Questions and answers Business Economics PDF

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ANSWERS TO SELECTED END-OF-CHAPTER PROBLEMS FROM

BUSINESS EC O NO M IC S: THEO RY A ND PTA C TIC E, 6 th Ed .

PART I: MICROECONOMICS By

Kenneth Matziorinis, Ph.D.

2012

Canbek Publications

1.1

a) A good is a tangible product, i.e. you can touch it, lift it, store it and transport it. A service is an intangible product. You can do none of the above A final product is a finished product that is ready to be put into the use for which it was intended. All products purchased by consumers for personal use are final as are all the capitalized machinery and equipment and the construction of buildings, whether they are for residential, industrial, commercial or institutional use. An intermediate product is a semi-processed or semi-finished product that is produced by one producer and sold to another producer to be used as an input in making a third product. b)

Type of Resources and Forms of Remuneration

Human Resources

Natural Resources

Artificial or Man-made Resources

Labour

Wages & Salaries

Entrepreneurship

Profits (dividends)

Land (indestructible)

Rent

Raw material (nonrenewable)

Royalties

Raw materials (renewable)

Royalties

Financial capital (money)

Interest

Physical or real capital (machinery & equipment; buildings & structures)

Royalties and Profits

Human Capital (intellectual property: copyrights, patents & trademarks)

Salaries, Royalties and Profits

c)

Production is the transformation of resources into products with the help of technology. Consumption is the transformation of final products into consumer wellbeing (consumer satisfaction, or need satisfaction or utility) with the help of technology (know how or “savoir faire” or “savoir vivre” .

d)

Saving is the income that we choose not to spend or consume. Investment is the portion of our production that is not used for current consumption but to help us undertake more and better future production, therefore helps increase future consumption.

e)

Physiological needs are the needs of our body, what our body needs to survive individually or collectively, such as air, water, food, clothing, shelter and sexual reproduction. Physiological needs are part of our DNA and are transmitted genetically from one generation to the next. Psychological needs are the needs of our mind, our psyche and emotions. To live well we don’t only need to survive physically, but emotionally as well. They are the need for security, acceptance, affection, love, stimulation, joy, respect, control, achievement, justice and self-actualization. Psychological needs are learned needs, i.e. learned through exposure to our environment, or through conditioning. When we experience something good we want to experience it again, and once we begin to rely on good things we strive to maintain them.

f)

Hierarchy of needs is the term that Abraham Maslow used to describe the relationship between physiological and psychological needs as well as the inter-relationships among the psychological needs themselves. If the individual or a society are having difficulty assuring their physiological needs such as water or food, the mind is fixated on the satisfaction of the need that is most threatening to its survival and suppresses all other needs. “A hungry bear cannot dance”.

g)

Productivity is economic efficiency, i.e. the efficiency of the production process, which is the ratio of output divided by input. The more goods we produce with the same resources, the more goods are available to share among those that produced them and the community at large. Productivity is the result of working smarter, not harder. Increasing our productivity is a positive-sumgame, i.e. a win-win activity, because all stakeholders in society benefit from the rise in productivity. Workers get to be paid more, shareholders earn more, consumers pay less and/or get better products and the government gets more tax revenue to do its work.

h)

Income inequality refers to the distribution of income earned annually by households (a flow variable) whereas wealth inequality

refers to the distribution of wealth, i.e. assets accumulated over the years by households i)

1.2

Personal income is our income from all sources (earned and unearned such as transfer payments from government). Personal disposable income is our personal income that is left after the payment of income (including payroll) taxes, therefore what is left and available to us to spend or to save.

a) Economic activity stems from our physiological and psychological needs. We need to consume a range of goods and services in order to satisfy our needs, but to consumer we first need to produce the goods and services that we consume. There can be no consumption without production. Once you get started in the business of consuming and producing, then you need to carry out all other essential support activities such as exchange, trade, saving, investing, financing and government activities. If you examine all the type of industries in the economy you will realize that each of them corresponds to one or a combination of needs. b) Economics can be defined as the study of how human societies go about producing, consuming, trading, saving and investing, among others, for the satisfaction of human needs. Economics is a behavioural social science.

1.3

a) The three reasons people save are three (3): liquidity, precaution and investment income. 1) liquidity - to build cash balances (capital) for planned future expenditures such as buying a car, a house, children’s education and retirement income; in this sense saving is postponed future consumption; 2) precaution - to build a buffer of protection against unforeseen, unexpected and adverse events such as illness, loss of work, accidents and natural disasters as well as the means to take advantage of opportunities when they arise. Saving provides a blanket of security and gives people a sense of financial security and confidence; 3) investment income – people gradually realize that accumulating capital provides a source of future investment income in the form of interest, dividends, capital gains and rental income. A society, (households, business and government) needs to save at least 20% of its annual income in order to be in a position to finance investment activity. A society needs to invest every year in order to maintain and replace aging infrastructures such as roads and buildings and to build new and better ones to serve its needs in the future. The societal cost of not investing in its future is a reduction in its standard of living, a gradual but persistent drop in average and median income per capita and an increase in poverty. Investing in structures, machinery and equipment by the private and public sector is not a luxury but a necessity. b) The main reason why some earn more than others is possession of capital, either financial capital, physical capital (property) or human capital and

entrepreneurial drive. For those who do not inherit wealth, the accumulation of human capital (education and skill acquisition) and entrepreneurship are the only legitimate avenues toward financial security and wealth. Society accepts that those who contribute more should earn more. If the degree of income inequality is accentuated or if the means of acquisition come to be perceived as illegitimate, then either the economic system collapses or people revolt or both. See pp. 19-20. 10% of people own 60% of wealth while 1% own 36% of wealth. 1.4

a)

Road Repairs

Y0

.Y

Y1

.

.

X

U

Xo

X1

City Cleanup

The production possibilities boundary (PPB) shows the maximum amount of two products that can be produced by a society when making full use of all the available resources and technology. In the above example, the PPB shows the various combinations of two municipal services that can be produced by a city government based on the city’s resources. It can pave and repair roads, do city clean up or various combinations of the two while still making full use of the city’s resources. b) The opportunity cost of moving from X to Y is: X1 – X0 ; from Y to X: Y1 – Y0; from U to Y: no opportunity cost; from X to U: X0 – X1. c)

i)

ii)

iii)

iv)

v)

vi)

•

1.5

a) b) c) d) e)

The opportunity cost is his hourly fee, i.e. $120.00 per hour The opportunity cost is his hourly fee, i.e. $120.00 per hour He can save 20 hours x $10 = $200 for cleaning and 20 hours x $20 = $400 for painting, in total he can save $600 He benefits by not having to pay $600 but he loses by losing 40 hours of billable time, i.e. 40 hours x $120 = $4,800 Hire someone else to do the painting and he stick to his work as a lawyer.

1.6

See charts in textbook, pp. 36 & 39

1.7

You are given the following equations for the demand and supply: P = 10 - 0.1 Q P = 0.1 Q a) See diagram below b) The slope of the demand curve (ΔP / ΔQ ) is : - 0.1 The slope of the supply curve (ΔP / ΔQ ) is: + 0.1 c) The equilibrium price is P = $5 and the equilibrium quantity is Q = 50 units d) To find the equilibrium price and quantity algebraically, solve for Supply = Demand to find the equilibrium quantity: 0.1 Q 0.2 Q Q Q

= 10 - 0.1 Q = 10 = 10 / 0.2 = 50 units

Then, insert the answer to the demand equation to find the price : P = 10 - 0.1 (50) P = 10 - 5 P = $5 per unit e) What happens if the demand changes to P = 12 - 0.1 Q? Do the same as d) above but using the new demand equation: 0.1 Q 0.2 Q Q Q

= 12 - 0.1 Q = 12 = 12 / 0.2 = 60 units

Then, insert the answer to the demand equation to find the price : P = 12 - 0.1 (60) P = 12 - 6 P = $6 per unit The slope of the new demand curve remained the same at -0.1

f) Now, if the supply changes as well to P = 2 + 0.1 Q, do the same: 2 + 0.1 Q = 12 - 0.1 Q 0.2 Q = 12 - 2 0.2 Q = 10 Q = 10 / 0.2 Q = 50 units Then, insert the answer to the demand equation to find the price : P = 12 - 0.1 (50) P = 12 - 5 P = $7 per unit

P

$12 D’

S”

D

S

$10

$7 $6 $5

$2 D

D’

0

Q 50

60

100

120

Diagnostic & Review Math Exercises 1.

Y=5+2X

The slope or coefficient is: 2

Y = 0.5 X + 5 The slope or coefficient is: 0.5 2.

The constant or y-intercept is: 5 The constant or y-intercept is: 5

Q = 20 -1 P a) The dependent variable is the one to the left of the equation: Q b) The independent variable is the one to the right of the equation: P c) The slope is -1; The constant is 20 d) This equation denotes an inversely proportional relationship, because the sign in front of the coefficient is negative. It means that as the price (P) increases, the quantity demanded (Q) decreases, and vice versa e) There are two types of relationships, directly proportional or direct relationships where as the value of the independent variable increases, the value of the dependent variable increases as well. In an inversely proportional or indirect relationship, as the value of the independent variable increases, the value of the dependent variable decreases, and vice versa. Directly proportional relationships are often referred to as positive relationships, because the sign in front of the slope is always positive. Inversely proportional relationships are known as negative relationships because the sign is always negative. Y

Y

Y

X Directly Proportional 4.

a)

dy/dx = 65

b)

dy/dx = 15 X2 – 6 X + 4

c)

dy/dx = 40 X - 5

X Inversely Proportional

X No relationship

2.1

a)

The determinants of the demand for a product are:

f

DD

=

( T&P, I, Ps, Pc, N, E, O )

T&P

=

The tastes and preferences of the individual consumers;

I

=

Ps

=

The buying power of consumers as measured by their personal disposable income The price of other products which serve as substitutes to the product in question, i.e. competing goods;

Pc

=

The price of other products which serve as complements to the product in question, i.e. they are consumed together;

N

=

The number of individual buyers in the market (individuals, families, households or the population at large);

E

=

The expectations of the buyers with respect to the future price (P) of the product, their future ability to buy (I), the future prices of substitutes and complements, and more generally, the state of consumer confidence;

O

=

Other factors; these can range from the weather, seasonal factors, consumption taxes such as excise and sales taxes, advertising expenditures and others.

b)

What is the law of demand? The law of demand is the inversely proportional relationship between the price of the product (P) and the quantity demanded (Qd) of the product, all other variables remaining constant.

c)

Which variables cause a “change in demand” ( a shift in the demand curve) as opposed to a “change in the quantity demanded” ( a movement along the demand curve) ? When any variable such as T&P, I, Ps, Pc, N, E, O change, there is a change in demand, i.e. the demand curve shifts to the right or to the left. The only time there is a change in the quantity demanded is when the price (P) changes. When the price changes there is an adjustment in the quantity demanded, i.e. a movement up or down along the same demand curve.

d)

The determinants of the supply of a product are:

SS

=

f ( Tech.,Goals, Pr, Po, N, E, O)

Tech. =

Production Technology (Production Function); it refers to the technical ability to turn inputs into outputs (output-input specificity) and the rate of utilization these inputs;

Goals =

The goals of the producers as conditioned by the structure of the industry which they occupy; these goals vary from short-term profit maximization to sales revenue maximization, market share protection, among others;

Pr

=

The prices paid by producers for resource inputs, e.g. wage and salary rates; raw material and energy prices; land, building and machinery prices; interest rate and profit rates;

Po

=

The selling price of other products that can be produced using the same technology and resource inputs e.g. growing corn vs wheat using the same land and farm implements;

N

=

The number of individual producers occupying the industry;

E

=

The expectations of the producers with respect to future prices of their product, resource prices or other factors

O

=

e)

What is the law of supply?

Other factors; these can range from the weather, seasonal factors, taxes such as income and sales taxes, government subsidies, strikes and institutional constraints such as health and safety regulations, food and drug regulations, environmental protection laws, etc.;

The law of supply is the directly proportional relationship between the price (P) of a product and the quantity supplied (Qs) of that product, all other variables remaining constant. f)

Which variables cause a “change in supply” ( a shift in the supply curve) as opposed to a “change in the quantity supplied” ( a movement along the supply curve) ? When any variable such as production technology, goals, Pr, Po, N, E, O change, there is a change in supply, i.e. the supply curve shifts to the right or to the left.

The only time there is a change in the quantity supplied is when the price (P) changes. When the price changes there is an adjustment in the quantity supplied, i.e. a movement up or down along the same supply curve. g)

Examples of complements: wine and cheese automobiles and gasoline computers and printers locks and keys house and mortgage loan Examples of substitutes: wine or beer mashed potatoes or french fries buy or lease pants or skirt corn oil or olive oil

h)

What is the significance of equilibrium price (Pe) and equilibrium quantity exchanged (Qe) ? Equilibrium is the Latin word for balance, balance between two opposing forces Equilibrium price (Pe) is the price which equates the quantity demanded with the quantity supplied ( Qd = Qs ) and leaves neither a surplus nor a shortage of the product on the market. When the price is in equilibrium, there is no more pressure for the price to rise or fall, so it tends to stay at the same level Equilibrium quantity (Qe) is the quantity which equates the demand price with the supply price ( Pd = Ps ) and leaves neither a surplus nor a shortage of the product on the market. When the quantity exchanged is in equilibrium, there is no more pressure for the quantity demanded or supplied to rise or fall, so it tends to stay at the same level.

i)

What is the role of the price mechanism in a market economy? When there is an imbalance between the demand and supply of a product (excess demand or excess supply) it results in shortages or surpluses, which in turn place up-ward or down-ward pressure on the market price. The resulting change in the price of the product communicates to the market participants that there is a shortage or abundance of the product

on the market. Based on this information, market participants adjust their consumption and production decisions. For example, when the price is rising, the market is telling consumers that the product is scarce and that they should consume less of it while the same message tells the producers that they should supply more. The combined effect of reducing consumption and increasing production then results in the elimination of the shortage and the price stops rising. When the price is falling, the market is telling consumers that the product is plentiful and that they may consume more of it while the same message tells the producers that they should supply less. The combined effect of increasing consumption and decreasing production then results in the elimination of the surplus and the price stops falling. In other words the price mechanism, the constant upward or downward adjustment in prices through time plays the same role as traffic lights do in regulating car traffic in the city. When the light is green you go, when it is red you stop. In so doing the market helps in the allocation of resources and products in the economy. It helps determine a) which products are produced; b) in what quantity they are produced; c) how they are produced and d) for whom they are produced. Have you ever wondered how producers know what to produce and how much to produce? What is the glue that keeps markets together? What is the mechanism that coordinates the production and consumption decisions of millions of participants? The answer is the price mechanism of the market. Adam Smith, the father of Economics, in his famous book the Wealth of Nations used the phr...