assignment on old is gold by vijay sakya
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Exam 2012 Fall Microeconomics
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NEPAL COLLEGE OF INFORMATION TECHNOLOGY
ASSIGNMENT
(MICRO ECONOMICS)
SUBMITTED BY: SUBMITTED TO:
VIJAY SHAKYA TAK BADHADUR THAPA
DAYANIDHI TIMILSINA LECTURER, ECONOMICS
SURAJ DEO NCIT COLLEGE
Exam 2012 Fall Microeconomics
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Assignment On
OLD IS GOLD EXAM 2012 FALL QUESTIONS
Submitted as per requirement of college assignment for BBA 2nd semester
Submitted By:
VIJAY SHAKYA
DAYANIDHI TIMILSINA
SURAJ DEO
Under Supervision Of
TAK BADHADUR THAPA
Date:
27 DEC 2015
Exam 2012 Fall Microeconomics
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TABLE OF CONTENTS
SCARCITY “BEGINNING OF ECONOMIC ACTIVITIES”……….... 4
SOLVED EQUATION FOR ELASTICITY OF DEMAND………….... 4
SOLVED EQUATION FOR EQUILIBRIUM PRICE AND OUPUT... 6
DIFFERENCE BETWEEN TOTAL AND MARGINAL UTILITY…. 7
RELATIONSHIP OF TU AND MU WITH DIAGRAM…………….... 8
INCOME AND SUBSITUITION EFFECTS FOR A NORMAL
GOODS WHEN PRICE FALLS ……………………………………….. 9
SHORT RUN PRODUCTION FUNCTION WITH DIAGRAM
OF TP, AP AND MP…………………………………………………….. 10
PRODUCTION MAXIMIZATION……………………………………. 11
SOLVED EQUATION OF TOTAL COST FUNCTION…………….. 12
RELATIONSHIP OF AR AND MR IN PERFECTLY COMPETITIVE
AND MONOPOLY MARKET………………………………………… 14
PRICE AND OUTPUT DETERMINATION UNDER MONOPOLY.. 16
SHORT NOTES ON IC AND CROSS ELASTICITY OF DEMAND.. 17
REFERENCE………………………………………………………... 20
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1. a. Scarcity is not only problem but also the beginning of economic activities. Explain
The starting point of economic analysis is the existence of human wants. Human beings
have unlimited wants. That is to say that there is never such a time that a human being is
satisfied and not in need of anything. On the other hand, resources available in nature,
which should be used to meet those human wants, are limited. The available resources
can never be enough to satisfy all human needs. This phenomenon, where there are
unlimited human wants which are to be met by very limited resources, is essentially what
economists call scarcity. Scarcity is referred to as the fundamental economic problem,
and all economic activities revolve around trying to solve this problem.
Economics is basically born with scarcity of resources which leads to development of
other economic concepts, principles, theory and practice, since the scarcity makes the
people to act with rationality, scarcity (of resources) is a natural state that leads to explore
alternative.
Without Scarcity, the science of economic would not exit, economics is the study of
production, distribution and consumption of goods and services. If society did not have to
make choices about what to produce, distribute and consume, the study of those actions
would be relatively baring. Society would produced distribute and consume an infinite
amount of everything to satisfy the unlimited wants and needs of humans. Everyone
would get everything they wanted and it would all be free. But we all know that is not the
case. The decision and trade off society makes due to scarcity is what economics study.
b. Define the price elasticity of demand and measure it by are method when price changes
from Rs 20 to Rs 10 in the given example.
Price (Rs.) 20 10
Demand (units) 40 80
Other things being equal, price elasticity is the ratio of the percentage in the quantity
demanded with the percentage change in price. In other words, it is a measure of relative
change in the quantity demanded of goods in response to a relative change in the price.
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According to Ferguson, “price elasticity is the proportionate change in quantity
demanded divided by the proportionate change in price.”
Thus,
% change in quantity demanded
ep =
% change in price
In symbolic term,
Q p1
ep = - *
p q1
where Q= Q2– Q1, Q1= initial quantity demanded, Q2= new quantity demanded
P= P2 – P1, P1= initial price, P2= new price.
Here,
P1= 20, P2 = 10, Q1= 40, Q2=8
Q= Q2– Q1= 80- 40 = 40
P= P2– P1 = 10 – 20 = -10
We know that,
q p1
ep = - *
p q1
40 20
ep = - *
-10 40
= 2 > 1
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2. A market consists of three consumers, A, B, and C, whose individual demand equations
are as follows:
QdA = 30 – 1.00P, QdB = 22.5 – 0.75P, QdC= 37.5 – 1.25P, and the industry supply equation
is given by Qs = 40 + 3.5P
a. Find out the market demand function and derive the market demand curve.
b. Determine the equilibrium price and quality mathematically.
c. Determine the amount that will be purchased by each individual.
Market demand function = QdA +QdB+ QdC
= 30 – 1.00P + 22.5 – 0.75P + 37.5 – 1.25P
= 90 – 3P
Market demand schedule
Market demand curve
y
25
20
15
10
5 D
O 15 30 45 60 75 x
Quantity demanded
Price ( rs) Market demand( 90 – 3P)
5 75
10 60
15 45
20 30
25 15
P
rice
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b.
For market equilibrium price,
Qd = Qs
Or, 90 – 3P = 40 + 3.5P
Or, 50 = 6.5P
Or, P= 7.7
When p= 7.7 Qs = 40 + 3.5*7.7= 66.95 and Qd= 90 – 3*7.7 = 66.95
So, equilibrium price = Rs 7.7 and equilibrium quantity = 7.7
c.
when p = 7.7
QdA = 30 – 1.00* 7.7 = 22.3
QdB = 22.5 – 0.75*7.7= 16.725
QdC= 37.5 – 1.25* 7.7= 27.875
3. a. Distinguish between total utility and marginal utility. Show the relationship between
total utility and marginal utility.
Difference between total utility and marginal utility
TOTAL UTILITY MARGINAL UTILITY
1. It refers to the total satisfaction derived by the
consumer from the consumption of a given
quantity of goods.
1. It is defined as the addition made to the total
utility by consuming one more unit of a
commodity.
2. It is the aggregate of marginal utilities 2. It is the ratio of change in the total utility with
the change in the total consummation of units of
a commodity
3. Mathematically,
TU = MU1 + MU2 + …………. + MUN
3. Mathematically
TU
MU=
Q
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4. It has no types. 4. It has got 3 types.
i). Positive Utility
ii). Zero Utility
iii). Negative Utility
5.For example, a person consumes eggs and
gains 50 utils of total utility. This total utility is
the sum of utilities from the successive units (30
utils from the first egg, 15 utils from the second
and 5 utils from the third egg)
5, For example, when a person increases the
consumption of eggs from one egg to two eggs,
the total utility increases from 30 utils to 45 utils.
The marginal utility here would be the15 utils of
the 2nd egg consumed.
Relationship between total utility and marginal utility in diagram
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1. In figure (2), MU curve moves downward having negative slope while in figure (1) TC
curve, having negative positive slope moves upward but tendency to move is towards x-
axis, which shows decreasing rate.
2. A point F´ in figure (2) MU curve cuts the s-axis at the 6th unit and TU curve has its
maximum point F which is saturation point.
3. At 7th unit MU curve is below x-axis as in figure (2) and TU curve declines from point
'F' to 'G' as in figure (1).
b. Measure diagrammatically, Income and Substitution effects for a normal good when its
price falls.
If X is an normal good, the income effect of a fall in the price of X will be positive because as
the real income of the consumer increases, less quantity of X will be demanded. This is so
because price and quantity demanded move in the same direction On the other hand, the negative
substitution effect will increase the quantity demanded of X.
The negative substitution effect is stronger than the positive income effect in the case of normal
goods so that the total price effect is negative. It means that when the price of the normal good
falls, the consumer purchases more of it due to compensating variation in income. Initially, the
consumer is in equilibrium at point R where the budget line PQ is tangent to the curve I1. With
the fall in the price of X, he moves to point T on the budget line PQ1, at the higher indifference
curve His movement from R to Tor from В to E on the horizontal axis is the price effect. By
compensating variation in income, he is in equilibrium at point H on the new budget line MN
along the original curve I1.
The movements from R to H on the I1 curve are the substitution effect measured horizontally by
BD of X. To isolate the income effect, return the increased real income to the consumer which
Exam 2012 Fall Microeconomics
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was taken from him so that he is again at point T of the tangency of PQ; line and the curve l2.
The movement from H to T is the income effect of the fall in the price of X and is measured by
DE.
This income effect is positive because the fall in the price of the normal good X leads, via
compensating variation in income, to the decrease in its quantity demanded by DE. When the
relation between price and quantity demanded is direct via compensating variation in income, the
income effect is always positive.
In the case of an normal good, the negative substitution effect is greater than the positive
income effect so that the total price effect is negative. Thus the price effect (-) BE = (-) BD
(substitution effect) + DE (income effect). In other words, the overall price move from R to T
which comprises both the income and substitution effects has led to the increase in the quantity
demanded by BE after the fall in the price of X. This establishes the downward sloping demand
curve even in the case of an normal good.
4.a What is the short run production function? Explain this with the help of a total product
curve, AP and MP curves.
Short run production function refers to the functional relationship between the units of
variable factors and the output. In short run production function, we study the effect of
change in the quantity of one variable input on the output, by keeping all other inputs
constant. It is also called single variable production function or production function with
one variable input.
Algebraically, it is written as:
Q=f (Nvf) K
Where Q= output, f= Function ,Nvf = Quantity of variable factors, K= constant units of
fixed inputs.
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b. How can the producer maximize the production at the given total cost and input prices.
Explain
The producer can maximize the production at the given total cost and input prices from
two approaches:
A) Total revenue-Total cost approach
b) Marginal revenue- Marginal cost approach
A. Total Revenue- Total cost approach
With the help of the diagram we can generate the three stages:
Stage I: Increasing Returns: In this stage the total product increases throughout, but it increases at increasing
rate initially and both MP and AP increases and MP gets its maximum point and starts decreasing.
Stage II: Decreasing Returns: In this stage, The TP increases at the decreasing rate and reaches its maximum
point. Both AP and MP starts to decrease and MP cuts the x-axis.
Stage III: Negative Returns: In this stage TP starts to decline and TP curves slopes downward. The MP of a
variable factor is negative and MP curve goes below the x-axis. The AP decrease continuously and slopes
downward.
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To obtain the profit maximizing output quantity, we start by recognizing that profit is equal to
total revenue (TR) minus total cost (TC). Given a table of costs and revenues at each quantity,
we can either compute equations or plot the data directly on a graph. The profit-maximizing
output is the one at which this difference reaches its maximum.
In the accompanying diagram, the linear total revenue curve represents the case in which the firm
is a perfect competitor in the goods market, and thus cannot set its own selling price. The profit-
maximizing output level is represented as the one at which total revenue is the height of C and
total cost is the height of B; the maximal profit is measured as CB. This output level is also the
one at which the total profit curve is at its maximum.
If, contrary to what is assumed in the graph, the firm is not a perfect competitor in the output
market, the price to sell the product at can be read off the demand curve at the firm's optimal
quantity of output.
B. Marginal Revenue-Marginal Cost Approach
An equivalent perspective relies on the relationship that, for each unit sold, marginal profit (Mπ)
equals marginal revenue (MR) minus marginal cost (MC). Then, if marginal revenue is greater
than marginal cost at some level of output, marginal profit is positive and thus a greater quantity
should be produced, and if marginal revenue is less than marginal cost, marginal profit is
negative and a lesser quantity should be produced. At the output level at which marginal revenue
equals marginal cost, marginal profit is zero and this quantity is the one that maximizes
profit.[2] Since total profit increases when marginal profit is positive and total profit decreases
when marginal profit is negative, it must reach a maximum where marginal profit is zero - or
Exam 2012 Fall Microeconomics
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where marginal cost equals marginal revenue - and where lower or higher output levels give
lower profit levels.[2] In calculus terms, the correct intersection of MC and MR will occur
when:[2]
The intersection of MR and MC is shown in the next diagram as point A. If the industry is
perfectly competitive (as is assumed in the diagram), the firm faces a demand curve (D) that is
identical to its marginal revenue curve (MR), and this is a horizontal line at a price determined
by industry supply and demand. Average total costs are represented by curve ATC.
Total economic profit is represented by the area of the rectangle PABC. The optimum quantity
(Q) is the same as the optimum quantity in the first diagram.
5.a. Total cost function of a producer is given by TC= 1000 + 10Q – 0.9Q + 0.004Q3. Find
TFC, TVC, TC, AFC, and MC to produce 5 units.
Here,
TFC = 1000
TVC =10Q+ 0.004Q3- 0.9Q when q=5 TVC=10*5+ 0.004*(5)3-0.9*5 = 46
TC= TFC + TVC = 1000+46 = 1046
AFC= TFC/Q = 1000/5 = 200
AVC = TVC/Q = 46/5 = 9.2
MC = derivative of TC
= 10 – 0.9Q + 0.012Q2
When q=5
= 10 – 0.9*5 + 0.012 * 52
= 5.8
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b. Show the relationship between average and marginal revenue curves in perfectly
competitive and monopoly market.
Under perfect competition.
The average revenue curve is a horizontal straight line parallel to the A-axis and the marginal
revenue curve coincides with it. This is because under pure (or perfect) competition the number
of firms selling an identical product is very large.
The price is determined by the market forces of supply and demand so that only one price tends
to prevail for the whole industry, as shown in Table 1.
It is OP as shown in panel (A) of Figure 1. Each firm can sell as much as it wishes at the market
price OP. Thus the demand for the firm’s product becomes infinitely elastic. Since the demand
curve is the firm’s average revenue curve, the shape of the AR curve is horizontal to the А-axis
at price OP, as shown in panel (B) and the MR curve coincides with it. This is also shown in
Table 1 where AR and MR remain constant at Rs 20 at every level of output. Any change in the
demand and supply conditions will change the market price of the product, and consequently the
horizontal AR curve of the firm.
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Under Monopoly
The average revenue curve is the downward sloping industry demand curve and its correspond-
ing marginal revenue curve lies below it. The relation between the average revenue and the
marginal revenue under monopoly can be understood with the help of Table 2. The marginal
revenue is lower than the average revenue.
Given the demand for his product, the monopolist can increase his sales by lowering the price,
the marginal revenue also falls but the rate of fall in marginal revenue is greater than that in
average revenue. In Table 2, AR falls by Rs. 2 at a time whereas MR falls by Rs. 4. This is
shown in Figure 2, in which the MR curve is below the AR curve and lies half way on the
perpendicular drawn from AR to the T-axis. This relation will always exist between straight line
downward sloping AR and MR curves.
In order to prove it, draw perpendiculars CA and CM to the У-axis and X-axis respectively from
point С on the AR curve. CA cuts MR at В and CM at D. We have to prove that AB = BC. In
Figure 2, the rectangle ACMO is the TR of OM output at CM price and the area. PDMO also
represents total revenue in terms of aggregate marginal revenue ( MR) at OM output.
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6.a Define Monopoly. How price and output is determined in the short run of the firm
under monopoly?
Monopoly is said to exist when one firm is the sole producer or seller of a product which
has no close substitutes. The following three condition are necessary to exist monopoly:
i. There is a single producer or seller of a product.
ii. There are no close substitutes for the product.
iii. Strong barriers to the entry of new firms in the industry exist.
Price and Output determination Under Monopoly
MC
AC
AR AR
MR MR MR
X
In Monopoly, Price is determined by the firm itself by the help of AR because AR is equals to
price and output is determined by firm when MC is equal to MR. In the above figure, there is a
firm which has got 3 situation:
i) Abnormal Profit (AR>AC)
ii) Normal Profit (AR=AC)
iii) Loss (AR<AC)
Y YY
MC F MC
E AC AC
P F H
G H
E
O OUTPUT OUTPUT
Fig (i) Fig (ii) Fig (iii)
P
O Y
G
P
E
O OUT PUT X
PR
ICE
PR
ICE
PR
ICE
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i) Abnormal Profit
Abnormal profit is that condition where AR is greater than AC which we can see in Fig i. In fig I
PFGH is the super normal profit where AR is greater than AC.
ii) Normal Profil
Normal profit is that stage where AR is equal to AC which we can see in fig ii. Though AC=AR
we say it normal profit because AC includes both AFC and AVC. In fig ii the point E is normal
Profit.
iii) Loss
Loss is that condition where AC is greater than AR. In the fig iii GFPH is the loss where AC is
greater than AR
7. Write short notes on any two:
a. Properties of indifference curve
i) IC convex to the origin
Indifference curves is usually convex to the origin. In other words, the indifference curve is
relatively flatter in its right-hand portion and relatively steeper in its left-hand portion.
Due to diminishing MRS, IC is always convex to the origin as
we can see in the figure.
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ii) Higher Indifference curve yields Higher level of satisfaction than lower
It is because that the higher IC3 contains more units of both goods
or more units of at least one good than IC2 and so on. So IC3 has
more level of satisfaction than the IC2 .
iii) IC do not intersect each other
If two indifference curves intersect each other, it would imply that an indifference curve
indicates two different levels of satisfaction or that two different combinations – one being larger
than the other yield same level of satisfaction.
iv) Indifference Curve always slopes downward to right
This property follows the assumptions of non-satiety, i.e. the consumer prefers more goods to
less of it. The negative slope of an indifference curve shows that the two goods are substitutes for
one another. This must be so if the level of satisfaction is to remain the same on an indifference
curve.
v) Indifference Curve never touches x-axis
If IC touches the x-axis then we can’t take x good i.e x good will be 0 which is against our
assumption. So, IC never touches x axis.
b. Cross elasticity of demand
Cross elasticity of demand (XED) measures the percentage change in quantity demand for a
good after the change in price of another.
XED = % change in Q.D. good A
% change in P good B
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Cross elasticity of demand for Coffee / Tea
For example: if there is an increase in the price of tea by 10%. and Q.D of coffee increases by
2%, then XED = +0.2
Substitute goods
For goods which are substitutes, we expect to see a positive cross elasticity of demand. If the
price of Asda bread increases, people will buy more of an alternative, such as Mother’s Pride
bread.
Weak substitutes like tea and coffee will have a low cross elasticity of demand
Alternative brands of chocolate, e.g. Dairy Milk vsWispa are quite similar, so will have a higher
cross elasticity of demand.
Complements goods
These are goods which are used together, therefore the cross elasticity of demand is negative. If
the price of one goes up, you will buy less of both goods.
For example, if the price of DVD players goes down, you will buy more DVD players and also
there will be a increase in demand for DVD disks.
If the price of Samsung mobile phones goes down, we will also buy more Samsung related
phone apps.
Using knowledge of cross elasticity of demand
When setting prices firms will have to look at what alternatives the consumer has, if there are no
close substitutes they will be able to increase the price. For this reason firms spend a lot of
money on advertising to differentiate their products and reduce cross elasticity of demand.
A firm may offer a loss leader to attract complementary sales. For example, a firm may offer a
printer, at a low price, because it knows this will lead to increased sales for the highly profitable
ink cartridges.
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REFERENCE
Managerial economics, dr. h.l ahuja
Micro economics, gyan ratna adhikari
www.wikipedia.com
www.2knomics.com