Supply and Demand and Marks

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BUECO5903
Business Economics Assignments
Part A – Microeconomics

Question 1:

(a) Explain the impact of external costs and external benefits on resource allocation; (2.5 marks)

The external cost and external benefit is a cost or benefit imposed on people other than the consumers and producers of a good or service. External cost is negative and may be detrimental to the third party, conversely, external benefits is positive and beneficial to third party. Because of this concept, it will effect resource allocation. An external cost, i.e. a negative externality, is not taken into account, so there is more production, at a higher price, resulting in an over-allocation of resources. An external benefit, a positive externality, will result in an under-allocation of resources. (b) Why are public goods not produced in sufficient quantities by private markets? (2.5 marks)

Public good is a good or service that government, rather than the market, must provide if it is to be made available in sufficient quantity. So people can benefit from public good without pay, so if asked how much they were willing to pay the answer is likely to be nothing, or a very low amount. This free-rider problem means it is not possible for the private market to function effectively.

(c) Which of the following are, or are not examples of public goods (or services)? Please explain your reason.
(1 mark each which includes ½ marks for each reason).

(i)The Judicial system Yes/No
(ii)Pencils Yes/No
(iii)The quarantine service Yes/No
(iv)The Great Wall of China Yes/No
(v)Contact lenses Yes/No
*

Question 2:
(a) Suppose the income elasticity of demand for pre-recorded music compact disks is +5.0 and the income elasticity of demand for a cabinet maker’s work is +0.5. Compare the impact on pre-recorded music compact disks and the cabinet maker’s work of a recession that reduces consumer incomes by 10 per cent. (2 marks)

Under income elasticity, when the consumer income reduces by 10 per cent, the pre-recorded music would be 5*10%=50% and cabinet maker’s work would be 0.5*10%=5%, hence, a reduction of income from a recession will have a greater impact on pre-recorded music than cabinet maker’s work. The pre-recorded music is larger than 1, so it is a luxury good, the cabinet maker’s work is lower than 1, so it is a necessity good. The reduction of income from a recession will have a greater impact on luxury good than necessity good.

(b) How might you determine whether the pre-recorded music compact discs and MP3 music players are in competition with each other? (2 marks)

To determine whether the pre-recorded music compact discs and MP3 music players are in competition with each other, we have to use cross price elasticity of demand to estimate it. If we have the result is less than 0, it is complement, if it is larger than 0, it is substitute. Moreover, the larger the positive coefficient is, the greater the substitutability between the two products is.

(c) Interpret the following Income Elasticities of Demand (YED) values for the following and state if the good is normal or inferior; (3 marks total, 1.5 marks per part)

YED=+0.7, hence, it shows that it is normal good, because it is larger than 0. The coefficient of it is less than 1, so it is inelastic. YED=-3.4, hence, it shows that it is inferior good, because it is lower than 0. The coefficient of it is larger than 1, so it is elastic.

(d)Interpret the following Cross-Price Elasticities of Demand (XED) and explain the relationship between these goods. (3 marks total, 1.5 marks per part)

XED= + 0.75, hence, they are substitute good, because it is larger than 0. The coefficient of it is less than 1, so it is inelastic. XED= -2.5, hence, it shows that it is complement good, because it is lower than 0. The coefficient of it is larger than 1, so it is...
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