MAE101 – Economic Principles -

Trimester 2 2020
Assessment Task 1 – Individual Written
Assignment
PART I
Question 1
1a) Domestic market for face mask before and after the pandemic.

1b) Impact of reduction of availability of raw materials on demand and supply in the d
omestic market.

1c) Changes in supply and demand when domestic firms starts manufacturing face masks.
1d) The law of supply and demand is the most fundamental economic model of determination
of market prices. In the above three diagrams, it is seen how changes in demand and supply
of a commodity affects the price and quantity supplies and how market equipment is attained.

It is seen that the market equilibrium price and quantity of face mask before the pandemic is
at P¹ and Q¹ respectively as seen in 1a). However the sudden outbreak of coronavirus
pandemic triggered a huge demand for face masks in Australia as well as in the whole world
due to which the demand curve (D¹) shifts rightwards to (D²). This unprecedented increase in
demand contributes to a surge in market price of the face mask (P¹ to P²), supply remaining
constant initially. This increase in price further induces firms to produce more hence quantity
supplied also increases from Q¹ to Q². Therefore the new market equilibrium price is P² and
quantity is Q².

Raw materials being a factor of production impacts the supply of face masks in Australia,
contributing to a shift in the supply curve that causes market imbalance. Due to the reduction
in availability of raw materials, producers are unable to meet the market demands and hence
the supply curve shifts towards left from S¹ to S² and the quantity supplied also decreases
from Q² to Q³ as seen in 1b). Hence there is an overall shortage of face masks in Australia.
To move towards the market equilibrium, the decrease in supply further induces the price to
rise from P² to P³, demand being D² after the pandemic outbreak. Hence now the equilibrium
market price and quantity settles at P³ and Q³ respectively.

In case 1c) where several domestic companies of Australia initiates the manufacturing of face
masks which until now were not producing masks, the supply shifts outwards from S² to S³,
depicting the increase in supply. As we move downwards along the demand curve, it is seen
that with demand being constant at that particular time frame, the increase in supply of face
masks induces equilibrium price to drop from P³ to P⁴ and simultaneously the quantity
supplied rise from Q³ to Q⁴. Hence with increase in domestic production, quantity supplied
increases and the market price decreases relative to the hike in price seen owing to
unavailability of raw materials.

Question 2
Owing to the Coronavirus, face masks is witnessnessing skyrocketing demand irrespective of
the price increase. Moreover since face masks have no close substitute and have become a
necessary good after the pandemic crisis, the demand for it is inelastic. That is, the quantity
demanded for face masks is less responsive to the change in market price. Hence there will
not be any significant change in quantity demanded for face masks when there is a change in
its price.

PART II
Question 3
3a) The concept of scarcity and choice contributes to the notion of opportunity cost which
can be defined as the cost of something sacrificed when we choose another alternative. In
order words, opportunity cost is the value of the next best alternative.

Ali can make either 10 loaves of bread or 20 jars of jam in a day which means to make 10
loaves of bread Ali gives up 20 jars of jam.
 Ali's opportunity cost of making 1 loaf of bread
: 20/10 = 2

Hence Ali's opportunity cost of 1 loaf of bread is 2 jars of jam, since he sacrifices 2 jars of
produce 1 loaf of bread.

3b) Similarly Barb can make either 6 loaves of bread of 36 jars of jam.

Hence, Barb's opportunity cost of making 1 loaf of bread : 36 / 6 = 6

Hence Barb's opportunity cost of making 1 loaf of bread is 6 jars of jam since he sacrifices 6
jars of jam when he choose to make 1 loaf of bread.

3c) In 24 hours Ali can make 10 loaves of bread or 20 jars of jam. If time is spent evenly
between the production of two commodities then in 24 hours, Ali can make 5 loaves of bread
and 10 jars of jam.

Similarly, in 1 day Barb can make 3 loaves of bread or 18 jars of jam.

3d) If Ali devotes one day entirely in making bread and Barb making jam, then their total
production would result in 6 loaves of bread and 36 jars of jam.

3e) If Ali makes jams only and Barb makes bread, then in 1 day, they would produce 6 loaves
of bread and 20 jars of jam.

3f) Assuming Ali specializes in making bread and Barb in making jam, after trading Ali has 7
loaves of bread along with 12 jars of jam. Whereas Barb has 24 jars of jam along with 3
loaves of bread.

3g)

Opportunity cost of 1 Loaf Opportunity cost of 1 Jar of

of Bread Jam

Ali 20/10 = 2 10/20 = 0.5

Barb 36/6 = 6 6/36 = 0.16

Table 1 : Opportunity cost of making bread and jam for Ali and Barb

According to Mankiw (2014), comparative advantage can be defined as the ability of a

person to produce commodities at a lower opportunity cost compared to the other person.
From table 1, it is seen that Ali has a comparative advantage in making bread and Barb in
making jams.

This difference in opportunity cost that contributes to the comparative advantage, results in
gains from trade. When each person specializes in their comparative advantage good, the
total production in the economy is enhanced and this increase in economic pie results in
making each one better off.

When 3 loaves of bread are traded for 12 jars of jam, Ali would have 7 loaves of bread along
with 12 jars of jam who otherwise would have produced only 5 loaves of bread and 10 jars of
jam in a day if he devotes equal time in making both the commodities. Hence specialization
and trading makes Ali better off. Similarly, Barb now has 24 jars of jam along with 3 loaves
of bread who otherwise would have 18 jars of jam and 3 loaves of bread.
Hence both Ali and Barb with different opportunity costs are gaining from specialization and
trade as they obtain an increased amount of both the goods compared to the amount they
would have obtained if both had devoted equal time in producing each good.

PART III

Introduction
With the unexpected outbreak of the virus, there has been a sharp increase in global demand
for face masks while supply remains unchanged initially. This sudden upsurge in demand
hampers market stability and in order to reach equilibrium, the market price increases
significantly. Moreover due to the unavailability of raw materials at large quantities to meet
the excess domestic demands of each country, the supply curve shifts inwards, reducing the
quantity demanded and further increasing the market price rise. Hence to curb the intense
shortage, domestic companies start manufacturing face masks and simultaneously countries
limit its export or impose an export ban on face masks thereby increasing the quantity
supplied to some extent. However such unilateral actions from nations all across the world
might prove to be detrimental in the long run. Hence this report critically analyses whether
Australia should move away from globalisation and produce face masks and other essential
medical equipment itself or not.

Issues in the supply of face masks in the international market

scenario.

Distribution of face masks has been an important bottleneck in its global value chain. As
countries fight to secure the supplies of personal protective equipment (PPE) like face masks,
the general principles of international trade are out of the window in the wake of the
unprecedented outbreak of Covid-19 pandemic (Uren, 2020). The virus has triggered
skyrocketing demand for face masks from the entire world contributing to intense shortage in
its supply and robust increase in its price.
To mitigate the shortage, governments of most nations have stepped forward in taking
independent actions in ensuring supply rather than acting in unison. According to reports
from the World Trade Organisation, 72 member countries of WTO along with 8 non-WTO
members prohibited supply of essential medical equipment like face masks (Suneja, 2020).
This has exposed fractures in international trade and cooperation, contributing to a negative
economic outlook when the world is witnessing the most dramatic reversal ever since the
global financial crisis of 2008.

Critical Analysis of the issue.

Harmful implications of the unilateral and protectionist measures.
Such protectionist measures from the entire world symbolises a death knell for globalisation,
an influencing force that has significantly shaped modern human history over the last half
century (Vaneik, 2020). The export restrictions and unilateral actions have severe
consequences. It can actually backfire the nations imposing such restrictions when there
arises requirements of importing input to mask production or the need for additional medical
equipment (OECD, 2020). Countries with no production capacity are obstructed from gaining
access to vital supplies like masks. Further along with increased price, export license and
tariffs discourage exports and can result in trade delay of approved exports contradicting the
urgency in need of such supplies.

Moreover, restrictions on export demoralize the investment confidence of oversea companies,

thereby denying the host country from harnessing the benefits of capitals as well as the know-
how to build local potential in manufacturing masks (Moura & Forte, 2013). This calls for
avoiding barriers to trade that would jeopardize further investments. Further though the
restrictions and export prohibition in the short run contributes to increased domestic supply
with reduced price, it disincentivizes the local firms from production thereby reducing the
domestic availability of face masks in the long run (Edwards, 2020).

In addition to this, the unilateral actions undertaken by the individual nations adds to
uncertainty since it is significantly expensive for every nation to build production capacity
that matches the forecasted demand. Besides, in the long run, the reduced demand witnessed
by the domestic firms once the pandemic situation normalizes would not contribute to profit
and overcapacity once again would result in protectionist measures disrupting the global
market for face masks.

Importance of global trade in addressing the shortage.

Hence considering the welfare implications of international trade, the best policy response to
the crisis and shortage is allowing global trade and investment along the GVCs of face mask.
According to the Ricardian theory of international trade (1817), countries are better off when
they indulge in international trade even when one country has comparative advantage in one
commodity. According to Gujrati (2015) this can be explained by the fact that different
countries specialize in production of different commodities owing to the difference in their
opportunity cost which contributes to their comparative advantage in a commodity. Hence
exporting the commodity one has comparative advantage in and importing the good in which
it does not have comparative advantage would ultimately make both nations better off.

Since no country can alone cater to the towering demands for face masks and that some
countries have developed production capacities while others have not, global trade and lifting
of export bans are imperative to ensure full supply of face masks across the world especially
in countries where the pandemic is increasing rapidly. Further trade would enable efficient
exchange of different PPEs among all nations when each nation will produce the item they
specialize in. This would also reduce the overall skyrocketing market price of face masks.

Policy implications
According to McDonagh (2020), robutness required for firms in addressing supply risk does
not arises from self sufficiency. Also reliance on free trade or trade facilitation ensure enough
supply to meet demands. Hence according to OECD (2020), the best policy implications
would be a combination of international trade with building strategic stocks that ensure
supply meets the rising demand amidst crisis situation, market price remaining low.

Conclusion
The report clearly depicts that international cooperation is imperative to address current short
and the severe economic downturn. Considering the risk associated with unilateral production
and the welfare implications of trade, international trade would make each country better off
in the long run. Moreover if every country across the globe adopts sovereign notions by
setting barriers to serve the interest of their own nation, the global recover would be difficult
and long to achieve. In this contemporary society of 21st century, it is impractical to stop
globalisation. Hence Australia should embrace global trade and lift export bans on face masks
and vital medical supplies rather than moving away from globalisation.
References :
Edwards, J. (2020). The facts about global
trade in face masks, ventilators and test kits. The Interpreter. [Online]. Available at :
https://www.lowyinstitute.org/the-interpreter/facts-about-global-trade-face-masks-ventilators-
and-test-kits [Accessed : 5 September 2020].

Gujrati, R. (2015). The role of International Trade in the Global Economy & Its Effects On
Economic Growth. International Journal of Innovative Science, Engineering and
Technology, 2(7), pp. 453-462.

Mankiw, G. (2014). Principles of Economics. 6th Edition. Cengage Learning.

McDonagh, N. (2020). Sure, let's bring production onshore, but it might not ensure supplies.
The Conversation. [Online]. Available at :
https://www.google.com/amp/s/theconversation.com/amp/sure-lets-bring-production-
onshore-but-it-might-not-ensure-supplies-142270 [Accessed : 6 September 2020].

Moura, R., & Forte, R. (2013). The effects of foreign direct investment on the host country's
economic growth: Theory and empirical evidence. The Singapore Economic Review, 58(3),
pp. 1-23.

OECD. (2020). The face mask global value chain in the COVID-19 outbreak: Evidence and
policy lessons. OECD. [Online]. Available at : http://www.oecd.org/coronavirus/policy-
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lessons-a4df866d/#back-endnotea0z10 [Accessed : 6 September 2020].

Ricardo, R. (1817). On The Principles of Political Economy and Taxation. 1st Edition.
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Suneja, K. (2020). Around 80 countries limiting exports of face masks, other goods: WTO.
The Economic Times. [Online]. Available at :
https://www.google.com/amp/s/m.economictimes.com/industry/healthcare/biotech/
healthcare/around-80-countries-limiting-exports-of-face-masks-other-goods-wto/
amp_articleshow/75357835.cms [Accessed : 6 September 2020]

Uren, D. (2020). How Covid-19 infected global trade. The Strategist. [Online]. Available at :
https://www.aspistrategist.org.au/how-covid-19-infected-global-trade/ [Accessed : 6
September 2020]

Vaneik, S. (2020). Coronavirus hasn't killed globalisation – it proves why we need it. The
Conversation. [Online]. Available at : https://theconversation.com/amp/coronavirus-hasnt-
killed-globalisation-it-proves-why-we-need-it-135077 [Accessed : 7 September 2020].