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ECONOMICS TEST ASSIGNMENT

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Part 1

Question 1

The elasticity of demand measures the responsiveness of quantity demanded to change in

price. A higher elasticity means a slight price change will result in a more significant change in

the amount requested. In comparison, a lower elasticity implies that a price difference will have a

smaller effect on the quantity required.

Suppose the elasticity of demand for the company's product is 1.4. In that case, a one

percent increase in price will result in a 1.4 percent decrease in quantity demanded, and a one

percent decrease in price will result in a 1.4 percent increase in the amount required.

If the company raises the price, it will increase revenue if the elasticity is less than 1. If

the elasticity exceeds 1, the company should lower the cost to increase revenue. If the elasticity

equals 1, payment will be maximized at the current price.

Therefore, if the elasticity is 1.4, the company should lower the price to increase revenue.

If the elasticity were 0.6, the company should raise the price to increase revenue, while if

the elasticity were 1, payment would be maximized at the current price.

This analysis assumes that the company operates in a perfectly competitive market, where many

substitutes for its product and consumers have high price sensitivity.

Question 2

The domestic auto industry is subject to significant economies of scale, which means that

the cost per unit of production decreases as output increases. If the demand for domestic autos is

2.5 times the quantity produced at the bottom of the long-run average cost curve, more than one
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or two firms will likely survive in the long run. This is because the industry will be characterized

by excess capacity and intense price competition, leading to lower profits and the potential exit

of firms.

In the long run, the domestic auto industry will likely consolidate through mergers and

acquisitions, or some firms may exit the industry altogether. This consolidation will lead to fewer

firms, but they will be more extensive and efficient, producing at a larger scale and potentially

lowering costs further.

Question 3

The inflation rate is calculated using a basket of goods that reflects the typical

consumption patterns of households. The basket includes a range of goods and services weighted

according to their importance in the overall consumption bundle.

If the government statisticians update the basic basket of goods more frequently, say

every five years instead of every ten years, this will reduce the amount of substitution bias in the

inflation rate. Substitution bias occurs when consumers change their consumption patterns in

response to changes in relative prices. Still, these changes must be fully reflected in the basket of

goods used to calculate the inflation rate. By updating the basket of goods more frequently, the

statisticians will capture these changes more accurately and reduce the substitution bias.

On the other hand, updating the basket of goods more frequently may increase the

quality/new goods bias in the inflation rate. Quality/new goods bias occurs when new and

improved goods are introduced, but their quality improvements are not fully reflected in the price

index. This is because it is difficult to compare the price of a new good with the cost of an old
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interest. By updating the basket of goods more frequently, the statisticians may capture new

goods more accurately but still need help to capture quality improvements.

Part 2

Problem 1

Reducing consumer spending may be necessary for faster economic growth if the

economy suffers from inflation or trade deficits. Inflation occurs when too much demand is

chasing too few goods, and reducing consumer spending can help decrease the overall market

and bring prices back down. Similarly, declining consumer spending can help decrease imports

and shift the balance towards exports if an economy imports more than it exports.

However, reducing consumer spending may also have negative consequences, such as

decreased consumer confidence, decreased demand for goods and services, and potential job

losses in industries that rely on consumer spending. It can also lead to social and political unrest

if the reduction in expenditure disproportionately affects certain groups.

Whether reducing consumer spending is worth the sacrifice depends on the specific

circumstances of the economy and the goals of policymakers. In some cases, the benefits of

lowering spending may outweigh the costs, while the costs may be too high in other cases.

Problem 2

(a) North Korea's military spending = $40 billion x 0.148 = $5.92 billion

(b) South Korea spends more in absolute terms than North Korea. This is because its output

is 43.2 billion compared to North Korea, which has 1an output of 5.92 billion.

Problem 3
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Production possibilities curve

90
80
70
60
50
40
30
20
10
0
0 50 100 150 200 250 300 350 400 450

(A) If maximum healthcare is provided, the economy will produce hostile education units.

(B) The opportunity cost of increasing health care from 270 to 330 units can be calculated as

the slope of the PPF at that point. From the graph, we can see that the PPF is concave to

the origin, which means that the opportunity cost of producing health care increases as

we have more of it. The opportunity cost would be 0.6 (60/10)

Problem 4

(a) If the workforce is growing by 1 percent a year, but productivity does not improve, then the

output will increase by 1 percent yearly. This is because the formula for actual work in the

problem is simply the product of the number of workers and their productivity. If productivity

remains constant and the number of workers increases by 1 percent, then the total output will

increase by 1 percent.

(b) If productivity increases by 3 percent and the number of workers increases by 1 percent a

year, then the output will increase by the sum of these two growth rates, or 4 percent per year.

This is because the formula for actual work in the problem is simply the product of the number

of workers and their productivity. If productivity increases by 3 percent, the same number of

workers can produce 3 percent more output. If the number of workers increases by 1 percent, the
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total production will increase by 1 percent. Therefore, total output will increase by 4 percent per

year.

Problem 5

Income inequality refers to the distribution of income among individuals or households in

a country. When a small percentage of the population holds a large proportion of the total

revenue, it can lead to a wide income gap between the rich and poor. This can have negative

impacts on economic growth and social stability.

Generally, countries with high levels of income inequality tend to have a lower average

per capita income. This is because a large portion of the population may need more access to

education, healthcare, and job opportunities, which can hinder their ability to contribute to the

economy and increase their income. On the other hand, countries with lower levels of income

inequality tend to have higher average per capita income, as more people have access to

resources and opportunities to improve their economic situation.