FedQ1(a) Explainthe impact of external costs and external benefits on resource collection?Answer: In simpleterms, an externality is the effect incurred by unrelated third parties duringa commercial or economic activity. If the effects are positive such as anindustrial company providing first aid classes for employees to increase onthe job safety,this may also save lives outside the factory, it is an external benefit.Whereas if the effects are negative such as water contamination due toindustrial wastes exposed to the river is an example of external costs.
Therefore, externalities do have certain effects on resource allocation.External benefits will make efficient resource allocation by effectiveallocation of resources as well as saving the opportunity cost whereas anegative externality would mean resources being wasted as well as overallincrease in social cost.(b) Why are public goods not produced insufficient quantities by private markets?Answer: Gravelle andRees: “The defining characteristic of a public good is that consumption of itby one individual does not actually or potentially reduce the amount availableto be consumed by another individual”. But if provided by private sector torealise profit, it can cause market failure.Our economic and social rights can only berealized if the services and infrastructure we require to meet our fundamentalneeds are provided as public goods, rather than sold for private profits.
Thiswas one of the main findings of NESRI’s 2010 comprehensive analysis of the state of human rights in theUnited States. (Source: Eduardo Porter,8th January 2013, New York Times).This article reflects that public goods soldfor profit can cause market failure, increase in prices and thus increases externalcosts as well. Therefore, for better resource allocation and proper utilizationof goods and services, public goods are not provided in sufficient quantity byprivate sector.(c) Which of the following are or are notexamples of public goods (or services)? Please explain your reason.Answer: (i) The judicial system is a public good as its consumption by publicdoes not reduce the amount available to another person.
(ii) Pencils are not public goods as they areproduced by private sector to get profit and them will be reduced afterconsumed by people.(iii) The quarantine service again is apublic good as its not available to get profit and also its service won’t bereduced after consumption.(iv) The Great Wall of China is availableequally to all and indefinitely by government, thus is a public good.(v) Contact Lenses are provided by privatesectors and they earn profit through the selling, thus is not a public good. Fed Q2 (a) Suppose the income elasticity of demand forpre-recorded music compact disks is +5 and the income elasticity of demand fora cabinet maker’s work is +0.5.
Compare the impact on on pre-recorded musiccompact disks and the cabinet maker’s work of a recession that reduces consumerincomes by 10 per cent.Answer: Pre- recorded music compact disks are luxurygoods as income elasticity of demand is greater than 1 whereas cabinet maker’swork is a necessity good as its income elasticity of demand is +0.5. If the consumerincome reduces by 10 per cent, the impact on luxury goods and necessity goodswill be such that their demand decreases. The major difference would be thatthe decrease in demand for necessity good will be less than proportionate tothe income. And, the decrease in demand for luxury good will be more thanproportionate to the income (b) How might you determine whether pre-recordedmusic compact disks and MP3 music players are in competition with each other?Answer:The pre-recorded musiccompact disks and MP3 music players are substitute products which mean one canbe used in the place of the other. The demand of one product is inverselyproportionate to the demand of the other as the price of products can playmajor role to each other’s demand.
Therefore, we can measure cross elasticityof demand to determine the competition between them. The cross elasticity ofdemand of the substitute products is positive as the price of product X(compact disks) increase then the demand of product Y (MP3 players) alsoincreases. (c) Interpret the following Income Elasticity ofDemand (YED) values and state if the goods are inferior or normal?Answer:If the income elasticity ofdemand is positive then it is normal good whereas if the income elasticity isnegative then it is inferior good.
In the first instance the YED= +0.7, it is anormal good. Also the YED is between 0 and 1, which means the good is necessitygood as the increase in demand will be less than proportionate to the income.
Whereas, in the second instance the YED=-3.4. Therefore, it is inferior good as the increase in income of the consumerwill lead to fail in demand and may lead to changes to more luxurioussubstitutes. (d) Interpret the following Cross-Price Elasticityof Demand (XED) and explain the relationship between these goods.Answer:Cross Elasticity of demandshows the responsiveness of quantity demanded for a good to the change in pricefor another good. A negative cross elasticity shows the two products arecomplements whereas positive cross elasticity denotes two products are substitutes.
When XED= +0.75, the positive elasticity shows that the products aresubstitutes whereas when XED= -2.5 it shows the products are complements.
Fed Q3 (a) Complete the two tables.Answer:Firm A Quantity Total Revenue $ Average Revenue $ Marginal Revenue $ Total cost $ Marginal cost $ Average cost $ 0 0 ? 30 ? 10 12 1 10 10 42 42 10 8 2 20 10 50 25 10 10 3 30 10 60 20 10 16 4 40 10 76 19 10 24 5 50 10 100 20 10 40 6 60 10 140 23.34 Firm B Quantity Total cost $ Average cost $ Marginal cost $ Price $ Marginal revenue $ Total revenue $ 0 100 ? 140 0 34 130 1 134 134 130 130 20 110 2 154 77 120 240 23 90 3 177 59 110 330 39 70 4 216 54 100 400 50 50 5 266 53.2 90 450 100 30 6 366 61 80 480 (b) Are these firms operating in the short orthe long run?Answer: Firm A isoperating in short run (FC=$30) and firm B is operating in short run (FC=$100) (c) Are these firms operating under perfect orimperfect competition? Answer: Firm A is inperfect competition (horizontal demand curve) and firm B is in imperfect competition (downward sloping demandcurve). (d) What level of output will these firms producein the short run? Answer: Firm A: 2 or 3 units, where MC=MR Firm B: 4 or 5 units, where MC=MR (e) How would you describe their profit positions? Answer: Firm A makes aloss of $30 ($50-$20 or $60-$30).
This is the best it can do, and any other output would give a greaterloss. Firm B makes profit of $184 ($400-$216 or$450-$266). This is the maximum profit it can make given the figures in thetable.
Fed Q4 (a) Suppose you own a coffee shop. List some ofthe fixed inputs and variable inputs you would use in the shopAnswer: Fixed inputs are the inputs which doesn’tchanges over the period where as the variable inputs changes time and again.Some of the fixed and variable inputs incurred while operating a coffee shopare: Fixed Inputs Variable Inputs Coffee making instruments Part time salary Furniture Raw materials Vessels Electricity Permanent Salary Insurance License Internet Bill (b) Baubles and Beads manufacturing produces 100pendants per day. The Total fixed costfor the plant is $4000 per day and the variable cost is $13,000 per day.Calculate the average fixed costs, average variable cost, average total costand total cost at the current output level.Answer: Here, Total Fixed cost = $4000 Total Variable cost = $13,000 So,(i) Average Fixed Cost = Total Fixed cost/Total quantity produced =$4000/100 = $40(ii) Average Variable cost =Total variable cost / Total quantity = $13,000/100 = $130(iii) Average total Cost =Average fixed cost + Average variable cost = $40 + $130 = $170(iv) Total Cost = Total fixedCost + Total Variable Cost = $4000 + $13,000 = $17000 (c) An owner of a firm estimates that the averagetotal cost is $6.
71 and the marginal cost is $6.71 at the current level ofoutput. Explain the relationship between these two figures. Answer: Marginal cost is the change in the total costwhen quantity produced changes by one unit. In other word it is the cost ofproducing one more unit of good.
When Average cost remains the same that wouldmean the firm is not producing any extra unit of product. So since the level ofoutput hasn’t changed marginal cost is equal to average total cost. Therefore,the owner is efficiently producing in optimum level. Fed Q7