Economics 1 Individual Assignment

Faculty of Management Studies

Department of Business Administration
SQA HND
Academic Year: 2020

Assessor : Onalie De Silva

Unit Code : HP6P 48
Title of the Unit : Economics 1: Micro and Macro Theory and
Application Outcome : 1 Batch : 30 A | 30 B

Assignment Issued Date :

Assignment Submission Date :

Declaration of Academic Honesty

Student’s Full Name :L.H.N.Lakshan
Student ID number :19s08453
Declaration
1. I confirm that this assignment is my own work:
2. I confirm that where ever I have used someone else’s words, concepts, graphics or data
in my work, I have clearly indicated exactly where I have done so, using the Harvard
referencing system.
3. I confirm that I have clearly indicated, by referencing, where I have used someone
else’s words, concepts, graphics or data, irrespective of whether I have quoted verbatim
or I have paraphrased in my own words.
4. I have clearly indicated in my assignment any work that has been contributed by another
student.
5. I have clearly indicated in my assignment any work that has been carried out
collaboratively with another student/s
Student Signature: Date:

1
Title of the Unit : Economics 1: Micro and Macro Theory and Application
Assessor : Onalie De Silva
Unit Code : HP6P 48
Name : L.H.N.Lakshan
Batch : 30B

Content
1. As Sony begin production of their new product, Playstation Move, define the following costs
and explain the short run influences on each one. Illustrate your explanations of each cost
with a diagram.

a. total cost
b. average cost
c. marginal cost

2. The games console market is an example of an oligopoly.

a. Explain what is meant by the term ‘oligopoly’.

b. Describe the main characteristics of this type of market structure.
c. With the aid of a kinked demand curve diagram and with reference to price and
output behaviour, describe how firms are likely to behave under oligopoly
conditions.

3. Choose another market structure from either monopoly or perfect competition.

a. Define your chosen market structure.

b. Describe the main characteristics of your chosen market structure.
c. With the aid of a diagram, describe the price and output behaviour of your
chosen market structure.

4. The different market structures assume that firms aim to maximise profits. Explain
the concept of profit maximisation and the problems of achieving this objective.

5. Identify and explain an alternative theory to the objective of profit maximisation.

Question 1
As Sony begin production of their new product, PlayStation Move, define the following
costs and explain the short run influences on each one. Illustrate your explanations of each
cost with a diagram.

a) Total cost
It's expressed classically as a blending of all fixed costs and all variable costs. The total
cost could be defined in economics as the accumulation of all costs a firm incurred in
producing a certain level of output.

The notion of total cost is used to define average cost and marginal cost.
b) Average Cost
The average cost is the per-unit cost of production obtained by dividing total cost(TC) by
the total output (Q).
c) Marginal Cost
Marginal costs are the additional costs incurred when producing additional unit of a good
or service.
The influence of diminishing returns is that the longer a product is on the market the
more profits it can generate and demand will be satisfied, however demand will decrease
with time and the business will have to sacrifice profits to advertise in order to enhance
customer awareness. When demand rises past a certain level the economies of scale
work in reverse and because of the cost of purchasing too many units will increase the
cost per unit.
Question 2
a) Explain what is meant by the term ‘oligopoly’.

Market condition that affects each of the few producers, but does not control the market. Will
producer would have to weigh the impact of a price increase on the other producers' actions.

Ex: Automobile, Tobacco, Banks, Soft drinks.

b) Describe the main characteristics of this type of market structure.

❖ Market domination
❖ Price rigidity
❖ Higher advertising
❖ Homogeneous or heterogeneous product
❖ Interdependence of firms.

c) With the aid of a kinked demand curve diagram and with reference to price and
output behavior, describe how firms are likely to behave under oligopoly conditions.

The kinked demand curve model tries to explain that in non-collusive oligopolistic industries
there are not frequent changes in the market prices of the products. The demand curve is drawn
on the assumption that the kink in the curve is always at the ruling price. The reason is that a
firm in the market supplies a significant share of the product and has a powerful influence in the
prevailing price of the commodity.
Impact of price rise

 When a business increases the price, it is more competitive than its competitors and
therefore customers will turn to their competitors.
 Therefore a large decline in demand is likely to occur with a price increase.
Therefore demand is price elastic.
 For this situation, rising price firms may lose sales as the decrease for
demand percentage is greater than the rise in price percentage.

Impact of price cut

 If a firm lowers its price, it is likely to cause another impact. If a firm price reduction in
the short term, it will trigger a major increase in demand and therefore lead to an increase
in revenues. The company will win market share.

 Many companies do not want to see this market share decline, however, and so they
will respond by also cutting price to match the first firm.
 If a firm 's demand for a 'price war' is market relatively elastic – there's a lower
demand percentage increase.
 If demand becomes inelastic and prices fall, incomes will decline.
Question 3

a) Define your chosen market structure.

Monopoly Market

In a monopoly market, factors like government license, ownership of resources, copyright and
patent and high starting cost make an entity a single seller of goods. All these factors restrict the
entry of other sellers in the market. Monopolies also possess some information that is not known
to other sellers.
b) Describe the main characteristics of your chosen market structure.

Characteristics of Monopoly Market structure

 Profit maximizer: Monopolies maximize profit. Because of the lack of competition a

business will charge a fixed price over what would be paid in a competitive industry,
thus increasing its profits.

 Price maker: The monopoly increases reliability on the price of the good or of the good
sold. The price is determined by quantity determination to obtain the price the firm
needs (maximizes revenue).

 High barriers to entry: Many sellers are not permitted to access the monopoly market.

 Single seller: Under a monopoly one seller generates all the good or service production.
A single company represents the entire sector. For practical purposes the business is
similar to the industry

 Price discrimination: The business can change the price and quantity of the goods
or services in a monopoly.

c) With the aid of a diagram, describe the price and output behavior of your
chosen market structure.
 A monopolist should take market demand as a curve of their own production.
 The company is a profit maker but can't demand a profit the customers won't bear.
 A monopolist has market control and is capable of raising prices above marginal costs
without fear of losing supernormal income to new market entrants.
 In this sense, the elasticity of demand serves as a restraint on the monopolist 's market-
power
 Assuming that the monopolist aims to maximize profits (where MR = MC), a
short- term price and production balance are defined as shown in the diagram
below.
Advantages of Monopoly Market Structure

 Stability of prices: On the other hand, in a monopoly, since there is no competition,

there is only one seller of a good on the market, the seller sets the prices according to his
wishes and whenever he decides to change the price

 Source of revenue: Given the fact that monopolies are also a source of restricted
competition and other sellers entering the sector, they continue to be promoted
since monopolies may earn good profits

 Profits: a monopoly refers to a single seller operating and selling a good in the market
of a large number of buyers

Disadvantages of monopoly Market Structure

 Price discrimination: Since Monopolies decide their own prices on the markets without
caring about competition, it has always been found that the retailer prefers to charge
different prices from different buyer groups, resulting in price discrimination.

 Quality of goods: Since there is no competition in such a market, a monopoly will also
produce products of poor or lower quality to reduce their manufacturing costs and make
more money, thereby causing customers to lose out.

 Price discrimination: Since Monopolies decide their own prices on the markets without
caring about competition, it has always been found that the retailer prefers to charge
different prices from different buyer groups, resulting in price discrimination.
Question 4
The different market structures assume that firms aim to maximize profits. Explain the
concept of profit maximization and the problems of achieving this objective.

In economics, profit maximization is the short run or long run process by which a firm may
determine the price, input, and output levels that lead to the highest profit

The profit maximization theory has been severely criticized by economists on the following
grounds:

1. Profits Uncertain:

The principle of profit maximization assumes that firms are certain about the levels of their
maximum profits. But profits are most uncertain for they accrue from the difference between the
receipt of revenues and incurring of costs in the future

2. No Perfect Knowledge:

The profit maximization hypothesis is based on the assumption that all firms have perfect
knowledge not only about their own costs and revenues but also of other firms. But, in reality,
firms do not possess sufficient and accurate knowledge about the conditions under which they
operate.

3. Firms do not bother about MC and MR:

It is asserted that the real world firms do not bother about the calculation of marginal revenue
and marginal cost. Most of them are not even aware of the two terms

4. Principle of Average-Cost Maximizes Profits:

Hall and Hitch found that firms do not apply the rule of equality of MC and MR to maximize
short run profits. Rather, they aim at the maximization of profits in the long run. For this, they
do not apply the marginality rule but they fix their prices on the average cost principle
Question 5
Identify and explain an alternative theory to the objective of profit maximization.

1. Sales Revenue maximization

Such an approach does not focus on costs; managers are simply interested in the value of sales.
As a result of separation of ownership and control managers would like to increase sales rather
than profits as their performance is directly related with that.

2. Satisficing behavior

This involves the owners setting minimum acceptable levels of achievement in terms of business
revenue and profit. The profounder of satisfying theory hold that firms operate in under
uncertainty. In the long-run their success or failure depends on their ability to adopt innovation
and change. Because of existence of risk firms normally tend to be risk averse and do not change
their behavior until and unless profits are down alarmingly.

3. Full cost pricing

Based on empirical findings in 1930s, full cost pricing theory says that firms set price equal to
average cost at normal capacity output plus a conventional mark- up instead of equating its
marginal cost with marginal revenue. Price will change if average cost change. In the short run it
was observed that firms change their output, not price, in response to fluctuations in demand
which is not profit maximizing behavior.