Course Name: Micro Economics

Course code: Eco-201.

Submitted to Course Teacher: Nur -EAlam Siddique Lecturer

Faculty of Business and Economics

Submitted By:
Ashiq Hossain ID: 083-11-558 Daffodil International University

Date of Submission: August 18, 2009.

Question 1: Define the social cost of tax? How much should government tax? Question2: Define the maximum price? Graphically explain the maximum price/ price ceiling? Question 3: Define the price Floor? Graphically explain the price floor in case of agriculture?

Question 4: Define the minimum wage Law? Graphically explain the minimum wage Law? Question 5: Explain the meaning and condition of perfect competition?

Question 1: Define the social cost of tax. How much should government tax?

Social Cost of Tax:

Taxing a good will typically increase the price paid by the demanders and decrease the price received by the suppliers. This certainly represents a cost to the demanders and suppliers, but from the economists point of view the real cost of tax is that the output has been reduced. We can explore the social cost of tax by using the concept of consumers and producers surplus tools.

S + tax

A P1 Price P0 P1-t B D F C E

tax E0

D O Q1 Q0 Quantity X

Figure: Dead weight loss or Social cost of tax

Graphical Explanation:
A per unit tax t paid by the supplier shifts the supply curve up from so to s1. Equilibrium price-rises form Po to P1 and equilibrium quantity falls from Q2 to Q1. Consumer surplus is represented by areas A, B, and C before the tax and area A after the tax. Producer surplus is represented by areas D. E, and F before the tax and area F after the tax. Government collects tax shown by areas B and D. The tax imposes a deadweight loss, represented by the welfare loss triangle if areas C and E.

The Cost of Taxation:

The costs of taxation to society include the direct cost of the revenue paid to government, the loss of consumer and producer surplus caused by the tax. For a given good a per unit tax t paid by the supplier increases the price at which suppliers are willing to sell that good. The increase in price is shown by a shift upward of the supply curve from so to S1. The equilibrium price of the good rises and the quantity sold declines. Before the tax, consumers pay Po and producers keep Po. Consumer surplus is represented by areas A+B+C, and producer surplus is represented by areas D+E+F. With the tax t, equilibrium price rises to P1 and equilibrium quantity falls to Q1. And consumer surplus is represented by areas B+C and producer surplus is represented by areas D+E. Now consumer pays P1, but producer keep only P1-t. Tax revenue paid to the government the area B+D. As a result consumer also loses area C and

producer lose area E. The triangular area C+E represents a cost of taxation in excess of the revenue paid to government. It is lost consumer and producer surplus that is not gained by government. Its a burden of society. The loss of consumer and producer surplus C+E from a tax is known as societal cost of tax, or dead weight loss.

Question2: Define the maximum price? Graphically explain the maximum price/ price ceiling?

Price ceiling /maximum ceiling/Maximum price

1. In maximum price, price is not allowed to rise above the regulated

price. 2. This will affect the market price and quantity only if the max. Price is set below the equilibrium price.
Y S

Graphically:

P Price Pc R

E T

D O X Q1 Quantity Fig : Price Ceiling Q Q2

Here, we can see initial equilibrium is defined by point Eo. At the point Eo, equilibrium price is OP and equilibrium quantity is OQ. Rent controls exist today in a number of American cities as well as other cities throughout the world. Many of the laws governing rent were first instituted during the two world wars in the first half of the 20th century. Consider Paris, for example. During World War I, the Paris government

froze rent to ease the financial burden of those families whose wage earners were sent to fight in the war. When the soldiers returned at the end of the war, the rent control was continued; removing it would have resulted in a tripling of rents, and that was felt to be an unfair burden for veterans. During World War II, the rent control laws were reaffirmed and additional housing was placed under government control. At the end of World War II, maximum rent was set at Pc a month. Without rent control, an apartment would have cost P a month. The below-market rent set by government created an enormous shortage of apartments. Initially this shortage didnt bother those renting apartments, since they got low-cost apartments. But it created enormous hardships for those who didnt have apartments. Many families moved in with friends or extended families. Others couldnt find housing at all and lived on the streets. However, eventually the rent controls started to cause problems even for those who did have apartments. The reason why is that owners of buildings cut back on maintenance. More than 80 percent of Parisians had no private bathrooms and 20 percent had no running water. Since rental properties werent profitable, no new buildings were being constructed and existing buildings werent kept in repair. It was even harder for those who didnt have apartments. Problems and Measures:
At the regulated price, D and S do not match. Consumers want

more but get less. As shortage arises somebody will have to go without the desired goods. If free market forces were allowed to operate, the market would clear with a higher price. But under price control, charging higher price is illegal. So, there follows a period of frustration and shortage. Some method will have to be used to allocate the goods.

a)

The seller may adopt the principle of first come first served approach and distribute the available supply of goods among those who are first in the queue before their shops Lines form and much time have to be spent for the desired goods.

b)

If the govt. does not like the allocation of the goods on the basis of above approach, it may introduce rationing of the good. The number of ration coupons issued to a family depends on the age of its members, sex, or the number of family members or any other criteria considered desirable.

However, whichever system is used, Black Market is

likely to develop. By black market we mean transaction at a price higher than the controlled price. Due to dissatisfaction both the demanders and suppliers may engage in such type of illegal transactions, if they have this type of privileged access.

Question 3: Define the price Floor? Graphically explain the price floor in case of agriculture?

Price Floor/Minimum Price or Minimum Wage Law

A price floor is the lowest legal price. A commodity can be sold at price floor are used by the government to prevent price from being too low. The most common price floor is used often to protect the farmers. 1) In the case of price floor or minimum wage low, setting the price/minimum wage below the regulated price is not allowed. 2) This will affect the market economy only if the minimum price/wage is set above the equilibrium price/wage. Why price floor for agriculture 1) To protect the farmer from the lowest income. 2) To raise the farmer income for their better living standard. Graphically:
Y S Pm P Price D A B

E0

Q1 Q Q2 Quantity Fig : Support Price

In the case of agriculture:

Initially, equilibrium is defined by the point, E from the intersection of demand and supply curves. At the point E, equilibrium price is OP and quantity is OQ. Now suppose govt. sets minimum price at OPM .At price, OPM demand (PMA) falls the short of supply (PMB). That means there arises surplus of goods. If the govt. does not purchase of the surplus, there will have a downward pressure on the price of agriculture goods. So to prevent this Government will have to purchase this surplus amount of goods. To purchase this surplus, Q1Q2 at OPM price expenditure will be Q1Q2XOPM = Q1ABQ2.This expenditure on purchase may be financed by the taxation of the people. With a minimum price law the farmer will sell OQ1 at OPM price in the free market and Q1Q2 to the govt. at OPM .Total income will be, OPMBQ2.Without law OQ amount will be sold at OP price and total income will be OPEQ .As OPMBQ2>OPEQ and OPM > OP. Problem in the case of disposal of the surplus: 1. They can buy up the entire surplus. For a while the US government bought grain surpluses in the US and then gave all the grain to Africa. This might have been nice for African consumers, but it destroyed African farmers. 2. The government can control how much is produced. To prevent too many suppliers from producing, the government can give out production rights or pay people not to produce. Giving out production rights will lead to lobbying for the lucrative rights or even bribery. If the government

pays people not to produce, then suddenly more producers will show up and ask to be paid. 3. They can also subsidize consumption. To get demanders to purchase more of the surplus, the government can pay part of the costs. This would obviously get expensive really fast.

4. There is less quantity demanded (consumed) than quantity supplied (produced). This is called a surplus. If the surplus is allowed to be in the market then the price would actually drop below the equilibrium So we can say that with the law farmers gain both in the terms of price and income.

Question 4: Define the minimum wage Law? Graphically explain the minimum wage Law?

Minimum wage law

Minimum wage would be likely to be set above the current level of pay given to low paid workers. Wage set below the minimum wage will be illegal.

Why Price floor for minimum wage law

Higher wage will help to raise the living standards of poorly paid

workers. May increase labors demand. May increase workers morale and stimulate labor productivity. Graphically:
Y SL Wm Wf Wage E

DL O L1 Lf L2 X

Employment Fig : Minimum wage for unskilled workers

Initially, equilibrium is defined by the point E0 from the intersection

demand and supply curve. At the point E0 shows the wage Wf and the employment level Lf. So government thinks that increases the workers wage and improves their living standard. Now government sets the minimum wage form Wf to Wm. At this higher wage rate, the quantity of labor supply rises to L2 and the demand declines to L1. This curves shows that more workers are ready to work but fewer jobs are available. For this reason, employment level reduces to OL1 and unemployment level increases to L1L2. Who wins and who loses from a minimum wage? The minimum wage improves the wages of the L1
workers

who are

able to find work. Without the minimum wage, they would have earned Wf per hour. The minimum wage hurts those, however, who cannot find work at the minimum wage but who are willing to work, and would have been hired, at the market-determined wage. These workers are represented by the distance Lf-L1. The minimum wage also hurts firms that now must pay their workers more, increasing the cost of production. The minimum wage also hurts consumers to the extent that firms are able to pass that increase in production cost on in the form of higher product prices. Effect of this Law: 1. There is likely to be a rise in unemployment. 2. Decrease in the employment of the low skilled workers.
3. Those who will get the job will be better paid. 4. If the demand curve is inelastic (in case of unskilled workers),

increasing the minimum wage will increase the income of the low paid workers.

Question 5: Explain the meaning and condition of perfect competition?

Meaning and condition of perfect competition

Perfect competition has 4th characteristics. 1. There are a large number of firms produci8ng and selling a product. 2. The product of all firms is homogeneous 3. Both the sellers and buyers have perfect information about the prevailing price in the market. 4. Entry into and exit from the industry is from the industry is free for the firms.

Large Number of Firms

The first condition of perfect competition is that there are a large number of firms in the industry. The position of a single firm in the industry containing numerous firms is just like a drop in the ocean. The existence of a large number of firms producing and selling the product ensures that an individual firm exercises no influence over the pri8ce of the product. The output of an individual firm continues a very small fraction of the total output of the whole industry so that any increase or decrease or decrease in output by an individual firm has a negligible effect on the total supply of product of the industry. As a result, a single firm is not in a position to influence the price of the product by the increasing or reducing its output. The individual firm under perfect competition therefore takes the price of the product as a given datum and adjusts its output to earn maximum profits. In other words, a firm under perfect competition is price-taker and output. The individual firm under perfect competition therefore takes the price of the product as a given datum and adjusts its output to earn maximum profits. In other words, a firm under perfect competition is price-taker and output adjuster.

Homogenous products
The second condition of perfect competition is that the products produced by all firms in the industry are fully homogeneous and identical. It means that the products of various firms are indistinguishable fr4om each other; they are perfect substitutes for one another. In other words, cross elasticity between the products of the firms is infinite. In case of homogeneous products, trade marks patents, special brand labels etc. do not exist since these things make the products differentiated. It should be noted that if there are many firms, but they are producing differentiated products, each one of them will have influence over the price of his own variety of the product. The control over price is completely eliminated only when all firms are producing homogeneous products. But whether or not products are homo9geneous should be judged from the viewpoint of the buyers. Products would be homogeneous only when the buyers consider them to be so. Even if the buyers find some imagined differences between the products, the products would not be products, the products would not be homogeneous, howsoever physically alike the may be. Anything which makes buyers prefer one seller to another, be it personality, reputation, convenient location, or the tone of his shop, differentiates the product to that degree, since what is bought is really a bundle of utilities of which these things are a part. Therefore, for the products to be homogeneous utilities offered by all sellers to buyers must be identical. If the bundle of utilities offered by all seller who will have a degree of control over their individual prices. Thus the existence of homogenous products signifies that the products of all sellers are completely identical in the eyes of consumers who therefore do not have any preference for one seller over another. Under such conditions it is evident that buyers and sellers will be paired in random fashion in a large number of transactions. It will be entirely a matter of chance from which seller a particular buyer makes his purchases, and purchases over a period of time will be distributed among all sellers according to the law of probability. After all this is only another way of saying that the products is homogeneous.

Perfect Information about the prevailing price

Another condition for perfect competition to prevail is that both the buyers and sellers are fully aware of the ruling price in the market. Because lonely when all buyers know fully the current price of the product in the market, sellers cannot charge more than the prevailing price. If any seller tries to charge a higher price than that ruling in the market, then the buyers will shift to some other sellers and buyer the good at the ruling price since they know what the ruling price in the market is. Similarly, all sellers are also aware of the prevailing price in the market and no one will charge fewer prices than this.

Free Entry and Exit

Lastly, perfect competition requires that there must be complete freedom for the entry of new firms or the exi9t of the existing firms from the industry in the long run. Their must be no barriers to the entry of firms. Since, in their short run, firms can neither change the size of their plants, nor new firms can enter or old ones can leave the industry, the condition free entry and free exit therefore applies only to long-run equilibrium under perfect competition. If the existing firms are maki9ng super-normal profits in the short run, then this condition requires that in the long run new firms will enter the industry to compete away the profits. If, on the other hand, firms are making super-normal profits in the short run, then this condition requires that in the long run new firms will enter the industry to compete away the profits. I f, on the other hand, firms are making losses in the short run , some of the existing firms will leave the industry in the long run with the result that the price of the product will go up and the firms left in the industry will be earning at least normal profits.

Reference: P.A Samuelson & W. Nordhaus: Economics, McGraw Hill, Latest edition. nd 2. D.N. Dwivedi: Microeconomics Theory & Application, 2 Impression, 2008 3. Domonick Salvatore: Microeconomics: Theory & Applications, Fourth edition 4. Colender David : : Microeconomics
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