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PRINICPLES OF MICROECONOMICS

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					Bryon Gaskin
 Instructor: Perry Hollowell
 Econ 202 IVY TECH FALL 2002

                               PRINICPLES OF MICROECONOMICS
                                           ECN 202
                                       Unit 3 Assignment


 The first two units explored a basic overview of the science of economics. The concept
 of scarcity, choice and opportunity cost was introduced. The need for economic systems
 was explored by introducing the market system. Both Macroeconomic and
 Microeconomic concepts were presented.
     The rest of the semester will focus on Microeconomics. Chapters 6, 7 & 8 begin this
 journey. Specifically the concept of price elasticity, a measure of consumers’ and
 producers’ responses to price changes is emphasized. I cannot stress strongly enough the
 need to understand how price elasticity of supply and demand, cross price elasticity, and
 income elasticity as it is important in element of economic analysis. Knowledge of the
 general nature of production costs is essential to understand how firms make decisions.
 Those decisions will depend upon prices (costs) of the resources essential to its
 production and the price the product will bring in the market place. Please include the
 questions with your answers.

 1. (A) Explain in detail a perfectly elastic demand curve and a perfectly inelastic
    demand curve.
    When talking about a perfectly elastic demand curve and a perfectly inelastic demand
    curve, one must keep in mind that there is a price range that is in reference; because
    even such things vital medical supplies, if the price changes so drastically it would
    effect inelastic demand. For example, if the cost of Zocor (a cholesterol medication)
    has an inelastic demand curve from a price range of $70 to $90 for a month’s supply,
    if the price were to jump to say $250 dollars, then the inelastic demand curve would
    be no more because less people would being ABLE to buy. Remember for demand,
    that not only does the consumer have to WANT to buy it, they also have to be ABLE
    to buy it.
         A perfectly elastic demand curve is a straight horizontal line can purchase any
    amount of the product they want at a given price. In a perfectly elastic demand curve,
    the smallest change in price will cause the consumers to change their consumption by
    a large amount.
         A perfectly inelastic demand curve is represented by a straight vertical line. It
    represents that idea that consumers will not change the quantity of goods consumed or
    purchased when the price of that good changes.

     (B) Price elasticity along a straight-line demand curve refers to what?
         Price elasticity along a straight-line demand curve refers to the idea that equal
         changes in price means equal changes in quantity. In other words a change x unit
         price will mean an equal y change in quantity. So a move from a unit price of
         $10 to $9 will mean a change in quantity demanded to go from 500 to 475, and a
         change in price of $9 to $8 will mean a change in quantity from 475 to 450. A $1
         dollar change in price means a 25-unit change in quantity demanded.
Bryon Gaskin
 Instructor: Perry Hollowell
 Econ 202 IVY TECH FALL 2002

 10 Points

                                                                                      2.
  (A) What are the major determinants of price elasticity of demand?
                 *The existence of substitutes
                 *The importance of the product in the consumer’s total budget
                 *The time period in consideration.
     (B) Use these determinants in judging whether demand for each of the following
 products is elastic or inelastic.
     (a) Oranges Some what elastic because you can substitute other comparable fruits.
     (b) Cigarettes Inelastic because there really are not much in the way of substitutes,
 and the time frame is short for their purchase.
     (c) Winston cigarettes Elastic, because not everyone is brand loyal when it comes to
 cigarettes.
     (d) Gasoline Inelastic because there are no substitutes.
     (e) Diamond bracelets . Elastic because a diamond bracelet purchase is a very
 significant percentage on the average consumer’s total budget.
 15 Points

 3. The income elasticity of demand for movies, dental services, clothing have been
 estimated to be +3.4, +1.0, and + 0.5, respectively. Interpret these coefficients.
 MOVIES =3.4
 DENTAL = 1.0
 CLOTHING = 0.5
 All of the goods mentioned above are normal goods, because the have
 coefficients above zero. In other words, when dealing with normal goods,
 income and quantity demanded move in the same direction. A 1% increase in
 come means a .5% increase in quantity demanded of clothing, a 1% increase in
 quantity demanded for dental services, and 3.4% increase in the quantity
 demanded for movies.

 15 Points

 4. Price discrimination is often used by businesses. Explain the conditions under which
 price discrimination is practiced and the economic consequences of price discrimination.
 Price discrimination is most common in business where you consumers can
 easily be divided into different groups or sectors and those sectors need not
 be something that is visual such as old young, rich or poor, but it can be. A
 personal example, is two weeks ago I sent a hard drive from work to have data
 recovered from it, I asked what the price cost would be and they said that if it
 is Hard Drive is being returned to an individual then the price is $800, if it is
 being returned to a business the price is $1100. The more choice that a
 specified group as, the more likely there is to be price discrimination.
 Discounts for senior citizens or children to eat or see movies, off peak minute
Bryon Gaskin
 Instructor: Perry Hollowell
 Econ 202 IVY TECH FALL 2002

 usage for cell phones, not paying a cover charge for arriving at a bar before
 9PM or scheduling your next airfare well in advance and taking a Saturday night
 stay, are all examples of price discrimination at work. So why do business use
 price discrimination? That is the real question, obliviously there must exist a
 motive, and the motive is profit. By tailoring their pricing strategy to
 definable groups they are better able to maximize profits. For me buying
 items such as coffee is an inelastic demand, if it costs $.40 cents from the
 vending machine or over $2.00 a Starbucks has no effect on how may cups I
 buy. However for senior citizens a $2.00 cup off coffee would be unthinkable
 so might a $1.00 cup, however if a place offering a cup of coffee for a $1.00 a
 cup to the general public but has very few senior citizens buying coffee at a
 $1.00 cup, then offers coffee at $.65 a cup for anyone over 65, and increases
 the number of cups of coffee sold to people over 65 by 55% then, they have
 good reason to practice price discrimination.
 15 Points,

  5. (A) Why would an ounce of gold be priced higher than an ounce of coffee beans,
 even though coffee is generally considered more essential than gold? Explain the
 paradox in terms of marginal and total utility.
 The paradox of one once of gold being priced higher than one once of coffee
 beans given that coffee is considered more essential than gold can be
 explained (as in most things in economics) through supply and demand. When
 the quantity demanded is limited and in the case of gold finite, but the
 quantity demanded is high, the price people will pay for that good will
 eventual reach an equilibrium price determined by market forces. If one only
 looks at marginal utility to compare the coffee beans and gold then that would
 not show the real picture because we would be comparing apples to oranges.
 If really want to understand how these goods relate, we must equalize their
 satisfaction. This is done by dividing marginal utility by price. In summary,
 the marginal utility of coffee beans is low, but so is its price, but it’s total
 utility is high. The total utility of all of the coffee beans is very high when
 compared to total utility to all of the gold purchased. We affix a higher price
 to gold because the supply available is so low when compared with the highly
 abundant amount of coffee beans available.

  (B) Describe the law of diminishing marginal utility. On what assumptions is this law
 based?
 The law of diminishing marginal utility is a model for describing how when one
 receives an additional good in a specific time period, the level of satisfaction
 one receives per additional good received decreases compared to the previous
 good received.
 On what assumptions is this law based?
 The law of marginal utility assumes that you can measure happiness. The word
Bryon Gaskin
 Instructor: Perry Hollowell
 Econ 202 IVY TECH FALL 2002

 “utility” in “law of diminishing marginal utility” is term used to measure
 happiness or just a unit of measure. Also the assumes that at least one
 resource is fixed.
  10 Points

  6. Define overhead, how it can be reduced and how it affects consumers and retailers.
 Overhead are the costs that not directly related to the production process.
 Overhead can be greatly reduced by technology. For instance, take a company
 that is involved in transporting goods from a warehouse to satellite sites
 around the country. They then win contracts to supply five times services they
 currently supply over the next 2 years. So they go from a firm of 50 trucks to
 200 trucks, and a work force of 75 to a work force of 250. What happened? As
 they increased the scale of the business they had to hire more people to
 perform some of administrative tasks such as tracking shipments, via fax,
 phone and email. This cost is not directly related to the production of the
 product. However; if the change t a web based computerized system using
 barcodes and check points, they could change their administrative costs from
 75 to 100 employees, this would decrease the overhead.

 15 Points

  7. Explain the difference between the short run and long run. What costs do firms
 consider in the short run and long run?
 10 Points
   The biggest difference between the short run and the long run is that the
 short run is constrained by the law of diminishing marginal returns and the long
 run is not constrained by this law. The reason for this is, is because short run
 contains at least one variable that cannot be changed. Whenever one variable
 cannot be changed then you will always run into a point in which adding more
 input will eventually decrease output. The long run does not have to be
 affected this way. In the long run the variable that was unchangeable in the
 short can be changed and therefore is not the limiting factor in production.
 When all of the resources in firm are changed in the long run, the change
 means the firm is operating at a different scale and the firm moves into a short
 run period.

 What costs do firms consider in the short run and long run?
 In the short run, firms are concerned about variable costs, because they
 cannot do anything about the fixed costs. In the long run firms are still
 interested in the variable costs, because what was once a fixed cost in the
 short run can become a variable cost in the long run. In the long run since all
 of the costs are variables, there are not diminishing marginal returns, for the
 mere fact that all of the resources are variable, it is only when you have at
Bryon Gaskin
 Instructor: Perry Hollowell
 Econ 202 IVY TECH FALL 2002

 least one resource that is variable are you restrained by the law of diminishing
 marginal returns.

 8.     (A) Use the concepts of economies and diseconomies of scale to explain the shape
       of a firm’s long-run ATC curve.
       First lets look at what three types economies of scale we have. 1st,
       economies of scale are situations were the cost of producing a unit good
       decreases as the quantity produced increased. 2 nd, constant returns to
       scale, this happens when there no change in cost of the each unit
       produced as the quantity produced rises. 3rd, diseconomies of scale is a
       situation in which the cost of producing each unit increases as the total
       quantity produced increases. The long run can be shaped as the normal U
       which represents economies of scale, constant returns to scales, and
       diseconomies of scale, or it can be a continuously gradual sloping line for
       an economy of scale or it can be a flat horizontal line when it is operating
       in a constant returns to scale. Regardless of which one it operates as, the
       long run ATC curve connects the lowest cost for each level of output
       represented by the Short run ATC. Even though the Long Run ATC can be
       different shapes, the Short Run ATC curve will always be “U” shaped
       because of the law of diminishing marginal returns.

       What is the concept of minimum efficient scale?
       The concept of minimum efficient scale is that it is the lowest point on the
       LRATC. It is the point where cost to make each unit of a product is the
       lowest or most efficient.

      (B) What bearing can the shape of the long-run ATC curve have on the structure of
 an industry?
 To explain what bearing the shape of the LRATC curve on a industry structure
 lets look at three main shapes. In the first shape if the average total cost
 descends rapidly to its minimum point and then rises very quickly there after,
 then the there are probably a lot of small firms in the industry. The second
 shape would be caused when there is a gradual descend over long range output
 until it reaches it’s minimum point, then there are only a few very large firms
 in the industry. The final shape is caused when the average total cost drops
 very quickly to the minimum cost over the long range of output, then industry
 is probably configured of large firms and small firms alike.
  10 Points

 TOTAL 100 POINTS
Bryon Gaskin
 Instructor: Perry Hollowell
 Econ 202 IVY TECH FALL 2002

 If really concentrate and learned the material in these 3 chapters, the remaining chapters
 will be much easier to understand. I always tell my students, “Don’t get lost in this part
 of the course.” This is the basic language of Microeconomics.

				
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