takers.
There are barriers for the new entrants.
The demand curve under monopoly market is downward sloping,
which means the firm can earn more profits only by increasing the
sales which are possible by decreasing the price of a product.
There are no close substitutes for a monopolists product.
Monopolistic Competition Market
The model of monopolistic competition describes a common
market structure in which firms have many competitors, but each
one sells a slightly different product.

Many small businesses operate under conditions of monopolistic

competition, including independently owned and operated high-
street stores and restaurants

Monopolistically competitive markets exhibit the following

characteristics:

1. Each firm makes independent decisions about price and

output, based on its product, its market, and its costs of
production.
2. Knowledge is widely spread between participants, but it is
unlikely to be perfect. For example, diners can review all the
menus available from restaurants in a town, before they
make their choice. Once inside the restaurant, they can view
the menu again, before ordering. However, they cannot fully
appreciate the restaurant or the meal until after they have
dined.
3. The entrepreneur has a more significant role than in firms
that are perfectly competitive because of the increased risks
associated with decision making.
4. There is freedom to enter or leave the market, as there are
no major barriers to entry or exit.
5. A central feature of monopolistic competition is that products
are differentiated. There are four main types of
differentiation:

Physical product differentiation, where firms use size,

design, color, shape, performance, and features to make
 their products different. For example, consumer electronics
can easily be physically differentiated.
Marketing differentiation, where firms try to differentiate their
product by distinctive packaging and other promotional
techniques. For example, breakfast cereals can easily be
differentiated through packaging.
Human capital differentiation, where the firm creates
differences through the skill of its employees, the level of
training received, distinctive uniforms, and so on.
Differentiation through distribution, including distribution via
mail order or through internet shopping, such as
Amazon.com, which differentiates itself from traditional
bookstores by selling online.

6. Firms are price makers and are faced with a downward

sloping demand curve. Because each firm makes a unique
product, it can charge a higher or lower price than its rivals.
The firm can set its own price and does not have to take' it
from the industry, though the industry price may be a
guideline, or becomes a constraint. This also means that the
demand curve will slope downwards.
7. Firms operating under monopolistic competition usually must
engage in advertising. Firms are often in fierce competition
with other (local) firms offering a similar product or service,
and may need to advertise on a local basis, to let customers
know their differences. Common methods of advertising for
these firms are through local press and radio, local cinema,
posters, leaflets and special promotions.
8. Monopolistically competitive firms are assumed to be profit
maximisers because firms tend to be small with
entrepreneurs actively involved in managing the business.
9. There are usually many independent firms competing in the
market.
Equilibrium under monopolistic competition

In the short run supernormal profits are possible, but in the long
run new firms are attracted into the industry, because of
low barriers to entry, good knowledge and an opportunity to
differentiate.
Monopolistic competition in the short run

At profit maximization, MC = MR, and output is Q and price P.

Given that price (AR) is above ATC at Q, supernormal profits are
possible (area PABC).

As new firms enter the market, demand for the existing firms
products becomes more elastic and the demand curve shifts to
the left, driving down price. Eventually, all super-normal profits are
eroded away.
Monopolistic competition in the long run

Super-normal profits attract in new entrants, which shifts the

demand curve for existing firm to the left. New entrants continue
until only normal profit is available. At this point, firms have
reached their long run equilibrium.

Clearly, the firm benefits most when it is in its short run and will try
to stay in the short run by innovating, and further product
differentiation
 Examples of monopolistic competition

Examples of monopolistic competition can be found in every high

street.

Monopolistically competitive firms are most common in industries

where differentiation is possible, such as:

The restaurant business

Hotels and pubs
General specialist retailing
Consumer services, such as hairdressing

The survival of small firms

The existence of monopolistic competition partly explains the

survival of small firms in modern economies. Most small firms in
the real world operate in markets that could be said to be
monopolistically competitive.

Evaluation
The advantages of monopolistic competition

Monopolistic competition can bring the following advantages:

1. There are no significant barriers to entry; therefore, markets

are relatively contestable.
2. Differentiation creates diversity, choice and utility. For
example, a typical high street in any town will have many
different restaurants from which to choose.
3. The market is more efficient than monopoly but less efficient
than perfect competition - less allocatively and less
productively efficient. However, they may be dynamically
efficient, innovative in terms of new production processes or
 new products. For example, retailers often constantly must
develop new ways to attract and retain local custom.

The disadvantages of monopolistic competition

There are several potential disadvantages associated with

monopolistic competition, including:

1. Some differentiation does not create utility but generates

unnecessary waste, such as excess packaging. Advertising
may also be considered wasteful, though most is informative
rather than persuasive.
2. As the diagram illustrates, assuming profit maximization,
there is allocative inefficiency in both the long and short run.
This is because price is above marginal cost in both cases.
In the long run the firm is less allocatively inefficient, but it is
still inefficient
Inefficiency

The firm is allocatively and productively inefficient in both the

long and short run.

There is a tendency for excess capacity because firms can

never fully exploit their fixed factors because mass production
is difficult. This means they are productively inefficient in both
the long and short run. However, this is may be outweighed by
the advantages of diversity and choice.

As an economic model of competition, monopolistic competition

is more realistic than perfect competition - many familiar and
commonplace markets have many of the characteristics of this
model.
 The Oligopoly market
The Oligopoly Market characterized by few sellers,
selling the homogeneous or differentiated products. In
other words, the Oligopoly market structure lies between
the pure monopoly and monopolistic competition, where
few sellers dominate the market and have control over
the price of the product.

Under the Oligopoly market, a firm either produces:

Homogeneous product: The firms producing the

homogeneous products are called as Pure or Perfect
Oligopoly. It is found in the producers of industrial
products such as aluminum, copper, steel, zinc, iron, etc.
Heterogeneous Product: The firms producing the
heterogeneous products are called as Imperfect or
Differentiated Oligopoly. Such type of Oligopoly is found
in the producers of consumer goods such as automobiles,
soaps, detergents, television, refrigerators, etc.
 Types of Oligopoly Market
1. Open Vs Closed Oligopoly: This classification is made based on
freedom to enter the new industry. An open Oligopoly is the
market situation wherein firm can enter into the industry any
time it wants, whereas, in the case of a closed Oligopoly, there
are certain restrictions that act as a barrier for a new firm to
enter the industry.
2. Partial Vs Full Oligopoly: This classification is done based on
price leadership. The partial Oligopoly refers to the market
situation, wherein one large firm dominates the market and is
looked upon as a price leader. Whereas in full Oligopoly, the price
leadership is conspicuous by its absence.
3. Perfect (Pure) Vs Imperfect (Differential) Oligopoly: This
classification is made based on product differentiation. The
Oligopoly is perfect or pure when the firms deal in the
homogeneous products. Whereas the Oligopoly is said to be
imperfect, when the firms deal in heterogeneous products, i.e.
products that are close but are not perfect substitutes.
4. Syndicated Vs Organized Oligopoly: This classification is done
based on a degree of coordination found among the firms. When
the firms come together and sell their products with the common
interest is called as a Syndicate Oligopoly. Whereas, in the case
of an Organized Oligopoly, the firms have a central association for
fixing the prices, outputs, and quotas.
5. Collusive Vs Non-Collusive Oligopoly: This classification is
made based on agreement or understanding between the firms.
In Collusive Oligopoly, instead of competing, the firms come
together and with the consensus of all fixes the price and the
outputs. Whereas in the case of a non-collusive Oligopoly, there
is a lack of understanding among the firms and they compete
against each other to achieve their respective targets.
Features of Oligopoly Market
Few Sellers: Under the Oligopoly market, the sellers are few, and the customers
are many. Few firms dominating the market enjoys a considerable control over the
price of the product.
Interdependence: it is one of the most important features of an Oligopoly
market, wherein, the seller must be cautious with respect to any action taken by the
competing firms. Since there are few sellers in the market, if any firm makes the
change in the price or promotional scheme, all other firms in the industry must
comply with it, to remain in the competition.
Thus, every firm remains alert to the actions of others and plan their counterattack
beforehand, to escape the turmoil. Hence, there is a complete interdependence
among the sellers with respect to their price-output policies.

Advertising: Under Oligopoly market, every firm advertises their products on a

frequent basis, with the intention to reach more and more customers and increase
their customer base. This is due to the advertising that makes the competition
intense.
If any firm does a lot of advertisement while the other remained silent, then he will
observe that his customers are going to that firm who is continuously promoting its
product. Thus, to be in the race, each firm spends lots of money on advertisement
activities.

Competition: It is genuine that with a few players in the market, there will be an
intense competition among the sellers. Any move taken by the firm will have a
considerable impact on its rivals. Thus, every seller keeps an eye over its rival and
be ready with the counterattack.
Entry and Exit Barriers: The firms can easily exit the industry whenever it
wants, but has to face certain barriers to entering into it. These barriers could be
Government license, Patent, large firms economies of scale, high capital
requirement, complex technology, etc. Also, sometimes the government
regulations favor the existing large firms, thereby acting as a barrier for the new
entrants.
Lack of Uniformity: There is a lack of uniformity among the firms in terms of
their size, some are big, and some are small.
5. Theory of Production

The Theory of production explains the principles by which a business firm decides how
much of each commodity that it sells (its outputs or products) it will produce, and
how much of each kind of labor, raw material, fixed capital good, etc., that it employs
(its inputs or factors of production) it will use. Economics, models and theories are
generally not dynamic; they are fixed to a time. So, economic models are based on the
short run, medium run or long run. The difference in these time frames is the ability to
change the factors of production. For example, in the short run, its impossible set up a
new factory, but its more plausible to hire a new worker. It shows that in a period,
current output can change only so much. While in the long run, you can make many
more changes. In this post we will do analysis of the Theory of Production in the Short-
Run.

Theory of Production: Short-Run Analysis

The Short-Run is the period in which at least one factor of production is
considered fixed. Usually capital is considered constant in the short-
run.
In the Long-Run, all factors of production are variable, while in the very
long-run all factors of production are variable, and research and
development is possible.
Law of Diminishing Marginal Returns
If more and more of a variable Factor of Production is used in a
combination with a fixed factor of production, marginal product, then
average product will eventually decline. The law of diminishing
marginal returns determines behavior of output in the short-run. Think
of a pizzeria, with tables, chairs and ovens (fixed factor of production).
With no workers the output is zero, with one worker the output is say
x units. The worker takes orders, makes pizzas, cleans tables and
serves the bill. If there are two workers, the second worker can do the
same work as the first and the output will be 2x units. They can
specialize and further increase output.
TOTAL PRODUCT
 MARGINAL PRODUCT

Output will increase at an increasing rate till L1, therefore the

marginal product is increasing till L1.
Adding extra workers increases total output, but at a decreasing
rate, more workers contribute less each, and marginal product
begins to fall (L1 to L2). Hiring more workers results in each new
worker adding less to the output.
After L2, there is too much labor for the available capital, workers
get in each others way, and each contribution of everyone new
worker is negative.
No firms hire beyond L2; too much labor to capital, and less than
L1; too much capital to labor.
AVERAGE PRODUCT (AP)
Total Product / Variable Factor of Production. Average product is
maximum at the point that total product is the steepest.
MARGINAL PRODUCT (MP)
Marginal Product is the change in total product because of changing
the variable factor of production by 1 unit. Ex: When one more chef is
added, and production increases to x units, when the second worker is
hired the output increases by more than 2x units.

If Marginal Product > Average Product, then Average Product will rise
If Marginal Product < Average Product, then Average Product will drop
If Marginal Product = Average Product, then Average Product will be at
maximum
For example: If you think of scores, in Jacks sixth test (marginal), he
gets a score higher than his average, then his average will increase. If in
the next test (marginal) he gets a score lower than his average, then his
average will drop. If he gets a score thats the same as his average, then
his average wont change.