Beo1105 Economic Principles And Decision Assessment Answers

Question 1

Ceteris paribus, assume a global shortage of petrol has resulted in a doubling of petrol prices. Use graphical demand and supply analysis to support your explanation of the impact on equilibrium price and quantity in the market for:

Low fuel efficient petrol cars.

Cars that use liquid gas (a substitute for petrol), where the price has not increased.

In your answers explain the market equilibrium adjustment process 

Question 2

Use graphical demand and supply analysis to support your explanation of the effect the following events will have on the market for beef. (Assume ceteris paribus for each of the event).

A sharp fall in average wages, assuming beef is a normal good.

Farmers have access to high quality cattle feed (food for the cows), which has reduced the time it takes to get cattle ready for the market.

Governments in beef producing countries have not only ordered the mass slaughter of cows due to the spread of mad cow disease but they have also warned consumers about the dangers of consuming beef. (HINT: Explain all possible impact on price and quantity)

Question 3

Ceteris paribus, assume the increase in new commercial apartments has at the same time been accompanied by a decrease in the demand for such apartments. Use graphical demand and supply analysis to support your explanation of the impact on equilibrium price and quantity of the market for new commercial apartments.

Explain all possible impact on price and quantity

Question 4

If the price of a good increase from $3.25 to $4.00, leading to a fall in quantity demanded from 25 to 18 units, what is the price elasticity of demand for the good at this price range?

Explain why it is important for the business owner to understand the meaning of the elasticity value.

Question 5

The CEO of HAPPY enterprise has decided to change its business strategy from a sales maximising strategy to a profit maximising strategy. Use graphs to support your explanation of the two methods a company can use to decide on how much it has to produce to ensure it achieves a profit maximising output level.

Question 1

Part a

Low fuel efficient means that this cars spend less quantity of oil. So irrespective of the increment in price, the demand by the owners will be inelastic. If a reduction in demand after a price doubling is to occur the magnitude of decrease will be too small in comparison. This is illustrated below.

At the initial equilibrium e1, quantity demanded at price P1 is Q1. The doubling of price encourages supply causing S1 to shift to S2 indicating an increment in supply. The doubling is from price P1 to P2. This results in demand fall from Q1 to Q2 resulting in a new equilibrium at a higher point e2. The steeply sloped demand indicates the inelasticity of demand for cars that are low oil efficient when price changes. This shows that a price doubling causes a small demand fall.

Part b

For cars that use liquid gas as a substitute for petrol, if the price of petrol doubles, the demand for oil will completely reduce as the owners will shift to the cheaper liquid gas whose price has not changed. This means that the demand for products with close substitutes is price elastic. This is illustrated below.

Price increase from P1 to P2 causes demand for substitute (liquid gas) to increase to Q2

At the initial equilibrium e1, quantity demanded at price P1 is Q1. The doubling of price encourages supply causing S1 to shift to S2 indicating an increment in supply. The doubling is from price P1 to P2. This results in demand fall from Q1 to Q2 resulting in a new equilibrium at a higher point e2. The flatly sloped demand indicates the elasticity of demand for cars that use liquid gas substitutes when price changes. The change in demand is more than price change since consumers can fully shift to consumption of the substitute good.

Question 2

Part a

At the initial equilibrium e1, quantity demanded at price P1 is Q1. A fall in wage results in a lower income and thus forces households to cut the initial demand Q1 to Q2. Holding supply constant, the lower demand forces a price fall to P2. Thus, a wage fall causes a demand reduction and a price fall in the beef markets and a new equilibrium is reached at a lower point e2.

Part b

At the initial equilibrium e1, quantity demanded at price P1 is Q1. The reduction in the time taken to get a cattle ready for the market due to the availability of high quality food results in an increased supply. High supply holding demand constant results in price fall to P2. The new low point equilibrium is e2. Thus supply increase and demand decrease in the beef market.

Part c

At the initial equilibrium e1, quantity demanded at price P* is Q*. Since the mad cow disease resulted in a mass slaughter for cows, the supply falls from Supply 1 to Supply 2. As can be observed from the graph and recalling of the supply theory, the price goes up with a low supply. The warning of consumers on dangers of beef consumption lowers demand from D1 to D2. Similarly, as can be observed from the graph and recalling of the demand theory, the price falls with a low supply. The effect of the reduction in supply and reduction in demand creates a new equilibrium level e2 at the same price level but at a lower beef quantity of Q1.

Question 3

At the initial equilibrium e1, quantity demanded at price P* is Q*. Supply increase to S2 causing price to fall; on the other hand, demand falls to D2 causing price to fall again. The new equilibrium point at a lower point is e2. Therefore, supply increase and demand decrease results in no change in quantity but a fall in price.

Question 4

Part a

PED =

%Δ =

%Δ quantity demanded = = -28 %

%Δ Price = = 23.08 %

PED =  = -1.2

PED = -1.2

Part b

A business owner should understand the elasticity value as a guide for pricing decision. If PED is elastic, priced cannot be increased but if inelastic, price can be increased (Siddiqui, 2011). The negative value indicates that relationship between price and demand is negative.

Question 5

Source: Economicsonline.co.uk (2017)

This firm employs the strategy of maximizing its sales. It does this by ensuring that it sells the maximum possible quantity without making losses. Thus it sells at the point where ATC = AR. Losses will be made is more than Q is supplied and sales will not have been maximized if less than Q is supplied.

Graph: Profit maximization strategy

Source: Capital (2013)

For a firm employing the profit maximization strategy, it produces at the interception of the MR and MC.

According to Avenir (2017), sales and profit maximization are different but mostly perceived to be the same. Increment in sales increases sale expenses and cost of goods sold; thus profit is not necessarily maximized. Therefore the strategy taken by the firm determines its production level.

References

Avenir, R. (2017). Sales Maximization Vs. Profit Maximization. [Online] Yourbusiness.azcentral.com. Available at: https://yourbusiness.azcentral.com/sales-maximization-vs-profit-maximization-6340.html [Accessed 29 Apr. 2017].

Capital. (2013). Theory of the Firm – Profit Maximization. [Online] Available at: https://friedmanseconomy.wordpress.com/2013/01/27/profit-maximization/ [Accessed 29 Apr. 2017].

Economicsonline.co.uk. (2017). Revenue and sales maximization. [Online] Available at: https://www.economicsonline.co.uk/Business_economics/Sales_and_revenue_maximisation.html [Accessed 29 Apr. 2017].

Siddiqui, A. (2011). Comprehensive Economics XII. Laxmi Publications.