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BEO2264 Microeconomic Analysis Assignment

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Due Date: 30th

September 2017

Value: 20%

Required reading: Pindyck, R.S. & Rubinfeld, D.L. (2013). Microeconomics (8th Edition)

Boston, USA, Pearson

*Graphs/diagrams are needed when necessary*

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Question 1 (Maximum 200 words, 5 marks)

(a) “Even though parking meters yield no profit or make a small loss, they should be

retained because of the rationing function they perform.” Explain.

Parking meter is widely used device to perform the spot rationing function. The economic

rationale behind the rationing function of parking meter is simple. As per the economic

fundamentals, it rations the scarce resource when the demand for parking vehicles exceeds

the supply of available spaces. This parking meter helps to improve the economic efficiency

of the use of parking lot which in turn enhances the social efficiency. The opportunity cost

for not using the parking meter is no doubt higher. Thus the parking meter must be retained

even if it yields small loss. (Pejovich 1972)

(b) Suppose you are a government official responsible for establishing a scheme to raise

new revenue by the use of taxes. Would elasticity of demand be important to you in

deciding which product to tax? Explain.

Elasticity of demand is one of the most crucial factors that need to be considered while

establishing a new pricing strategy to raise revenue by the use of taxes. Whether the rise in

price will lead to raise the total revenue or not that solely depends on elasticity of demand. If

the demand is relatively inelastic like tobacco products then only taxation policy will be

effective – it would generate new revenue for the government. But if the demand is highly

elastic, a rise in price through tax will not be much effective as it will not increase rather

decrease the total revenue. Hence the value of elasticity coefficient has important

implications in deciding which product to tax. (Robert S. Pindyck 2013)

Question 2 (Maximum 200 words, 5 marks)

The advent of mobile shopping apps has led to an enormous growth in online shopping,

particularly for electronic goods. Explain the effects of the introduction of shopping apps on:

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(a) Competition in the retail market for electronics, and the consumer surplus of

purchasers of electronics

The advent of mobile apps has a huge impact on the market for online shopping especially for

electronic goods. The consumer can now buy directly the electronic products from their

mobile apps at any point of time. It has significantly reduced the search time and cost. The

competition among the electronic product buyers has increase that leads to reduce the price

distortions in the market. Consumers can enjoy a lower price and higher consumer surplus.

Mobile apps are found to be most convenient platform where the buyers and the consumers

can directly interact with each other. Sellers can provide all important and relevant

information to the potential buyers. The use of mobile apps significantly promotes

competition among the sellers. (NéstorDuch-Brown 2017)

(b) The profitability of the traditional brick-and-mortar retailers of electronics.

Introduction of the mobile shopping apps will hardly hit the sales and profitability of brick

and mortar retailers of electronics. Nowadays a growing number of consumers find it more

convenient to buy through mobile shopping apps than to brick and mortar visits. It definitely

saves time and cost. It offers a better shopping experience overall. Traditional brick –and –

mortar retail stores have observed a drastic fall in sales and profit. At the bottom line, after

the advent of mobile shopping apps, the traditional brick and mortar retailers are in a state of

huge crisis with a rapid fall in their profitability. (Bogaisky 2014)

Question 3 (Maximum 200 words, 5marks)

An Australian researcher has discovered a drug that weakens a sheep’s wool fibers just above

the sheep’s skin. The drug sharply reduces the cost of shearing (cutting the wool off) sheep

because the entire coat pulls off easily in one piece. Assume that the wool market is perfectly

competitive.

(a) Explain the short run effects of the introduction of this new drug for prices, quantities

and profits.

A new drug has been discovered that significantly reduce the cost of shearing sheep. The new

drug weakens sheep’s wool fiber just above the skin so that entire coat comes out in one

piece. As the cost of wool production has reduced, it would positively affect the supply of

wool. Assuming the wool market is perfectly competitive, the MC curve of wool will shift to

the right. As a result, equilibrium quantity will increase. Since the perfectly competitive firms

are rice takers, there will be no change in the equilibrium price in the short run. Due to

introduction of new drug, the profit for each firm will increase in the short run.

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(b) Explain the long run effects of the introduction of this new drug for prices, quantities

and profits.

In the long run, many other firms will also enter in the market by attracting the short run

positive profit. The industry supply curve for wool will shift to the right causing the market

price of wool to fall. Since more firms enter in the industry, existing wool firms will

experience a drop in profit. The entry of new firms will continue until the profit is eliminated.

Long run equilibrium will occur at the point where the demand curve is tangent to the long

run average total cost curve. At this point, firms can only earn zero economic profit or normal

profit in the long run. The profit maximizing condition in the long run can be stated as

P = AR = MR = MC = ATC

As far as the long run effects are concerned, equilibrium price will come down, equilibrium

quantity will increase and the profit will become zero due to the introduction of this new

drug. (Robert S. Pindyck 2013)

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Question 4 (Maximum 200 words, 5 marks)

(a) Suppose the lawn-mowing industry approximates a perfectly competitive industry.

Suppose also that a single firm buys all the assets of the lawn-mowing firms and

establishes a monopoly. Contrast these two market structures with respect to price,

output, and allocation of resources. Would you expect the monopoly to survive?

Explain.

Perfectly competitive firms and monopoly are two distinctively different market structures.

When the lawn mowing industry was a perfectly competitive industry, there were many firms

and all the firms have to accept the single price. No forms in lawn mowing industry enjoy any

market power. But as soon as one firm buys all the assets of the lawn mowing firms it

became a single producer with no close substitutes. The firm becomes the sole producer with

absolute market power in lawn mowing industry.

In case of perfectly competitive market, the perfectly competitive lawn mowing firms acted

as a price taker and can earn only short run economic profit. But in the long run, all the lawn

mowing firms can enjoy only zero economic profit. As soon as one lawn mowing firm

becomes the sole producer and the market structure shifts from perfect competition to

monopoly, the firm can enjoy economic profit both in the short run and in the long run. As far

as the price – output is concerned, the equilibrium price will be more and equilibrium

quantity will be less in monopoly. Since the monopoly firm can enjoy profit both in the short

run and in the long run, it can survive in the market. (Robert S. Pindyck 2013)

AC Pm

B

C

D

Price

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Monopoly

(b) The Best Computer Company just developed a new computer chip, on which it

immediately acquires a patent, and becomes monopoly producer/seller. Show and

explain what happens to consumer surplus, producer surplus and the deadweight loss

(DWL) if the firm goes from a single price monopoly to perfect price discrimination.

In case of perfect price discrimination, The Best Computer Company will charge each

consumer according to their willingness to pay. Since the consumers are paying as per their

maximum willingness to pay, they do not have any consumer surplus. In case of perfect price

discrimination, the perfectly competitive firms will receive zero consumer surpluses. On the

other hand, the firm extracts all consumer surpluses. The comparison between monopoly and

perfect price discriminant monopoly is shown in the following diagram

AR

MR

Output Qm O

A

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References

Bogaisky, J 2014, Retail In Crisis: These Are The Changes Brick-And-Mortar Stores Must Make, viewed

10 September 2017, <https://www.forbes.com/sites/jeremybogaisky/2014/02/12/retail-in-crisis-

these-are-the-changes-brick-and-mortar-stores-must-make/#2649283f13f9>.

NéstorDuch-Brown 2017, 'The impact of online sales on consumers and firms. Evidence from

consumer electronics', Innternational Journal of Industrial Organization , vol 52, pp. 30-62.

Pejovich, EGFAS 1972, 'Property Rights and Economic Theory: A Survey of Recent Literature', Journal

of Economic Literature , vol 10, no. 4, pp. 1137-62.

Robert S. Pindyck, LR 2013, Microeconomics , Pearson , Boston.