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QUARTER SEMESTER ASSIGNMENT
NAME; Danfulani Gladys Mwanret
MATRIC NO; 13/SMS01/012
DAPARTMENT; Economics department
COURSE; ECO201(INTRODUCTION TO MICROECONOMICS)
1. PAGE 80;
NO 3; Distinguish between the substitution and the income effect of an
increase in the price of rice on households’ demand.
Substitution effect is defined as the fall in price of a commodity X is the increase in the quantity
demanded of X that was motivated by the increase in the relative price of other related goods.
Income effect is defined as the change in the price of a commodity is the change in the quantity
demanded of the commodity as a result of the fact that the consumer feels richer or has more
power consequent to the price change.
In the increase of the price of rice on households’ demand, rice is a normal good as to the fact
that no matter the level of increase/decrease in the price of rice or income of the consumer, rice
will still be bought but will be reduced. The substitution effect to rice is negative as its close
substitute beans, is really not a close substitute but can be bought in the place to it. So also in the
sense to the income effect, it is also negative as a fall in price raises the demand for the
commodity and vice versa. The income and substitution effects explain the shape for the demand
curve. For the normal good, the negative income effect combines with the negative substitution
effect to generate a pronounced downward sloping demand curve. An increase in price leads to
significant reduction in quantity demanded and vice versa.
NO 5; what is an Engel curve? Explain the behavior of such curves in the case
of a normal and inferior good.
The Engel curve is a graphical diagram used to depict the relationship between the income of the
consumer and the quality of a commodity that is purchased. The curve shows the various
quantity of a commodity the individual (household) will purchase at different income levels, the
price of the commodity and other factors remaining constant. The shape of the Engel curve
varies to different types of goods;
a. Normal goods; the Engel curve for a normal good explains the upward sloping of the
curve as higher income equals higher demand.
b. Inferior goods; the Engel curve for an inferior good explains its downward sloping as
higher income leads to lesser demand due to the costumer’s need to get better goods.
a. PAGE 172
4. The law of diminishing returns is at best a short run phenomenon. Discuss!
The law of diminishing returns states that, if a factor is fixed and perfectly inelastic and
another factor is variable, given a fixed technical relationship, successive application of the
variable factor to the fixed factor will cause the output to rise at an increasing rate first and then
at a diminishing rate. In other words, the law of diminishing returns states that when one more
production factor is added and others constant would eventually lead to a decrease in the per unit
returns. In the short run firms cannot build new factories to produce output. Therefore increase in
production depends on the variable. The extra revenue gained by adding one more unit per time
with the Fixed Cost remaining unchanged, the productivity of VC is decreasing therefore STC is
increasing. In the short run as factors of production is added to a fixed factor, the MP of the
variable factor will rise and eventually start decreasing when more of that factor is added and the
same occurs with the STP and SATP.
7. What is an Isocost? How do we derive one? Using the tools of the Isocost
and Isoquant, show the firm’s output-maximizing decision subject to a cost
constraint.
The isocost is the locus of various combinations of factor inputs that gives the same level of
expenditure/cost. It is similar to the budget line and the theory of consumer behavior. This is a
line which is important in the analysis of producers’ behavior. It illustrates all the possible
combinations of two factors that can be used at given costs and for a given producers budget
i.e. it represents a combination of inputs which all cost the same amount. The slope of the
Isocost is given by the ratio of the factor prices therefore giving it a constant slope. It is derived
by intercepting the labor and capital axis at their maximum possible levels of purchase. It can
be derived through the production function K=C/r – w L/r.
Page 188;
NO 2; Fill in the gap of the table below and plot the graphs of the
corresponding cost curves.
Q
10
20
30
40
50
60
STC
1000
1200
A=1350
1450
B=1600
1850
TFC
500
500
C=500
500
D=500
E=500
TVC
500
F=700
850
G=950
1100
H=1350
SAC
I=100
J=60
K=45
L=36.3
M=32
N=30.8
AFC
O=50
P=25
Q=16.7
R=12.5
S=10
T=8.33
SMC
U=100
V=20
W=15
X=10
Y=15
Z=25
STC =TFC + TVC
TFC= TVC at least cost or starting cost
TVC=STC – TFC
SAC= STC/Q
AFC= TFC/Q
SMC= TVC/Q
120
100
80
SAC
60
AFC
SMC
40
20
0
10
20
30
40
50
60
2000
1800
1600
1400
1200
STC
1000
TFC
800
TVC
600
400
200
0
10
20
30
40
50
60
In the graph one (1) above, AFC is decreasing as the output increases which is a negative slope
and the SMC intercepts the ATC and also the AVC at their minimum points.
In graph two (2) above, TVC has a positive slope same as STC cause it varies with the output.
STC and TVC are of the same slope-shape but STC is higher than the TVC with an equal
distance to the TVC and TFC curve is a horizontal line because of the fixed price.
NO 3a; rigorously examine the relationship between: a. AFC, SAC & AVC
curves. B. STC, TVC & TFC curves.
Average fixed cost is the ratio of the total fixed cost to the level of output.AFC cannot be equal
to zero as each unit of unit of output must carry some of the fixed cost even at the highest
conceivable level of output.
Short run average cost is the short run total cost per unit of output, i.e, the total fixed and variable
cost expended on a unit of output.
Average variable cost is the variable cost on a unit of output produced. The AVC curve reaches
its minimum point before the SAC curve, in other words, the SAC may still be falling even when
the AVC has started rising. Since output increases, change in AVC is positive while change in
AFC is negative; it follows that the net effect on cost of the increase in output will be less than
change in AVC.
B. Short run total cost (STC) is the total cost that is used by the firm during the productive year.
It comprises of the total variable and total fixed costs.
The total variable cost (TVC) is the costs and expenditure that is used to finance the output
production of the firm.
The total fixed cost (TFC) is the fixed cost that is constant all throughout the productive year.
No. 3 nature of returns to scale
a. 60-100units
%change in output = 100-60/60 x 100 = 40/60x100 =66.6%
%change in input = 30-20/20 x 100 = 1/2x100 =50%
This is a increasing returns to scale
b. 100-140units
%change in output = 140-100/100 x100 =40%
%change in input = 40-30/30 x100 = 1/3x100 =33.3%
This is an increasing return to scale
c. 210-240units
%change in output = 230-210/210 x100 = 20/210x100 =9.5%
%change in input = 70-60/60 x100 = 10/60x100 =16.6%
This is a decreasing return to scale