ASSIGNMENT MEMORANDUM

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1 Page 1 of 5 ASSIGNMENT MEMORANDUM SUBJECT : MICRO ECONOMICS (MIC) ASSIGNMENT : 1 st SEMESTER 2009 SPECIFIC INSTRUCTIONS Answer ALL questions. SECTION A 40 MARKS QUESTION 1 (MULTIPLE CHOICE) [40] 1.1 e 1.11 b 1.2 d 1.12 d 1.3 c 1.13 c 1.4 b 1.14 d 1.5 a 1.15 b 1.6 b 1.16 c 1.7 a 1.17 d 1.8 d 1.18 c 1.9 e 1.19 e 1.10 c 1.20 d [20 X 2 = 40 marks] SECTION B 50 MARKS QUESTION 2 [10] 2.1 Movement: Occurs when the price of a product changes, called a change in the quantity demanded. (1) Shift: Occurs because of a change in any one or a combination of the other factors determining demand, for example a change in taste, income, price of other goods, etc. It is called a change in demand. (1) 2.2 Cost concepts: See figure 11-6 on page 212 of prescribed textbook

2 Page 2 of 5 Marginal cost (MC) is the increase in total cost when one additional unit of output is produced. There is only one marginal cost curve (MC), but there are 3 average cost curves: Average Fixed Cost AFC (which falls as output increases) Average fixed cost (AFC) = total fixed cost divided by total product. Average Variable Cost AVC (which falls, reaches a minimum and then increases) Average variable cost (AVC) = total variable cost divided by total product. Average Total Cost (or simply average cost) AC (which also falls, reaches a minimum and then increases). Average cost (AC) = total cost divided by total product. Average cost includes average fixed cost & average variable cost. Both AVC and AC reach a minimum where they are intersected by MC. (2X2 =4) 2.3 Shifting of the curves: a) Demand curve shifts to the left. (1) b) Demand curve shifts to the left. (1) c) Demand curve shifts to the right / supply curve shifts to the left (BOTH are correct) (1) d) Supply curve shifts to the left. (1) QUESTION 3 [20] 3.1 Cases of market failure include (See page 341): Monopoly and imperfect competition

3 Page 3 of 5 A strong firm can protect its position by conducting a price war against a competitor entering the market. Public goods The market fails to provide sufficient quantities of public goods and services, for example good health services and good police services to address crime. Externalities Are costs or benefits of a transaction or activity that are borne or enjoyed by parties not directly involved in the transaction or activity. They are also called third party effects, spill over effects or neighbourhood effects. Where there are external costs, we refer to negative externalities, e.g. pollution. Where there are external benefits, the term positive externality is used, e.g. a flower garden beautifying the environment. Asymmetric information Ignorance and uncertainty makes it difficult for people to make informed decisions. Example: The suppliers of cigarettes are aware of the health hazards of smoking, but do not release this information to potential buyers of cigarettes. Common property resources Common property resources belong to no one and are available free of charge to anyone who wants to use them. No one can be excluded from using them. But they are revalrous in consumption. One person s use of the common resource reduces the availability to other persons. Examples of common property resources include the fish in the ocean, other wildlife, rivers and common land. (Any 4 x 2 = 8) 3.2. Rent control: See figure 8.9 on page marks are allocated for the graph. Consequences: See page 146 for the discussion (One mark each: maximum 3) - Demand exceeds supply - Market shortage Owners of rented accommodation may: - sell the flats under sectional title - convert the building into offices - lower their operating costs by skimping on maintenance and repairs - cease to erect new rented accommodation. (3+3=6)

4 Page 4 of Minimum/ Floor price: Please consult figure 8.12 on page marks for the graph Options open to the government: (3 marks) Government purchases the surplus and exports it. Government purchases the surplus and stores it (provided the product is non-perishable) Government introduces production quotas to limit the quantity supplied to the quantity demanded at the minimum price in Figure 8-12 the aim would be to limit production to 4 million tons, thus eliminating the surplus. Government purchases and destroys the surplus. Producers destroy the surplus. (Any 3x1=3) QUESTION 4 [20] 4.1 Different market structures. Please consult table 13.1 on page 243. (3 x 2 = 6) 4.2 Perfect competition: from abnormal/economic profit to normal profit (The answer is a combination of figure 12.6 on page 232, figures 12.8 and 12.9 on page 235, as well as figure on page 236 of the prescribed textbook) The original demand and supply curves in (b) are D 1 and S 1, yielding a price of P 1. At P 1 the individual firm earns an economic profit where MR 1 = MC, since AR exceeds AC at that point (E 1 ). At E 1 the industry is in disequilibrium. The economic profits attract new firms to the industry, thus shifting the supply curve in (b) to S 2 in the long run.

5 Page 5 of 5 The price falls to P 2, where industry equilibrium is established, since the individual firm is only earning a normal profit and there is no incentive for firms to enter or leave the industry. The figure above shows a situation in which the firm makes an economic profit (or supernormal profit), equal to the shaded area (C 1 P 1 E 1 M), which is equal to the profit per unit of output multiplied by the quantity produced (Q 1 ). Alternatively, the area representing total profit can be obtained by subtracting the firm s total cost (0C 1 MQ 1 ) from its total revenue (0P 1 E 1 Q 1 ). The figure above shows how the firm now just breaks even. The market price (and therefore also the firm s AR and MR) is P 2. It is equal to MC at the point where MC intersects AC (i.e. at the minimum point of AC). The corresponding level of output is Q 2. At that level of output AR = AC (and TR = TC) and the firm therefore does not earn an economic profit. It does, however, earn a normal profit, since all its costs, which include normal profit, are fully covered. (14) PRESENTATION (10)