ECS MAY/JUNE SOLUTIONS TO EXAM QUESTIONS ,,,Microeconomics II Only Study Guide for ECS2601 First and second semesters

Welcome to the module Microeconomics at second year level. The purpose of this module is to provide you with thinking tools when analyzing the relationship between consumption (the demand side) and production (the supply side) in the economy. Ultimately we want you as a student to understand how different kinds of markets form, how they function, how they change and how some even fall apart. Aims of the module The aims of this module are: ¾to study the relationship between the consumption (consumers) and production (suppliers) in the economy from a microeconomic perspective ¾to become acquainted with the behaviour of consumers ¾to become acquainted with the behaviour of producers ¾to see the analogous nature of the tools used in consumption versus production analysis ¾to see how the interaction of the two sides of the economy lead to varied markets ¾to identify and study the results/consequences of the behaviour of consumers and producers in different market structures ¾to study the interactions of consumers and producers in an economy where a general equilibrium exists (Detailed learning outcomes are provided at the beginning of each study unit.) To achieve these aims, you should acquire the following knowledge and abilities by working through the prescribed study material: ¾a solid knowledge base of the economic theory underlying microeconomics ¾an informed understanding of the key terms used in microeconomics ¾an awareness of how microeconomics relates to the rest of economic theory ¾a sound knowledge and understanding of the basic procedures, operations and techniques relating to microeconomics ¾the ability to solve specific problems using correct procedures and relevant evidence ¾the ability to critically analyse and synthesise information ¾the ability to present such analysis and synthesis in the appropriate manner x ECS2601/1/2012-14 ¾the ability to present and communicate information logically, coherently, persuasively and reliably, using academic discourse, and the appropriate conventions and formats Prescribed tutorial matter The prescribed tutorial matter consists of the textbook, the study guide and tutorial letters that you will receive during the semester. The following textbook is prescribed for this course: Pindyck, RS & Rubinfeld, DL. 2009. Microeconomics. 7th edition. London: Pearson Educational International. In this study guide we shall refer to it as "Pindyck and (&) Rubinfeld (2009)" or "the textbook". The textbook is an American work that includes international case studies. Discourses (media reports) on economic issues are reported in the newspapers, periodicals, television programmes and the Internet on a daily basis. You are advised to follow these media reports and to try to understand the microeconomic theory (where applicable) underlying these issues. (Note: In accordance with Unisa editorial policy, Standard English spelling, not American, is used in the study guide, eg "labor", "behavior", "enrollment" is "labour", "behaviour", "enrolment" etc. This should not affect your studies in any way.) The study guide guides you through the textbook. We give you certain study instructions, namely to revise, read, ignore and/or study indicated sections in Pindyck and Rubinfeld (2009). Note the following differences between the four types of instruction: Study! These sections form the basis for examination questions and you should study them with this in mind. Read! These sections contain essential background information for a better understanding of the prescribed or study sections, but no examination questions will be set on them. Omit! These sections may be left out. xi ECS2601/1/2012-14 Remember the following general rule: Study guide: You should study all the sections in the study guide (unless otherwise stated). All are prescribed for the examination. Textbook: You need study only those sections in the textbook that we refer you to in the study guide. These sections are prescribed for the examination. Those of you who have access to the Internet, may read messages concerning the module on MyUnisa. If you do not have access to the Internet, you will receive this information in tutorial letters. You may also visit the website, self-study questions there which can be answered for revision purposes. Please note that these questions are not necessarily examination questions, and studying them to the exclusion of all others will not sufficiently prepare you for the examination. Questions that are considered to be important will be repeated in this study guide or in tutorial letters. Suggested method of study This study guide comprises 18 study units, although not all of them contain study material (ie study units 1, 2, 5, 13, 14, 17 and 18). Each study unit to be studied includes learning outcomes, study instructions, and possible examination-type questions. Below, we suggest a possible method of study. While you are free to choose a different study method for this course, we strongly recommend the method set out below. It is actually more of a general guideline than a method, and you might find it necessary to adapt it to your own circumstances and abilities. Step 1 Study guide Read through a study unit in the study guide to gain an overall picture of the subject matter. Step 2 Study guide and textbook Have your study guide at hand and read a heading and the section below it carefully. Note the important concepts that are pointed out. Then read the corresponding section in the chapter in the textbook. Take note of the diagrams. Make summaries xii ECS2601/1/2012-14 as you go along. Bear in mind that your summaries should be concise --- you should be able to summarise a whole chapter in a maximum of four or five A-4 pages. Summarising requires you to extract the essence of a text, not rewrite chunks from the textbook. Find key words in each paragraph of the textbook! Step 3 Activities Once you have completed a section or a couple of sections as described in step 2, proceed to the activity that follows. Complete the true/false questions of the specific activity. These true/false questions are followed by multiple-choice questions. (The answers to these questions are supplied at the end of each study unit.) The next category of questions are those which require written answers in the form of a calculation, a paragraph or a short essay. We recommend that you work out paragraph- or essay-type answers and keep them for subsequent revision. The study guide will not provide answers to these questions. It is also important to answer the questions following each chapter in the textbook (Pindyck & Rubinfeld 2009). These questions are important and you may encounter them in the examination. Note that some answers to the exercises appear in the back of the textbook (Pindyck & Rubinfeld 2009:711). Step 4 Assignments Answer the questions asked in the assignment that relate to the relevant chapter in the textbook. Submit the assignments in good time. Step 5 Revision It is impossible to master the study material by studying it once only. When you start studying new work, you should allow enough time for at least three systematic revisions of the study material that you have already completed. Do the first revision shortly after your initial study (say, one day later), the second revision, say, another three days later, and the third revision a week later. In this way, the subject matter will sink in and really become part of your thinking. Step 6 Study programme Tutorial Letter 101 contains a study programme as well as guidelines regarding study hours to give you an indication of the rate at which you should work. It is vitally important to stick to this programme. If you fall behind, it is your responsibility to catch up. Remember, a semester is very short. xiii ECS2601/1/2012-14 Step 7 Further reading At the end of most study units, additional sources for further reading, websites, books and articles are given, if available. This is not for examination purposes, but for those of you who are interested in getting more out of a specific topic. Each chapter in the textbook also ends with a list of additional sources (Pindyck & Rubinfeld 2009). We wish you every success with your studies!1 ECS2601/1/2012-14 Study unit 1: Assumptions of prior learning in Microeconomics OMIT pages 3 - 19 This study unit alerts you to what you must already know from your prior microeconomics training. You need to revise all your first year microeconomics. In this course it is assumed that you have studied the following introductory concepts: 1) Scarcity, choice and opportunity cost, Economics as a science 2) What should be produced, how and for whom? 3) Interdependence between major economic sectors, markets, and flows in mixed economies 4) Demand, supply and prices 5)Demand and supply in action 6)Some concepts in Elasticity 7)Background to demand: the theory of consumer choice 8)Background to supply: the theory of production and cost 9) Perfect competition 10)Monopoly and imperfect competition ± overview 11)The labour market ± introduction To revise the above concepts revise the work from most first year economics textbooks, including Mohr, Fourie, L & Associates. 2007. Economics for South African Students 4th edition: Chapters 1,2,3,7,8,9,10,11,13 and 14 2 ECS2601/1/2012-14 Study unit 2: Elasticity OMIT pages 21 ± 33. Economics in action When the prices of television sets go up, what happens to purchases of TVs at electronic stores? When many skilled foreign builders enter a country like South Africa, what do you think happens to the quantity supplied of houses? When students graduate and start earning middle class incomes, what happens to their demand for taxis? These are some of the questions that can be asked with respect to the RESPONSIVENESS of quantity demanded or supplied in response to changes in price (also wages) and incomes. You encountered the basics of elasticity in you first year, this year we expand on this topic and expect you to not only remember your first year conceptual work but to calculate and apply this concept in real world economic questions. Contents and learning outcomes After you have completed this study unit, you should be able to: ¾ explain the meanings and calculation of different elasticity concepts 3 ECS2601/1/2012-14 ¾ discuss the consequences of government intervention in the market STUDY Study pages 34 - 48. 2.4 Various types of Elasticity Elasticity measures the sensitivity of one variable to another. For example, what is the percentage change in variable A if variable B changes with 1%? (This is based on the assumption that the two variables are related to each other.) We said previously that quantity supplied (Qs) and quantity demanded (QD) are determined by various factors, including the own price of a specific product. This was illustrated in the equations Qs = Qs(P, ST, L, M«DQGQD = QD(P, I, SP, CP, T«1 When the price elasticity of demand is calculated, we want to know by how much the quantity demanded changed due to a 1% change in the own price of the product. Note that when calculating the price elasticity of demand, the answer must be negative (if the price of a product increases (decreases) the quantity demanded decreases (increases)). However, in the case of this type of elasticity we are interested in the absolute value of the answer, so we can ignore the negative sign. In theory it should be possible to calculate the elasticity of any of the abovementioned factors --- P, ST, L or M in the case of quantity supplied, and P, I, SP, CP or T in the case of quantity demanded. What would the percentage change in quantity demanded be if income changed with 1%? Or what would the percentage change in quantity demanded be if taste changed with 1%? However, we must be realistic. To calculate the elasticity, it must be possible to express it in a quantifiable unit. It would be very difficult to put a monetary value on taste. The different types of elasticity of demand are summarised in table SG2.2. In the case of supply, we are interested in the percentage change of quantity supplied with a 1% change in the own price of the good or service.2 1 See sections 2.1.1 and 2.1.2 in this study unit. 2 We can also refer to supply elasticity with respect to the non-own price determinants of the good or service (as in the case with demand elasticity). 4 ECS2601/1/2012-14 Table SG2.2: Point and arch elasticity of demand and supply Type of elasticity Magnitude Elasticity Description3 Price elasticity of demand (Ep) ’ Infinitely elastic Figure 2.11: Where P = 4 and Q = 0, or figure 2.12 (a) 1 Price elastic Figure 2.11: P between 4 and 2, or Q between 0 and 4 =1 Unitary price elastic Figure 2.11: Where P = 2 and Q = 4 1 Price inelastic Figure 2.11: P between 2 and 0, or Q between 4 and 8 = 0 Completely inelastic Where P = 0 and Q = 8, or figure 2.12 (b) Income elasticity of demand 0 Normal goods and services Example: telephones, houses, cameras, etc 1 Luxury goods and services Example: sport cars, yachts, exotic holidays, etc 0 - 1 Necessities Example: medicine, milk, bread and porridge. 0 Inferior goods and services A bicycle relative to a motor vehicle. Ball point pens relative to fountain pens. Cross-price elasticity of demand = 0 Goods and/or services have no relationship with each other Butter and petrol. Computers and wood. House plants and holidays overseas. = positive Goods and/or services will be substitutes Example: butter and margarine. A bolt and a nut. = negative Goods and/or services will be complementary Example: motor cars and petrol. Shoes (left and right). Price elasticity of supply = positive Will usually be positive with increase in own price Example: with an increase in the price of gold, marginal gold mines will start production (and supply will increase). = negative Will usually be negative with increase in the price of inputs Example: with an increase in the price of labour, insecticides and/or fertilisers, production (supply) will decrease. In figure 2.11 (Pindyck & Rubinfeld 2009:35) point elasticity of demand is used; this 3 Figure 2.11 is on page 35 and figure 2.12 on page 36 (Pindyck & Rubinfeld 2009). 5 ECS2601/1/2012-14 refers to the elasticity at a specific point. However, if we calculate the elasticity of demand or supply over a range of prices or quantities demanded (or supplied), we must use arch elasticity of demand or supply. Pindyck and Rubinfeld (2009:37) illustrate the reason why we must use the mid-point between the original price (or the quantity demanded) and the end price (or quantity demanded). We thus use average price (or quantity demanded) and we measure the arch elasticity of demand. According to table SG2.2, the nature of the product can determine the elasticity of demand and supply. Another factor which can have an influence is the time span. We know that human behaviour changes over time. Consumers may act immediately after a price increase of a certain product by buying less of the product (the short run). However, over time the consumer may become used to the higher price and the quantity demanded will return more or less to its previous levels (the long run). The influence of time (short and long run) on elasticity is discussed in the textbook (Pindyck & Rubinfeld 2009:40 - 48).