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Economic Principles: Price Analysis Report (Assessment)


How does the principal of opportunity cost apply to you attending college? For example, if you decided to save some expenses by not buying the textbook and study guide for this unit what might be the opportunity cost of that decision? (1 mark).

In the context of opportunity cost, literacy is far much better than remaining illiterate. Attending college is a profitable gain since the knowledge gained help in improving one’s efficiency in performing certain tasks that require applied skills. This also applies to the opportunity cost of forgoing part time or full time work for the purpose of earning income. According to the example given the opportunity cost for not buying textbook or study guide could be saving for some educational trip to some popular organization. This will enhance practical application of the skills theoretically learned in class. Also outlaying the cost of textbooks and study guide may enable settling full time cost for the college fees.

For each of the following, draw a diagram that illustrates the effect on the market for cars and show the effect on equilibrium price and quantity:

The price of petrol, a complementary product, keeps rising.

The price of petrol, a complementary product, keeps rising

This will lead to a decrease in the quantity demanded due to increase in prices. The equilibrium quantity will shift from E to E1. The demand will eventually go down because there is no substitute for petrol in the market hence consumers have no other alternative to turn to.

There is an increase in the price of compulsory car insurance.

There is an increase in the price of compulsory car insurance.

With the increase in insurance cost, the cost for the cars also increases. This has led to decrease in quantity demanded hence decrease in supply, shown by the movement from E to E1. High insurance cost is seen by the consumers as an addition on the normal prices of cars, this makes them shy away from buying cars. This is because the income of the consumers is still the same despite increase in price of commodities.

A technological innovation reduces the cost of production.

A technological innovation reduces the cost of production.

With the innovation of new technology, the cost of production is reduced and the supply increases. Before, the number of cars bought was Q0 at price P0. New technology lowers the cost of production hence the numbers of cars Q1 are bought at price P0. The equilibrium price and quantity shifts from E to E1.

A local government imposes a green tax on car ownership (2 marks).

Imposition of tax by the government leads to decrease in supply and quantity demanded. The same cars now cost more as compared to previous prices. Before government tax the supply stood at Q0 at price P0, after the supply is only at Q0 at price P1.

A local government imposes a green tax on car ownership (2 marks).

The supply of oil will never actually run out. Why? (1 mark)

According to principles of economics the supply of oil will never run dry if the markets are allowed to function freely. The changes brought by new technology coupled with the changes in consumer patterns on its use which is ultimately brought by increase in prices of the commodity is an indication that the supply will never physically run dry. The ever improvement in technology that enables new ways of drilling will ensure that the supply of oil is steady throughout the generations. Another confirmation that the oil supply will never run out is the fact that the oil wells that were dug centuries ago have never run dry.

Under a situation of rent control on units, flats and apartment who actually wins and who loses? What are the long term implications of having rent control? (2 marks)

The rent control is usually seen to benefit the tenants either in low or high rental environment. The landlords are used to operate their business where there are free market forces; hence it is a loss to them when they invest in rent-controlled environments where the value of their investment might be interfered with. The tenants under controlled environments benefit from property improvements and maintenance.

The long term implications of rent control is that sometimes the landlord might ignore some important aspects hence allowing the building to deteriorate after some duration of time. On the other hand it also makes it difficult for some tenants to secure affordable accommodation since most apartments are taken for long term by the first luckiest. It also leads to reduced mobility of labour force since tenants will not feel comfortable moving from a rent controlled apartment to other areas.

Why do most governments not place sales tax on those goods which have a high price elasticity of demand? What goods do governments typically tax? (1 mark).

This is because most of these goods serves majority of the population therefore if taxes are charged the prices of the goods affected may go high and these leads to extreme drop in sales due to low demand, hence the expected revenue may not be realised. Placing sales tax on these goods leads to market distortion. The governments impose taxes only on public goods. These are the goods that the government provide to its citizen and are characterized mostly by externality.

The price of computers has fallen significantly in the years since they were first introduced, yet demand for them has increased significantly. Is this a contradiction? Illustrate your answer with a diagram (2 marks).

There is an influence by a monopolist to the economy as per the prices it fixes on its goods. The higher the prices of computers despite its demand the more will be the people or classes of individuals that will be completely excluded from consumption of the computers. However, selling them at a reduced price will mean that more of the population will be provided by it. The higher the prices the larger the population of competitors for the computers excluded from acquiring it, and less other population classes will benefit and hence the lower the sales will be. This can be attributed to the fact that computers have become like a basic commodity all over the world.

 The price of computers has fallen significantly in the years since they were first introduced, yet demand for them has increased significantly. Is this a contradiction? Illustrate your answer with a diagram (2 marks).

Before improvement, or realisation of its necessity the quantity bought was Q0 of the cars at price P0. The demand has since shifted from D to D1, due to the fact that computers have become like basic necessity to homes and every institution.

This is because fixed and variable costs are part of production in any operating firm and so the firm will still incur total loss in fixed costs. This can only be minimised when production continues that will ensure revenues greater than the variable cost of production. The excess of revenues over variable cost would cater for the fixed costs that the firm might incur in short run. However, it is advisable for a firm to shut down with immediate effect if it does not expect its revenues to exceed its variable cost of production because this may make the firm to incur greater losses more that the total fixed cost.

Discuss the main strengths and weaknesses of game theory as a theory of oligopoly behaviour and as an aid to a real world corporate oligopolist in deciding prices and output. (2 marks)

The cooperative game theory will ensure examination of how firms work when they reach agreements on certain issues. It will enhance coordination in the channels of distribution and at the same time cool down the price wars that might occur. The large number of firms will lead to great amount of goods produced hence low prices.

The weakness arises whereby it is easy for the consumers to be subjected to price abuse. It is easier for the firms in oligopoly to realise smaller profits due to low prices charged on goods. The firms in oligopoly cannot make individual decisions without thinking of the reactions of other firms in the industry.

Why should we study perfect competition if it does not actually exist in the real world? (1 mark)

By studying perfect competition, we can learn what level of impact an ideally functioning market system can have. This makes it possible to make comparison within the real world market structures. Perfect competition also acts as a base through which equality can realised in terms of human production and supply of commodities. It tends to minimise the level of exploitation that producers can have over other competitors and ultimately consumers. It provided sufficient knowledge necessary for controlling the market forces and indicators, in this case supply, demand and quantity, prices respectively.

Explain how the entry and exit cost in an industry in which there may be only one firm operating affects the level of prices the firm will charge. (1 mark)

When a firm leaves an industry supply will fall and prices rice leading to elimination of economic losses. The prices charged will tend to be equal to minimum average cost in the long run. The firm may choose to down size to reduce the economic losses that it might incur hence replacing by normal profits. The exit of a firm reduces market supply and acts as a boost to prices to the other firms still operating within the industry.

Explain and illustrate with diagrams the differences between diminishing marginal returns and decreasing economies of scale and give some examples (2 marks).

Production function

Diminishing marginal returns is realised when there is an addition of a variable factor of production with other factors of production fixed at a constant state of technology. In the illustration the shape of the Total Product (TP) curve increases as the variable input added increases, it rises rapidly in the initial stages the slows slightly up to the maximum value before declining. The curve undergoes three stages as shown in the figure. For example, addition of one or two workers are in the production line will result in increase to the level of output, however using excess workers on the same fixed amount of work may result into them getting into each other’s way hence decrease in production. This is what causes the TP curve to turn down after the maximum limit making the increase in marginal product to be negative. Good example can be applied in agricultural firm where addition of one worker increases the amount of land tilled and seeds planted hence increase in output level.

In the situation where diseconomies of scale exert some effect, the resulting situation is that the long-run average cost curve rises. This can be due to situation whereby the management within a firm are unable to make some decisions due to too much work. This can be attributed to growth of the industry that ultimately exerts heavy burden on the management. The other cause can be due to too much competition for the available resources like labour. This causes a firm to pay more the resource resulting to high cost of production. Example can be in retailing sector or publishing industries.


More Holden cars have been sold in the last year than any other model of car despite the price of Holden cars having risen. Does this mean that the law of demand does not actually hold? (1 mark)

The law of demand still holds, whereby the lower the prices the higher the demand of that particular good. This situation brings out the difference between total and marginal utility. In case of total utility, consumers buy low price goods because of the amount of satisfaction it brings on their income. But in the case of marginal utility the consumer is willing to sacrifice to purchase a particular good at high price because of the additional satisfaction he/she gets from using the commodity. This case is likened to marginal utility whereby consumers are willing to pay for the high priced Holden cars in order to enjoy the additional satisfaction that it provides.

The price elasticity of demand rose for Holden cars because they are regarded as luxurious cars. This situation calls for perfectly inelastic demand whereby the consumers are willing to pay the higher price in order to enjoy the luxury benefits that goes along with it.

Why have western governments introduced a price for carbon emissions? Is there, however, a prisoner’s dilemma at play in explaining why some countries are reluctant to charging a price for carbon emissions?

The price for carbon emissions is referred to as carbon offset. The prices are charged because they view it as an important policy tool that ensures that the negative effects of carbon and other greenhouse gases to environment are reduced and economic stability maintained. However, the policy may cause difference in prices of carbon in the world and can lead to economic damage to countries that have low carbon prices. In some countries they believe that setting prices for carbon emissions may adversely affect some livelihoods. This is because in some countries majority of the population earn their living from collection and selling firewood and so setting carbon prices may render them jobless.

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