ASSIGNMENT

ECO162 MICROECONOMICS
JULY – NOV 2009

Instructions:
1. Form a group of 4 or 5 members.
2. On the cover of the assignment, please write:
a. Names and matrix no. of ALL group members.
b. Programme/part/group.
3. The assignment must be submitted NO LATER than 15th October 2009.

TASK 1 – Answer ALL questions.

1. Explain how Socialism and Capitalism solve the three basic economic problems.
2. Explain 4 differences between Islamic and conventional economic systems.
3. Explain the concept of scarcity, choice and opportunity cost.
4. Draw all diagrams (with labels) as stated below:
a. Chapter 1: The concave PPC with points showing efficient production, inefficient production and
scarcity problem.
b. Chapter 2: i) The consumer’s equilibrium.
ii) The changes in Qd and changes in Dd curve.
c. Chapter 3: Market equilibrium with a floor price.
d. Chapter 4: i) The production curves (TP, MP, AP) in one diagram.
ii) The cost curves (TC, TVC and TFC) in one diagram.
e. Chapter 5: i) Perfect Competition curve – the 3 short run profits and long run profit.
ii) Monopoly curve – the 3 short run profits and long run profit.
iii) Oligopoly curve – the Sweezy’s model.
5. Write down the formula to calculate cross elasticity of demand. Explain the importance of its
coefficient.
6. Summarize the concept of the Law of Diminishing Marginal Return.
7. Explain 4 determinants of demand.
8. Explain 4 determinants of price elasticity of demand.
9. Using a diagram, explain and distinguish between elastic supply and inelastic supply.
10. Discuss 4 characteristics of monopolistic competition.

TASK 2 (PAST FINAL EXAMS) – Answer PART C ONLY.

Each group must select ONE of the past final exam questions as listed below. Please make sure that you
don’t choose the same question. Attach a copy of the question.

1. APR 2009 8. NOV 2005 15. MAR 2002

2. OCT 2008 9. MAR 2005 16. SEPT 2001
3. APR 2008 10. OCT 2004
4. OCT 2007 11. MAR 2004
5. APR 2007 12. OCT 2003
6. OCT 2006 13. APR 2003
7. APR 2006 14. SEP 2002

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QUESTION 1

Explain how Socialism and Capitalism solve the three basic economic problems.

There are three basic economic problems, there are What to produce?, How to
produce? And For whom to produce?. In different economy systems there are different ways
to overcome or solve this problems

The first basic economic problem is What to produce?. In Capitalism, they use price
mechanism to overcome this problem. The price consumers willing to pay serves as signal
for producer to decide what to produce. Normally they will produce product that are highly
demanded. In Socialism, the decision are made by the goverment. The authority plans what
to be produced based on society need not individual need.

Second basic economic problem is How to produce?. In Capitalism, producers

normally choose methods in order to maximize profits. They can either choose labor
intensive or capital intensive based on prices of the factors. In Socialism, the methods
determined by the government depending on economic purpose. Capital intensive is used
to increase economic growth while labor intensive is used to reduced unemployment
problem.

The third basic economic problem is For whom to produce?. In Capitalism, it depends
on consumer purchasing power. If income increase, they will increase their demand. In the
othet hand, in Socialism, goverment fairly divide the goods to the society. The basic needs
will be distributed according to overall society needs.

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QUESTION 2

Explain 4 differences between Islamic and Conventional Economic Systems.

There are many differences between Islamic and Coventional economic systems. The
differences are, there is no separation between religion and economics in Islam. Everything
is under Allah. The second different between Islamic and conventional economic systems is
in Islamic economic is religiously value loaded. In Islam, we have clear cut between haram
and halal. There are more halal items than haram that can be explore by people.

Other than that, Islam prohibits riba. This is to promote social justice and to uphold
the principle of brotherhood. Islam use equity participation and profit sharing
(mudharabah). Lastly, in Islam the concept utility is for this world and hereafter, not just for
this world satisfaction only. Muslim produce goods and services according to their hierarchy
of needs.

For example in Malaysia, majority people are Muslim so it could prevent people from
doing the bad things. Then, its will decrease the gap between poor people and rich people.
Citizens also would change their mind set, from negative to positive. All people are same
range because all of the human is creation of Allah s.w.t.

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QUESTION 3

Explain the concept of scarcity, choice and oppurtunity cost.

Scarcity is the situation in which human wants are forever greater than available
supply of time, goods and resources. It occurs when the society wants exceed the ability of
the economy to meet those wants. This is because human wants are unlimited, whereas the
resources to satisfy these wants limited.

Choice, it occurs when you choose something or when a decision is made on certain
preference that will give maximum satisfaction. Choice will involve a set of alternatives and
decision is made due to cost, benefits and satisfaction.

Opportunity cost is the second best alternatives that a person has to forego.
Anything that consumer has to give up or sacrifice in order to gain somethings. Example, we
have two choice to make, to buy fried chicken or to buy burger. The opportunity cost of buy
fried chicken is we have to forego burger and vice versa.

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Question 4

Draw all diagrams (with labels) as stated below:

a. Chapter 1: The concave PPC with points showing efficient production, inefficient
production and scarcity problem.

b. Chapter 2: i) The consumer’s equilibrium.

ii) The changes in Qd and changes in Dd curve.

c. Chapter 3: Market equilibrium with a floor price.

d. Chapter 4: i) The production curves (TP, MP, AP) in one diagram.

ii) The cost curves (TC, TVC and TFC) in one diagram.

e. Chapter 5: i) Perfect Competition curve – the 3 short run profits and long run
profit.
ii) Monopoly curve – the 3 short run profits and long run profit.
iii) Oligopoly curve – the Sweezy’s model.

Note : Answers behind.

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QUESTION 5

Write down the formula to calculate cross elasticity of demand. Explain the
importance of its coefficient.

FORMULA of Cross Elasticity of demand (PEDxy):

∆Qx P₁y
PEDxy = ×
Q₁x ∆Py

Q₂x−Q₁x P₁y
= ×
Q₁x P₂y−P₁y

Q₁x = initial quantity of good X

Q₂x = new quantity of good X

P₁y = initial price of good Y

P₂y = new price of good Y

The importance of coefficient of cross elasticity of demand is how responsive the

quantity demanded of one good is to a change in the price of another good. If the cross
elasticity of demand is a positive (+), then, the relationships of goods is a substitute goods.
When cross elasticity of demand is a negative (-), then, the relationship of goods is a
complementary goods. If the cross elasticity of demand is equal to 0, the relationship of
goods is a unrelated goods.

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QUESTION 6
Summarize the concept of the Law of Diminishing Marginal Return.

Law of Diminshing Marginal Return states that after a certain point, when additional
units of variables input (eg. labor) are added to fixed input (eg. capital or land), the Marginal
Product (MP) of the variable input declines.

In other word, additional workers are applied to a constant amount of capital

equipment (fixed resources), output will eventually rise by smaller and smaller amounts as
more worker are employed. We must assume that the all units of variable input are equal in
quantity. The significant of Law of Diminishing Marginal Return is to enable the producers to
identify the most economical stage of production, given the fixed and variables factors of
production.

The example is, assume that we have a small furniture factory, which has several
machines for cutting, painting and so on. In this situation, we use labour as our variable
input. Many things such as raw materials and utilities can be the variable input in real world.
If we have one or two worker, our production would be very slow. We can solve this
problem by adding more workers in our factory. The marginal product of each succeeding
worker would arise, as the operation become more efficient. The benefit of specialization
could be realized.

But, if we keep adding workers, the problems of overcrowding would arise. Worker has
to wait to use the machines. Now, total output would increase at a diminishing (decrease)
rate. Some machines may be over-utilized. If we add more workers, the marginal product
would become negative- total product (output) would decline instead of increasing, because
the factory become so crowded and congested until no work can be done. Some workers
would sit idling, could not do any work.

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QUESTION 7

Explain 4 determinants of demand.

First determinant of demand is the price of related goods. A change in the price of
related good may increase the demand for a product, depending on wether the related good
is a substitute or a complementary. Substitute goods is a pair of goods alternatives to each
other. Examples, coffee and tea, magarine and butter. As a price of one good goes up, the
demand for its substitute will also increase. Thus, Dd curve of substitute will shift to right.
Complementary goods is a pair of goods consumed together. Examples, camera and film,
cars and petrol. As price of one good goes up, the demand for its complementary good will
fall. Thus, Dd curve of complements shift to left.

Second determinant of demand is consumer’s income. As income increase, buying

power will increase. Therefore, demand for most goods will rise. There are different effects
on different goods. If it is a normal/luxury goods, when income increase, demand also
increase. If the goods is a inferior goods, when income increase, demand will decrease. If the
goods is a necessities, when income increase, demand will be constant.

Tastes and preference also is the determinant of demand. The more desirable people
find the good, the more they will demand. Affected by advertising, trend of fashion, by
consideration of health, by the experience from consuming the good on previous occasions
etc. Example, brand-conscious person / comfortable with certain brand, therefore the more
you will demand for that product even thought there is no change in price.

Last but not least, seasons and climate also the determinant of demand. Seasons or
climate can also affect demand. For example, in rainy season, people will use umbrellas or
rain coats. Therefore demand for those products will increase. Different products will also be
demanded at different festive seasons. For example, during Hari Raya, traditional Malay
cookies, baju kurung, raya card will be highly demanded.

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QUESTION 8

Explain 4 determinats of price elasticity of demand.

First, determinant of price elasticity of demand (PED) is the number and closeness of
substitute goods. The more substitute and the closer they are, the more elastic the demand
will be. For example, automobiles like Toyota, Honda, Ford, Nissan and many others became
perfect substitute for Proton. So the demand curve for Proton must be elastic. For goods
that has no close substitute, the demand is highly inelastic.

Second, determinant of price elasticity of demand is the proportion of income spent

on the good. The higher the proportion if income that is spent on a particular good, the
more we will be forced to cut consumption when its price increase. Therefore price elasticity
of demand will be more elastics. The lower the proportion of income spent on certain good,
then the more inelastic the demand will be.

Habit forming also is the determinant of the price elasticity of demand (PED). The
more people get used to one product, the more inelastic the demand will be. People don’t
want to switch to other products).

The fourth determinant of price elasticity (PED) is the time period. The longer the
time period after a price of certain goods changed, the more elastic is the demand. Example,
price of a rises by 20%, the consumers may not switch immediately, but as time goes by they
may shift to other brand of shampoo.

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QUESTION 9

Using a diagram, explain and distinguish between elastic supply and inelastic
supply.

ELASTIC
P

Ss

P₂
P₁

0 Q₁ Q₂ Q

Q₂−Q₁ P₁
%∆Qs > %∆P : ×
Q₁ P₂−P₁
The Ss curve is less steep.
The coefficient = 1 < PES < α

Elastic supply means that an increase in price causes a bigger increase in supply. It has a PES
of greater than 1. Supply will be elastic if it is easy for a firm to increase supply e.g. spare
capacity in factory, easy to employ more factors of production.

INELASTIC
P

Ss

P₂

P₁

0 Q₁ Q₂ Q

Q₂−Q₁ P₁
%∆Qs < %∆P : ×
Q₁ P₂−P₁
The Ss curve is steep.
The coefficient = 0 < PES < 1

Inelastic demand. This means that an increase in price causes a smaller increase in supply. It
has a PES of less than 1. Supply is often inelastic in short-term, when it is difficult for firms to
increase their capacit

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QUESTION 10

Discuss 4 characteristics of monopolistic competition.

First characteristic of monopolistic competition is many sellers. The industry has

many sellers but less than in perfect competition industry. The firm only has a small market
share. Each firm has a comparatively small percentage of the total market, so each has
limited control over the market. There are no collusion, because the presence of large
number of firms ensure that collution is very unlikely and there is little interpendence, each
firm can determine its own pricing without considering the possible reactions of rival firms.
One seller cuts its price and increase in sales, the other firm may not fell it.

Differentiated products is also the characteristic of monopolistic competition.

Monopolistic competition provide produts slightly different from competing products with
regard to product attributes, services to consumers, location and accessibility, or other
qualities, real or imagined. In a simple word, differentiated products explain the products
are similar in nature but different in terms of packaging, quality, brand names etc.

Third characteristic of monopolistic competition is relative easy entry and exit.

Anybody can set up firms easy but not as easy in perfect competition. New firms have to
come up with new product features and brands to compete or establish their reputations.

Lastly, the non-price competition. It has significant role because sellers cannot really
compete in terms of prices. Examples, advertising and packaging. Monopolistic competition
firms advertise their products heavily in effort to inform consumer about their product
differentiation, a strategy to make price less important factor in consumer purchases and
product differences is a greater factor.

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PAST FINAL EXAM QUESTION PAPER - MARCH 2004
PART C (30 MARKS)

Question 1

a) Discuss how a capitalist economy uses market mechanism to solve basic economic
problems.

In this economic system, consumers are very powerful they can influence the
producer decisions. The price they are willing to pay for any goods, serve as signals for
producer and seller to decide what to produce and how much to produce.
Producer will produce goods that are higher demanded which pay the highest price
in order to maximize profits. Price of resources and production factors or inputs, indicate
what production methods to use to minimize production cost. The three basic economic
problems is what goods and services will be produced? Due to limited resources, all
economic must make a choice. They may use different decision making rules and
mechanisms on deciding in what goods to be produce more of one goods, we have to
produce less of another good.
How will goods and services be produced? The economic system must determine
how output is to be produced. Which resources should be used, and how output is to be
produced. Which resources should be used, and how they should be combined to
production, more labor and less capital, etc. m order to maximize production.
For whom will goods and services be produced? Who will consume the goods and
services produced? What is the basis of the distribution? This question is also known as a
distribution question.

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b) With the help of an appropriate diagram, explain the concepts of scarcity, choice and
opportunity cost.

Choice occurs when you choose something or when a decision is made on certain
preference that will give satisfaction. Based on the diagram, the points PPC signifies the
concepts of choice. We have to make a choice among the various combination of rice and
car. To move an alternative A to alternative B, it means that we have made a choice of
producing more rice and less car.

Opportunity cost is anything that consumers has to give up or sacrifice in order to

gain something. From the PPC, we can say that if we switch from point B to point C we are
actually sacrificing the production of the car in order to produce more rice.

Scarcity occurs when the individual or society wants exceed the ability of the
economy to make those wants. This is because human wants are unlimited, whereas the
resources to satisfy these wants are limited. Based on the diagram above, if we choose to
produce at point Y, it is unattainable due to the problem of scarcity or not enough resources
to produce at that point.

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Question 2

a) Explain why agricultural products are more supply price inelastic compared to that of
industrial products.

Firstly, the time period or adjustment period of agriculture products are responsive
to price. This means that a change in market price during which producer cannot respond
with the change quantity of supplied. For example, a farmer planting tomatoes, he must sell
his current crop at whatever price, his current supply is inelastic because tomatoes cannot
be stored for long time and any change in price can only affect the next growing season. In
short-run, the crops capacity of individual producers is persumed fixed. But they still have
limited way to increase production and supply. Example, a farmer can use more fertilizer to
increase output in response to a presumed increase in demand.

Agricultural product requires a long period of production, from planting to harvest.

That will make the agriculture products is inelastic. The agriculture products also are
perishable. If the products are easily perishable, then the supply would be inelastic. Even the
price is increase supplier would not increase their quantity supply in large volume due to
perishable problem. Examples of agriculture products that is perishable are tomatoes,
carrot, fish etc. Sometimes the agriculture products are too costly to store, it will have a low
elasticity of Ss (inelastic). Goods that are too costly to be store is goods that are to be store
in large amount. As example, fishes or vegetables that harvests in large quantity.

Most of the industrial products that are not perishable compare agricultural
products. The time period to produce the industrial products is short. This is because of the
nature of the industrial products are long lasting and more durable than agricultural
products. So, the supply of the industrial products is elastic. The firm can use any kinds of
materials for its input resulting in supply of its output become elastic.

b) Explain the difference between a change in quantity supplied and a change in supply.

Change in supply and change in quantity supply is the same concept as change in demand
and change in quantity demanded. Change in supply means a change in the entrée schedule
or a shift of the enterer curve. It is caused by a change in one or more of the determinants of
supply such as number of sellers, technology, resource price, taxes and subsidies,
expectation, and price of other goods. But change in supply is a change in any one or more
of these determinants of supply or supply shifters will more the supply curve for a product
either to the right (increase in supply- producers supply larger quantity of the product at
each possible price) or to the left ( decrease in supply). Resource price, the higher resource
(input of the production) price will raise the production cost and reduce the profit. In
technology, improvement in technology enables firms to produce more unit of output at
lower costs; these increases the firms profit and therefore encourage them to increase their
supply. Managerial specialization (managerial economies). Large-scale production also
means better use of, and greater specialization in management.

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Question 3

a) With the use of a diagram, describe the three (3) stages of production in the short-run.

TP/AP/MP

Stage 1 Stage 2 Stage 3

TP

AP

0 Q of L
MP

Stage 1. The firm will start from the source until the intersection of MP and AP.
There is a sharp will increase of TP as we increase the units of variable input, example labor.
It means that each additional will increase in labor units results in greater increase of TP. For
rational producer will continue producing goods at this stage since TP can be increase by
adding more labor.

Stage 2. From the intersection of MP and AP until MP equal 0 and TP at the max. The
values of AP and MP are decreasing but still positive. This is the most efficient stage of
production it because the combination of variable and fixed inputs are used efficiently. The
inputs are fully utilized; no machines are left idle as we have the right number of labors to
operate all machines. A rational producer will produce at this stage. If the firm continues
produce the product after this stage, the TP will start to decline.

Stage 3. Begins when MP=0 and continues to decline thereafter. A rational producer
should not be producing the product at this stage. It because, TP start to decline. There is
overutilization of capital.

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b) Explain four (4) factors that lead to economies of scale experienced by large-scale firms.

The four factors that influence is job specialization, it means one worker with only a few
tasks, repeating the same work, increase the skills, quantity will increase also and the AC will
decrease. Other than that, marketing economies, it means the firms buy inputs in bulk, get
special discounts, decrease the cost and AC will decrease also. Then, financial economies, big
and established firms normally get favorable term when borrow money from banks (lower
interest rate and longer repayment period). The fourth one is managerial economies. This
means that when a manager can manage a bigger output efficiently at the same wage, quantity
increase and AC will decrease.

Question 4.

a) Compare any four (4) characteristics of perfect competition and monopoly.

Perfect competition Monopoly

Many buyers and sellers. Sole producer.

 Neither of them have the influence over  There is only one seller with many
the market price. buyers.
 The sellers are normally the price takers
because the output sold is relatively
small compared to the market volume.

Free entry and exit. There are barriers to entry.

 Firms can enter the industry without
restrictions from relevant authorities or
government.
 Firms can also freely exit from the
market if incur losses.
 There are restrictions for a new firm to
enter the market. ( government laws
and regulations)

Role of non-price competitions. Role of non-price competition.

 Producers or seller in this market
structure don’t have to advertise their
product.
 Even if they do advertise, no guarantee
the sales will increase.
 The product is sold by many other sellers
or a fixed price.
 Advertisement is not needed to promote
sales. Since the monopolist is the only
seller in the market, consumers do not
have other choice. If advertising is
undertakes, this is to have a good
relationship with the consumers.

Perfect knowledge. The monopolist has power to control the

 Both buyer and sellers have perfect market price.
knowledge of market condition.
 If a seller increases the price, the other
sellers and the buyers will come to know
about it.

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b) Explain why firms in a perfectly competitive industry are not able to maintain
supernormal profit in the long-run.

P P S₀

ATC S₁

P₁ P₁

P₀ MR P₀

D₀ D₁
0 Q 0 Q
Single firm Industry
 Show the long run equilibrium position of a competitive firm, P= MC= Minimum ATC.
Temporary profit.

P ATC P S₁

S₀

P₀ P₀

P₁ MR P₁
D₀
D₁
0 Q 0 Q
Single firm Industry
 Show the long run equilibrium position of a competitive firm, P= MC= Minimum ATC.
Temporary loss.

Entry eliminates economic profit. If P exceeds ATC, the economic profits enjoyed by
the existing firm will attract new firm to the industry. Supply will increase until it force the P
back to minimum ATC.
Exit eliminates losses. If P less than ATC, the firm will incur losses. This will cause the
firm to leave the industry. As they leave, total supply will decline, bringing the P back to
equality with minimum ATC. In the short run, firms may not have sufficient time to liquidate
their assets and go out of the business.
In long run equilibrium. The firm produces at MR=MC and the price is equal to
minimum ATC. Economic profit here is zero, and the industry is in equilibrium. The existing
firms are earning normal profit.

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