the impact of external costs and external benefits on resource collection?
Answer: In simple
terms, an externality is the effect incurred by unrelated third parties during
a commercial or economic activity. If the effects are positive such as an
industrial company providing first aid classes for employees to increase on
the job safety,
this may also save lives outside the factory, it is an external benefit.
Whereas if the effects are negative such as water contamination due to
industrial wastes exposed to the river is an example of external costs.
Therefore, externalities do have certain effects on resource allocation.
External benefits will make efficient resource allocation by effective
allocation of resources as well as saving the opportunity cost whereas a
negative externality would mean resources being wasted as well as overall
increase in social cost.
(b) Why are public goods not produced in
sufficient quantities by private markets?
Answer: Gravelle and
Rees: “The defining characteristic of a public good is that consumption of it
by one individual does not actually or potentially reduce the amount available
to be consumed by another individual”. But if provided by private sector to
realise profit, it can cause market failure.
Our economic and social rights can only be
realized if the services and infrastructure we require to meet our fundamental
needs are provided as public goods, rather than sold for private profits. This
was one of the main findings of NESRI’s 2010 comprehensive analysis of the state of human rights in the
United States. (Source: Eduardo Porter,
8th January 2013, New York Times).
This article reflects that public goods sold
for profit can cause market failure, increase in prices and thus increases external
costs as well. Therefore, for better resource allocation and proper utilization
of goods and services, public goods are not provided in sufficient quantity by
Which of the following are or are not
examples of public goods (or services)? Please explain your reason.
(i) The judicial system is a public good as its consumption by public
does not reduce the amount available to another person.
(ii) Pencils are not public goods as they are
produced by private sector to get profit and them will be reduced after
consumed by people.
(iii) The quarantine service again is a
public good as its not available to get profit and also its service won’t be
reduced after consumption.
(iv) The Great Wall of China is available
equally to all and indefinitely by government, thus is a public good.
(v) Contact Lenses are provided by private
sectors and they earn profit through the selling, thus is not a public good.
Suppose the income elasticity of demand for
pre-recorded music compact disks is +5 and the income elasticity of demand for
a cabinet maker’s work is +0.5. Compare the impact on on pre-recorded music
compact disks and the cabinet maker’s work of a recession that reduces consumer
incomes by 10 per cent.
Answer: Pre- recorded music compact disks are luxury
goods as income elasticity of demand is greater than 1 whereas cabinet maker’s
work is a necessity good as its income elasticity of demand is +0.5. If the consumer
income reduces by 10 per cent, the impact on luxury goods and necessity goods
will be such that their demand decreases. The major difference would be that
the decrease in demand for necessity good will be less than proportionate to
the income. And, the decrease in demand for luxury good will be more than
proportionate to the income
How might you determine whether pre-recorded
music compact disks and MP3 music players are in competition with each other?
The pre-recorded music
compact disks and MP3 music players are substitute products which mean one can
be used in the place of the other. The demand of one product is inversely
proportionate to the demand of the other as the price of products can play
major role to each other’s demand. Therefore, we can measure cross elasticity
of demand to determine the competition between them. The cross elasticity of
demand of the substitute products is positive as the price of product X
(compact disks) increase then the demand of product Y (MP3 players) also
Interpret the following Income Elasticity of
Demand (YED) values and state if the goods are inferior or normal?
If the income elasticity of
demand is positive then it is normal good whereas if the income elasticity is
negative then it is inferior good. In the first instance the YED= +0.7, it is a
normal good. Also the YED is between 0 and 1, which means the good is necessity
good as the increase in demand will be less than proportionate to the income.
Whereas, in the second instance the YED=
-3.4. Therefore, it is inferior good as the increase in income of the consumer
will lead to fail in demand and may lead to changes to more luxurious
Interpret the following Cross-Price Elasticity
of Demand (XED) and explain the relationship between these goods.
Cross Elasticity of demand
shows the responsiveness of quantity demanded for a good to the change in price
for another good. A negative cross elasticity shows the two products are
complements whereas positive cross elasticity denotes two products are substitutes.
When XED= +0.75, the positive elasticity shows that the products are
substitutes whereas when XED= -2.5 it shows the products are complements.
(a) Complete the two tables.
Total Revenue $
Average Revenue $
Marginal Revenue $
Total cost $
Marginal cost $
Average cost $
Total cost $
Average cost $
Marginal cost $
Marginal revenue $
Total revenue $
(b) Are these firms operating in the short or
the long run?
Answer: Firm A is
operating in short run (FC=$30) and firm B is operating in short run
(c) Are these firms operating under perfect or
Answer: Firm A is in
perfect competition (horizontal demand curve) and firm B is in imperfect competition (downward sloping demand
(d) What level of output will these firms produce
in the short run?
Answer: Firm A: 2 or 3 units, where MC=MR
Firm B: 4 or 5 units, where MC=MR
(e) How would you describe their profit positions?
Answer: Firm A makes a
loss of $30 ($50-$20 or $60-$30). This is the best it can do,
and any other output would give a greater
Firm B makes profit of $184 ($400-$216 or
$450-$266). This is the maximum profit it can make given the figures in the
Suppose you own a coffee shop. List some of
the fixed inputs and variable inputs you would use in the shop
Answer: Fixed inputs are the inputs which doesn’t
changes over the period where as the variable inputs changes time and again.
Some of the fixed and variable inputs incurred while operating a coffee shop
Part time salary
Baubles and Beads manufacturing produces 100
pendants per day. The Total fixed cost
for the plant is $4000 per day and the variable cost is $13,000 per day.
Calculate the average fixed costs, average variable cost, average total cost
and total cost at the current output level.
Total Fixed cost = $4000
Total Variable cost = $13,000
Average Fixed Cost = Total Fixed cost/Total quantity produced =
$4000/100 = $40
Average Variable cost =
Total variable cost / Total quantity = $13,000/100 = $130
Average total Cost =
Average fixed cost + Average variable cost = $40 + $130 = $170
Total Cost = Total fixed
Cost + Total Variable Cost = $4000 + $13,000 = $17000
An owner of a firm estimates that the average
total cost is $6.71 and the marginal cost is $6.71 at the current level of
output. Explain the relationship between these two figures.
Answer: Marginal cost is the change in the total cost
when quantity produced changes by one unit. In other word it is the cost of
producing one more unit of good. When Average cost remains the same that would
mean the firm is not producing any extra unit of product. So since the level of
output hasn’t changed marginal cost is equal to average total cost. Therefore,
the owner is efficiently producing in optimum level.