Microeconomics (short questions) Part A – Microeconomics: Question 1: Suppose that oil prices rise sharply for years as a result of a war in the Middle East. Illustrate with a diagram what happens to...

Microeconomics (short questions)
Part A – Microeconomics:
Question 1:
Suppose that oil prices rise sharply for years as a result of a war in the Middle East. Illustrate with a
diagram what happens to the: (1 mark each)
Demand for automobiles?
Answer 1)
Oil is used to run automobiles.Hence , it is a complementary good for automobile.
So if the price of oil rises, cost of running automobile increases.Hence effectively real running price
of automobile rises.Hence Demand of Automobile will fall.
Demand for home insulation?
Answer )
Home insulation. It doesn’t use oil. Hence demand for it will not change.
D” D
D=D”
Demand for coal?
Coal and oil are substitutes .So if the price of oil rises, demand for coal will rise keeping other factors
constant.
Coal quantity
Demand for tyres?
Since we saw demand for automobiles will fall, hence demand for tyres will fall when the price of oil
ises.
Tyres
Demand for bicycles?
Since bicycle is a substitute to automobiles.Demand for bicycle will rise since, demand for
automobile will fall.
bicycle
D D” Price coal
D” D
D D” Price
Explain the impact of external costs and external benefits on resource allocation; (2.5 marks)
Answer)
External cost is a negative externality. It is the cost that falls on people other than those who pursue
the activity.
External benefit is opposite of external cost, it is a positive externality. It is the benefit of an activity
eceived by people other than those who pursue the activity.
When an activity does not create an externality, the optimal level of the activity for the individual
will equal the socially optimal level of the activity.
When an activity generates a negative externality, the level of the activity will be greater than the
socially optimal level.
When an activity generates a positive externality, the level of the activity will be less than the
socially optimal level.
Q)Why are public goods not produced in sufficient quantities by private markets? (2.5 marks)
Public goods are over utilized. It has positive externality.
Public goods are goods that cannot be produced efficiently in markets.
1. Non rival in consumption
a. One person’s consumption doesn’t reduce another person’s consumption
. Marginal cost of providing the service to another person is zero or nearly so
2. Non excludable
a. Once produced, you can’t prevent consumption of the good by anyone
Since social marginal benefit is much higher than private marginal benefit of a public good,
Social equili
ium will always say product more quantity than the private equili
ium because the
purpose of the private market is profit maximization and not social welfare maximization.
Question 2:
Explain why scarcity forces individuals and society to incur opportunity costs. Give specific examples.
(2.5 marks for explanation and diagram plus 2.5 marks for specific examples)
All factors are scare in the economy. For production factors of production are required.
The absolute value of the slope of any production possibilities curve equals the opportunity cost of
an additional unit of the good on the horizontal axis. It is the amount of the good on the vertical axis
that must be given up in order to free up the resources required to produce one more unit of the
good on the horizontal axis.
Slope is the opportunity cost.
Q)
Suppose a chocolate bar manufacturer promotes its products by advertising and opportunity to win
a ‘free car’. Is this car free because the winner pays zero for it? (2.5 marks)
A)No it is not a free car.
If the chocolate bar manufacturer promotes its product by advertising, it implies that the demand
for that chocolate will go up. Since the demand will go up hugely because of advertisement. People
will demand more because they will feel they have a chance to win a free car. So their profits will
ise by a very high amount since quantity demanded rises. So many people who paid for the
chocolate didn’t win. Only one wins.So its actually not a free car.
Why is the production possibility frontier bowed outwards? (2.5 marks)
Answer)
The production possibility frontier is bowed out or concave with respect to the origin. It implies that
increasing amounts of one good (tractors) must be sacrificed in order to obtain equal successive
increases in the other good (food). An alternative way of describing this is to say that equal
eductions in tractor production will result in...