Solutions to the Questions (Assignment

Part A – Microeconomics)
Solution of Question 1
1.1) Cross price elasticity of demand of Stop Decay Company and Decay
Fighter Company is computed by a formula; which is complex but
comprehensive

Cross price elasticity of demand = {(Sale of Company A after change in Price

of Company B MINUS Sale of A before change in Price of Company B) DIVIDED
BY (New Price of Company B Product MINUS Old Price of Company B Product)}
MULTIPLIED BY {(New Price of Company B Product PLUS Old Price of
Company B Product) DIVIDED BY (Sale of Company A after change in Price of
Company B PLUS Sale of A before change in Price of Company B)} (Nicholson,
2014)

Cross price elasticity of demand will be calculated by putting values of sales by

Stop Decay Company and values of price by Decay Fighter Company.

Cross price elasticity of demand = {(6,500 MINUS 8,000) DIVIDED BY (30

MINUS 35)} MULTIPLIED BY {(30 PLUS 35) DIVIDED BY (6,500 PLUS 8,000)}

After calculations of these values in formula;

Cross Price Elasticity of Demand = 1.34

Products of Stop Decay Company and Decay Fighter Company are substitutes
and they have close relation in nature among them.

1.2) – In this scenario, price elasticity of demand is already known and we

have to find the price which can give same number of units sold to Stop
Decay Company. Computation of price will be done by using price
elasticity of demand formula and mathematical computations to find Price.

Price Elasticity of Demand = (Change in demand of quantity for Product A

DIVIDED BY Average in demand of quantity for Product A) DIVIDED BY
(Change in Price of quantity for Product A DIVIDED BY Average Price of quantity
for Product A) (Nicholson, 2014)
Price will be calculated by putting price elasticity if demand value, which is -1.5,
and sales quantity of Stop Decay.

-1.5 = {(8,000 MINUS 6,500) DIVIDED BY {(8,000+6,500)/2} DIVIDED BY {Price

MINUS 25 DIVIDED BY (Price PLUS 25)/2}

Applying mathematical equation to find the value of Price;

Price = $22 (Approximately)

Price level of $22 shows that, at this price Stop Decay Company could able to
sell previously sold number of units; 8,000 after the price reduction of Decay
Fight Company.

1.3) Average monthly totally revenue of Stop Decay Company is calculated by

Number of Toothbrush sold Multiplied By Price per unit of tooth brush.

Monthly revenue is calculated before the price effect in Part 2 by multiplying

6,500 sold units by $25 price and result is $162,500 that is monthly revenue
before change of price.

Monthly revenue is calculated after the price effect in Part 2 by multiplying 8,000
sold units by $22 price and result is $176,000 that is monthly revenue after
change of price.

1.4) Change in the result in above part is desirable because company able to
enhance its sales and revenue.

There is reduction in profit margin on this price, however company will take it.
Because by reducing price Stop Decay is able to retain its customers and they
are generating more revenue. It will enhance liquidity position of the company
because more money is coming in the company.

Solution of Question 4
4.1) Inferior Goods

Inferior goods are type of goods which are different from normal goods in the
sense that demand of inferior goods decrease in case of increase in income.
Similarly if income goes down inferior goods demand goes up. These are kind of
cheaper substitutes of normal goods that’s why their behavior is opposite to
normal goods. (Foster, 2011)
Above figure shows that demanded quantity ‘D’ is increasing if income is
decreasing and vice versa.

4.2) Substitute Product

Substitute products are type of products which are purchased by the customers
in case of price increase or non availability of original products use by the
customers. Keeping this in mind, if price of original product is decrease
customers will go back to purchase original product and demand of substitute
product will decreased.

In above figure, price of original product ‘L’ is decreased from P1 to P2 which

shows decrease id demand ‘D’ of substitute product ‘M’.
4.3) Decline in Income

Normal goods are type of goods that fit in the criteria of income effect. If income
goes up, demand of normal goods also goes up. Similarly if income goes down,
demand of normal goods also goes down. This effect is shown in the below
figure where D is quantity demanded. As income goes down in $ figure, demand
curve also moves down side as D1 that shows decrease in income also lowers
the demand of goods. (Nicholson, 2014)

4.4) Complementary Goods

It is important to understand the concept of complementary goods. These type of

goods are used as additional to other goods to enhance the effectiveness. In
other words there is more benefit if both goods are used together. In economics
term, if price of a commodity goes up demand of complimentary goods will go
down because less people will buy commodity whose price goes up which
definitely leads to lower demand of complementary goods as well. This effect is
also illustrated in below diagram:
 Solution of Question 6
Perfect competition is form of market where many firms are operating and there
are little barriers to entry and exit. In contract, monopoly is the situation where
only one firm is operating in the industry and has sole control over prices and
supply. Talking about lawn-mowing firms, in perfect competition, firms are price
takers and have no control over price selection (Foster, 2011). Once a large firm
buys all the resources and assets of the industry to become a monopoly, now it
becomes price makers where it has liberty to set own prices. Output is measured
by allocation of resources and supply between all firms in the industry in case of
perfect competition. In case of monopoly, output is measure by the resources
used by the monopolistic firm. Similarly resource allocation is distributed among
all firm in lawn-mowing industry equally based on their value. Monopolistic firm
has sole authority of allocation of resources (Foster, 2011).

Above figure illustrates market demand and market supply in (a) perfect
competition and (b) monopoly. Perfect competition demand and supply meets an
equilibrium price where all firm are operating. In case of monopoly, price is set by
the monopolistic firm itself. Monopolistic firm also reduce its output to the level
where marginal revenue become equal to marginal cost as shown in diagram.
Coming to second part whether monopoly will survive, it depends on the behavior
of monopolistic firm. If firm do not analyze the customer behavior against price
and set highly priced product, it is possible that customers tend to reduce and
firm start to lose profits. So it is important to maintain reasonable prices if firm
want to retain monopoly in long run (Foster, 2011).

Solution of Question 7

7.1) Monopolistic Competition

Firms in monopolistic competition have little differentiation over each other and
this differentiation is their brand image. For example, in food industry, few big
names in food chains have product differentiation for which they are known. A
monopolistic firm can set its price up to some extent in case of product
differentiation. However these firms can not set prices independently without
considering other factors. Firms in monopolistic competition do not compete on
prices rather they compete on differentiation and if they have a really
differentiated product then they can charge premium price for this differentiation.
It is also a fact that firms in monopolistic competition spend highly on their
marketing campaigns and advertisement so it is difficult for them to reduce price
for competition base. By this way they could be vanished from market in the long
run (d’ Aspremont, 2016).

7.2) Oligopolistic Industry

Oligopoly is the market situation where only few firms are capturing the industry.
These firms are big in size so there is hardly any place for small firms in case of
oligopolistic industry. In mature markets, firms in oligopolistic industry collude for
the purpose of getting mutual benefits. They do not waste their energy and
money for the sake of making other firms out of the market because it is not in
their own interest. They agree on terms to collude and set premium prices
collectively in order to make sure that they have collective monopoly in the
industry. Unions and secret arrangements play vital role in this regard (d’
Aspremont, 2016).
Success and failure of such collusions depends on various sectors because it is
not as easy as people perceive. If they have colluded successfully, they will gain
more profits as prices are set higher. Competition is lowered if firms collude with
each other so they could save advertisement cost and expensive marketing
campaigns. There are failure factors as well like laws relating to prices as well as
coordination among these firms are also problematic. New firm can make way in
the industry which is not form collusion and give tough time on pricing.
References:

Foster, J. B., McChesney, R. W., & Jonna, R. J. (2011). Monopoly and

competition in twenty-first century capitalism. Monthly Review, 62(11), 1.

d’Aspremont, C., & Ferreira, R. D. S. (2016). Oligopolistic vs. monopolistic

competition: Do intersectoral effects matter?. Economic Theory, 62(1-2),
299-324.

Nicholson, W., & Snyder, C. M. (2014). Intermediate microeconomics and

its application. Nelson Education.