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BUS302 – Microeconomics – Midterm Review

Scarcity:

What do economists mean when they discuss “scarcity”? (10/100)

Scarcity is a basic economic problem that indicates the gap between limited resources and wants and needs that are theoretically limitless. Scarcity may be in terms of any natural resources or any scarce commodity. This situation calls for the efficient and judicious allocation of resources to meet the needs of society (Davies, 2019). Free natural resources can also be scarce resources as a result of the incremental costs of obtaining and consuming them.

Scarcity is caused by two phenomena; demand-induced scarcity and supply-induced scarcity, and a combination of the two. Demand-induced scarcity results due to the tendency of the demand for a particular resource or product is far more than the supply that can be provided by the economy whereas supply-induced scarcity results when environmental degradation or other unforeseen factors cause the supply of a resource or commodity to greatly decline even though the demand remains in within normal limits.

Scarcity is important as it makes people reach informed decisions about how available resources are allocated (Davies, 2019). In business, it helps ensure continued profitability when for instance manufacturers facing scarcity of a product or resource make adjustments like switching to alternatives to ensure continued sales and revenue generation. It also provides for the needs of consumers where firms that want to continue providing their customers with goods make necessary adjustments to meet customer demand.

Scarcity forces society to confront three critical issues. List those issues and explain how they are related to the problem of scarcity.   (10/100)

Society faces three critical issues as a result of scarcity. These are what to produce, how to produce, and for whom to produce. The problem of what to produce arises because there are limitless wants and needs that have to be met while there are limited resources to produce enough commodities or services to satisfy them. It is therefore not possible to produce adequate quantities of goods/services to meet everyone’s needs and wants. What is produced by the economy is only that which is in high demand by consumers, but even so not in enough quantities to satisfy everyone. Society must therefore decide what is the best combination of products to produce to satisfy its varying needs and wants and what amounts of different resources should be allocated to these products (Mateer & Coppock, 2018).

The second critical problem posed by scarcity is how to produce. This is the problem of what means to be used to produce a commodity or a good. Society is therefore required to decide the best combination of factors to produce the desired quantities of commodities. For instance, society may decide to take action to increase economic growth by increasing production ability for example through better technology. Scarcity, therefore, forces society to evaluate precisely how much of the factors of production should be used to produce consumer goods (Mateer & Coppock, 2018).

Thirdly, scarcity causes the problem of for whom to produce, also called the problem of distribution. Society has different groups of people each with varying needs and wants (Mateer & Coppock, 2018). It has to therefore decide the persons who will benefit from the output from the society’s economic activities and what amount each will receive.

Markets and prices

What are the roles of markets and prices in an economy?  (15/100)

Markets play a significant role in the economy. They facilitate trade and enable the distribution and allocation of resources in society. They also allow any tradable products to be evaluated and priced. Markets have been found to be effective and efficient mechanisms for the coordination of the allocation decisions of economic factors (Mateer & Coppock, 2018). They bring economic factors together and by the interaction of buying and selling of products, coordination of allocation decisions results.

Prices have an important role to play in the economy. They are the most important determinant factors in the distribution of goods and resources in the economy which is a major function. Besides, prices serve as; the medium of communication between buyers and sellers, a signal of economic conditions, and an incentive for producers. As an incentive, prices provide a standard measure of value in the market. They provide ground for adjustments by producers and consumers and also inform buyers and sellers whether goods are readily available or are in short supply (Mateer & Coppock, 2018). With its flexibility and free nature, prices allow for a wide array of goods and services to be available in the market.

Price as a signal tells producers whether a product is in demand and hence the need for more production or vice versa and indicates to producers when the supply of a product is excess or whether they should be more careful with their purchase decisions.

Flexibility in prices implies that they can be increased to solve problems of short supply or decreased to solve the problem of surplus.

What is the law of demand and how do we illustrate it? (15/100)

The law of demand states that the quantity of a good demanded and its price are inversely proportional assuming that all other factors remain constant. This implies that when the price of a good increases, its quantity demanded decreases. The law of demand is illustrated with a demand curve which is drawn to show the correlation between the price of a good and the quantity demanded of the same good. The curve varies depending on the type of goods. In most cases, however, the demand curve is concave in shape (Heakal, 2015). The curve is drawn versus the quantity demanded on the x-axis and the price on the y-axis. The curve slopes in a downward direction.

The law of demand does not apply to all types of goods. It comes with a few exceptions where there is no indirect correlation between the price and the quantity demanded. In these exceptions, the demand curve is upward sloping. Goods that are exempted from the law of demand include Giffen goods, which are inferior goods without close substitutes and consume a significant amount of the consumer’s income, and Veblen goods which are certain types of luxury goods that reveal the social and economic status of the owner (Heakal, 2015). Consumers of Veblen goods will tend to consume them even when their prices increase.

What is the law of supply and how do we illustrate it? (10/100)

The law of supply expresses the correlation between the quantity supplied of a given commodity and its price. The law states that as the price of a commodity increases, the quantity supplied of the good will increase and vice versa assuming that all other factors remain constant. This occurs due to shifts in the producers’ behavior for changes in prices. It thus indicates that there is a positive correlation between the quantity of a given commodity that is supplied and the price. It defines the direction in which quantity supplied changes with a change in price (Heakal, 2015). The law of supply is illustrated using a supply curve.

The supply curve is a graph showing the correlation between quantity supplied and price for a given period. Typically, the graph shows the price on the vertical axis while the quantity supplied appears on the horizontal axis. This curve will usually shift upward from left to right expressing the law of supply (Heakal, 2015). This implies that quantity is a dependent variable while the price is an independent variable. A movement of the curve to the right reflects an increase in the quantity supplied while a shift to the left corresponds to a decrease in the quantity of product supplied.

Explain what would happen to the equilibrium price and quantity of oranges if the supply of oranges increased while the demand for oranges decreased. (10/100)

A change in demand and supply towards different directions implies that the corresponding change in the equilibrium price can be established. However, it is not possible to accurately determine the equilibrium quantity (Karl et al., 2019). When demand and supply of oranges change, equilibrium quantity and price also change. In this case, with the increase in the supply of oranges and a decline in the quantity demanded, the result is that there will be a fall in equilibrium price. However, the impact of this shift on equilibrium quantity cannot be established precisely. It means that for any amount of oranges, the consumer will place a lower value on the commodity while the producer will likely take a lower price and hence the price will eventually drop. The impact on the output quantity of oranges will be based on the relative size of the two changes (Karl et al., 2019)

The equilibrium quantity will rise since there will be an increase in the amount of oranges being brought to the market. Due to the decrease in the quantity demanded of oranges, there will be a surplus in the market. This will therefore result in a decline in equilibrium price.

7. Suppose that the quantity demanded and quantity supplied in the market for milk is as follows:

Price per Gallon	Quantity Demanded	Quantity  Supplied
$5	1,000	5,000
$4	2,000	4,500
$3	3,500	3,500
$2	4,100	2,000
$1	6,000	1,000

1. What are the equilibrium price and quantity of milk?

At the equilibrium price, the quantity demanded of a good is equivalent to the quantity supplied. In this case, this will occur when the price of milk is $3. This is when both the quantity demanded of milk and the quantity supplied is 3500 gallons for each. The equilibrium price is, therefore, 3$ and the equilibrium quantity is 3500.

If the government places a price ceiling of $2 on milk, will there be a shortage or surplus of milk? How large will it be? How many gallons of milk will be sold? (20/100)

By imposing a price ceiling of $2 on the milk, there will be a shortage of milk. The total shortage will be 2000 gallons because, at the price of 2 dollars, milk suppliers will only be willing to supply 2000 gallons which is against the actual consumer demand of 4000 gallons at the 2-dollar price. It calls for the determination of the deadweight loss, which is calculated using the formula;

Deadweight loss= ½*(P2-P1) * (Q1-Q2), where P1 ($3) and Q1 (3000) represent the price and quantity demanded before the imposition of the price ceiling while P1 ($3) and Q2 (2000) represent the new price and quantity demanded after the price ceiling has been imposed. Therefore, the deadweight loss will be 1/2*($2-$3) * (3000-2000) = $500. The cost that society will have to pay for the inefficiency created by the price ceiling is, therefore, $500.

 If the percentage change in quantity demanded is greater than the percentage change in price, can you determine if the demand is elastic, unit elastic, or inelastic? Explain your answer. (20/100)

If the percentage change in quantity demanded is greater than the percentage change in price, demand is deemed to be very responsive to price changes or otherwise price elastic. In calculating the price elasticity of demand, the percentage change in the quantity of a good demanded is divided by the percentage change in the good’s price (Klingensmith, 2019). In the event that the price elasticity of demand is greater than one, then the demand is very price-sensitive, i.e. elastic.

Under unit elastic demand, any change in the price of a good will lead to an equally proportional change in the quantity demanded of the commodity. This means that the percentage change in quantity demanded is equivalent to the percentage change in price. The demand elasticity of a good with unit elastic demand is one (Klingensmith, 2019).

Inelastic demand would result when the quantity demanded of a good remains constant regardless of an increase or a drop in the product’s price. This occurs on things that are vitally important for people to have such as gasoline and food (Klingensmith, 2019). The inelastic demand curve is steeper than the unit elastic curve that is diagonal.