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Microeconomics Final Exam study guide

By tjamil Jul 30, 2014 1717 Words
Perfect Competition:
1. I disagree with the statement. In the short run, the firm has to remain in the industry and it will continue to operate if P > AVC. In this way it will be minimising its losses. If P < AVC it would shut down which means the firm is facing loss, so it will not continue operating so it will shut down. However, at the end of the short run, i.e. in the long run, if the market situation has not changed and P > AVC, the firm may exit the industry because the profit should be equal to ATC. If only P > AVC but is not equal to ATC, the firm should exit the industry, not continue to operate at a loss. 2. I disagree with the statement. The profit maximising criterion is MR = MC. In the short run, a firm may be making economic profits, zero profits or economic losses at the point MR = MC. However, one thing that has not been considered- Total Revenue (TR), TR can be above Total Cost (TC) or below TC. In zero profit, TR=TC. TR will differ from TC when economic profits or losses occur. Monopoly:

1. The resort can charge higher prices than those at the nearby village hotels because guests can purchase the drinks more easily and conveniently rather than take the time to travel to the village. There is also a ‘captive’ element in a resort: it has a locational monopoly. 2. Barriers to entry derive from the ownership of assets, legal barriers and economies of scale. For legal barriers, a good example would be Astro in Malaysia. Government put barriers for other firm to enter into satellite broadcast business in Malaysia as government want to closely monitor what people can watch and cannot watch in Malaysia. An example of ownership of assets would be- De Beers controls the vast majority of the world's diamond reserves, allowing only a certain number of diamonds to be mined each year and keeping the price of diamonds high. Monopoly state competition and oligopoly:

1. A concentration ratio is a measure that is used by economists to gauge the extent to which the largest firms in an industry dominate the market. The ratio indicates the percentage of total sales in the industry that are generated by its largest firms. Yes, concentration ratio in a monopolistic competitive likely to be higher than for a perfectly competitive industry. Although, ‘a large number of sellers’ is a common characteristic of perfect competition and monopolistic competition, monopolistic competition will have a higher concentration ratio for its products than perfect competition. In compare to oligopoly, perfect competition, and monopolistic competition, oligopoly will have the highest concentration among these three because of the characteristics of oligopoly where a market is dominated by very few numbers of large firms. 2. Monopolistic competition might be preferred to perfect competition as an ideal market structure. Like perfect competition, monopolistic competition cannot make the positive economic profits that monopoly and oligopoly can make in the long run, so it is less wasteful of resources and will offer more quantity at lower prices than those market structures. However, unlike perfect competition, it offers consumers variety through its differentiated products and information through its advertising to make that differentiation. Measuring the size of the economy:

1. The circular flow model is based on the assumption that all output is purchased by households in the product markets. The quantity of output multiplied by the price determines the dollar value of expenditures, which are receipts for business firms. All revenues (value of output) received by firms are paid to households as factor payments (income). Factor payments include wages, salaries, interest, rents and profits, which are generated only by the value of output produced and sold. Hence, the value of businesses’ output of goods and services equals the income of households. 2. GDP only tells how big total output or income of one country is compared to another. To determine whether one country is better off than another, GDP per capita should be used, as it measures the average income earned in one country over another. This, though, still says nothing about the distribution of income among a country’s residents or the composition of the goods and services comprising the GDP. It can often be found that a country with high GDP has very high income inequality which means many people are poor. So, GDP cannot tell whether people are happy or not. GDP does not measure the value of destruction to a nation’s stock of natural resources; it measures the flow of dollars determined by market transactions in a period of time. In the case of the BP ocean-based oil disaster, GDP would be increased because of the expenditures required to clean up the damage. GDP would not be decreased by an amount representing the environmental and social damage done by this disaster. In this way, GDP would be a misleading indicator of the true impact of this disaster, and generally will hinder the sustainable development of our world by not being able to take such damage into account. Business cycle and economic growth:

2. The two phases of the business cycle are recessions and expansions. A recession is a downturn in the business cycle in which output, sales and employment decline. An expansion is an upturn in the business cycle where real GDP, employment and other measures of aggregate economic activity rise. 3. The point at which a business cycle expansion finishes is called a peak, while the point at which a business cycle recession finishes is called a trough. 4. A macroeconomic indicator that typically begins to change its direction of growth before an economy enters a new business cycle phase is called a leading indicator. A macroeconomic indicator that typically switches into a new phase at around the same time as the business cycle switches into a new phase is called a coincident indicator. A macroeconomic indicator that typically switches into a new phase after the business cycle has switched into a new phase is called a lagging indicator. Inflation and unemployment:

1. Keynesian view: An expansionary monetary policy, which aims at increasing the money supply will first reduce the interest rate, which increases the investment level and consequently aggregate demand. The resulting effect will be a rise in the price level (i.e. inflation) as well as increased output, unless the economy is at full employment output. Monetarist view: An increase in the money supply directly affects the nominal aggregate demand and thereby raises the price level. This argument is based on the equation of exchange, MV = PQ. If V is constant (or nearly so) and M increases, then PQ must also increase. If Q is already the full employment level of output, then the increase in M will lead to an increase in P. Here M is the supply of money, and V is the velocity of turnover of money (i.e., the number of times per year that the average dollar in the money supply is spent for goods and services), while P is the average price level at which each of the goods and services is sold, and Q represents the quantity of goods and services produced. 2. Keynesians believe that the aggregate supply curve is relatively flat. This means that increases in the aggregate demand curve will add much to real GDP and little to the price level. Monetarists believe the aggregate supply curve is relatively steep. This means that increases in the aggregate demand curve increase real GDP by a rather small amount, but the price level rises sharply. Fiscal policy :

1. Discretionary fiscal policy is the deliberate use of changes in government spending and/or taxes to alter aggregate demand (AD) and stabilise the economy’s business cycle. If an economy is in a recession, discretionary fiscal policy can help boost spending (i.e. increase AD) via a reduction in taxes and/or an increase in government spending. Both approaches aim to increase the consumption (C) and government spending (G) in AD. In doing so, this will shift the AD curve towards the full-employment level and increase real GDP. On the other hand, during inflation, discretionary fiscal policy can help to reduce expenditure or consumption (C) via increasing interest rate, reducing government expenditure (G). This helps to slow down the economy. By doing so, the AD curve will shift to left which means there will be decrease in demand and subsequently, decrease in price. 2 (a): the government increases government spending: The fiscal policy is expansionary due to the increase in government spending. It will make the AD curve shift to the right which will increase demand, increase GDP and price. 2 (b) the government decreases taxes: The fiscal policy is expansionary, due to the decrease in taxes which increase household spending. This decrease in tax will make the AD curve shift to the right which will increase demand, increase GDP and price. 2 (c) the government decreasing spending and taxes by an equal amount: The fiscal policy is contractionary; assuming the balanced budget multiplier is one, the decrease in G more than offsets the increase in C (from the decreased taxes). The net effect is for the aggregate demand curve to shift to the left. 3. WHAT IS THE DIFFERENCE BETWEEN DISCRETIONARY FISCAL POLICY AND AUTOMATIC STABILISERS? Repeat question please see earlier answers. 4. Explain the idea of “crowding out “ . Repeat question please see earlier answers. 5. Consider and discuss this statement : our grandchildren will carry the burden of our failing to pay for current government expenditure out of current government tax revenue. What the statement is trying to say is that when the government borrows money, it is in fact borrowing from its own residents (i.e. taking money out of your left pocket). The borrowed money is then spent on improving infrastructure or some other form of government activity that benefits its residents. Also true is that the interest on the debt and the repayment of principle is made from taxation revenue raised from the country’s residents. So, this is somewhat true that our next generation has to pay the debt of government that government has took to improve infrastructure and do other things in the country.

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