Principal of Microeconomics - Communication Technology - Essay Example

Principal of Microeconomics - Communication Technology Table of Contents Answer to Question 1 1 Answer to Question 2 6 Answer to Question 3 11 References 21 Answer to Question 1 a) In the present case the national administration is torn between its choices for making a new national telecommunications network and the construction of new schools, out of a limited amount of funds. The adjoining diagram shows the shape that the PPF takes in case both goods are being given an equal weight. The vertical axis represents the construction of new schools while the horizontal axis represents the number of new telephone lines being made. S and N are respectively the maximum number of each item which could be made through expending all the available resource. Ideally, the point which is tangent to the isocost line will be the one where the economy must produce. The shape and position of the PPF would be determined by the total available resources for expenditure and the amount that each unit of producing a particular good costs. If one good costs less per unit than the other, then the intercept at the corresponding axis will be at a point higher than that for the other. If the engineers developed communication technology so that per unit of telecommunication line thus made would cost less, there will be more amounts left for expenditure on both items. Hence, the PPF will move vertically upwards (b) (i) The equilibrium condition in the pizza market has been depicted in the adjoining diagram. The equilibrium amount of quantity demanded for pizzas is equal to 81 units and the corresponding price at the point of equilibrium is $ 8 per unit. (ii) In case that the national government fixes a price floor of an amount $ 10 in the pizza market. Then the quantity of pizzas offered by the producers for sale is equal to 110 units. On the other hand, the product actually sold is equal to the amount being demanded by consumers, which is equal to 53 units. Hence, there is a market surplus in this case. If now, the government decides to remove the price regulation, the primary drive towards the point of equilibrium will be the existence of excess supply in the market which compels the producers towards reducing their supply price. As price is lowered, more people will be tempted to buy a particular good (in case it is a normal one) so that ultimately, the point of equilibrium is reached where there is neither a surplus and nor a shortage. (iii) If the final price per unit falls by a flat $ 2 at all levels owing to a fall in the prices of raw materials, the supply curve will be found to shift lower to depict the fact that same quantities are being supplied at lower prices. Hence, the point of equilibrium shifts down as well. Given the same demand schedule, the price is much lower while the quantity is found to be higher in the new equilibrium. Again, if the price of raw materials returns back to its normal state, the supply schedule moves back to its original position as well, so that at the point of new equilibrium, there is an excess demand. To cope up with this excess demand, market price is hiked and the original equilibrium settles in. (iv) If the number of buyers increases by 10%, it automatically pushes the demand schedule upwards, as depicted in the diagram (from D0 to D1). Given a constant supply schedule, the equilibrium point is shoved up from E to F. At the latter point, both market price and quantity demanded at equilibrium is higher than the original amounts. Some possible reasons behind rise in population could be – A shift in demand from a substitute commodity to the present one or a rise in demand of a complementary good. Reduction in child mortality rates or life expectancies. Rise in consumer base owing to demands from foreign markets as well, etc. (c) (i) Milk is the primary raw material for the production of cream cheese. Hence, a fall in the price of milk is likely to push the supply schedule downwards as producers can produce same quantities at lower prices. So, the equilibrium output of cream cheese will rise (from Q0 to Q1) while its price falls (from P0 to P1). (ii) Electricity and solar PV panels are substitutes of each other so that a rise in price of the former automatically increases the demand for the latter. A shift in demand schedule for solar PV panels (from D0 to D1), leads to a rise in the point of equilibrium from E to F. At F, both equilibrium price and quantity of solar PV panels are higher than that at E. (iii) Steel is an important raw material being used in production of cars. A rise in price of steel will increase the cost of production of cars leading the supply schedule to move up. With given demand schedule, D0, equilibrium point shift leftwards from E to F. At F, though quantity is much lower than that at E, the equilibrium price is found to be higher. (iv) Demand for child minding services will rise with a rise in population owing to lower rates of child mortality. However, if number of such organisation stays constant, there is an obvious shift in equilibrium from E to F. At F, both price and quantity are found to have increased significantly from those at E. Answer to Question 2 (a) (i) When the cheese producer is the only seller of cheese in the market it enjoys a monopoly in the cheese market. It faces the entire market demand since it has no other competitor. Therefore an advertisement which can stimulate people towards more cheese consumption will definitely raise the level of market demand and as a result the demand facing the monopoly producer will also rise. Geometrically, the ceteris paribus demand curve for cheese will shift rightward as a result of this campaign. Since this producer has monopoly market power, it will take up even a very high expenditure in terms of advertisement devised for stimulating the demand for cheese. If a very high expenditure on advertisement leads to even a small increase in the market demand, the entire benefit of such increased demand will accrue to this cheese producer and as a result his total revenue will rise sufficiently to cover the high costs of advertisement. (ii) If this producer is only one among many (viz. 100) producers in the market it can hardly enjoy any market power and the market demand curve is shared among all such producers present in the market. Now assuming that cheese produced and marketed by different producers are almost homogeneous, each producer does not have sufficient market power. An advertisement campaign will definitely lead to an increased market demand for cheese; but it will have a little effect on individual demand facing each cheese producer, since the benefits of the advertisement will be shared among all the producers equally. Thus unlike the cheese producer in (i), in this case the cheese producer’s total revenue will rise only by a small amount and it will not be economically viable for this ‘small’ producer to sustain a high expenditure of advertisement, in order to reap such small benefits of increased revenue. (b) (i) The completed table has been depicted underneath. (ii) The AC, AFC, AVC and MC curves according to the table above, have been depicted as follows – (iii) Profit is maximised at the point where the difference between total cost and total revenue is maximum. According to the table in (i), the difference is found to be the highest at 30 units when amount of profit is $400. In addition, diagrammatically, profit could be considered as maximum at the point where the average cost curve is the lowest, which is clearly at level 30. (iv) Even if price per unit is $200, the output level where profit is found to be highest is 30, where the amount of profit is $1950. The fact could be assessed diagrammatically as well as has been depicted underneath. (c) (i) The table has been completed as follows – (ii) According to the diagram depicted below, the monopolist who tries to produce at the point where marginal revenue equals marginal cost. In the present situation, this happens at the point corresponding to output level 2, which is what the monopolist actually produces. (iii) Monopolist produces at the output level where MC and MR equal each other. However, he charges the price that corresponds to the demand curve, AR. In the present situation, however, the producer must charge a negative price which is almost inconceivable. (iv) Misallocation of resources mainly occurs due to the fact that under perfect competition, consumers as much as possible are being served while the same is not true in case of the latter where producer surplus makes up a chink of the total social surplus. Answer to Question 3 (a) (i) Basically, there are four fundamental market structures namely, perfect competition, monopoly, oligopoly and monopolistic competition. They could be distinguished in terms of the integral characteristics which define them. Points of such distinction have been discussed underneath – Number of buyers and Sellers Number of buyers and sellers is found to be the highest in case of perfect competition. A monopoly market structure on the other hand, s characterised by a single seller and a large number of buyers. Oligopolistic market structure is that which contains a few sellers and a large number of buyers. Lastly, in case of monopolistic competition, the number of sellers is larger than in oligopoly but lower than that in perfect competition; moreover, the number of buyers is large as well. Barriers to entry Barriers to entry are found to be the most prevalent in case of monopolists and oligopolists. On the other hand, the sellers who operate in a perfectly competitive market do not enjoy a huge market share which could enable it to enact barriers to entry. Firms which belong to a monopolistically competitive environment, however, have a greater amount of power than the perfectly competitive ones, to implement the same. Homogeneity of product quality Product quality is found to be homogeneous for sellers who operate in a perfectly competitive market. For a monopolist who does not have a rival, only a single variant of any good is produced. Oligopolists distinguish between their products through incorporating subtle changes in the form of substitute ingredients or different brand names. For sellers operating in a monopolistically competitive environment, there exists product differentiation only apparently; these producers attempt to single out their goods from almost perfect substitutes produced by others through focusing upon the brand of the product. Hence, in monopolistic competition, there is no actual product differentiation but only a virtual one. Profit Structure A perfectly competitive firm might or might not earn normal profit in the short run. However, during the long run, the profit is always normal in nature unlike in the case of monopoly where sellers earn super-normal profit irrespective of the duration of time. In oligopolistic firms too, producers are found to earn super-normal profit both during the short and long runs. Lastly, for monopolistic competition, profit though is super-normal during the short run, the producers always come down towards earning normal profit in the long run when their apparent distinction of products become clear (Mankiw, 2008, p. 349). (ii) A monopolist is rarely found to produce at an efficient level. Usually, production is considered to be efficient in nature in case that the producer supplies an amount equal to the market demand. However, in most of the cases, monopolists are found to hold back the potential amount to be produced and hence, artificially soaring up the product price. Such methods of production are rarely considered to be efficient. In fact, it is only in perfectly competitive markets that production is found to be efficient in nature. The difference in the social surplus – sum of consumer and producer surplus – in case of monopoly compared to that in perfect competition is known as deadweight loss. In monopoly, there both exists producer and consumer surplus; rather the proportion of the former is much higher than that of the latter due to an artificial boosting. On the other hand, perfectly competitive markets are found to contain consumer surplus as the only component of social surplus (Taylor & Weerapana, 2007, p. 284). The following diagram depicts deadweight loss to the society in case a product is produced in a monopoly firm rather than a perfectly competitive one. Source: Taylor & Weerapana, 2007, p. 285 At a theoretical level, competition leads to much better outcome than monopoly as far as the society is concerned. In contrast to that in a monopoly, perfectly competitive firms produce higher amounts so that the entire industry potential is utilised. In fact, producers target at hiking the amount of profit through increasing the total supply of the products rather than the price since the latter could be malevolent for their respective firms. Moreover, since no barriers to entry and exit are present, production continues to take place as long as each firm starts earning normal profit. Hence, greater volumes of the concerned product are available in the market in addition to their price being low as well. However, monopolists mark up their price to an artificial level so that many people can no longer afford the same. Hence, these producers aim at maintaining this marked up price through keeping a huge proportion of their potentials unutilised. This is the very reason why monopolists are considered to be of less efficient than perfect competitions at theoretical level. (iii) Natural monopoly arises in situations when a producer is automatically privileged by a low cost environment due to his entry in the market at the earliest stage. In such situations, no rival could match the profits and revenues of the former given that the first mover is always at a position to give its rivals a price competition. In such circumstances, the first mover automatically enjoys the benefits of barriers to entry unlike in the case of a normal monopoly when the producers need to frame ways through which to create barriers to entry of rivals. The commonest of methods being implemented are patent laws on their products or any possible substitutes of the same. (iv) Options available to the government of a nation to curb monopoly practices are – The national government of a nation can decide to intervene into the market directly through accessing the firm’s right to produce the particular good under the wings of the government. Such a step helps to slash down the marked up prices of such goods, thus making the organisation a non-profit making one. India had once assorted to such a policy when scores of monopoly firms had been nationalised. In addition, there are indirect methods like putting a ceiling over the prices to be charged by the producer or specifying the amount which must be produced at the end of a particular period. Through such a way, the national government can put a check upon the activities of monopolists by a large extent (Jain & Ohri, 2010, p. 332). (v) In Australia, the newspaper agency named Australia Post is one that is being run by the national government. It is one of the oldest news services in the nation and enjoys a natural monopoly in the Australian market. It is due to the presence of the particular organisation that many potential newspaper agencies in the nation have failed to establish themselves in the market. Owing to the natural monopoly that they enjoy, the company can provide its customers at a cheaper rate than what is offered by other rivals in the private sector. Hence, the national government is often accused of not being sufficiently encouraging towards the small business houses operating in the particular industry. Here comes the situation of deadweight loss which accounts for a loss in potential producer surplus even though consumer surplus is quite high. However, since consumer surplus is well enough, the national government does not take much initiative in curbing any of its monopoly practices. However, such a strategy seems to be non-protective of other small private houses and hence, it is suggested that the national government must limit the production of newspaper to some extent so that some consumers are forced to purchase them from private agencies. (b) (i) Positive externality is said to exist in a market when social marginal benefits from consuming a good or service, traded in that market, is higher than the private marginal benefit. In such cases the social desirability of consuming a good is very high, because some external benefits are associated with these goods. But private marginal benefit does not include the social benefits derived from these goods and as a result the price of such goods does not reflect the true benefit of consuming them. As a result the market mechanism fails to attain the social welfare maximizing price-output solution. By equating private marginal benefit with the private marginal cost, only the private benefit is maximized, but the maximization of social benefit or social welfare requires equalization of social marginal benefit with the social marginal cost, which is not possible without government intervention in the market operation. In China the market for health services can be considered as a market with sufficient positive externalities or external benefits associated with it. Consumption of health care services is assumed to have external benefits on the following grounds: i) A better health of general population leads to better quality of labour, increased productivity and less absenteeism in work. ii) An improved health also leads to a rise in the standard of living. iii) Improved health also prevents spreading of contagious diseases. Thus in many ways health services provide social benefits which spills over the private marginal benefits of consuming them. We will now illustrate the social and private marginal benefits of health services with the help of the adjoining diagram. Here PMB represents the private marginal benefit and SMB represents the social marginal benefit of health care services. Clearly the SMB is higher than the PMB in case of goods with external benefits and the vertical distance between them shows the marginal external benefits at each level of consumption. There is a competitive market for the health care and that there is no externality in production, i.e. social marginal cost is equal to private marginal cost (SMC = PMC). When individuals take into account their own benefits from the health services, the market ends up at the intersection of PMB and PMC, i.e. at the point C with Qp units of output. But that is not a socially optimum output level of health care services. Social optimum solution is given by the intersection of the SMB and the SMC curves, i.e. by the point B with a higher level of output Qs. Thus from the aspect of social efficiency, consumption of health services is below the optimum level when only the private benefits are taken into account-society as a whole could definitely be made better off by producing and consuming health services upto Qs. Society as a result is deprived of the social welfare equal to the summation of (SMB – PMB) over the entire region from Qp to Qs. This is given by the area of the triangle ABC and this loss of social welfare due to under-consumption of health services is the deadweight loss to the society. Chinese government took a long time before it could actually incorporate changes in the domestic healthcare industry to make up for the long withstanding market failure situation in the same. However, changes became prominent post 1980, when the national government undertook measures which could assist in the privatisation of the industry. During the initial 25 years post health sector reforms in China, the proportion of government expenditure in the industry has remarkably reduced from 36% to 15%. Privatisation is an important aspect which could actually take care of the problem of market failure looming over any industry, even though the objective of private owners is sheer profit-making, which goes against the interests of the needy patients. In these government-funded hospitals, however, 46-58% of the expenses are incurred for drugs, medications and incorporation of modern equipments in the treatment. However, the equipments that the nation contains are not adequate to treat every kind of disease which is why it has initiated the privatisation move. The national government in collaboration with China’s State Food and Drug Administration (SFDA) is busy undertaking measures to turn in foreign investors in the national health sector, primarily because many healthcare units in China are involved in clinical trials which need expensive and up-to-date equipments. Some intricate measures that the national government of China has undertaken to address the presence of positive externalities in the market have been illustrated as follows. In order to strengthen the degree of positive externality in the industry, the national government aims at reconciling and organising the sector, through some measures. The national government has introduced GMP standards to measure the efficiency of different medical units; this initiative has helped to reduce the number of medical units from 5000 to 3700, with each of them ranking high in terms of efficiency of service. The national government has taken initiatives to close the operations of 691 companies due to allegations about the violation of Intellectual Property Rights, brought against them. The national communist government has been taking up initiatives to build up a stronger logistic chain for the distribution of medicine throughout the nation. According to recent statistics only 20% of total available volumes of medicines in the nation are sold in pharmacies, which obviously are detrimental for the needy patients (Yuan, 2007). (ii) The ideal policy of the Chinese government should be to subsidise health services so as to make them available in abundant quantities to its nationals. If the Chinese nationals are able to consume health services up to a level that maximizes the social welfare, then the deadweight loss will be eradicated from the market. It has already been shown that socially desirable level of consumption is much higher than the market determined level for a good or service which has a positive externality. Hence there is need for heavy subsidisation of these goods and services in order to make them cheaper than their market price and helps its countrymen to avail these goods and services easily and in higher quantities. Subsidies provided with such purpose are known as ‘Pigouvian subsidies’ and they are the most popular way of resolving market failure due to positive externalities. The problem with services like health care is that it is very difficult to assign property rights and collect charges from the neighbour who derives benefit from vaccination or immunization of one individual. Moreover such benefits would be spread over a very long time and its valuation would be very much subjective. Therefore the Pigouvian policies are the most effective remedy in such a case. But there are some other devices as well to deal with the market failure arising from positive externalities. All such possible policies are discussed one by another below: Firstly, the government can use tax payers’ money to supply the basic health facilities at free of cost. The health services in such case would be given the status of a public good which should be made available to the entire population. Although such policy will necessarily make them available for free to the consumers, but this will involve a huge opportunity cost and thus impose constraint on the public budget. Moreover for maximizing social welfare it may not be required to distribute such ‘costly’ services entirely for free to the individuals-in that case a very nominal charge may be levied by the local government. Secondly, the producers of such health services may be offered a certain amount of money in order to make the health facilities available at relatively cheaper rate, but in this case too, the exact amount of subsidy is not easy to determine and there is risk of fiscal profligacy. Thirdly, the government can directly or indirectly encourage its people to buy and consume more merit goods. It can issue health cards for each individual and it will be mandatory for them to go through regular health check ups for a very nominal price. This can be made compulsory for the people through legislation. Again this policy can be proved to be very costly for the government and may not be as effective as it seems to be. Finally, the instrument of the ‘Pigouvian subsidies’ can be used more efficiently and more widely. The horizontal base of subsidy should be sufficiently wide so as to include maximum population under its purview. Public sector investment should be increased in this sector and the grass root level of government should be made more active to supervise the proper implementation of the public policies, devised to attain the maximum social welfare. The government should also follow economic planning in this regard in order to reap the maximum benefit from its policy formulation. References Jain, T. R. & Ohri, V. K. (2010). Principal of Microeconomics. New Delhi, India: VK Publications. Mankiw, N. G. (2008). Microeconomics. New York: Cengage Learning. Taylor, J. B. & Weerapana, A. (2009). Principles of Microeconomics (6th ed.). USA: Houghton Mifflin. Yuan, R. (July 15, 2007). “China Cultivates Its Healthcare Industry: The Risks and Opportunities in a Society Undergoing Explosive Change”. GEN News, Vol. 27 (12). Available at http://www.genengnews.com/gen-articles/china-cultivates-its-healthcare-industry/2165/. Read More