Economics Assignment # 2

PROGRAM B.S.C.S

Ece-355 Economics

TEACHER Dummy

ID # 112233 Awain Main

DATE: 9th December, 2013

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Question # 1:

Name two types of market failure. Explain why each may cause market outcomes to be
inefficient.

Answer # 1:

Market failure
Market failure is a concept within economic theory describing when the
allocation of goods and services by a free market is not efficient.

Different economists have different views about what events are the sources of market
failure.

Mainstream economic analysis widely accepts a market failure (relative to Pareto efficiency)
can occur for three main reasons :

1) If the market is "monopolized" or a small group of businesses hold significant market

power.
2) If production of the good or service results in an externality,
3) OR if the good or service is a "public good"

Question # 2:

What Is Marginal Product & What Does it Mean if it Is Diminishing?

Answer # 2:

Marginal Product

In technical terms, marginal product is the extra output that results from adding
one unit of input, assuming all other variables remain constant. Suppose you have a factory
full of machines, as well as all the raw materials you need to make widgets. If you hire one
worker to run a machine, he will be able to produce 10 widgets in a workday. If you hire
another worker - if you add one unit of input - your workers’ combined output is 20
widgets. So that second worker has a marginal product of 10, because her involvement led
to an additional 10 units of output.

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Diminishing Marginal Product

Your factory’s diminishing marginal product means the beneficial effect of adding new
workers is decreasing. This is known as the law of diminishing returns: In any fixed
production scenario, adding inputs eventually causes the marginal product to fall. While you
can’t avoid the reality of diminishing returns, it’s helpful for small-business owners to
recognize that investing in greater capacity and resources is sometimes better for growth
than hiring new workers.

Question # 3:

Give an example of an opportunity cost that an accountant might not count as a cost.
why would the accountant ignore this cost?

Answer # 3:

Example of an opportunity cost:

A person who invests $10,000 in a stock denies himself or herself the interest
that could have accrued by leaving the $10,000 in a bank account instead. The opportunity
cost of the decision to invest in stock is the value of the interest.

An accountant would not count the owner’s opportunity cost of alternative employment as
an accounting cost. The accountant ignores this opportunity cost because money does not
flow into or out of the firm.

Question # 4:

Define economies of scale and why they would arise.

Define diseconomies of scale and explain me why they might arise?

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Answer # 4:

Economies of scale:

Unit cost decreases as volume produced expands. They arise as fixed costs are
spread over a larger volume of production.

Diseconomies of scale

Emerge when unit costs increase as production increases. These might arise due
to diminishing marginal returns application of additional factors of production have smaller
impact on overall production.

Question # 5:

Evaluate the following two statements. Do you agree? Why or why not?

a. A tax that has no deadweight loss cannot raise any revenue for the government.

b. A tax that raises no revenue for the government cannot have any deadweight loss.

Answer # 5:

a) False. If demand is perfectly vertical (or supply for that matter), a tax will raise revenue
but cause no DWL, (as no resource misallocation).

b) False. If a tax is levied that is so high that it causes all market activity to cease for that
good, it will raise no revenue for the government as there is no activity to tax and would
create a huge deadweight loss.

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Question # 6:

What happens to consumer and producer surplus when the sale of a good is taxed? How
does the change in consumer and producer surplus compare to the tax revenue? Explain.

Answer # 6:

When the sale of a good is taxed, both consumer surplus and producer surplus decline. The
decline in consumer surplus and producer surplus exceeds the amount of government
revenue that is raised, so society's total surplus declines. The tax distorts the incentives of
both buyers and sellers, so resources are allocated inefficiently