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BUS102 Introduction To Microeconomics
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BUS102 Introduction To Microeconomics
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Course Code: BUS102
University: Kingston University
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Country: United Kingdom
Question:
Bush fires and drought have destroyed coffee plantations in Brazil, the world’s leadingproducer of coffee. Manufacturers of coffee products are discussing ways of averting a projected shortfall in coffee in the next five years. Nestle, manufacturer of Nescafe and Nespresso, is teaming up with Brazil to trial plantations of new coffee specie that could mature in twelve months.With the aid of the demand and supply diagram, answer the following questions:
a. Analyse the impact of the drought and bush fires on the supply of coffee. b. Suppose worldwide demand for coffee products increases soon after the drought and bushfires. Analyse the effect on the world equilibrium quantity and price of coffee. c. Analyse the effect on the world equilibrium price and quantity of coffee, if the trial of the new specie is successfully. Clearly state any assumptions you make.
Answer:
Answer a
Figure 1: Production Possibility Curve
Answer b
Every economy faces the problem of scarcity because of unlimited wants of people and access to only limited amount of resources. The presence of scarcity makes it extremely important to allocate resources efficiently. The concept of Production Possibility Curve addresses the economic problem of scarcity and describes the allocation of scarce resources ( Fine 2016). The Production Possibility Curve generally represents a hypothetical situation to make a choice of production between two goods.
The theoretical framework of Production Possibility Curve is based on a number of assumptions. The main assumptions of PPF are as follows
The mode assumes that amount of resources in an economy is fixed. The resources however can be transferred from one industry to another to adjust the level of output.
Given the resources, the economy can produce only two goods
There are no unutilized resources. That is all the resources are completely and efficiently engaged in production process.
Resources though can be moved from one industry to another but are not equally efficient in producing all goods (Baumol & Blinder, 2015). As a result, when resources are transferred from one industry to another, productivity decreases because of a decline in efficiency.
The technology of production is assumed to be constant.
The main properties of PPF are gives as follows
i)PPF is downward sloping: PPF represent maximum possible combination of two goods that can be produced in a nation given the resource base and technology. Under this situation, increasing output of one good comes at the expense of decreasing output of the other as resources needs to be pulled out from some other industry to increase output of a particular good (Friedman, 2017). The inverse relationship between output of two goods makes the PPF downward sloping from left to right.
ii) Concave to the origin: On the PPF, moving from one point to another point involves an opportunity cost. The opportunity cost increases as more and more of one commodity is sacrificed to increase production of some other. Because of increasing opportunity cost PPF bowed outward or it is concave in shape.
iii) Moving from left to right along the PPF indicates an increasing marginal rate of transformation.
iv) Point on the PPF shows feasible combination of two goods produced with fully utilizing resources.
Answer c
Newland initially had a demand of 3,000 bicycle and 18,000 cars. Given the PPF schedule it is a feasible production point. However, as the demand for both bicycle and cars increases simultaneously to 4000 bicycles and 20,000 cars, it represents a point outside the PPF. In order to increase output of both the goods simultaneously the production capacity of Newland needs to be increased. Technological advancement can provide one way out to this problem. With the aid of advanced technology more output from both the industry can be increased given the resources. Another way is to increase the resource base by exploring new resources (Arrow, 2015). As more and more resources put into the industry, there is an increase in output. Additionally, to meet the new demand Newland should focus on using the available resources in a more efficient way. Specialization is one technique to increase resource efficiency.
Answer 2
Part I
At equilibrium,
After tax buyers have to pay a higher price for per pizza purchased
New demand equation
After tax equilibrium
Price paid by buyers
Figure 2: Tax incidence in the pizza market
Before tax, market equilibrium is at E. The equilibrium price is $7 and equilibrium quantity is 6. As tax is imposed on purchase of Pizza it directly affects the demand which shifts leftward. The new equilibrium is at F (Cowen & Tabarrok, 2015). Price paid by buyers increases to $8 while price received by seller is $5. The dead weight loss is given by the triangle EFG.
Deadweight loss
Part II
Answer a
Figure 3: Effect of US firm bill
Demand and supply function in the wheat market is presented as DD and SS respectively. The equilibrium point is at E. Corresponding to the equilibrium, the price is $250 and equilibrium quantity is 1000 kilo tons. After, the farm bill sets price above the equilibrium level of $250. At $300, the quantity demand is 800 while the quantity supplied is 1200. The high price discourages consumers to demand less wheat while encourages producers to supply more (Nicholson & Snyder, 2014). As a result, there exists a surplus in the market of amount (1200 – 800) =400 kilo tones
Answer b
Figure 4: Change in Consumer Surplus, Producer surplus and deadweight loss
(Source: as created by Author)
Under free market equilibrium, consumers enjoy surplus given by the area A+B+C. The surplus to producers is measured by the area D + G +F. As a result of setting price to $350, consumer surplus now reduces to A only. Loss in consumer surplus is B+C. Part of the consumer surplus is transferred to producer. The producers receive a surplus of C+D+G. The resulted dead weight loss is B+F.
Before far bill
After farm bill
Answer c
Answer d
The intention of the firm bill is to protect the interest of the farmers. With a high price there is a definite increase in surplus to farmers. However, because of the law the buyers have to pay a high price reducing surplus to buyers. There exists an excess supply in the market. In order to make the program successful government should stand ready to purchase the excess supply at the high price. This creates unnecessary burden on government. The notion of fairness implies that the economic pie should be divided equally (Mochrie, 2015). However, under such program, the benefits to farmers come at the cost of buyers. Some surplus to consumers are transferred to producers. Moreover, in order to finance such price support program government often raises tax burden to common people. The political lobbying further reduces the efficiency of such price support program. The farm bill thus is not a fair policy to protect interest of the farmers.
Answer 3
Answer a
The production of coffee requires a favorable climate condition. The natural calamities are unexpected shocks in the production (Moseley, 2015). This hampers coffee yields leading to a shortage of supply. This can be explained in terms of the diagram given below.
Figure 5: Effect of drought and bushfires on coffee supply
(Source: as created by Author)
The supply and demand in the coffee market is depicted by the curves SS and DD respectively. The initial equilibrium is at point E. Corresponds to the equilibrium point, the market price and quantity are obtained as P* and Q* respectively. Now, drought and bushfires hampers the yield of coffee bean. This is observed from a resultant shift in the supply curve from SS to S1S1. The equilibrium moves up from E to E1. At the new equilibrium market price increases to P1 while available quantity in the market reduces to Q1.
Answer b
The expected increase in the coffee products after drought and bushfire creates an upward pressure on demand. Brazil being one of the leading suppliers of coffee devices a significant control over the world market. The supply shortage in Brazil following drought and bushfires affect the global market. In the world market, there is now a simultaneous increase in coffee demand and a contraction in supply (Ashwin, Taylor & Mankiw, 2016). The increased demand creates a force that pushes up both price and quantity in the world market. The contraction in supply on the other hand though increases price in the world market but reduces the available supply in the market. Under this situation world price is expected to increase certainly. The effect on equilibrium quantity is however ambiguous because of the workings of two opposing forces. The demand side pressure increases quantity while the supply shortage reduces quantity. Whether equilibrium quantity increases or decreases in the market that depends on the underlying forces and magnitude of demand and supply. Based on the circumstances, there are three possible cases.
In the following three figures DD and SS represents the world demand and world supply curve respectively (Katz, 2016). The world price is set at P*. Depending on the magnitude of changes in demand and supply the world equilibrium quantity differs.
Case I
Here, increase in world demand exceeds the fall in supply resulted in decrease in increases in an increases in both world price and quantity.
Figure 6: Increased demand exceeds supply shortage
(Source: as created by the Author)
Case II
In this case, increase in world demand is less than the contraction of supply resulted in decrease in increases in an increases world price but a decline in world equilibrium quantity.
Figure 7: Contraction in supply exceeds increased demand
(Source: as created by Author)
Case III
Here, the magnitude of demand and supply change is same. Hence, the effect on world equilibrium quantity is nullified while price increases as usual.
Figure 8: Demand and supply changes by same magnitude
(Source: as created by Author)
Answer c
If the trial of new specie is successful, then world supply of coffee is likely to increase. The increased supply in combination pf increased demand affect world equilibrium price and quantity. Both demand and supply side forces give an upward pressure on equilibrium quantity. However, what happens to equilibrium price that depends on the magnitude of demand and supply side forces (Mahanty, 2014). Increased demand pushes world price up while increased supply pushes price down. Here again there are three possible scenarios, one which price decrease, one in which price increases and one where price remains the same.
Case I
In this case supply force dominates demand force and therefore world price decreases (Moulin, 2014).
Figure 9: Supply force greater than demand force
(Source: as created by Author)
Case II
Here, supplies side force is less than demand force and hence, world price increases
Figure 10: Supply force less than demand force
(Source: as created by Author)
Case III
The demand and supply change by same magnitude. Hence, world price remains the same.
Figure 11: Supply force equals demand force
(Source: as created by Author)
Reference list
Arrow, K. (2015). Microeconomics and operations research: Their interactions and differences. Information Systems Frontiers, 17(1), 3-9.
Ashwin, A., Taylor, M. P., & Mankiw, N. G. (2016). Business economics. Nelson Education.
Baumol, W. J., & Blinder, A. S. (2015). Microeconomics: Principles and policy. Cengage Learning.
Cowen, T., & Tabarrok, A. (2015). Modern Principles of Microeconomics. Palgrave Macmillan.
Fine, B. (2016). Microeconomics. University of Chicago Press Economics Books.
Friedman, L. S. (2017). The microeconomics of public policy analysis. Princeton University Press.
Katz, J. (2016). The macro-and microeconomics of natural-resource-based growth. Neostructuralism and heterodox thinking in Latin America and the Caribbean in the early twenty-first century. Santiago: ECLAC, 2016. LC/G. 2633-P. p. 223-237.
Mahanty, A. K. (2014). Intermediate microeconomics with applications. Academic Press.
Mochrie, R. (2015). Intermediate microeconomics. Palgrave Macmillan.
Moseley, F. (2015). The marginal productivity theory of capital in intermediate microeconomics textbooks: A critique. Review of Radical Political Economics, 47(2), 292-308.
Moulin, H. (2014). Cooperative microeconomics: a game-theoretic introduction. Princeton University Press.
Nicholson, W., & Snyder, C. M. (2014). Intermediate microeconomics and its application. Cengage Learning
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