North South University

School of Business and Economics

Spring 2020

Course: ECO101

Final Assignment

Date of Submission: June 4, 2020

Submitted By:

Name: Raisa Musharrat Hossain

ID: 1931471030

Section: 36

Contact: raisa.hossain@northsouth.edu

Submitted To:

Dr. Sakib Bin Amin

Faculty, Department of Economics

School of Business and Economics

Section A: Multiple Choice Answers

1. D

2. C

3. A

4. D

5. A

6. E

7. C

8. A

9. A

10. D

11. E

12. A

13. C

14. B

15. A

16. E

17. C

18. D

19. B

20. C
Section B: Essays/Problems

1) A) Perfect competition refers to a market situation in which no single firm or

company is big enough to affect market price. Perfect competition follows these
assumptions:

1) There are a huge number of buyers and sellers. Because a single firm is
amongst a plethora of many firms, it has no significant influence on the market
price or the supply. If a seller enters or exits a market, it will not affect the
market in any way. If a buyer enters or exits the market, there will be no effect
on the market or the demand. Thus, actions made by a firm have no
consequence on the market scene.
2) All the firms/companies involve sell the same identical product, also called
homogeneous products. Because of this, buyers do not have the option of
preferring the product of one seller over the product of another seller because
of the product’s innovation. So, the buyer will focus on the price and will
always choose to buy from the supplier with the lowest price.
3) The buyers and sellers have perfect knowledge of the market This means that
the firms and customers know exactly the price of the product in different parts
of the market. By knowing all the information, they will find the best deal for
the market to run efficiently.
4) A firm can enter or exit the industry whenever it wants. If a firm believes it can
make money, they can enter the market without any hindrance. It can also lave
the market anytime it wants if it isn’t earning enough money.

B) The demand curve faced by a perfectly competitive market takes shape as a result
of the two assumptions that a huge number of buyers and sellers are present and everyone is
selling the same product. Because of this, the demand curve of a perfect competition is infinitely
elastic, giving the curve a horizontal line parallel to the x axis. The sellers can sell any of their
products at the existing market price.

C) In a “short run” no new firm will be able to enter the market and no existing firm
can exit the market. Once a market price has been changed, no firm can influence that price to
change. With this in mind, a firm’s main target is to maximize its profit by producing an amount
of output where price equals to average revenue and marginal revenue (P=AR=MR). A firm can
incur loss if the total revenue (TR or MR) exceeds total cost (TC or MC). In the short run, a firm
can continue production and business even after incurring loss only if it has the capability to
maintain variable costs. Since it deals with both fixed and variable costs, it must produce output
in such a way it covers up variable costs at the minimum. As a result, the loss will equal to the
fixed costs.
 Diagram for abnormal loss in short run

2) A) A monopolistic competition cannot be confused with a monopoly because the two

market structures are entirely different. A monopolistic competition follows these assumptions:

1) A large number of firms/sellers are present, so each firm has almost

insignificant influence on the market.
2) Firms sell differentiated products, but they are close substitutes to each other.
3) There is free entry and exit for firms in the market.
4) Since the products are different but similar at the same time, there is a non-price
competition based on the innovation of the product.

So, from these assumptions, monopolistic completion is similar to perfect competition

but differ in terms of having differentiated products and non-price competition.
 B)

C) A monopoly describes a market situation in which there is only one firm/seller for a
certain product in the market. As a result, that firm deals with the entire demand curve of that
product. Characteristics of a monopoly include: maximizing profit, high barriers for entry to the
market, single seller who is the price maker, and discrimination in price-setting. High barriers to
entry the market means that other sellers are unable to enter the monopoly market due to
economies of scale, legal barriers, or the ownership of a scarce resource by a single firm that
makes it next to impossible to enter the market.
In economies of scale, for some industries, low unit costs are acquired through large scale
production. So if a new firm wants to enter and compete in the market, it must enter with a large
scale production on its back. However, such production is extremely costly and risky and thus
poses as a barrier. Legal barriers take place because of public franchises, government licenses,
and patents. A public franchise is a right granted to a firm by the government that allows the firm
to sell a particular good or service and excludes any other firm who wants to do the same. As for
government licenses, some industries require them to be even allowed to enter the market.

3) A) Utility is the satisfaction or benefit a person gets from the consumption of a good or
service. Total utility is the total satisfaction a person gets from the consumption of a good or
service. As quantity consumed of a good increases, total utility also increases. However, total
utility increases at a decreasing rate. On the other hand, marginal utility is the change in total
utility from a one-unit increase from the quantity of a good or service consumed. Marginal utility
is always declining because total utility is always changing at a decreasing rate.

B) Adam Smith noted that water, which is essential for survival, has a very low market
price whereas diamonds, which are not essential for survival, has a very high market price. Adam
Smith’s observation has been called the Diamond-Water Paradox. According to this theory, if a
product is extremely useful, then its total utility will be equally as high. So, total utility is related
to value in use. Since water is extremely useful, its total utility is very high but marginal utility is
low because there is plenty of water. There is so much of it that people give less value to it. In
contrast, since diamonds do not have nearly as much usefulness as water does, it total utility is
much lower than water. However, marginal utility is much higher for diamond than water and
just high in general because diamond is a scarce resource. And if the marginal utility is high then
the price is high as well.

C) The equimarginal principle states that a consumer faced with the given market price and
a fixed income will attain maximum satisfaction when and if the marginal utility of the last dollar
spent on a product is equal to the marginal utility of the last dollar spent on another product. If
any one product marginal utility/money, utility would increase for that product and money will
be taken away from other products to be spent on that product.

4) A ) Total product (TP) is the number of outputs produced by a firm using all the inputs it
has at a given time while other factors are constant. Marginal product (MP) is the additional
output produced by the firm that results when an additional unit of input is employed by the firm
while other factors are constant. As TP increases at an increasing rate, MP follows and also
increases until it reaches its maximum (stays positive). However, MP declines (gets negative)
when TP increases at a diminishing rate. This continues until TP reaches its maximum. When
this happens, MP becomes zero. The diagram and graph below explains the situation.

Units of Labor Total Product Marginal Product

0 0 -
1 10 10
2 30 20
3 45 15
4 52 7
5 52 0
 6 48 -4
*numbers have been collected from the internet

B) The Return to Scale theory shows the percentage change in output as a result of
percentage change in input. There are three type of return to scale:
1) Constant Returns to Scale: When there is an m percent increase in all input production,
then there is m percent increase in output. (CRTS= change in Y/ change in L=1)
2) Increasing Returns to Scale: When output increases by a larger percentage to nth number
of inputs. (IRTS= change in Y/change in L >1).
3) Decreasing Returns to Scale: When output increases by a smaller percentage to nth
number of inputs. (DRTS= change in Y/change in L <1).

C) The Law of Diminishing Return states that there will be less and less extra output when
an additional amount of input is added while holding all other variables constant.

5) A) Fixed cost is a cost where the value does not change as output rates change. So, fixed
cost is constant. Average fixed cost (AFC) is the fixed cost of per unit of output. AFC is
calculated in a way where the total fixed cost is divided by the output change. Mathematically
speaking, the constant is divided by a divisor that is increasing in most cases. The quotient
results in a very small number. The AFC curve is sloping downwards towards the right a fixed
cost is being distributed over a volume that is constantly getting larger as the quantity produced
increases.

B) Marginal Cost (MC) is defined as the change in total cost when quantity produced
changes by a single unit. I other words, it is the cost a firm bares when it produces one more unit
of a product. MC includes the cost of any input that is required to produce the next output.
Average cost (AC) is the total cost divided by the number of products produced. All fixed and
variables costs are included when calculating AC. When AC declines, MC is less than AC.
When AC increases, MC is greater than AC. When AC stays same, MC equals to AC.

C) We find the total fixed cost first:

TC = TVC + TFC
$30,000 = $14,000 + TFC
So,
TFC = $16, 000
Then, we find average fixed cost:
AFC = TFC/Q
AFC= $16000/100
AFC = $160

The AFC at 100 units is $160.

6). A) Price elasticity of demand is the change in percentage of quantity demanded in

response to a change in percentage of price when all other things are held constant. The three
determinants of price elasticity of demand are: luxuries versus necessities, availability of close
substitutes, and time horizon.
Luxuries versus necessities: If the price of an inexpensive product, such as sugar, increases,
people will usually be indifferent towards such an insignificant price change. Thus, sugar has a
low elasticity of demand. However, if the price of an already expensive product, like a car
increases, it will have an effect on whether or not people will choose to buy it or not. So, cars
have a high elasticity of demand.
Availability of close substitutes: If a product has lots of close substitutes, for example ice
cream, people will have a strong reaction to the price increase of one company’s ice cream. As a
result, the price elasticity of demand of that company’s ice cream is high.
Time horizon: Price elasticity of demand is higher if the effects of a price increase are
observed over a long period of time rather than short. The longer time period allows people to
adjust to the change. If price of gasoline suddenly increases, buyers cannot change their amount
of gasoline consumption over a week. However, given two years, they have the time to adjust
and find ways to deal with the price change.

B) Cross Elasticity of Demand measures the affect the change in price of one product has
on the demand of another product. It is positive if the products are substitutes and negative if the
products are complements.

C) i) True; Rice is a staple food which means it has an inelastic demand. So, price increase
will increase profit.
ii) False; Cars have elastic demand so a slight change in price will result in a big change
in quantity. A slight increase in price will decrease quantity sold by a lot.