RECOLETOS DE BACOLOD GRADUATE SCHOOL

BACOLOD CITY

DOCTOR OF PHILOSOPHY MAJOR IN BUSINESS MANAGEMENT

ADVANCED MICROECONOMICS
BM309E 030

MIDTERM EXAMINATIONS

SUBMITTED BY:
LEONARD A. GUILARAN, CPA, MBA

SUBMITTED TO:
JOSEPH G. GUEVARRA, PHD

FEBRUARY 15, 2019

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 1. Why is the supply curve for hamburger upward sloping?

Supply Curve of Hamburgers

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Price ($/hamburger)

0
0 4 8 12 16 20 24
Quanity (1,000s of hamburgers/day)

There are a number of explanations of the direct relationship of supply and price of

hamburgers, including the law of diminishing marginal returns. The law of diminishing marginal

returns explains what happens to the output of hamburgers when a firm uses more variable inputs

while keeping a least one factor of production fixed. Real capital, such as buildings, machinery,

and equipment, is usually the factor kept fixed when demonstrating this principle.

Economic theory predicts that, when employing these extra variable factors, such as labour,

the marginal returns from each extra unit of hamburger will eventually diminish.

For a firm which produces hamburgers, its expense for machineries and equipment is fixed.

Extra workers can be hired to increase the output of hamburgers. At first, the addition of extra

workers creates a significant benefit because it becomes possible to divide up the labour, and for

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workers to specialise in undertaking one task. Initially, there are increasing marginal returns to

each additional worker.

However, marginal returns will eventually fall because the opportunity to divide labour

and to specialise must eventually ‘dry up’. Gradually, each additional worker contributes less than

the one before so that total output of hamburgers continues to rise, but at a decreasing rate. The

falling marginal returns from each successive worker leads to a rise in the cost of using them.

Firms need to sell their extra hamburger at a higher price so that they can pay the higher marginal

cost of production. Hence, decisions to supply are largely determined by the marginal cost of

production. The supply curve slopes upward, reflecting the higher price needed to cover the higher

marginal cost of production. The higher marginal cost arises because of diminishing marginal

returns to the variable factors.

2. Why is the demand curve for hamburger downward sloping?

Demand Curve of Hamburgers

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5
Price ($/hamburger)

0
0 4 8 12 16 20 24
Quanity (1,000s of hamburgers/day)

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 At higher prices, the quantity of hamburgers demanded is less than at lower prices. The

demand schedule of hamburgers indicates that, typically, there is an inverse relationship between

the price of a product and the quantity demanded. This relationship is easiest to see in the graph

plotted above.

Demand curves generally have a negative slope indicating the inverse relationship between

quantity demanded and price. There are at least three accepted explanations of why demand curves

slope downwards; the law of diminishing marginal utility, the income effect, and the substitution

effect.

One of the earliest explanations of the inverse relationship between price and quantity

demanded for hamburgers is the law of diminishing marginal utility. This law suggests that as

more of a product is consumed, the marginal benefit to the consumer falls, hence consumers are

prepared to pay lesser and lesser. This is because most benefit is generated by the first unit of a

good consumed for it satisfies all or a large part of the immediate need or desire. A second unit

consumed would generate less utility - perhaps even zero, given that the consumer now has less

need or less desire. With less benefit derived, the rational consumer is prepared to pay rather less

for the second, and subsequent, units, because the marginal utility falls.

While total utility continues to rise from extra consumption of hamburgers, the additional

utility from each hamburger falls. If marginal utility is expressed in a monetary form, the greater

the quantity consumed the less the marginal utility and the less value derived - hence the rational

consumer would be prepared to pay less for another unit of hamburger.

The income and substitution effect can also be used to explain why the demand curve

slopes downwards. If we assume that money income is fixed, the income effect suggests that, as

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the price of a hamburger falls, real income - that is, what consumers can buy with their money

income - rises and consumers increase their demand.

Therefore, at a lower price, consumers can buy more hamburgers from the same money

income, and, ceteris paribus, demand will rise. Conversely, a rise in price will reduce real income

and force consumers to cut back on their demand.

In addition, as the price of hamburger falls, it becomes relatively less expensive. Therefore,

assuming other alternative products like hotdog sandwich stay at the same price, at lower prices

the hamburger appears cheaper, and consumers will switch from the hotdog sandwich to

hamburgers.

It is important to remember that whenever the price of hamburger changes, it will trigger

both an income and a substitution effect.

3. What does the equilibrium price and quantity of hamburger in the market look like?

Demand and Supply of Hamburgers

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5 DEMAND SUPPLY
Price ($/hamburger)

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EQUILIBRIUM
PRICE
3 MARKET EQUILIBRIUM

EQUILIBRIUM
1 QUANTITY

0
0 4 8 12 16 20 24
Quanity (1,000s of hamburgers/day)

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 The equality of quantity demanded and quantity supplied is an indicator of the established

equilibrium. In the graph showing the demand and supply curves above, the point of intersection of

these two curves is the point of equilibrium. This is because at the point of intersection the demand and

supply become equal to each other. In this case, the equilibrium price is $3 per hamburger while the

equilibrium quantity is 12,000 hamburgers per day.

Equilibrium means a state of no change. Evidently, at the equilibrium price, both buyers and

sellers of hamburgers are in a state of no change. Technically, at this price, the quantity of hamburgers

demanded by the buyers is equal to the quantity of hamburgers supplied by the sellers. Both market

forces of demand and supply operate in harmony at the equilibrium price.

Graphically, this is represented by the intersection of the demand and supply curve. Further,

it is also known as the market clearing price. The determination of the market price is the central

theme of microeconomics. That is why the microeconomic theory is also known as price theory.

A detailed look at the above supply and demand schedule reveals a bag full of information

about the market. Most importantly, we can observe that the demand and supply become equal at a

price of 3. Thus 3 is the equilibrium price.

Next, note how the impact on price is downwards when the price of hamburger is too high for

the buyer’s taste, which is the portion above the equilibrium price. Lastly, again the impact on price

is upwards when it is too low for the supplier’s taste. To point out, the price tends to move towards

the equilibrium mark.

Both consumers and sellers do not want to shift from the equilibrium price. In that case, the

equilibrium price can change only when there is a change in both demand and supply. An increase in

only demand or only supply is taken by horns by a self-adjusting mechanism.

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 When the price of hamburgers increases, the sellers flock to the market with their products for

an opportunity to earn higher profits. This creates a condition of excess supply, ultimately leading to

a surplus of the hamburgers in the market. In order to sell this surplus, the sellers have to reduce the

price. Effectively, the price continues to fall until it reaches the equilibrium level.

When the price of hamburger decreases, the consumers sense an opportunity to buy the

product at a lower price. This creates gives birth to excess demand of hamburgers. Consequentially,

there starts brewing a situation of competition among the buyers which eventually pushes up the price.

Eventually, the price continues to rise until it reaches the equilibrium level.

The supply and demand schedule mentioned above is an indicator of all these processes.