MICROECONOMIC CONCEPTS, MODELS AND APPLICATIONS

1. UNIVERSITY OF CAPE COAST
COLLEGE OF HUMANITIES AND LEGAL STUDIES
FACULTY OF SOCIAL SCIENCE
INSTITUTE OF OIL AND GAS
PES 807: APPLIED ECONOMICS FOR BUSINESS
DECISIONS
THEME A: MICROECONOMIC CONCEPTS, MODELS
AND APPLICATIONS

2. 1. A monopoly is described as a situation in which only one supplier of a certain item or
service exists. The best example of an organization with significant market power is a
monopoly. In this instance, the corporation can raise prices by lowering output or cutting
supply. As a result, demand for the goods rises, allowing the provider to raise the price. A
monopoly is a company that confronts downward sloping demand and may set its own
price without fear of losing all of its clients since there are no competitors. Examples of
monopoly in the energy sector in Ghana are; Electricity Company of Ghana (ECG) who
solely clown with the power of distribution of electricity in the middle and southern belt of
Ghana; Northern Electric Distribution Company (NEDCO) slowly responsible for
distribution of electricity to the northern regions of Ghana; Ghana Grid Company
(GRIDCo) the sole company responsible for the transmission of power in Ghana. Examples
of monopoly is the Saudi Aramco also known as Saudi Arabian Oil Company which has
monopoly on the Saudi Arabia’s oil. The following are the sources of monopoly power in
the energy sector.
a) The most common source is to be granted a monopoly by the government, either
through patents in which case the monopoly is temporary or through a government
legislation. For example, Electricity Company of Ghana (ECG), Northern Electric
Distribution Company (NEDCO), Ghana Grid Company (GRIDCo) and Saudi
Aramco are all enjoying monopoly because of government legislation.
b) A second source of monopoly is a large economy of scale. The scale economy needs
to be large relative to the size of demand. A monopoly can result when the average
cost of a single firm serving the entire market is lower than that of two or more
firms serving the market. Economies of scale in electricity generation meant that
companies that are large are very likely to dominate the sector hence creating
monopoly. Another example is the Saudi Aramco since the drilling of all requires

3. large cost this company been government own is able to pull large resources hence
able to produce larger quantity which enable her to enjoy economics of scale
resulting in monopoly.
c) The third source of monopoly is control of an essential, or a sufficiently valuable,
input to the production process. Such an input could be technology that confers a
cost advantage. For example, Volta River Authority (VRA) and Bui Power
Authority has control over the River Volta and Black Volta through government
legislation hence enabling them to be the sole generators of hydroelectric power in
Ghana. This was possible because they have control over the most important input
for the power generation which is the water body.
2.
a) 𝑃𝑋 ∗ 𝑋 + 𝑃𝑌 ∗ 𝑌 = 𝐼
But 𝑃𝑋 = $3.00 𝑎𝑛𝑑 𝑃𝑌 = $4.00 𝑎𝑛𝑑 𝐼 = $12.00
Budget line or consumer budget constraint = 3𝑋 + 4𝑌 = 12
b) 𝑃𝑋 ∗ 𝑋 + 𝑃𝑌 ∗ 𝑌 = 𝐼
Making Y the subject
𝑃𝑌𝑌
𝑃𝑌
=
𝐼
𝑃𝑌
−
𝑃𝑋𝑋
𝑃𝑌
𝑌 =
𝐼
𝑃𝑌
−
𝑃𝑋𝑋
𝑃𝑌
𝑑𝑦
𝑑𝑥
= −
𝑃𝑋
𝑃𝑌
since 𝑃𝑋 = $3.00 𝑎𝑛𝑑 𝑃𝑌 = $4.00
The slope of the budget line is
𝑑𝑌
𝑑𝑋
= −
3
4
The following are the assumptions made about the budget constraint.
i. Income of the customers: The income of the customer is limited and it is
designated to buy only two products.

4. ii. Market price: The cost of each commodity is known to the customer.
iii. Expense is similar to income: It is assumed that the customer spends and
consumes the whole income.
c) Using the Lagrange approach
𝑈(𝑋, 𝑌) = 𝑋2
𝑌, 3𝑋 + 4𝑌 = 12
𝐿 = 𝑋2
𝑌 + 𝜆 (12− 3𝑋 − 4𝑌)
𝑑𝐿
𝑑𝑥
= 2𝑋𝑌 − 3𝜆 = 0… … …… … …… … …… … … …… … . . (1)
2𝑋𝑌 = 3𝜆 … … …… … …… … …… … … …… … …… … …(1𝑎)
𝑑𝐿
𝑑𝑥
= 𝑋2
− 4𝜆 = 0 …… … … …… … …… … …… … … …… … . (2)
𝑋2
= 4𝜆 … … …… … …… … … …… … …… … …… … . (2𝑎)
𝑑𝐿
𝑑𝜆
= 12 − 3𝑋 − 4𝑌 = 0 …… … …… … … …… … …… … …. . (3)
Dividing equation (1𝑎) by (2𝑎)
2𝑋𝑌
𝑋2
=
3𝜆
4𝜆
2𝑌
𝑋
=
3
4
Making X the subject 8𝑌 = 3𝑋
𝑋 =
8𝑌
3
… … …… … …… … …… … …… … … …… … …… … …… … (4)
Putting equation (4) into equation (3)
12 = 3(
8𝑌
3
)+ 4𝑌
12 = 8𝑌 + 4𝑌

5. 12 = 12𝑌 ⥤ 𝑌 = 1 units
𝑋 =
8
3
(1) =
8
3
= 2.6667 units
Equilibrium or consumer optimal choice of the two energy services are Hydroelectricity (X) =
2.6667 units and Liquified Petroleum Gas (Y) = 1 unit.
3. Market failure is the economic situation defined by an inefficient distribution of goods and
services in the free market. Furthermore, the individual incentives for rational behavior do
not lead to rational outcomes for the group. Market failure occurs when there is a state of
disequilibrium in the market due to market distortion. It takes place when the quantity of
goods or services supplied is not equal to the quantity of goods or services demanded.
The following are the circumstances under which this concept may arise in the energy
industry.
a) The first source of market failure in the energy sector is Externality. An externality
refers to a cost or benefit resulting from a transaction that affects a third party that
did not decide to be associated with the benefit or cost. It can be positive or
negative. A positive externality provides a positive effect on the third party. On the
other hand, a negative externality is a negative effect resulting from the
consumption of a product, and that results in a negative impact on a third party. For
example, during the generation of electricity from thermal plants, the pollution
generated from the plant using fossil fuels such as coal has negative impact on the
surrounding communities which is a social cost or negative externality to the
community. The damming of hydro may have result in flooding and other potential
catastrophic effect on the people living upstream and downstream.

6. b) Another source of market failure is public goods. Public goods are goods that are
consumed by a large number of the population, and their cost does not increase with
the increase in the number of consumers. Public goods are both non-rivalrous as
well as non-excludable. Non-rivalrous consumption means that the goods are
allocated efficiently to the whole population if provided at zero cost, while non-
excludable consumption means that the public goods cannot exclude non-payers
from its consumption. Public goods create market failures if a section of the
population that consumes the goods fails to pay but continues using the good as
actual payers. For example, the provision of street lights enables all users of street
to enjoy whiles only those using the services of ECG or NEDCO to pay for it. Solar
power, wind power, tidal power and geothermal energy are all examples of public
goods. For example, nobody can be prevented from using the sun for solar energy
and there is an unlimited amount of sunlight to be used. Also, government program
to provide cheap and affordable electricity to rural areas may be to a large extent
be classified as public good since the consumers as such service sometime do not
pay for them.
c) Also, another source of market failure in the energy industry is imperfect market
structure or market control. Market control occurs when either the buyer or the
seller possesses the power to determine the price of goods or services in a market.
The power prevents the natural forces of demand and supply from setting the prices
of goods in the market. On the supply side, the sellers may control the prices of
goods and services if there are only a few large sellers or a single large seller
(monopoly). The sellers may collude to set higher prices to maximize their returns.
The sellers may also control the quantity of goods produced in the market and may
collude to create scarcity and increase the prices of commodities. On the demand

7. side, the buyers possess the power to control the prices of goods if the market only
comprises a single large buyer (monopsony) or a few large buyers (oligopsony). If
there is only a single or a handful of large buyers, the buyers may exercise their
dominance by colluding to set the price at which they are willing to buy the products
from the producers. The practice prevents the market from equating the supply of
goods and services to their demand. For example, after the sanction’s imposition
on Russia, China tends to be the largest buyer of the crude oil from Russia hence
been able to buy the product at a lower price compare to the international market
price. Another example of market control is the activities of OPEC, which one way
or the other controls the quantity of crude in the market hence manipulating the
price.
d) Lastly, market failure may also result from information asymmetry. lack of
appropriate information among the buyers or sellers. This means that the price of
demand or supply does not reflect all the benefits or opportunity cost of a good.
The lack of information on the buyer’s side may mean that the buyer may be willing
to pay a higher or lower price for the product because they do not know its actual
benefits. On the other hand, inadequate information on the seller’s side may mean
that they may be willing to accept a higher or lower price for the product than the
actual opportunity cost of producing it. For example, a study by Lanz and Reins
(2021) showed that asymmetric information is an important barrier to the adoption
of energy efficient technologies.

8. 4.
a) 𝑃1 = 15 − 𝑞1 and P2 = 25 − 𝑞2
2
. If the company’s total cost function is estimated to be
𝑇𝐶 = 5 + 3𝑞.
For market 1
𝜋1 = 𝑇𝑅1 − 𝑇𝐶1
But 𝑇𝑅1 = (15 − 𝑞1)𝑞1 = 15𝑞1 − 𝑞1
2
𝜋1 = (15𝑞1 − 𝑞1
2
)− (5 + 3𝑞1)
𝑑𝜋1
𝑑𝑞1
= 15 − 2𝑞1 − 3 = 0
15 − 2𝑞1 − 3 = 0
12 − 2𝑞1 = 0
12 = 2𝑞1
𝑞1 = 6 and 𝑃1 = 15 − 6 = $9
Therefore, 𝑃1 is $9 and quantity one will be 6 units.
For market 2
𝜋2 = 𝑇𝑅2 − 𝑇𝐶2
But 𝑇𝑅2 = (25 − 𝑞2)𝑞2 = 25𝑞2 − 𝑞2
2
𝜋1 = (25𝑞2 − 𝑞2
2
) − (5 + 3𝑞2)
𝑑𝜋1
𝑑𝑞1
= 25 − 2𝑞2 − 3 = 0
25 − 2𝑞2 − 3 = 0
22 − 2𝑞2 = 0
22 = 2𝑞2
𝑞2 =
22
2
𝑞2 =
22
2
= 11 units

9. 𝑞2 = 11 and 𝑃2 = 25 − 11 = 14
Therefore, 𝑃2 is $14 and quantity two will be 11 units.
b) 𝜋 = 𝜋1 + 𝜋2
𝜋1 = 𝑇𝑅1 − 𝑇𝐶1 = ( 𝑃1 ∗ 𝑞1) − 𝑇𝐶1
𝜋1 = ( 9 ∗ 6) − (5 + 5(6))
𝜋1 = 54 − 23 = $31
Therefore, profit one market one will be $31
𝜋2 = 𝑇𝑅2 − 𝑇𝐶2 = ( 𝑃2 ∗ 𝑞2) − 𝑇𝐶2
𝜋2 = ( 14∗ 11) − (5 + 3(11))
𝜋2 = 154 − 38 = $116
Therefore, profit will be equal to profit in market one plus profit in market two.
𝜋 = 𝜋1 + 𝜋2
𝜋 = $31 + $116 = $147
Total profit will be $147
c) 𝑃2 = 𝑃2 = 𝑃 and 𝑄 = 𝑄1 + 𝑄2
Making Q the subject is all the demand function
𝑃1 = 15 − 𝑞1⥤ 𝑞1 = 15 − 𝑝1
𝑃2 = 25 − 𝑞2⥤ 𝑞2 = 25 − 𝑝2
𝑞 = 𝑞1 + 𝑞2

10. 𝑃2 = 𝑃2 = 𝑃
𝑞 = (15 − 𝑝) + (25 − 𝑝) = 40 − 2𝑝
𝑞 = 40 − 2𝑝
𝑝 = 20 −
1
2
𝑞
But 𝑇𝑅2 = (20 −
1
2
𝑞) 𝑞 = 20𝑞 −
1
2
𝑞2
𝜋1 = (20𝑞 −
1
2
𝑞2
) − (5 + 3𝑞)
𝑑𝜋1
𝑑𝑞1
= 20 − 𝑞 − 3 = 0
20 − 𝑞 − 3 = 0
17 = 𝑞
𝑞 = 17
𝑞 = 17 units
𝑞 = 17 and 𝑝 = 20 −
1
2
(17) = $11.5
Therefore, price is $11.5 and quantity two will be 17 units.
For profit 𝜋 = 𝑇𝑅 − 𝑇𝐶 = ( 𝑝 ∗ 𝑞) − 𝑇𝐶
𝜋2 = ( 17∗ 11.5) − (5 + 3(17))
𝜋2 = 195.5 − 56 = $139.5
Therefore, profit one market one will be $139.5
d) The pricing policy in (c) may be classified as not Optimal since the profit gotten when
multinational oil company sells its output in two separate markets it makes a profit of $147

11. but bringing the market together, he made a profit of 139.5. this implies that separating the
market gives more profit than bringing them together. But if the producer care more about
the welfare of the consumer much more than his or her profit then he could classify the
strategy used in (c) as optimal since the social welfare of the consumers will have higher
compare separating the market.

12. Reference
Lanz, B., & Reins, E. (2021). Asymmetric information on the market for energy efficiency:
Insights from the credence goods literature. The Energy Journal, 42(4).