Economics Questions and Answers on Resources and Profit

Economics Questions and Answers on Resources and ProfitAssignment QuestionsQuestion 1The removal of imperfections in the market leads to an increase in efficiency in the parcelling of resources. cover whether you agree with this view (25 marks)Question 2Explain what is meant by traffic pattern and ab familiar profit and when such profits might occur (12 marks)Discuss the three reasons as to why people deal m whizy, according to the liquidity gustatory perception theory (13 marks)Table of Contents (Jump to)Question 1A. Allocative Efficiency and Perfectly Competitive marketB. Allocative Efficiency and MonopolyQuestion 2 (a)A. Perfect oppositionB. MonopolyC. non war-ridden CompetitionQuestion 2 (b)A. Transaction MotiveB. Precautionary MotiveC. Speculative MotiveReferencingList of casts (Jump to)Figure 1 Pure Competition multiple sclerosis mutual savings bank CurvesFigure 2 Consumer Surplus Producer SurplusFigure 3 The poor spiel and long scat in perfect competitorFigur e 4 The suddenly run and long run monopoly marketFigure 5 The short run and long run monopolistic challengerFigure 6 Money Demand Curves (liquidity preference theory)Question 1The removal of imperfections in the market leads to an increase in efficiency in the allocation of resources. Discuss whether you agree with this view (25 marks)A. Allocative Efficiency and Perfectly Competitive MarketAllocative Efficiency occurs when it is not possible to reallocate resources in order to make case-by-case better off without making at least an opposite person worse off. It arises whereMarginal Social Cost ( atomic number 62) = Marginal Social Benefit (MSB).The MSC refers any extra terms to society of producing one more unit of output. The law of diminishing returns implies that MSC pass on be upward sloping. On the former(a) hand, the MSB is any extra benefit to society of producing one more unit of output. The law of diminishing marginal utility implies that MSB will be downward sloping .For example If the 20th unit of output is produced, then it costs the society $10, but yields a benefit of $20. Thus, the societys welfare increases by $10 (i.e. MSB MSC). Since MSB is greater than MSC, people is better off. On the contrary, it is not in the societys interest to produce the 40th unit.In perfect argument, twain consumer surplus and producer surplus is maximised (as illustrated by figure 1), where the footing is equal to the marginal cost. The consumer surplus is the total net benefit lie withed by all consumers buying the product. For instance, a consumer paying $20 for a product whose market price is $15 t because enjoying the benefit of $5 ($20 $15 = $5).Producer surplus is the difference between the market price the producer receives and the marginal cost of producing this unit.Demand curves measure the maximum price that consumers are spontaneous to pay for a given quantity of a good. Hence, the demand curve is a measure of marginal benefit (or marginal utility) to the consumer. Therefore, in absence of externalities, MSB = D = P. In perfectly competitive market, the supply curve is a measure of the marginal cost in the industry. In the absence of externalities, MSC = S = MC.Therefore, an effective allocation of resources under perfect competition happens when price equals to marginal cost, i.e. P = MC, in the short and long run.B. Allocative Efficiency and MonopolyMonopoly market structure is one of the major sources of market imperfections. A monopoly is having one firm producing and selling a product with the existence of barriers to entry. A monopolist is a price taker. The monopolist laughingstock set the price or the output, but not both. They buttocks even earn antidromic profits at the expense of efficiency and welfare of consumer and society.Since price is higher than marginal cost, this will lead to a loss of allocative efficiency and a failure of the market. In fact, the monopolist is extracting a price from consumer that is higher than the cost of resources required. Thus, at price Pm, the monopolist is charging a higher price and restricting output to Qm, whereby capturing a portion of the consumer surplus.Under monopoly, there is a portion (triangle ABC) where both the consumer surplus and producer surplus are recovered. This is known as deadweight loss.Figure 2 Consumer Surplus Producer SurplusImperfections in the market leads to misallocation and underutilisation of resources and lessening in consumer surplus since price is greater than marginal cost, i.e. P MC.But imperfections in market do have some benefits such as monopolist are supplying products on a very large scale, thus they may be in a better place to exploit increase returns to scale leading to a fall in average total costs of production. This reduction in costs will lead to an increase in monopoly profits, but some gains in productive efficiency may pass onto consumer in the form of lower prices.Earning abnormal profits in th e long run may lead to faster rate of technological development thereby reducing costs and producing of better quality.Supernormal profits may be utilise to invest in research and development programmes that have the potential to bring dynamic efficiency gains to consumers in the markets.Question 2 (a)Explain what is meant by normal and abnormal profit and when such profits might occur? (12 marks) natural profit is the minimum level of profit that a company needs to take a breather competitive in the market. If firms in an industry are making normal profit, then there is no reasons for them to leave or for other firms to join the industry. Normal profit occurs when revenue equals cost.Abnormal profit (or super normal profit) is profit in excess of normal profit. If firms in an industry are making abnormal profit, then there is a reason for other firms to join the industry if they can. Abnormal profit occurs when the revenue is greater than the costs.A. Perfect CompetitionIn the sh ort run, firms can make abnormal profits or losses, whereas they can only make normal profits in the long run, as illustrated belowFigure 3 The short run and long run in perfect competitionB. MonopolyMonopolies can earn abnormal profits in the short run and in the long run due to the existence of strong barriers to entry.Figure 4 The short run and long run monopoly marketC. Monopolistic CompetitionMonopolistic competition involves many sellers with differentiated products, e.g. shoe producers or restaurants. In the short run, firms can make abnormal profit whereas in the long run, other firms will be attracted by the abnormal profits causing firms demand to fall until only normal profits are made.Figure 5 The short run and long run monopolistic competitionAs a conclusion, if firms are making abnormal profits, other firms will be attracted by such profit, and will try to enter that particular market to reap some of that profits. As a result, firms in perfectly competitive market and monopolistic competitive market will enjoy normal profit with the entrance of new firms in the long run. On the other hand, firms in monopoly market will enjoy abnormal profits both in the short run and in the long run due to the existence of strong barriers to entry.Question 2 (b)Discuss the three reasons as to why people demand money, according to the liquidity preference theory (13 marks)According to Keynes Liquidity gustatory sensation theory, people demand moneyand conquer their wealth in monetary form because of the following three main reasonsA. Transaction MotiveDay-to-day performances are performed by both individuals and firms. An individual person holds cash in order to meet his/her daily expenditures. Business holds cash to meet its current needs such as payments of raw materials, etcTherefore, we can say that money needed by consumers, businessmen and others, is known as the demand for money for transactions motive. This demand depends upon the followingSize of the i ncome If income is high, more will be available for daily transactions and delinquency versa.Time gap between receipts of income If a person gets his pay daily, he/she will demand less cash and ill-doing versa.Spending habit If a person is spent a lot, he/she will do more transactions and thus will demand more money.B. Precautionary MotivePrecautionary motive for holding money refers to the desire to hold cash for unforeseen contingencies such as illness, accidents, unemployment, etc Business keeps cash reserve to safeguard their future. This type of demand for liquidity is called demand for precautionary motive. This demand depends upon many factorsSize of the income If a person earns a high income, he/she will demand more money for safeguarding his future.Nature of the person Some persons are optimistic, i.e. they anticipate less of future risk and danger, and hence they will demand less money for precautionary motive. On the other hand, pessimistic persons foresee dangers, cala mities, and emergencies in the future, and hence, they want to have more cash with them. foresight They are persons who can proper guess of the future, and thus they will keep more money (in cash) with then in case of more emergencies expectation and vice versa.C. Speculative MotiveThe speculative motive relates to the desire to hold cash and take advantage of future changes in the rate of interest or wed prices. For instance, if the price of bond is expected to rise, meaning the rate of interest is expected to fall, then people will buy bonds and sell later when the price rises, and vice versa.According to Keynes, the higher the rate of interest, the lower the speculative demand for money and vice versa.Figure 6 Money Demand Curves (liquidity preference theory)Keynes hold that the transaction and precautionary motives are completely interest inelastic, whereas the speculative demand for money is a smooth curve which slopes downward from left to right, as illustrated in higher up figure.ReferencesGILLESPIE, A (2001) Advanced Economics through Diagrams. 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