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 Assignment 1 Questions: Week 1, 2 & 3

Q1: Define price ceiling and price floor and give an example of each. Which leads to a shortage? Which
leads to a surplus? Why? [2.5 Marks]
Q2: Export or Import, what is the option available for a nation if it has a comparative advantage in the
production of agricultural produce over the other country? Explain. Why do a group of economists favor
the policies that restrict imports? (Minimum 500 words). [2.5 Marks]
Q3: Pick any two principles of economics from Chapter 1 and explain each with an example.

[2.5 Marks]
Q4: Take an example of a two-goods economy and explain the concept of opportunity cost with
the help of the Production possibility curve (PPC). Also, draw a PPC and explain why any
combination outside the PPC is not possible.
[2.5 Marks]

Answer:

Answer 1

Governments employ price floors and ceilings as crucial instruments to control pricing in a variety of

markets. Let's first examine what each of these ideas means before delving into the consequences they

have in terms of shortages and surpluses.

A price ceiling is primarily a limitation placed by the government on the highest price that may be

charged for a certain commodity or service within a market. This intervention is frequently used to

protect customers against high pricing, especially when specific products or services are deemed

necessary or during economic downturns (Ye et al., 2020). The widespread use of rent control in

metropolitan areas is a prime illustration of a price cap. For instance, in order to make housing more

accessible for locals, cities like New York have rules that set limits on the amount of rent that landlords

may charge for certain homes.

Price floors, on the other hand, are legally required minimum prices set for particular commodities or

services. These are often used to help producers and guarantee that they are paid fairly for their goods.

The minimum wage law is a well-known illustration of a pricing floor. In this situation, governments set

a minimum hourly rate that businesses must pay their employees (Gregory, 2011). This ensures that

even low-skilled workers get paid enough to cover their basic necessities.

Let's now focus on the effects of these price regulations on shortages and surpluses in the marketplaces

that they each affect:

Price limits have a tendency to lead to shortages when they are implemented. This is due to the fact that

an imbalance results when the government sets a maximum price (the ceiling) that is lower than the

equilibrium price (the price at which supply and demand are equal) (Ye et al., 2020). Simply said, at this

artificially low price, there is a greater demand than supply. Referring back to the rent control example,

a surge in demand for apartments at the lower rate results when rent prices are capped below what they

would ordinarily be in the market.

There may not be enough rental properties available since landlords may not be able to make a profit by

renting out their homes at the mandated price. This results from an imbalance between supply and

demand brought about by the imposed price cap.

On the other hand, price floors result in market surpluses. Governments encourage producers to create

more of the item or service than customers are prepared to buy at this higher price point when they set a

minimum price (the floor) that is higher than the equilibrium price. The minimum wage is used here as

an example. Employers may respond by decreasing their workforce, lowering employee hours, or not

employing new workers if the government sets a pay rate that is higher than what would otherwise be

established by the labor market (Dean et al., 2020). As a result, there is an excess of labor, which causes
unemployment since more people want to work for the higher pay but there aren't enough jobs available

at that level to accommodate the larger labor force.

In summary, price ceilings cause shortages in markets by lowering prices below the equilibrium, which

causes a scenario in which demand exceeds supply. Price floors, on the other hand, cause surpluses by

raising prices above the point of equilibrium, which results in an excess of supply against demand. Both

of these policies have clear social or economic aims, but it's important to understand that they may also

have unexpected effects on markets, underscoring the significance of thorough study and necessary

revisions to effectively accomplish their desired objectives.

Answer 2

The best course of action in the context of international trade is to concentrate on exporting certain

agricultural products when one country has a comparative advantage over another in terms of

production. According to economist David Ricardo's concept of comparative advantage, nations should

focus on producing products or services where they can do so at a lower opportunity cost than their trade

counterparts (Siddiqui, 2018). For instance, it makes economic sense for Country A to emphasize the

cultivation and export of these items if Country A can produce agricultural products more effectively

and with less resources than Country B. By doing this, the country not only plays to its advantages but

also gains from trade by getting access to items that it might not be able to manufacture as effectively,

thereby promoting reciprocal economic growth between trading partners.

Although a country may have a comparative advantage in agriculture, a group of economists frequently

supports laws that limit imports. These economists may advocate for protectionism in the form of tariffs,

quotas, or subsidies to stave against foreign competition in indigenous industries like agriculture. Their
reasoning is based on a number of tactical and economic factors. Protecting domestic agriculture can be

a question of national food security, according to one important argument (Laursen, 2015). A nation

may protect its ability to feed its population and lessen its dependency on imports by fostering a stable

and healthy agricultural industry. When there are interruptions in the global supply chain or an economic

crisis, this becomes very important.

The preservation of domestic jobs is another argument in support of import restrictions. Import

restrictions can aid in maintaining job prospects in the agricultural industry and adjacent businesses.

Foreign agricultural products flooding the local market, according to opponents of open trade, might

result in employment losses in agriculture and related industries, which could have social and political

ramifications.

Some economists also contend that trade restrictions might be deliberately employed to gain advantage

in interstate talks. A nation might use these trade obstacles as negotiating chips in trade talks by putting

tariffs or quotas on imported agricultural goods in an effort to get better terms for its exports in other

industries. The defense of home industry and employment is one of the main points. These economists

contend that a nation may protect its indigenous job possibilities and retain the vibrancy of important

industries like agriculture by enacting import restrictions (Gregory, 2011). They argue that uncontrolled

imports might result in societal instability and job losses as native firms struggle to compete with

cheaper imported goods. As a matter of national security and self-sufficiency, they also stress the

necessity of maintaining critical industries and competencies, notably in agriculture, particularly during

times of global crisis or supply interruption.

In order to maximize economic gains, exporting agricultural products is a country's main choice when it

has a competitive advantage in production. The preservation of local jobs, national food security, and

strategic advantage in international trade discussions are among the justifications frequently offered by a
group of economists who favor policies that limit imports. With proponents and opponents arguing for

their respective stances based on a variety of economic and strategic concerns, the argument between

free trade and protectionism continues to be a complicated and divisive subject in economics and policy-

making.

Answer 3

The law of supply and demand and the concept of opportunity cost are two basic tenets of economics.

One of the pillars of economic theory is the law of supply and demand. According to this, the balance

between an item or service's supply by producers and demand by customers determines its price and

quantity in a market where there is competition. pricing often increase when a product's demand

outpaces its supply, which encourages manufacturers to create more of that product to profit from higher

pricing (Gregory, 2011). In contrast, prices tend to decline when supply exceeds demand, which forces

firms to cut back on production. Take the market for smartphones as an example. When a brand-new, in-

demand model is introduced, demand soars and prices rise as a result. In time, when the market

approaches equilibrium and more units are created to satisfy this need, prices may eventually settle or

even go down.

The concept that each option has a cost associated with the next best alternative that must be forgone is

emphasized by the principle of opportunity cost (Gregory, 2011). It emphasizes the idea of trade-offs in

making decisions. The opportunity cost of going to college, for instance, is the potential money one

could have made during those years of study if they had chosen to do so rather than immediately

entering the job. In other words, by selecting education, they are forgoing the income they would have

received from employment. Understanding opportunity cost is essential for rational decision-making
because it enables people and organizations to assess the relative worth of various options and allocate

resources effectively.

In conclusion, the law of supply and demand demonstrates how quantities and prices are established in

competitive marketplaces, where changes in prices are influenced by an imbalance between supply and

demand. The notion of opportunity cost, on the other hand, underlines the need of taking into account

the trade-offs involved in decision-making, realizing that selecting one choice frequently entails

forgoing the advantages of another. These ideas work as the cornerstones of economic research and

serve as a roadmap for people, organizations, and decision-makers in the allocation of resources and

functioning of the market.

Answer 4

Let's think about the creation of two items in a two-goods economy: autos and computers. A Production

Possibility Curve (PPC), usually referred to as a production possibility frontier, is a useful tool for

illuminating the idea of opportunity cost. When resources and technology are fully used, a PPC reflects

the greatest amount of one good that can be produced for any given amount of the other good. Let's

create a condensed PPC to illustrate this idea.

Let us consider a graph where computers are on the vertical axis and vehicles are on the horizontal axis.

Typically, the PPC trends downward, showing a trade-off between manufacturing vehicles and

computers. Various automobile and computer configurations that a society may build effectively with its

available resources are shown as we go along the curve. Consider that the PPC has two points: 100

computers and 50 automobiles are represented by Point B, whereas 50 cars and 100 computers are

represented by Point A.
Let us now talk about opportunity cost using these arguments. Moving from Point A to Point B results in

a loss of 50 computers as the opportunity cost of generating an extra 50 automobiles. In contrast, at

Point B, travelling from Point B to Point A would cost 50 automobiles in order to produce an additional

50 computers. This illustrates the idea of opportunity cost, whereby society must sacrifice some amount

of one benefit in order to obtain more of the other.

Because of the limitations imposed by the available resources and technology, no combination outside

the PPC is feasible. The PPC makes the assumption that resources are few and must be distributed

wisely. Points inside the PPC, like Point C with 60 automobiles and 60 computers, show that resources

are not being used to their full potential and society is not getting the most out of its resources. On the

other hand, given existing resource limitations, sites outside the PPC, such Point D with 120

automobiles and 70 computers, are unreachable. Additional resources or technical developments would

be necessary to produce at Point D. The PPC emphasizes the boundaries of what a two-goods economy

can produce with its current resources and technology by acting as a visual depiction of opportunity

cost.
 References

Dean, E., Elardo, J., Green, M., Wilson, B., & Berger, S. (2020). Price Ceilings and Price

Floors. Principles of Economics: Scarcity and Social Provisioning (2nd Ed.).

Laursen, K. (2015). Revealed comparative advantage and the alternatives as measures of international

specialization. Eurasian business review, 5, 99-115.

Mankiw, N. G. (2012). Principles of macroeconomic, 6th ed. Mason, OH: South-Western Cengage

Learning.

Siddiqui, K. (2018). David Ricardo’s comparative advantage and developing countries: Myth and

reality. International Critical Thought, 8(3), 426-452.

Ye, M., Zheng, M., & Li, X. (2020). Price ceiling, market structure, and payout policies (No. w28054).

National Bureau of Economic Research.