Economic Principles
Student’s Name
Institutional Affiliation
Economic Principles
Elasticity
Question 1
An oversee trip will have a higher price elasticity because consumers can change their preferences while prescription medicine is inelastic since an increase in price does not change the demand of the drugs. The major determinants of demand elasticity include luxury vs. necessity, substitutes, income level, and time.
Question 2
Coffee sold in a café or hotel will have a higher elasticity of supply than hotel accommodation in Sidney during the Olympics. The number of rooms cannot be increased due to the Olympics games. The main determinants of elasticity of supply include time to respond, availability of raw materials, mobility of factors of production, and amount of inventory.
Question 3
Demand inelastic means that a change in price results in small change in demand where elasticity is less than one.
In the graph, when pineapples’ price increases from $10 to $40, the resulting changes in quantity demanded are minimal. The decrease is less than 10%. This shows that consumers will continue to purchase a product at the same quantities even after an increase in prices since there are no substitutes. Inelastic demand is helpful for the few farmers whose crops were not destroyed by floods since they will sell the produce at high prices.
Market Power
A monopoly exists where there are many buyers of a product and only one producer of the given good. In this scenario, a producer is the price maker of the product, where a firm regulated the quantity demanded in the market to fix prices at given levels.
Fig 1.2 shows a graphical representation of a monopoly market (Roesler & Szentes, 2017)
In fig 1.2, a monopoly makes a profit where the MC is equal to MR of a product. The quantity supplied is determined by the intersection of MR and MC curves. Since the MR is below the demand curve, the price will always be above the MC.
Question 2
In the long run, Callaway may experience new competitors in the market to take advantage of the high prices charged. With the entry of new firms, the firm’s demand curve shifts to the left until it is tangent to the average total cost curve at a maximizing price level of output in the firm. Monopolies tend to have economies of scale, which will help them benefit from lower long-run average cost. In the long run, the profits decrease with the threat of new entrants into the market. A monopoly must diversify to be profitable, which may increase its average costs.
This is illustrated in the graph below:
If there are many entrants into the industry, the firm will incur losses, especially if it is inefficient. In the long run, the market price will be equated to the average total cost where marginal revenue=marginal cost. Since the firm does not operate at minimum average cost, the firms would lose money if they opened more clubs to achieve productive efficiency. However, the firm will gain economic profit in the future if it has some advantages over competitors. This is illustrated in the graph below:
Quantity
Business Strategy
Question 1
A negative externality refers to the cost incurred by a third party as a result of an economic transaction (Chen, 2010). This externality occurs when consumption or production imposes external costs outside the market and is not compensated (Chen, 2010). From the case study, the occurring negative externality discussed is that which is caused by the presence of traffic in Sydney’s clogged roads. As a result of this traffic, businesses incur huge losses due to a lot of wasted time on the roads. Therefore, the negative externality is that the traffic makes it difficult for goods to be delivered on time and makes the cost of providing the goods expensive due to high fuel consumption by vehicles.
A negative externality leads to an inefficient price and level of output in two ways. First, since the third party is forced to deliver a good or service at a more cost, this necessitates the need to shift the extra fees to the consumer to cover the suffered losses (Chen, 2010). In covering these losses, the consumers pay for goods and services at a higher cost, inefficient. The level of output is also affected in the following way. As the third party incurs additional expenses due to the externality, this brings down their output level (Chen, 2010). For instance, from the case study, the fact that businesses incur more costs in fueling the vehicles means that the extra money that ought to have been used in producing goods ends up as part of fuel expenses. As a result of the additional cost incurred and caused by the traffic (negative externality), this makes the level of output go down. As explained in the diagram below, inefficiencies in the Social Marginal Benefit increase prices (P0 to P2) and decrease the output level (Q2 to Q1).
Fig 1.1 showing how a negative externality leads to an inefficient price and level of output (Chen, 2010).
The government can address negative externality by imposing taxes on goods whose production leads to additional/spillover costs and subsidizing activities that lead to the externality.
Question 2
Nash equilibrium is a concept under Game theory. Each player is assumed to know the equilibrium strategies of the other player, where there is no incentive to deviate from the original strategy.
The strategies for AMD and Intel include to conduct R&D or not to conduct R&D. If Intel chooses to conduct R&D, AMG will accept $20 as the payoff. IF AMG decides not to conduct R&G, AMG chooses 15 as the payoff. On the side of AMG, if AMG chooses to conduct R&D, Intel chooses $5 as the payoff while Intel chooses $15 as the payoff if AMG decides not to do R&D. The Nash equilibrium, in this case, is strategies NO R&D for Intel and No R&D for AMD. The payoffs at Nash equilibrium for the two firms are (8,15).