Question 1: 

1. Explain the profit maximisation strategy for perfectly competitive firm. 

A perfectly competitive firm will maximize its profits at a point where its marginal revenue is equal to its marginal cost, that is, MR = MC (Ostroy et al., 2001). 

Marginal revenue is nothing but slope of the revenue curve. In case of perfect competition, the marginal revenue is same as the demand curve and price (Maxurek et al., 2019).

Hence, as long as the price of the product (or MR) is higher than the average total cost of the product, a perfectly competitive firm can keep expanding as it will increase its profits. Its optimal production output will be when the price of the product (or MR) is equal to the average total cost as beyond this output point, the profit will reduce for the firm.

2. A perfectly competitive firm (Top Pizza) is selling pizza in Sydney market whose marginal cost (MC), average variable cost (AVC), and average total cost curves (ATC) are shown in the diagram below, 

                      250                400             Q slices/day

 a. Determine the profit-maximising level of output at a price of $2.50 using the above diagram. 

As discussed above, the price is also MR in case of perfectly competitive firm. Hence, MR is $2.50. The MC curve intersects this level when output Q = 400 slices/day. The profit maximizing level is when MR=MC.

Hence, profit maximizing output is Q = 400 slices/day.

b. At the profit maximising level of output, calculate how much profit will this producer earn if the price of pizza is $2.50 per slice? (2 marks) 

Price/slice = $2.50

Q = 400 slices

ATC_Q:400 = $2.00

Profit/slice = $2.50-$2.00 = $0.50/slice

Total Profit = $0.50*400 = $200/day

Question 2  

Think about the demand for the three popular laptops: ACER, ASUS and DELL. Using supply and demand diagrams, explain the effect on the demand for ACER or the quantity demanded of ACER (other things remaining the same) as a result of the following: 

1. The price of an ACER rises? (1 mark) 

As per law of demand, there is inverse relationship between the price of a commodity and the quantity demanded for the product (Jackson et al., 2007 and Mazurek et al., 2019). Hence, as price of ACER increases, other things remaining the same, quantity demanded of ACER decreases.

In above diagram, let’s say initially, ACER was priced at P3 when quantity demanded will be Q3. Now, price for ACER has increased from P3 to P2 which will lead to decrease in the quantity demanded from Q3 to Q2.

2. The prices of an ASUS and a DELL decrease? (1 mark) 

ASUS & DELL are substitutes for ACER. When the price of substitute good decreases, the consumers will move away from now expensive ACER and start demanding more of cheaper ASUS & DELL. Hence, quantity demanded of ASUS & DELL will increase but demand for ACER will decrease.

3. Programmers who develop operating system for ACER become more costly to hire? (1 mark) 

The more costly hiring for building operating system for ACER will lead to increase in cost of ACER. 

• If this cost is passed on to the consumer, then the price of ACER will increase. As per law of demand, there is inverse relationship between the price of a commodity and the quantity demanded for the product (Stonecash et al., 2009). Hence, as price of ACER increases, other things remaining the same, quantity demanded of ACER decreases.
• If this increase is not passed on to the consumer, the manufacturer will either need to spend more to produce same quantity or it will supply reduced number of laptops now. 
• In Sydney market, demand for ACER is given by the equation P=30−2Q^d and supply of ACER is given by the equation P=6+4Q^s. If Sydney market is in equilibrium, determine the equilibrium price (P) and quantity (Q) of an ACER and show the equilibrium condition in a graph. (3 marks) 

The above diagram shows equilibrium where demand and supply curve intersect such that equilibrium price is p and equilibrium output is q. 

Since the Sydney market is in equilibrium, the demand and supply will intersect to determine equilibrium price and equilibrium output. At this point, D=S. We know that: 

D: P = 30-−2Q^dAnd S: P=6+4Q^s

At equilibrium, D=S and the price (P) and output (Q) will be same or,

30−2Q^d = 6+4Q^s

24 = 6Q

Q = 4

Using P = 30−2Q and Q=4:

P = 30-2(4) = 30-8

P = 22

Hence, equilibrium price is 22 and equilibrium output is 4.

4. From the equilibrium in part d), if price of an ACER decreases to $16, what would be the quantity demanded for ACER, show this using a graph. In this case, calculate the price elasticity of demand for ACER. (3 marks) 

D: P = 30-−2Q^d And S: P=6+4Q^s

Using Demand equation and P=16:

16 = 30−2Q^d

2Q^d = 30-16

Q^d = 14/2

Q^d = 7

The equilibrium price was 22 and equilibrium quantity was 4. Now, price has reduced to 16 leading to increase in quantity demanded to 7. At this point, demand exceeds supply which means there will be shortage. This will drive the prices up till the equilibrium is restored in the market (Frank and Bernanke, 2019).

Elasticity of demand = %change in quantity/%change in price = 0.75/-0.2727 

Elasticity of demand = -2.75

Question 3  

Kim can produce 100 pies or 400 cakes an hour. Liam can produce 150 pies or 300 cakes an hour. 

1. If Kim and Liam spend 30 minutes of each hour producing pies and 30 minutes producing cakes, how many pies and cakes does each of them produce? (2 marks) 

2. Calculate opportunity cost of producing pies and cakes for Kim and Liam. (3 marks) 

3. Determine comparative advantage for each product and decide who should make pies and who should make cakes? Explain why. (3 marks) 

Kim has comparative advantage in making cakes as he makes more cakes (200 cakes in 30 minutes as compared to Liam who makes 150 cakes in 30 minutes) and his opportunity cost of making cakes is lower at 0.25

Liam has comparative advantage in making pies as he makes more pies (75 pies in 30 minutes as compared to Kim who makes 50 pies in 30 minutes) and his opportunity cost of making pies is lower at 2.0

4. If Kim and Liam specialise and trade, what is the highest price of a pie at which Kim and Liam would agree to trade pies and cakes? What are the gains from trade? (3 marks) 

Kim and Liam can produce either of the following:

If Kim and Liam specialise, then according to lower opportunity cost:

If Kim and Liam trade, then:

It can be seen that Kim (blue curve) has a steeper PPC and Liam (green curve) has a flatter PPC. The steeper PPC is better for cakes while flatter PPC is better for pies. To get 1 cake, Kim will give 0.25 pie and Liam will give 0.5 pie. 

So, 200 cakes can be exchanged for 50 pies. The exchange rate is 4 cakes per pie.

If Kim gives 200 cakes, he will have 200 cakes and 50 pies. If Liam gives 50 pies, he will have 200 cakes and 100 pies. The total production is 400 cakes and 150 pies. This is higher than the initial situation when this combination as unachievable as seen in below tables:.