Question 1

“The Stop Decay Company sells an electric toothbrush for $25. Its sales have averaged 8,000
units per month over the last year. Recently, its closest competitor Decay Fighter reduced the
price of its electric toothbrush from $35 to $30. As a result, Stop Decay’s sales declined by
1,500 units per month.”

Solution
i) Cross Price Elasticity of Demand
Cross price elasticity of demand (Ec) is the response measure of change in quantity of demand
for one product as compare to change in price of other product. Formula to calculate cross price
elasticity of demand is :

“Ec = (Qs2 – Qs1)/(Pd2-Pd1) * (Pd1+Pd2)/(Qs1+Qs2)”

Where,

Ec = Cross Price Elasticity of Demand

Qs1 = Sales before change in price of other product

Qs2 = Sales after change in price of other product

Pd1 = Price of other product before any change

Pd2 = Price of other product after change (Varian, 2014)

Applying the formula to calculate cross price elasticity of demand between Stop Decay and
Decay Fighter:

Ec = (6500 – 8000) / (30 – 35) * (30 + 35) / (8000 + 6500)

Ec = -1500/5 * 65/14500

Cross Price Elasticity of Demand = - 1.34

If Ec is less than Zero then products are substitutes. So these results indicate that there is
substitute relationship between these two products and having close relation.

ii) Price Calculation

Price elasticity of demand tells about response of change in demand of quantity due to change
in price. Formula to calculate price elasticity of demand is:
 PED = (Change in quantity demanded/Average quantity demanded) / (Change in
price/ Average price)

Where,

PED = Price elasticity of demand that is -1.5 (Varian, 2014)

As price elasticity is known in case of Stop Decay, applying formula to get the new price
to sell same number of toothbrushes:

-1.5 = {(8000-6500)/{(8000+6500)/2} / {P-25/(P+25)/2}

-0.14 = {P-25/(P+25)/2}

Price = $21.72

So, Stop Decay has to sell the product for $21.72 to get same number of quantity sold.

iii) Calculation of Monthly Revenue

Monthly Revenue before Price Change:

Units Sold = 6,500

Unit Price = $25.00

Revenue = $162,500

Monthly Revenue before Price Change:

Units Sold = 8,000

Unit Price = $21.72

Revenue = $173,760

iv) Result Analysis in Part-iii

Result in Part=iii is somehow desirable as sales increase by $11,260 that shows sales increased
by reducing the price. However, it should also be considered that product price is decrease by
around 13% that is reasonable percentage in decrease. Extra units sold against this price
decrease also have some cost involved in manufacturing them. These factors should be
considered as well because profit margin is decreased for Stop Decay.
Question 2
(a) Explain the differences between accounting profit, economic profit and normal profit

Accounting profit is pure accounting term where profit means excess of sales/ revenue from the
expenses. Difference between revenue generated and expenses incurred is called accounting
profit. Economic profit is surplus amount which is calculated by deducting total cost from total
revenue. All explicit and implicit cost is deducted in case of economic profit. Normal profit is the
amount that is minimum amount required for survival. It is also exists in breakeven point.
Accounting profit is usually higher than the economic profit and economic profit is higher than
normal profit (Baumol, 2015).

(b) Suppose that due to changing tastes there is a sudden increase in demand for emu
meat.

b-i) Profit

Profit increased as the number of units sold increase while cost is remaining same. Profit in the
emu meat industry will rise as the sales will increase. Cost of the meat will remain same but
quantity of sold meat will increase which ultimately lead to increase profits.

b-ii) Resource Movement

As demand of meat increase which means there is potential to sell more meat. Many traders
would want to avail the opportunity because emu meat selling becomes hot trend so there
would be more traders. Resources will move to the industry as there is potential of getting profit
in this business due to increased demand.

b-iii) Long Run Profits

More firms will join emu meat industry that will lead to more competition in the market in long
run. More competition will ultimately lead to less profit for the firms because of perfect
competition.

b.iv) Normal Profits

Normal profit is calculated as total revenue minus total cost becomes zero. There comes a stage
in perfect competition when firms work in normal profit which is also possible in emu meat
industry. Opportunity cost is also included in normal profit so firms are earning something in
normal profit as well (Baumol, 2015). Another factor lead to normal profit in the industry as
more firms step in they will reduce prices to a level where total revenue equals total cost.
Question 3
(a)Critically analyse and explain the following statement. “Goods and services are scarce
because resources are scarce”.

It is essential to know that resources are fundamental s that determines whether goods and
services are available easily or there is scarcity of their availability. Because resources are
required to produce, develop or manufacture goods as well as services can also be provided if
there are enough resources available. If resources are not available then it is not possible for an
economy to produce enough goods and services to cater the demand. Lack of availability in
resources is leading to shortage of goods and services which result in imbalance between
demand and supply in the economy. Important point to mention is that resources produce
goods and services (Nicholson, 2014). If resources were unlimited there would be no shortage in
goods and services. So this above statement is totally true that “goods and service are scarce
because resources are scarce”.

(b) During a five year period, the ticket sales of a city’s professional football team have
increased by 30 percent at the same time that average ticket prices have risen by 50 percent.
Do these changes imply an upward sloping demand curve? Explain.

It is not necessary that this scenario is the true case of upward sloping demand curve. It could be
the case of Giffen Goods where price increase lead to quantity increase as well. As shown in the
below figure, curve moves to the right side. However, its movement is not along the demand
curve as previous (Varian, 2014). Demand curve increased as price increased, but it is not due to
price factor rather there are other factors as well like status symbol, craze for football and
playing of star players could have increase in demand even prices is increased.

In the figure P1 is the Price and P2 is the increase in price, due to Giffin Goods, which is opposite
to law of demand. As price increased, quantity also increased from Q1 to Q2 that shows
Demand curve moves to right.
Question 7
(a) In practice, can firms in monopolistic competition really set their own prices without
reference to the pricing decisions of their competitors? Explain.

Monopolistic competition is economics term where firms are in some way or other are in
competitions with each other with little distinction in their product line. Pricing is crucial stage in
monopolistic competition where price and demand comparison is different from perfect
competition and monopoly. Profit maximization is the main goal in case of monopolistic
competition so firms in monopolistic competition do not fluctuate much prices in order to gain
more revenue (Cowen, 2015). In other words, monopolistic competitor’s liberty to set prices is
higher than perfect competitor and less than monopoly, as shown in figure:

Above figure shows that demand curve is downward sloping in case of monopolistic competitor
that means in this case, it has the liberty to raise the price without fear of losing much customer.
Similarly monopolistic competitor can lower the price and attract more customers. It can be said
that monopolistic competitors can set their prices without fearing competitor; however, if price
is raised then some customer will choose to go to other competitor. Monopolistic competitors
set their prices much more like in monopoly but they have to manage the price and quantity so
their price is not independently fluctuates as in case of monopoly (Baumol, 2015).

(b) Why do firms in an oligopolistic industry have an incentive to collude? What are the factors
that will influence the success or failure of their collusive efforts?

Oligopoly is economics term which shows when few big numbers of organizations are leading
the industry and have most sales between them. Oligopolistic firms have two options; either
they destroy each other economically or collude with each other to get collective benefits.
Perfect competition arises if they do tough competition with each other and their profit level
could come to minimal level (Cowen, 2015). However, they have to option to get incentives
through colluding and establish good business relationship. By colluding effectively, oligopolistic
firms can behave like monopoly and set higher prices which ultimate leads to higher profits for
them. They get incentives by avoiding any sort of competition and make agreements with each
other in a way that they get premium profits by joining hands. There are various factors that
result in success or failure of collusion efforts. Success factors are mutual interdependence,
raising profits, lowering competition cost and reducing uncertainty. Failure factors could be
enforcement issues, non collusion firms, exposing of scandals or successful entry of non
collusion firms (Nicholson, 2014).

References:

Baumol, W. J., & Blinder, A. S. (2015). Microeconomics: Principles and policy. Nelson

Education.

Varian, H. R. (2014). Intermediate microeconomics with calculus: a modern approach.

WW Norton & Company.

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

application. Nelson Education.

Cowen, T., & Tabarrok, A. (2015). Modern principles of microeconomics. Macmillan

International Higher Education.