June 2010 unit 1 paper 2 answer


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June 2010 unit 1 paper 2 suggested answer by Edward Bahaw

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June 2010 unit 1 paper 2 answer

  2. 2. EDWARD BAHAW CAPE ECONOMICS PAST PAPER SOLUTIONSJune 2010 – Unit 1 – Paper 2Units of Good X Consumed Total Utility Marginal Utility 0 0 1 150 150 2 250 100 3 330 80 4 380 50 5 400 201 a i) )Total utility refers to the total level of satisfaction derived from the consumption ofa given quantity of a good or a service. As shown in the table, if an individual consumes0 units, then 0 utils of satisfaction is derived. As 1 unit is consumed, 150 units ofsatisfaction are gained and if 2 units are consumed, total satisfaction increases to 250utils. As the table shows, by the time 5 units are consumed, total utility rises to 400 utils.1 a ii) Marginal utility gives the change in satisfaction derived from the consumption ofeach additional unit of a good or service. The third column of the table shows this. Asconsumption rises from 0 to 1 unit, total utility changes from 0 to 150, this means thatmarginal utility is 150. As consumption increases further from 1 to 2 units, total utilityrises from 150 to 250, thus, marginal utility is 100.1 a iii) The law of diminishing marginal utility states, that as a consumer increasesconsumption of a good or a service, the marginal utility will diminish. As can be seen,marginal utility in the table declines as consumption increases, thus demonstrating thelaw of diminishing marginal utility.1 b i) Total Marginal Marginal Utility per Dollar Quantity Utility Utility (MU/Price) Bread Buns Bread Buns Bread Buns 0 0 0 1 6 5 6 5 6 5 2 11 9 5 4 5 4 3 15 12 4 3 4 3 4 18 14 3 2 3 2 5 20 15 2 1 2 11 bii)3 bread @ $1 each = $32 bag of buns @ $1each = $2Total Expenditure = $5 EDWARD BAHAW CAPE ECONOMICS PAST PAPER SOLUTIONS
  3. 3. EDWARD BAHAW CAPE ECONOMICS PAST PAPER SOLUTIONSP ($) D $2 $1 D 2 3 Quantity of Bread1 biii)2 bread @ $2 each = $41 bag of buns @ $1each = $1Total Expenditure = $51b iv) Total Marginal Marginal Quantity Utility Utility Utility per Dollar (MU/Price) Bread Buns Bread Buns Bread Buns 0 0 0 1 6 5 6 5 2.5 2 2 11 9 5 4 2 1.5 3 15 12 4 3 1.5 1 4 18 14 3 2 1 0.5 5 20 15 2 1 3 52 a i) Consumer demand can be defined as the total quantity of a good or servicepurchased over a specific period of time at a particular price.2 a ii) This first law of demand states that as the price of a good or service is lowered,consumers would demand a larger quantity as long as all other variables are heldconstant. That is to say, there is an observed inverse relationship between the price offinal output and the quantity purchased by consumers.2 a iii)As price changes, quantity demanded changes giving rise to a movement along the EDWARD BAHAW CAPE ECONOMICS PAST PAPER SOLUTIONS
  4. 4. EDWARD BAHAW CAPE ECONOMICS PAST PAPER SOLUTIONSdemand curve. A fall in price resulting in an increased quantity demanded which istermed an extension of demand. An increase in price resulting in a decreased quantitydemanded which is termed a contraction of demand.An increase or decrease in demand, which results in a shift of the demand curve, isbrought about by a factor other than a change in price of the good or service underconsideration. These factors are called the conditions of demand. A rightward shiftindicates that an increased quantity is demanded at all price levels and is termed anincrease in demand. Leftward shifts, on the other hand, indicate that a decreased quantityis demanded at all price levels and are termed a decrease in demand.2 b i) Factors influencing the demand for beef.1) Changes in income;2) Price of other goods (substitutes or compliments);3) Seasonal factors affecting demand;2 b ii) Four factors influencing the demand for digital cameras. An increase in income would lead to an increase in demand for digital cameras as consumers would purchase more of all goods and services. This is shown by a rightward shift of the demand curve. If the price of a substitute such as increases then this would encourage consumers to buy more beef and less chicken. This is shown by a rightward shift of the demand curve for beef. During festive seasons such as Christmas the demand for beef would rise as consumers increase consumption of food. This is shown by a rightward shift of the demand curve.3a i) Number of Barriers to Type of Competition Nature of Product Firms Entry and Exit Heterogeneous – Substitutable apart from Oligopoly Few Yes perceived differences through branding Heterogeneous – Not easily Monopolistic substitutable due to real Many No Competition differences through product differentiation3a ii) Although, firms under monopolistic competition sell differentiated products,consumers can substitute output from one firm with the output produced by other firms.Firms therefore attempt to create customer loyalty though advertising which builds thebrand image of their products. Advertising therefore reduces the cross elasticity ofdemand between the output of firm and other producer in a monopolistically competitiveindustry. Firms therefore gain some degree of market control as consumers would regardthe output of each firm less substitutable. EDWARD BAHAW CAPE ECONOMICS PAST PAPER SOLUTIONS
  5. 5. EDWARD BAHAW CAPE ECONOMICS PAST PAPER SOLUTIONS3b)The firm can earn abnormal profits in the short run if AR is greater than AC. This isshown in the figure, where at the quantity where MR = MC, (QE) AR is greater than AC,thus the shaded region represents abnormal profits.Short Run Abnormal Profits earned by the firm under Monopolistic Competition Price ($) AC MC PE MR= MC MR AR O QE QuantitySuch abnormal profits earned by existing firms would encourage new firms to enter theindustry. As more and more firms enter the industry, the market share of each firm isdiluted and this has the effect of reducing the abnormal profits earned by each firm. Thiswould be shown by a leftward shift of the demand curve. The entry of new firms in themonopolistically competitive industry would continue until all abnormal profit iseliminated from the increased competition. This is shown in figure, where the AR curvehas shifted until it becomes tangential to the AC curve.Long Run Normal Profit earned by the firm under Monopolistic Competition EDWARD BAHAW CAPE ECONOMICS PAST PAPER SOLUTIONS
  6. 6. EDWARD BAHAW CAPE ECONOMICS PAST PAPER SOLUTIONSPrice ($) AC MC AC = MC PE MR = MC MR AR O QE QO Quantity Excess CapacityIn the figure, at the output level where MR = MC, normal profits is earned, that is AR =AC. This implies that no additional firms would be motivated to enter the industry as anyfurther dilution of market share and hence a further leftward shift of the demand curvewould lead to losses. This situation where all abnormal profits are competed away and allfirms earn just normal profits, is the long run equilibrium under monopolisticcompetition.4a i) Market failure occurs whenever the quantity of a good or service produced in amarket does not occur at the productive and allocative efficient level. When productionefficiency and allocative efficiency are simultaneously achieved, it means that resourcesare being efficiently used and allocated towards the production of goods and serviceswhich generate the highest level of economic well-being. In other words, when marketfailure exists the welfare of society is not maximized as welfare losses exist.4bi) Public goods have two main characteristics:• Non-rivalry in consumption• Non-excludability in consumptionNon-rivalry in consumption means the good or service can be consumed by a group ofconsumers at the same time. Non-excludability in consumption means that consumers canmake use of the good or service even though they do not pay for it. The producer cannot EDWARD BAHAW CAPE ECONOMICS PAST PAPER SOLUTIONS
  7. 7. EDWARD BAHAW CAPE ECONOMICS PAST PAPER SOLUTIONSprevent anyone from consuming such goods and services. The non-excludability featureof public goods means that people who use public goods and services do not pay forthem. If left to the market, no private producer would be willing to supply goods andservices which are non-excludable. This is because no consumer would be willing to payfor the goods and services and producers would therefore not get any revenue. The freerider problem is the term often used to describe this situation. Public goods wouldtherefore be under-produced if produced by private producers. As a result, welfare wouldnot be maximized and a welfare loss would exist. 4b ii) Monopoly firms do not produce at the level of output where production efficiencyis achieved. This means that resources are not used efficiently to produce goods andservices to cater for the wants and needs of people. As a result, welfare is not maximizedand a welfare loss exists. Also under monopoly, allocative efficient is not achieved. Thisis because the firm maximizes profits where MR = MC. Allocative efficiency occurswhere P = MC. Since under monopoly MR ≠ P, at the level of output where MR=MC, P≠ MC. As a result, the good is under producers and a welfare loss exists.4c) Solutions to Market Failure due to Monopoly and Public Goods 1. NationalizationUnder this approach, the government takes ownership of the production facilities andtakes charge of production. As such, the government would choose to produce thequantity of output which achieves allocative efficiency. This means in the case publicgoods and monopolies, the government would take charge of production and ensure thatallocative efficiency is achieved. Of course public goods would be provided free to thepublic as the state would not be able to directly charge price for them. Instead thegovernment would use its taxation revenue to cover the cost of providing these goods. 2. RegulationThe state also has this option of regulating the level of output produced by the privateproducers. In theory, the government could set a quota on output corresponding with theallocative. This cannot be applied to public goods but to monopolies. This may requirethe establishment of regulatory bodies to monitor the producers.5 a) 5 a ii) Value of Units of Labour Total Product 5 a i) Marginal Product Marginal Product ($) 0 1 1 10 9 13.5 2 30 20 30 3 60 30 45 4 100 40 60 5 136 36 54 6 146 10 15 7 150 4 6 EDWARD BAHAW CAPE ECONOMICS PAST PAPER SOLUTIONS
  8. 8. EDWARD BAHAW CAPE ECONOMICS PAST PAPER SOLUTIONS5b i) Value of Marginal Product and Wage Rate5b ii) The firm would employ 6 workers as this is the level of employment at which MRPis equal to the wage rate. If the firm employs less than 6 units of labour then profits canbe increase by employing more workers. If the firm employs more than 6 units of labourthen it would incur a loss on all workers in excess of the 6th employee. The firm thereforemaximizes profits when the quantity of labour is 6.6a) In a competitive labour market the wage rate is determined by MRP theory. In thistheory, the wage rate is determined by the interaction between the industry’s demand andthe industry’s supply of labour. This gives rise to an equilibrium wage which all firms inthe industry accept as they are price takers. In panel A of the figure, the industry’sdemand curve intersects the industry’s supply at point E. At this point, equilibrium isachieved, as the quantity of labour which firms are willing to employ, coincides with thatbeing supplied by workers. As such, the equilibrium wage established in the market is W Eand each firm must accept this price as firms are price takers in a competitive labourmarket. This is shown in panel B of the figure, where, at the wage rate of W E, theindividual firm employs 10 units of the labour.Factor Price Determination EDWARD BAHAW CAPE ECONOMICS PAST PAPER SOLUTIONS
  9. 9. EDWARD BAHAW CAPE ECONOMICS PAST PAPER SOLUTIONS Panel A: Labour Market Panel B: The Individual Firm Wage WageRate ($) Rate ($) S EWE Equilibrium Wage Rate D 500 Quantity 10 Quantity of of Labour LabourIf demand increases, then the equilibrium wage rate would increase and firms would haveto adopt this increase. Also, if the supply of labour shifts to the right, then the wage ratein the competitive labour market would decrease and firms would take this new lowerwage rate.b i) Government – the state can have an impact on wage determination especially in theunskilled labour market through the implementation of minimum wages. These enableworkers to earn a minimum acceptable level of income to ensure that they can afford tocover their basic needs. These wages are usually higher than what would exist under themarket equilibrium for unskilled labour.b ii) Trade Union - trade union enables workers to act collectively bargain for higherwages. As group workers would have more negotiating power as oppose to if theyattempted to negotiate individually. Labour markets with trade unions usually have highwages than those without.b iii) Employers Association - this is an organisation that represents a group of employersin a particular industry. These groups exist to promote the interest of their members andwould negotiate on their behalf with trade unions. Employers’ associations thereforereduce the bargaining power of trade unions and this restricts wage increases. EDWARD BAHAW CAPE ECONOMICS PAST PAPER SOLUTIONS