Business Economics

Muhammad Syazwan Abdul Rahman FAL 12031054 Business Economics

Question 1

(a) Distinguish between Positive and Normative Economic Perspectives in

Economics.

Positive economics (sometimes called Descriptive Economics) is the study of

economic reality and why the economy operates as it does. It is biased purely on facts rather

than opinions. This type of economics is made up of positive statements which can be

accepted or rejected through applying the scientific method. "Malaysia bought five Sukhoi

last year" is a positive statement in which it happened to be a simple declaration of fact.

Normative economics (also called Policy Economics) deals with how the world

ought to be. In this type of economics, opinions or value judgments which is known as

normative statements are common. "We should reduce taxes" is an example of a normative

statement.

Positive economics is objective and fact based, while normative economics is

subjective and value based. Positive economic statements do not have to be correct, but they

must be able to be tested and proved or disproved. Normative economic statements are

opinion based, so they cannot be proved or disproved. While this distinction seems simple, it

is not always easy to differentiate between the positive and the normative. Many widely-

accepted statements that people hold as fact are actually value based.

For example, the statement, "government should provide basic healthcare to all

citizens" is a normative economic statement. There is no way to prove whether government

"should" provide healthcare; this statement is based on opinions about the role of government

in individuals' lives, the importance of healthcare and who should pay for it. The statement,

"government-provided healthcare increases public expenditures" is a positive economic

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statement, because it can be proved or disproved by examining healthcare spending data in

countries like Canada and Britain where the government provides healthcare.

Disagreements over public policies typically revolve around normative economic

statements, and the disagreements persist because neither side can prove that it is correct or

that its opponent is incorrect. A clear understanding of the difference between positive and

normative economics should lead to better policy making, if policies are made based on facts

of positive economics, not opinions (normative economics). Nonetheless, numerous policies

on issues ranging from international trade to welfare are at least partially based on normative

economics.

POSITIVE ECONOMICS NORMATIVE ECONOMICS

It expresses what is. It expresses what should be.

It is based on facts. It is based on ethics.

It deals with actual or realistic situation. It deals with idealistic situation.

It can be verified with actual data. It cannot be verified with actual data.

In this value judgments are not given. In this value judgments are given.

It deals with how an economic problem is

solved.

It deals with how an economic problem should

be solved.

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(b) Distinguish between Microeconomics and Macroeconomics

Microeconomics is generally the study of individuals and business decisions,

macroeconomics looks at higher up country and government decisions. Macroeconomics

and microeconomics, and their wide array of underlying concepts, have been the subject of a

great deal of writings.

Microeconomics is the study of decisions that people and businesses make regarding the

allocation of resources and prices of goods and services. This means also taking into account

taxes and regulations created by governments. Microeconomics focuses on supply and

demand and other forces that determine the price levels seen in the economy. For example,

microeconomics would look at how a specific company could maximize its production and

capacity so it could lower prices and better compete in its industry.

Macroeconomics, on the other hand, is the field of economics that studies the behaviour

of the economy as a whole and not just on specific companies, but entire industries and

economies. This looks at economy-wide phenomena, such as Gross National Product (GDP)

and how it is affected by changes in unemployment, national income, rate of growth, and

price levels. For example, macroeconomics would look at how an increase/decrease in net

exports would affect a nation's capital account or how GDP would be affected by

unemployment rate.

The bottom line is that microeconomics takes a bottoms-up approach to analyzing the

economy while macroeconomics takes a top-down approach. Regardless, both micro- and

macroeconomics provide fundamental tools for any finance professional and should be

studied together in order to fully understand how companies operate and earn revenues and

thus, how an entire economy is managed and sustained.

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MICROECONOMICS MACROECONOMICS

Microeconomics is the study of particular

firm, particular household, individual prices,

wages, incomes, individual industries, and

individual commodities.

Macroeconomics deals not with individual

quantities as such but with aggregates of

these quantities not with individual income

but with national income, not with individual

prices but with the price level not with

individual output but with national output.

Micro means very small or millionth part. Macro means large or whole.

The subject or example of microeconomics is

about person, an investor, a producer.

The subject of macro economics is about

national production, national income, income

level.

As it analyzes individually it provides a

partial concept or partial figure of a country.

As it analyzes overall it provides full figure

or complete reflection of a country.

Micro economics is concerned with the

individual entities.

Macroeconomics is concerned with the

overall performance of the economy.

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Question 3

(a) What is price elasticity of demand?

A measure of the relationship between changes in the quantity demanded of a particular

good and a change in its price. Price elasticity of demand is a term in economics often used

when discussing price sensitivity. The formula for calculating price elasticity of demand is:

Price Elasticity of Demand = % Change in Quantity Demanded

% Change in Price

If a small change in price is accompanied by a large change in quantity demanded, the

product is said to be elastic or responsive to price changes. Conversely, a product is inelastic

if a large change in price is accompanied by a small amount of change in quantity demanded.

(b) Describe price elasticity of supply and three elasticity concepts.

Price elasticity of supply measures the relationship between change in quantity supplied

and a change in price. The formula for price elasticity of supply is:

= Percentage change in quantity supplied

Percentage change in price

The value of elasticity of supply is positive, because an increase in price is likely to

increase the quantity supplied to the market and vice versa.

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Three Elasticity Concepts

Spare production capacity - If there is plenty of spare capacity then a business can

increase output without a rise in costs and supply will be elastic in response to a change in

demand. The supply of goods and services is most elastic during a recession, when there is

plenty of spare labour and capital resources.

Stocks of finished products and components - If stocks of raw materials and

finished products are at a high level then a firm is able to respond to a change in demand -

supply will be elastic. Conversely when stocks are low, dwindling supplies force

Time period and production speed - Supply is more price elastic the longer the time

period that a firm is allowed to adjust its production levels. In some agricultural markets the

momentary supply is fixed and is determined mainly by planting decisions made months

before, and also climatic conditions, which affect the production yield. In contrast the supply

of milk is price elastic because of a short time span from cows producing milk and products

reaching the market place.

(c) Explain Five ranges elasticity of demand

Alternative Coefficient (E)

Perfectly Elastic E = ∞

Relatively Elastic 1 < E < ∞

Unit Elastic E = 1

Relatively Inelastic 0 < E < 1

Perfectly Inelastic E = 0

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Perfectly Elastic

The top of the chart begins with perfectly elastic, given by E = ∞. Perfectly elastic

means an infinitesimally small change in price results in an infinitely large change in quantity

demanded.

Relatively Elastic

The second category is relatively elastic, in which the coefficient of elasticity falls in

the range 1 < E < ∞. With relatively elastic demand, relatively small changes in price cause

relatively large changes in quantity. Quantity is very responsive to price. The percentage

change in quantity is greater than the percentage change in price. Here a 10 percent change in

price leads to more than a 10 percent change in quantity demanded (maybe something 20

percent).

Unit Elastic

The third category is unit elastic, in which the coefficient of elasticity is E = 1. In this

case, any change in price is matched by an equal relative change in quantity. The percentage

change in quantity is equal to the percentage change in price. For example, a 10 percent

change in price induces a equal 10 percent change in quantity demanded. Unit elastic is

essentially a dividing line or boundary between the elastic and inelastic ranges.

Relatively Inelastic

The fourth category is relatively inelastic, in which the coefficient of elasticity falls in

the range 0 < E < 1. With relatively inelastic demand, relatively large changes in price cause

relatively small changes in quantity. Quantity is not very responsive to price. The percentage

change in quantity is less than the percentage change in price. In this case, a 10 percent

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change in price induces less than a 10 percent change in quantity demanded (perhaps only 5

percent).

Perfectly Inelastic

The final category presented in this chart is perfectly inelastic, given by E = 0.

Perfectly inelastic means that quantity demanded is unaffected by any change in price. The

quantity is essentially fixed. It does not matter how much price changes, quantity does not

budge.

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Question 4

(a) Explain the following terms..

Scarcity

A pervasive condition of human existence that exists because society has unlimited wants and

needs, but limited resources used for their satisfaction. In other words, while we all want a

bunch of stuff, we can't have everything that we want.

Opportunity Cost

The cost of an alternative that must be forgone in order to pursue a certain action. Put another

way, the benefits you could have received by taking an alternative action. The difference in

return between a chosen investment and one that is necessarily passed up. Say you invest in a

stock and it returns a paltry 2% over the year. In placing your money in the stock, you gave

up the opportunity of another investment - say, a risk-free government bond yielding 6%. In

this situation, your opportunity costs are 4% (6% - 2%).

Ceteris Paribus

Used as shorthand for indicating the effect of one economic variable on another, holding

constant all other variables that may affect the second variable. For example, when discussing

the laws of supply and demand, one could say that if demand for a given product outweighs

supply, ceteris paribus, prices will rise. Here, the use of "ceteris paribus" is simply saying that

as long as all other factors that could affect the outcome such as the existence of a substitute

product remain constant, prices will increase in this situation. Contrasts with "mutatis

mutandis".

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Comparative Advantage

A comparative advantage in producing or selling a good is possessed by an individual or

country if they experience the lowest opportunity cost in producing the good. For example, if

a cruise company found that it had a comparative advantage over a similar company, due to

its closer proximity to a port, it might encourage the latter to focus on other, more productive,

aspects of the business.

Absolute Advantage

The ability of a country, individual, company or region to produce a good or service at a

lower cost per unit than the cost at which any other entity produces that good or service.

Entities with absolute advantages can produce something using a smaller number of inputs

than another party producing the same product. As such, absolute advantage can reduce costs

and boost profits.

Law of Demand

The law of demand states that there is a direct relationship between the price of a good and

the demand for it. In particular, people generally buy more of a good when the price is low

and less of it when the price is high. This is a general rule that applies to most goods called

normal goods. As the price of a normal good increase, people buy less of it because they are

usually able to switch to cheaper goods.

Law of Supply

States that at higher prices, producers are willing to offer more products for sale than at lower

prices. States that the supply increases as prices increase and decreases as prices decrease.

States that those already in business will try to increase productions as a way of increasing

profits.

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(b) List and Explain categories of resources

Land

Economists include in the category of land all sorts of naturally occurring resources, such as

water and timber, as well as the actual physical expanse of land. These resources are all

limited and society has to weigh how best to use them. There are concerns that humanity may

run out of some natural resources if not used in moderation. That's why, for example, there is

a need to be careful about water consumption.

Labour

Labour refers to the resource represented by workers. Workers are necessary to produce any

sort of goods. An organization may be able to produce more quantities of a good by

employing more workers. However, the workers will have to be paid wages, and the business

will have to decide whether the costs of employing more workers are outweighed by the

benefits. If the business decides the benefits of employing more workers outweigh the costs,

it will employ more workers.

Capital

Capital includes the resources used in production. This includes physical capital such as tools

and machines, the human capital gained through education and training and the financial

capital needed to produce a good. There is a certain cost involved in assembling various

goods and financing them in order to produce an output. Entrepreneurs will only invest

capital if they expect the benefits to outweigh the costs.

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Question 5

(a) Identify and Explain types of unemployment

Structural Unemployment

Changes occur in market economies such that demand increases for some jobs skills while

other job skills become outmoded and are no longer in demand. For example, the invention of

the automobile increased demand for automobile mechanics and decreased demand for

farriers which is the people who shoe horses.

Frictional Unemployment

This type of unemployment occurs because of workers who are voluntarily between jobs.

Some are looking for better jobs. Due to a lack of perfect information, it takes times to search

for the better job. Others may be moving to a different geographical location for personal

reasons and time must be spent searching for a new position.

Cyclical Unemployment

This occurs due to downturns in overall business activity. It occurs during recessions

because, when demand for goods and services in an economy falls, some companies respond

by cutting production and laying off workers rather than by reducing wages and prices.

Wages and prices of this sort are referred to as ’sticky’. When this happens, there are more

workers in an economy than there are available jobs, and unemployment must result.

Seasonal unemployment

Unemployment that occurs because the demand for some workers varies widely over the

course of the year. Seasonal unemployment can be thought of as a form of structural

unemployment, mainly because the skills of the seasonal employees are not needed in certain

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labour markets for at least some part of the year. That said, seasonal unemployment is viewed

as less problematic than regular structural unemployment, mainly because the demand for

seasonal skills did not gone away forever and resurfaces in a fairly predictable pattern.

(b) List and explain three major concern of macroeconomics

Inflation

Inflation is an increase in the overall price level. Hyperinflation is a period of very rapid

increases in the overall price level. Hyperinflations are rare, but have been used to study the

costs and consequences of even moderate inflation.

Aggregate Output

Aggregate output is the total quantity of goods and services produced in an economy in a

given period. A recession, contraction, or slump is the period in the business cycle from a

peak down to a trough, during which output and employment fall. A depression is a severe

reduction in an economy’s total production accompanied by high unemployment lasting

several years. An expansion, or boom, is the period in the business cycle from a trough up to

a peak, during which output and employment rise.

Unemployment

The unemployment rate is the percentage of the labour force that is unemployed. The

unemployment rate is a key indicator of the economy’s health. The existence of

unemployment seems to imply that the aggregate labour market is not in equilibrium.

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Question 6

(a) Explain Market Structure

Market structure is best defined as the organisational and other characteristics of a market.

We focus on those characteristics which affect the nature of competition and pricing – but it

is important not to place too much emphasis simply on the market share of the existing firms

in an industry.

(b) Why would a firm stay in business while losing money?

The total revenue-total cost method is one way the firm determines the level of output that

maximizes profit. Profit reaches a maximum when the vertical difference between the total

revenue and the total cost curves is at a maximum.

Each firm in the industry is very small relative to the market as a whole, all the firms sell a

homogeneous product, and firms are free to enter and exit the industry. A price-taker firm in

perfect competition faces a perfectly elastic demand curve.

It can sell all it wishes at the market-determined price, but it will sell nothing above the given

market price. This is because so many competitive firms are willing to sell at the going

market price.

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(c) List and compare four market structures

Perfect competition

Perfect competition happens when numerous small firms compete against each other. Firms

in a competitive industry produce the socially optimal output level at the minimum possible

cost per unit.

Monopoly

A monopoly is a firm that has no competitors in its industry. It reduces output to drive up

prices and increase profits. By doing so, it produces less than the socially optimal output level

and produces at higher costs than competitive firms.

Oligopoly

An oligopoly is an industry with only a few firms. If they collude, they reduce output and

drive up profits the way a monopoly does. However, because of strong incentives to cheat on

collusive agreements, oligopoly firms often end up competing against each other.

Monopolistic competition

In monopolistic competition, an industry contains many competing firms, each of which has a

similar but at least slightly different product. Restaurants, for example, all serve food but of

different types and in different locations. Production costs are above what could be achieved

if all the firms sold identical products, but consumers benefit from the variety.

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