Download 1 - BrainMass

1. You are given the following individual demand information that represents the demand for
typing by students at a local college:
Price per page
$1.00
$1.50
$2.00
$2.50
$3.00
$3.50
$4.00
$4.50
$5.00
Tom
20
15
12
9
7
5
3
2
1
George
30
26
22
20
18
15
10
6
4
Lisa
7
6
5
3
2
1
0
0
0
Market
____
____
____
____
____
____
____
____
____
a. Give the market demand for pages per semester at each price.
ANSWER
Price per page
$1.00
$1.50
$2.00
$2.50
$3.00
$3.50
$4.00
$4.50
$5.00
Tom
20
15
12
9
7
5
3
2
1
George
30
26
22
20
18
15
10
6
4
Lisa
7
6
5
3
2
1
0
0
0
Market
_57___
_47___
_39___
__32__
_27___
_21___
_13___
__8__
__5__
b. What is the price elasticity of demand between $2.00 and $2.50?
Price elasticity of demand is defined as the percentage change in quantity demanded divided by the
percentage change in price.
When the price is $2.00 the demand is 39
When the price changed to $ 2. 50 the demand becomes 32
The percentage change (decrease) in quantity demanded =17.94%
The percentage change (increase) in price =25%
So the price elasticity of demand between $2.00 and $2.50= 17.94/25=0.71
c.
What is the relationship between price elasticity of demand and the effect of raising
prices on total revenues?
If elasticity is unity (e=1), the price change does not cause a change in total revenue. This is because the
proportional change in price is exactly offset by the proportional change in quantity. If demand is inelastic
then (e<1), then total revenue rises when price rises and total revenue falls when price falls. If demand is
elastic (e>1), then total revenue falls when price rises and total revenue rises when price falls.
2. You are given the following individual supply information for typing:
Price per page
$1.00
$1.50
$2.00
$2.50
$3.00
$3.50
$4.00
$4.50
$5.00
Ann
10
20
25
30
40
48
55
62
70
Bob
0
8
14
19
23
26
29
33
35
Cory
0
0
0
2
4
8
10
14
19
Market
____
____
____
____
____
____
____
____
____
a. Give the market supply for pages per semester at each price.
Price per page
$1.00
$1.50
$2.00
$2.50
$3.00
$3.50
$4.00
$4.50
$5.00
Ann
10
20
25
30
40
48
55
62
70
Bob
0
8
14
19
23
26
29
33
35
Cory
0
0
0
2
4
8
10
14
19
Market
_10___
_28___
_39___
_51___
_67___
__82__
_94___
_109___
__124__
b. What is the equilibrium price and quantity, using the demand curve in question #1?
Equilibrium quantity is 39 and equilibrium price is $2.00 because at this price the quantity
demanded and quantity supplied are equal.
c. What happens to the supply curve and price and output if Ann dropped out of the market?
S1
Price
S
$2
D
39
Quantity demanded & quantity supplied
If Ann dropped out of the market then market supply will be less. The market
supply curve will shift to the left, which is shown in the above figure. S1S1 is the new
supply curve. As a result the quantity supplied will be less and the price will be high.
3. The following is taken from the San Jose Mercury News, July 27, 2000:
“The Mexican arm of U.S. Internet giant America Online Inc. said on Wednesday it started a
financing program to help aid in the purchase of personal computers, joining a list of companies
that have launched similar programs to promote Internet use.
“AOL will be joined in the program by computer giant Compaq Computer Corp. and Mexico’s
second-largest banking group Banamex Accival, AOL said in a statement.
“The program, known as ‘PC Facil’ (Easy PC) aims to help clients acquire a PC, enabling them to
hook up to the Internet and the ‘unique benefits’ of AOL service, said AOL Director of Markets
Erick Sydow. In Mexico there are only an estimated five personal computers per 100 people,
which is one of the reasons that Internet use there is still low.”
Using the concepts you learned in this class, explain:
a. Why are AOL subsidizing computer sales in Mexico?
In Mexico only 5% percent people have personal computers. So this is a large potential
market for AOL. If they can increase the demand for personal computer they will be able to
provide the unique benefits of AOL Internet service to a large number of potential buyers. In order
to generate that demand they are interested to subsidized computer sales in Mexico. If computers
are subsidized there, it will help to increase the demand for PC (as it becomes cheaper than before)
and AOL will be able to incur huge amount of profit by providing Internet service to them.
b. What do you conclude about the cross-elasticity of demand for AOL services and
computer ownership?
The computer ownership and the demand for AOL service are complementary. If the
person does not have any computer he will not go for AOL service. The AOL service will be
useless unless Computer ownership is there. So the cross price elasticity between the price of
computer and the demand for AOL is negative. A decrease in the price of computer (i.e, an
increase in the demand of computer) will increase the quantity demanded of the AOL service.
c.
Why would Compaq and Banamex also be interested in this effort?
Compaq and Banamex also are interested in this effort because by this subsidy
programmed they also can increase their business to a large extent and can have a share of a large
amount of profit.
4. The automobile manufacturing industry is considered to be very competitive. Does that mean
that the industry can be described as perfectly competitive (u sing the definition given in your text
under “Competitive Markets”)? List the definitions of perfect competition and explain whether or
not the automobile manufacturing industry meets each definition. If the industry is not perfectly
competitive, what market structure best describes it and why?
The notion of competition is very widely used in economics in general and in
microeconomics in particular. Competition is also considered the basis for capitalist or free market
economies. Markets are the heart and soul of a capitalist economy, and varying degrees of
competition lead to different market structures, with differing implications for the outcomes of the
market place. These elements are perfect competition, monopolistic competition, oligopoly, and
monopoly. Based on the differing outcomes of different market structures, economists consider
some market structures more desirable, from the point of view of the society, than others.
In every competitive market of a market certain key characteristics differ. The
characteristics are: (a) number of firms in the market, (b) control over the price of the relevant
product, (c) type of the product sold in the market, (d) barriers to new firms entering the market,
and (e) existence of nonprice competition in the market. So competitive market does not always
imply perfectly competitive market structure. Same is the case for automobile manufacturing
industry.
The automobile manufacturing industry is considered to be very competitive- it does not imply
that it is perfectly competitive.
The four key characteristics of perfect competition are: (1) large number of small firms,
(2) identical products sold by all firms, (3) freedom of entry into and exit out of the industry, and
(4) perfect knowledge of prices and technology. These four characteristics mean that a given
perfectly competitive firm is unable to exert any control whatsoever over the market.
So far as the automobile industry is concerned, we are explaining below whether they are
satisfying the requirements of perfect competition.
(1) Large number of small firms- in an automobile industry there are small numbers of large
firms, which is just opposite to perfect competition.
(2) Identical products sold by all firms- the products sold by all the automobiles firms are not
identical. They are differentiated in terms of the model, size, color, technology, price etc.
(3) Freedom of entry into and exit out of the industry-In automobile industry there are huge
barriers to entry. These barriers can involve large financial requirements, availability of raw
materials, access to the relevant technology, or simply patent rights of the firms currently in
the industry.
(4) Perfect knowledge of prices and technology- it is also not applicable for automobile
industry. The technology used by automobile industry is so advanced and as it changes
everyday, it is not possible to have a sound and perfect knowledge of price and technology of
the products produced by them.
As the automobile manufacturing industry does not satisfy any of the characteristics of perfect
competition, we can conclude that it does not belong to perfect competitive market structure.
Automobile manufacturing industry belongs to the oligopoly market structure.
An important characteristic of an oligopolistic market structure is the interdependence of
firms in the industry. The interdependence, actual or perceived, arises from the small number of
firms in the industry. However, unlike monopolistic competition, if an oligopolistic firm changes
its price or output, it has perceptible effects on the sales and profits of its competitors in the
industry. Thus, an oligopolist firm always considers the reactions of its rivals in formulating its
pricing or output decisions.
There are huge, though not insurmountable, barriers to entering an oligopolistic market.
These barriers can involve large financial requirements, availability of raw materials, access to the
relevant technology, or simply patent rights of the firms currently in the industry. The U.S. auto
industry provides an example of a market where financial barriers to entry exist. In order to
efficiently operate an automobile plant, one needs at least half a billion dollars of initial
investment.
An oligopolistic industry is also typically characterized by economies of scale.
Economies of scale in production imply that as the level of production raises the cost per unit of
product falls for the use of any plant (generally, up to a point). Thus, an economy of scale leads to
an obvious advantage for a large producer. Once again, the automobile industry provides an
example of a market structure where firms experience economies of scale. It should be noted that
there might exist economies of scale in promotion just as there exist economies of scale in
production. In the automobile industry, the promotion cost per unit of product falls as sales
increase since promotion costs rise less than proportionately to sales.