BAEC1203 Application of Microeconomics Principle in Given Questions Assessment Answer

Q1(a)

Money available to Ali that is 300OMR, is a scarce resource in the example. He can make a choice by weighing pros and cons of either choice. Choice must be made between the alternative uses according to the priorities and what is more needed. Whatever is needed more and is high on priority, Ali must buy that product with limited 300OMR.

Q1(b)

1. Microeconomics Decisions: The word ‘micro’ has been originated from Greek word ‘MIKROS’ which means small.  Thus in microeconomics, the unit of study is an individual, firm, or household. 
2. Macroeconomics Decisions: The word ‘macro’ has been originated from Greek word ‘MAKROS’ which means large. Thus, Macroeconomics can be defined as that branch of economic analysis which studies the behavior of not one particular unit, but of all the units combined together. Macroeconomics is a study of aggregates.
3. For company’s benefit, a manager will decide:
   1. What to produce, 
   2. How to produce, 
   3. For whom to produce
   4. What price to charge.

Q2(a)

Economic System refers to the mode of production and the distribution of goods and services within which economic activity takes place. For example, capitalist, socialist, mixed economy etc. Each system has advantages and disadvantages. 

Q2(b)

In a capitalist economy factors of production are privately owned by the institutions and citizens. There is no interference by the government. It’s a free economy.  There is a freedom of choice for consumers, business and resource suppliers. Consumers may purchase whatever they want depends on their income. Businesses are free to purchase and utilize resources to produce whatever they want to produce and sell in to the market. 

The main motive behind the working of the capitalist system is to get profit. The decisions of businessmen, farmers, producers are based on profit which influences all economic activities.

In such a system, entrepreneurs feel free to take risks and introduce more technological innovations that quickly cause structural changes and high rates of economic growth and labor productivity. Hence, it will have maximum focus on creativity and innovation.

An example of a capitalist economy is United States which has a free economy with negligible interference from the government. However, in such an economy:

• It creates economic inequality among people of the society because some individuals concentrate all the resources in their control. Thus rich becomes richer and poor becomes poorer. 
• Some individuals who have more power can construct rules that limit diversity and competition.

 Q3(a)

The change is decrease in demand. Factors that affect quantity demanded are:

1. Taste and Preference of consumer: For example, if the consumer starts preferring Brand B now instead of Brand A earlier, the demand for Brand A will decrease.
2. Income of the People: Income directly translates to purchasing power and hence, lower income indicates lower demand and vice versa. For example, Lily was buying 2kg beef per week when her income was $1000 but now she buys 3Kg beef per week because she has been promoted and her income is now $1500.
3. Price of Substitutes: If price of substitute reduces, the consumer will choose that product instead and this will lead to decrease in demand for subject product. For example, Brand A and Brand B cookies sell for $5/packet and these are perfect substitutes. Brand A reduces price to $3/packet. The consumers of Brand B will also switch to cheaper substitute Brand A. This will cause decrease in demand of Brand B.
4. Change in Price: As per law of demand, higher price means lower demand and vice versa. For example, Abe was buying 2kg rice per week when price was $10/kg but now price has increased to $15/kg which led to decrease in quantity demanded to 1kg/week.

Q3(b)

The change is decrease in supply. Factors that affect quantity supplied are:

1. Change in Price: As per law of supply, higher price means higher supply and vice versa. For example, the price of rice has increased from $10/kg to $15/kg which will lead to increase in supply of rice.
2. Price of Other Goods: If price of other goods increase, the supplier may switch resources to that good instead of current good being supplied. For example, a farmer is producing wheat which is supplied at $5/kg. But the price of rice has increased from $10/kg to $15/kg. This may cause the farmer to produce and supply rice instead of wheat.
3. Cost of Factors of Production: Producing a good requires many resources, such as, labour, raw material etc. If their cost increases, it becomes expensive and less profitable for the supplier. This may lead to reduced supply of that product. Correspondingly, if cost of production declines, it may increase the supply of the good.
4. Taxes: If the government increases taxes on the good produced, the cost increases leading to reduced profitability. This may cause the supply to reduce.

Q3(c)

Due to COVID situation, there is an emergency and medical supplies have become a necessity. Hence, this is an exception to law of demand where:

• Necessity goods: In the case of necessity goods, the law of demand fails. This is because even the price of these goods increases, the people have to demand them. For example, due to COVID, even if the price of medical supplies rises, the people have to buy to use.
• Emergency: In the case of emergency, the people buy more even if the price is high due to the fear that whether goods will be available for next second or not. This is true in today’s situation where contactless thermometers, masks, sanitizers, ventilators etc. are required. The prices have shot up but still demand is there due to emergency and fear.

Q4(a)

An example of a price floor is the minimum wage. Minimum wage laws indicate the lowest wage a firm can legally pay to an employee. In the given case, the government of the sultanate of Oman stipulates that the minimum wage payable to an Omani should be R.O. 400. 

It is also given that this wage level is fixed as per the situations of demand and supply. Hence, it will not result in unemployment as the minimum wage is equal to equilibrium level of wage as determined by forces of demand and supply.

Q4(b)

If in the given case, the government of the sultanate of Oman stipulates that the minimum wage payable to an Omani should be R.O. 450, the minimum wage will be above the equilibrium level of wage as determined by forces of demand and supply. 

Hence, this will lead to labour surplus and unemployment as shown in following graph:

How the minimum wage affects the labour market is shown in Panel a.  and Panel b. below. Panel a shows a labour market in which the wage adjusts to balance labour supply and demand. The equilibrium wage is Owe. Panel b. shows the impact of a binding minimum wage. 

If the minimum wage is above the equilibrium level, the quantity of labour supplied exceeds (125) the quantity of labour demanded (75). The result is unemployment.(50)

Q5(a)

As seen price elasticity is calculated as %change in quantity demanded/ %change in price and comes to -0.625

Q5(b)

The price elasticity of demand is almost always negative due to law of demand. The value of coefficient, that is, 0.625 is less than 1 indicating that the demand for oranges is relatively inelastic as the change in price leads to less than proportionate change in quantity demanded.

Q5(c)

The demand is relatively inelastic with negative price elasticity of demand. Hence, the demand curve  will be a steep downward sloping curve