Microeconomics Principles and Policy

Question: Discuss about the Microeconomics for Principles and Policy. Answer: Introduction: The farmer is using the word profitable in an accounting sense only, that is, only the realized gain and loss is recognized (Wilkinson 2013). He refers his farm as profitable because the revenues are more than the accounting costs. But in the case of economic profits, where all gains and losses are recognized, be it realized and unrealized, the revenues are less than the economic profits and hence the sentiment is unconvincing if economic profits are referred. The revenue is less than the economic cost because the economic cost includes the cost of the farmers labor, intelligence, the revenue the farm can generate as an asset. Economies of scale can be defined as the cost advantage due to increase in output of a good (Polkinghorn 2016) and it arises because of inverse relation between the quantity that is produced and the per unit foxed costs, that is, greater the quantity produced, lesser the fixed costs per unit (Varian 2014). An industry with strong economies of scale can thus produce at a feasible minimum cost. Motorcar demand is greater than demand for trucks as motorcar is a transport of convenience. In the production of motorcar, the fixed costs constitute a greater proportion of total cost. With increased demand, the production increases and the cost of producing per unit of motorcar decreases. Whereas in the trucking industry, variable costs constitute a greater part of total cost and the demand for trucks is also less than motorcars. Therefore, economies of scale is absent in such a case and thus the motorcar production exhibits strong economies of scale than trucking industry. In the United States, per capita beef consumption has fallen. The beef producers operate in a perfectly competitive market and face a constant cost industry. The short run and long run effects of declining demand for beef for a typical firm and the market has been explained using diagrams. In the perfectly competitive market, firms are the price takers (Mankiw 2014). The market consists of all firms and equilibrium market price occurs at the point where market supply equals market demand. A constant cost industry is one in which the costs of production per unit remains constant irrespective of changes in the increase in demand and production (com 2016). Figure- 1: Short Run (Source: Author) In figure 1, in the short run, the demand curve shifts to its left from D to D1. As a result, the price falls for the industry as well as the firm from P to P1. The firms receive a lower price and run in losses as in the short run any adjustments in the economy are not possible. The loss of the firms can be shown by the rectangle ABP1P. Figure- 2: Long Run (Source: Author) Due to fall in demand and price, the firms running in loss will go out of business and this will decrease the supply. Therefore supply curve shifts to its left from S to S1. This causes increase in price to P2 where the firms earn only normal profits. Food, being a basic necessity, has low price elasticity. The demand for food is inelastic since there is no substitute for food (Hall and Lieberman 2012). It can even be said that the demand is completely inelastic at the minimum level of food that is necessary to survive. Therefore, imposing tax on food enables to raise revenue considerably. Due to inelastic demand, taxing food does not cause much deadweight loss, as shown in figure 1. Therefore, in this sense, taxing food is a good way to raise revenues. Though from the equity point of view, it is not good to impose tax on food as tax burden falls more on the lower income groups who spend larger proportion of their income on food expenditure than the higher income groups. Also, the fraction of income spent on food consumption by high-income groups also decline. Figure 3 (Source: Author) In figure 3, the price after tax imposition on food increases to P2 from P1. The deadweight loss is shown by the triangle ABC, which is very less due to inelasticity demand for food. Price ceiling can be defined as the maximum price set legally at which a seller can sell a good (Baumol 2015). Rent control is one of the ways to make housing more affordable. Many cities regulate the price of housing through rent controls (price ceiling), that is, the rents cannot be increased beyond the ceiling. A price ceiling below the equilibrium price of apartments will cause a shortage of housing in the short run as supply is perfectly inelastic, that is, fixed supply. In the long run, there will be no shortage due to elastic supply. Due to shortages, rationing will take place and the results will be deteriorating quality of apartments, under-table payments to landlords, discrimination between the high and low-income groups and long lists of waiting. Whereas if a subsidy is given so that people can afford the housing, then the resultant effects of a price ceiling will not occur. The wool industry in Hypothetica is highly competitive and the industry is that of constant cost. To increase the income of woolgrowers, the government is considering providing funds for the wool industry to improve marketing and increase demand. The effect of this policy on the typical woolgrower and industry is analyzed for the short run and long run. Figure- 4: Short Run (Source: Author) In the short run, the firms receive a subsidy and this enables the earning of supernormal profit by the typical firm as shown in figure 4. The subsidy shifts the marginal cost curve (MC) rightward to MC1 and the Average total Cost (ATC) curve shifts downward. Due to increase in demand, the profit will increase. Figure- 5: Long Run (Source: Author) In the long run, the subsidy and supernormal profit will attract other producers to enter the firm and the supply will increase till the equilibrium price and quantity Pe and Qe is reached where there will be only normal profits, as shown in the figure 5. References Baumol, W.J. and Blinder, A.S., 2015.Microeconomics: Principles and policy. Cengage Learning. BusinessDictionary.com. (2016). What is constant-cost industry? definition and meaning. [online] Available at: https://www.businessdictionary.com/definition/constant-cost-industry.html [Accessed 30 Sep. 2016]. Economicsonline.co.uk. (2016). Perfect competition. [online] Available at: https://www.economicsonline.co.uk/Business_economics/Perfect_competition.html [Accessed 30 Sep. 2016]. Hall, R.E. and Lieberman, M., 2012.Microeconomics: Principles and applications. Cengage Learning Mankiw, N.G., 2014.Principles of macroeconomics. Cengage Learning. Polkinghorn, A., 2016. Economies of scale.Br J Gen Pract,66(648), pp.351-351. Varian, H.R., 2014.Intermediate Microeconomics: A Modern Approach: Ninth International Student Edition. WW Norton Company. Wilkinson, J. (2013). Accounting Income vs. Economic Income The Strategic CFO. [online] Strategiccfo.com. Available at: https://strategiccfo.com/accounting-income-vs-economic-income/ [Accessed 30 Sep. 2016].