Economics Test - 3

The Soviet Union is the closest example of a centrally planned economy for the major part of the 20th Century. The economy of the Soviet Union was based on a system of state ownership of the means of production, collective farming, industrial manufacturing, and centralized administrative planning.

• The statement “Economics is what ought to” refers to Normative Economics.
• Normative Economics statements are opinion based, so they cannot be proved and disproved.
• It is subjective and value-based.

• A production possibilities curve (PPC) shows the maximum amount of one good that can be produced given a production level for some other good, and given the total amounts of inputs available for the production of both goods, and given the technology of production. 
• The PPC shows the limits on outputs of goods because society does not have unlimited resources. And it shows the trade-off society must bear if more of a good is to be produced.
• The Production Possibilities Curve (PPC) is a model that captures scarcity and the opportunity costs of choices when faced with the possibility of producing two goods or services.
• The production possibility curve represents graphically alternative production possibilities open to an economy.
• The productive resources of the community can be used for the production of various alternative goods.
• In other words, the production possibility curve can be defined as a graph that represents different combinations of quantities of two goods that can be produced by an economy under the condition of limited available resources. It is also known as the production possibility frontier(PPFs) or transformation curve.
• The PPCs are normally drawn as bulging upwards or outwards from the origin ("concave" when viewed from the origin), but they can be represented as bulging downward (inwards) or linear (straight), depending on a number of assumptions.
• In this diagram AF is the production possibility curve, also called or the production possibility frontier, which shows the various combinations of the two goods (Wheat & Cloth) which the economy can produce with a given amount of resources. 

• The Curve shows all of the possible combinations of 2 goods or services that can be produced within a specified time with all its resources fully and efficiently employed.
• The economy can produce at any combination on or inside the curve (C and H).
• Point outside the curve is not attainable (F).

Monopolistic competition is a type of imperfect competition in which many firms offer products and services that are similar to each other but are not perfect substitutes.Important Points 

Marginal Revenue is the difference in total revenue after changing the rate of sales by one unit.

Marginal Cost is the cost of producing an additional unit of the good.

Key Points

Profit Maximization Rule:

• Regardless of the type of firm, the Profit Maximization Rule states that when a company wants to maximize its profits, it must choose the output level where Marginal Revenue (MR) equals Marginal Cost (MC) and the Marginal Cost curve is rising.
• In other words, we can say that a company must produce output up to the level where MR=MC.

Therefore, the Profit maximizing rate of output of a firm is determined by equating Marginal Cost with Marginal Revenue.

Important Points

Reasons why profits are not maximized at points where MR is not equal to MC:

When MR>MC, then for each additional unit produced revenue will be higher than cost and the company would generate more quantity of goods.

When MRthen for each additional unit produced cost will be higher than revenue and the company would create less quantity of goods.

So the optimal point of production should be at a point where MR=MC.

The correct answer is Catherin's demand schedule

Key Points

• The supply curve is the graph of the relationship between the price of a good and the quantity supplied. 
• In economics, a demanding schedule is a table that shows the quantity demanded of a good at different price levels. This is what Okha's demand schedule is all about.
• Catherine's demand schedule is as follows and it shows the quantity demanded at each price:

• Price of Ice-cream cone	Quantity of Cones demanded
  $ 0.00	12
  0.50	10
  1.00	8
  1.50	6
  2.00	4
  2.50	2
  3.00	0

The correct answer is 'option 4'

Key Points

• Environmental goods are typically non-market goods, including clean air, clean water, landscape, green transport infrastructure (footpaths, cycleways, greenways, etc.), public parks, urban parks, rivers, mountains, forests, and beaches.
• Environmental goods are a sub-category of public goods. 
• A market failure occurs when there is an inefficient allocation of resources.
• It happens when the true cost of a good is not reflected in the price.
• This might be because a third party benefits but does not pay for that benefit.
• Or, it could arise due to a cost that is imposed on a third party without their consent and compensation.
  • Non-excludable goods mean every single person can access a certain public good and consume it.
  • Non-rivalrous goods can be consumed by any number of people. 
  • Public goods are both non-rival and non-excludable. Since environmental goods are public goods that are both non-rival and non-excludable, they are a cause of market failure.

Therefore, the correct answer is 'environmental goods are non-rival and non-excludable in consumption

Additional Information

Other causes of Market failure:

• A: Asymmetric Information: Is a factor of market failure. It falls in one of the categories. Asymmetric information leads to the selling of a product at a value which it does not hold. Hence, this does cause an imbalance and inefficient allocation of resources and thus market failure.
• B: Public Goods: The quality of public goods includes both non-rival and non-excludable and thus there is a free-rider problem and the consumer benefits but does not pay the price. Hence, they do cause market failure. 
• C: Externality: Externalities are market imperfections where the market offers no price for service or disservice. The presence of externalities in consumption and production also leads to market failure.

Few causes and examples of externalities which cause market failure include:​

• Negative Externalities- such as pollution and alcohol;
• Positive Externalities- such as education and health;
• Imperfect Information- for example, a second-hand car is sold as new;
• Monopolies- such as Government Monopolies sometimes;
• Merit goods- such as education and libraries;
• De-merit goods- such as smoking, etc; and
• Public goods-such as law, defense, etc. 

Elasticity is the measure of the responsiveness of one variable to changes in another variable that determines it. The price elasticity of demand for a good is a measure of the responsiveness of the quantity demanded of that good to changes in its price. 

Important Points

• A horizontal demand curve is a flat curve with a slope of infinity at all points of the curve.
• It is because a slight price rise brings a drastic change and reduces the demand to zero.​
• The demand curve of a market represents the responsiveness of consumers to price changes to a good. 
• The flatter the slope of a demand curve, the higher the responsiveness in quantity demanded a price change.
• A horizontal demand curve is used to represent a demand curve with a slope of zero.
• A change of price is impossible in this market due to the market competition and perfect substitution between suppliers.

• When the price elasticity of demand is infinite at every point along a horizontal demand curve. This means that even the slightest increase in price results in the consumers completely abandoning the product in favor of substitutes.
•  The horizontal demand curve indicates that the elasticity of demand for the good is perfectly elastic.

Thus, a horizontal demand curve implies that the elasticity of demand is infinite.

The Correct Answer is Oligopoly.

Key Points

• In the ordinary sense, the term market refers to a place where buyers and sellers meet for exchange. However, the Market need not be the place of exchange.
• Types of Market Structure
  • Perfect Competition:
    • Participants are high both buyers and sellers.
    • Products have many substitutes and no marketing or selling cost is incurred.
    • Knowledge of participants for entering into the market is perfect.
    • The seller is a Price taker, not a price maker.
    • A buyer willing to buy all at a certain price but none at price higher. So he is a price maker.
  • Monopoly:
    • Buyers are many but the seller is one.
    • Product has no substitute or no close substitute
    • Other competitors cant enter the market due to laws or patents.
    • Price discrimination is seen between poor and rich. Seller is a Price maker.
    • Relative Price inelastic increase means demand decreases by less than X% for an X% increase in price.
• A natural monopoly is when there is an extremely high fixed cost of distribution e.g. gas, water, electricity.

Additional Information

• Monopolistic competition:
  • Many buyers and sellers but each selling its differentiated version of good.
  • Marketing selling cost is high. Goods are of different brands where brand loyalty is seen to a limit but many substitutes are available.
  • Unrestricted and free entry.
  • Seller is Price maker to a level.
  • Price increases by x% but demand decreases by less than x% - relatively inelastic. But more elastic than monopoly.
• Oligopoly:
  • Buyers many but sellers few with intense competition.
  • Product has close substitutes and intense competition amongst sellers. If one seller introduces change others have to follow. High cost of marketing and selling.
  • Entry of new sellers tough due to economies of scale.
  • The seller is a price maker.
• Monopsony:
  • The monopoly of the buyer but multiple sellers present.
  • Entry closed for other buyers
  • Seen where the government wants to make a defense-related purchase and multiple sellers are bidding for it.
  • The Buyer is a price maker.

The correct answer is e = 1.

Key Points

• A rectangular hyperbola is a curve under which all rectangular areas are equal.
• When the elasticity of demand is equal to unity (e = 1) at all points of the demand curve, then the demand curve is a rectangular hyperbola.
• It is a downward-sloping curve as given in figure:

      

• In the case of any two points of A and B on the curve, each rectangular area shows total expenditure on the good. Thus, the total expenditure on the good remains constant even as the price of the good increases or decreases.

Additional Information

Price elasticity of demand:

• The price elasticity of demand for a good is defined as the percentage change in demand for a good divided by the percentage change in its price.
• Price elasticity of demand is a pure number, and it does not depend on the units in which the price of the good and the quantity of the good are measured.
• The price elasticity of demand is a negative number, as the demand for a good is negatively related to the price of a good.
•  At a particular price, the percentage change in demand for a good is less than the percentage change in price, and then the demand for the good is inelastic at that price. ep <1
•  At a particular price, the percentage change in demand for a good is equal to the percentage change in price, and then the demand for the good is unitary elastic at that price. ep =1
• At a particular price, the percentage change in demand for a good is greater than the percentage change in price, and then the demand for the good is elastic at that price. ep >1

The correct answer is Giffen goods

Key Points ​Income effect: Income effect refers to the change in the demand for a good as a result of a change in the income of a consumer. 

Substitution effect: The substitution effect describes the shift in demand for a commodity as a result of a shift in its relative price to that of other alternative goods. When the price of a good rises, for example, it becomes more expensive in comparison to other goods on the market. As a result, customers shift their attention away from the good and to its substitutes

Important PointsGiffen goods: 

• Giffen goods are low-cost items whose demand rises in tandem with their price.
• There are just a few alternatives for these things, which are required to provide the need for food.
• Giffen products include bread, wheat, and rice.
• The concept of Giffen goods disregards the fundamental logic of supply and demand.
• In the case of Giffen goods ​the Income effect of a price rise is greater than its substitution effect so that the consumer buys less of it when its price falls.