Name Keshav Thakur_ IMT COVID-19 Project

Question 1

Question 1A - Name and describe the phenomenon which involves such joint decision-making. What
are its advantages and disadvantages?

Ans 1A - The Phenomenon which involves joint decision-making is known as Collusion. Collusion takes
place in an Oligopoly market structure where large firms can come together to influence the output and price
of a product. A cartel is formed by a group of firms who have colluded. In our case this is OPEC.

The Advantages of collusion are:

 Price and Cost Control through Collusion: When producers within an oligopoly engage in
collusive practices, they can effectively influence market prices, ensuring their product maintains a
higher value. A notable illustration of this is evident in the case of OPEC. In response to the Russia-
Ukraine conflict, OPEC strategically reduced oil production, leading to an increase in the price of
crude oil. This deliberate supply cut in the global market enabled them to uphold elevated crude oil
prices.

 Competitive Oligopoly and Potential Price Wars: In a competitive oligopoly, the risk of price wars
and increased consumer surplus can arise. OPEC's advantage lies in its significant control over oil
prices, impacting global economies and products.

 Economies of Scale and Lower Costs: Dominant players within an oligopoly can achieve economies
of scale, leading to lowered product costs over the long term and increased profits.

 Stable Supply Benefits: Another benefit of collusive oligopoly is the potential for a consistent supply
of goods, illustrated by scenarios such as when WTI crude oil prices went negative, causing delivery
challenges due to excessive oil supply.

The Disadvantages of collisions are:

Price Escalation Through Collusion: Collusion can lead to increased product prices.

 Potential for Decision-Making Bias: Colluding firms might exhibit biased decision-making and
irrational behaviour due to reduced competition, attempting to mimic a monopoly.

 Creation of Entry Barriers: Collusion may result in intentional entry barriers, impeding the entry of
new firms into the market.

Question 1B: What made OPEC decide to cut the supply of oil? What was the desired outcome of the
decision? What was the change in the supply and demand curves of oil and the subsequent market
equilibria? Analyze the changes both before and after the decision to reduce supply.
Answer 1B: The pandemic led to numerous countries imposing lockdowns, causing a sudden drop in the
demand for oil and a subsequent exponential decrease in prices. This negative demand shock resulted in an
unprecedented oil surplus, reaching a point where benchmark prices even went negative in May 2020,
indicating people would pay to dispose of their oil. In response, OPEC made the decision to reduce oil supply
due to several reasons:

 Decreased demand
 Unprecedented oversupply
 Low prices

The objective of this supply reduction was to stabilize oil prices and address the surplus in the market. With
demand plummeting drastically, the world faced the risk of running out of storage space for oil sooner than
anticipated. This scenario would have forced oil producers to halt pumping due to the lack of storage options,
potentially leading to further price collapses. To prevent this, major oil suppliers worldwide contemplated
implementing substantial supply cuts to align with the historic drop in demand.

Change in Demand and Supply curve before the decision: There was a notable alteration in both the
demand and supply curves. The significant decline in oil demand caused the demand curve to shift noticeably
to the left (D2), while the supply curve remained constant. As a result, prices experienced a decrease,
contributing to a surplus in the market, as illustrated in the graph below.

Change in Demand and Supply curve after the decision: There would be a marginal increase in oil prices,
although not returning to pre-pandemic levels. The supply curve would experience a shift (S1), leading to a
new equilibrium characterized by a price increase and a subtle shift of the demand curve (D1) towards the
right as the year progresses.
Question 1C: What market structure does OPEC operate in? What are the key features of such a
market structure?

Answer 1C: OPEC operates in an Oligopoly market structure. It is a market state where there are a limited
number of suppliers/producers/distributors of a certain product. This configuration empowers this collective
to exert control over both the product's price and its supply, aligning with their diverse interests.

Key features of Oligopoly market structure are:

 Dominant Market Players: Oligopolies are characterized by a limited number of major entities that
dominate the market.
 Identical or Differentiated Products: Products sold can be either identical (like Airtel/Jio) or
differentiated (like KFC/Burger King).
 Interdependence of Firms: Oligopoly members are interdependent; actions of one firm can prompt
reactions from rivals, leading to countermoves.
 Entry Barriers for Newcomers: New entrants face barriers due to restrictions and the presence of
established giants.
 Varying Firm Sizes: Firms in oligopolies have varying sizes, resulting in an asymmetrical landscape.
 Price Rigidity: Firms in an oligopoly tend to maintain their prices due to the potential for price wars
if one firm changes its pricing strategy, leading to a lack of price adjustments.
Question 2A Assume that the business was operating at the profit-maximizing level of output before Covid-19.
Each article brought in an ad revenue of €375.

Fixed Total
Articles Cost Variable Cost Average
No. of per per Cost per per Total Marginal Marginal Total
Journalists Month Month Month Month Cost Cost Revenue Revenue Profit
1 15 8000 3000 11000 733.3   5625   -5375
2 29 8000 6000 14000 482.8 214.3 10875 375 -3125
3 42 8000 9000 17000 404.8 230.8 15750 375 -1250
4 54 8000 12000 20000 370.4 250.0 20250 375 250
5 65 8000 15000 23000 353.8 272.7 24375 375 1375
6 75 8000 18000 26000 346.7 300.0 28125 375 2125
7 84 8000 21000 29000 345.2 333.3 31500 375 2500
8 92 8000 24000 32000 347.8 375.0 34500 375 2500
9 99 8000 27000 35000 353.5 428.6 37125 375 2125
10 105 8000 30000 38000 361.9 500.0 39375 375 1375

a) How many articles was the business producing?

Ans: Based on the profit-maximizing level of output the company is producing 92 Articles.
b) What was the total profit?
Ans: The total profit was €2500.
c) Explain conceptually how you arrived at the profit-maximizing level of output. You don't need to show
exact calculations.
Ans: To arrive at the profit-maximizing level of output, the firm needs to understand the level where
marginal cost = marginal revenue because at this level there is no change in profit. Producing beyond this
level will increase the costs which is not beneficial.

Question 2B: On 9th March 2020, Italy went into lockdown. As a result, you had to shut down your office
and adopt a ‘work from home’ policy. This eliminated your fixed costs of €8000. At the same time, your ad
revenue per article reduced to €250. This was because all companies suddenly reduced their advertising
spending.
Answer 2B:

Articles Fixed Variable Total Average

No. of per Cost per Cost per Cost per Total Marginal Marginal Total
Journalists Month Month Month Month Cost Cost Revenue Revenue Profit
1 15 0 3000 3000 200.0   3750   750
2 29 0 6000 6000 206.9 214.3 7250 250 1250
3 42 0 9000 9000 214.3 230.8 10500 250 1500
4 54 0 12000 12000 222.2 250.0 13500 250 1500
5 65 0 15000 15000 230.8 272.7 16250 250 1250
6 75 0 18000 18000 240.0 300.0 18750 250 750
7 84 0 21000 21000 250.0 333.3 21000 250 0
8 92 0 24000 24000 260.9 375.0 23000 250 -1000
9 99 0 27000 27000 272.7 428.6 24750 250 -2250
10 105 0 30000 30000 285.7 500.0 26250 250 -3750
 a) How many journalists would you have to fire? Assume that you only care about maximizing profits.
Ans: After a drop in Ad revenue per article to €250, considering profit maximizing level of output the
company must fire 4 employees from the existing 8 employees as MC=MR is at 4 journalists.
b) What is your new total profit?
Ans: The new total profit is €1500.
c) Why did you fire the journalists? Explain your answer conceptually. You don’t need to show exact
calculations.
Ans: The profits are being maximized with 4 journalists. Profit maximization happens when Marginal
Revenue = Marginal cost. With the reduced total cost and reduced revenue, we attained MR=MC with 4
journalists. Additional journalists would contribute to additional costs and hence they need to be fired.

Marginal revenue = change in revenue/change in number of articles per month

Total Profits = Total Revenue – Total cost
MC=MR at 4 journalist
Total profit = €1500

Question 3

Question 3A: What type of unemployment would a country like India experience from such a
pandemic? Please provide an explanation.

Answer 3A: India would experience a Cyclical unemployment.

During a pandemic, economic activity often slows down significantly as people stay home to prevent the
spread of the virus. Businesses may close, production may decrease, and consumers may cut back on
spending. This leads to a decrease in demand for goods and services, which in turn leads to layoffs and
reduced hiring by employers. Unemployment typically rises during recessions and declines during economic
expansions. The pandemic caused aggregate demand in India to fall sharply which in turn forced the
producers to cut supply resulting in layoffs in many industries.

If the decline in aggregate demand is persistent, and the unemployment is long-term, it is called either
demand deficient, general, or Keynesian unemployment. The stock market crash could be an effect of cyclical
unemployment e.g. the tech crash in the 2000s and the financial crash in 2008.

Question 3B: What type of recession would be caused by such a pandemic? Provide an explanation.

Answer 3B: The type of recession caused by a pandemic as the one experienced globally is referred to as a
"Demand Led Recession". This term emphasizes the primary factor that triggers the economic contraction,
which in this case, is the sharp decline in aggregate demand.

Consumers are inclined towards higher savings due to future uncertainties, leading them to allocate spending
primarily to essential commodities such as groceries, medicines, and healthcare. Meanwhile, discretionary
spending on sectors like tourism, luxury items, and entertainment is curtailed. The impact of workforce
reductions and market unpredictability further induces a reduction in consumer expenditure and an increase in
savings.

Given that how much people spend on things plays a big role in the economy, the effects following the
pandemic are likely to result in a significant decrease in the demand for a broad range of products and
services. This decrease in demand is anticipated to trigger a corresponding reduction in business investments.

Question 3C: What would happen to the aggregate demand and aggregate supply in India because of
the above two phenomena? Elaborate your answer.

Answer 3C: Demand-led recession mutually contributes to a contraction in an economy's demand due to
reduced consumer spending, elevated unemployment, and diminished consumer confidence. This leads to an
overall decrease in the demand for goods and services within India, resulting in a decline in aggregate
demand.

Simultaneously, a surplus of goods and services and a decline in business investments, a decrease in
aggregate demand will cause the aggregate supply to decrease as well. Due to demand reduction, there will be
widespread supply chain disruptions, some people stay at home, others move to rural areas, imports are
interrupted, and international travel stops. This will negatively affect production in almost all industries.

Keynes' Law states that demand creates its own supply; a fall in aggregate demand would cause a fall in the
aggregate supply as well.

Question 3D: How will the AD/AS curves behave in this situation? Please elaborate on your answer.

Answer 3D: The aggregate demand (A D) curve will shift to the left due to less demand.

The recession-induced decline in demand will result in the Aggregate Demand shifting from AD1 to AD2, as
illustrated in the above graph. This shift will lead to a lowering of the equilibrium price level. This adjustment
occurs because businesses aim to reduce their inventories, and workers are willing to accept lower wages,
both of which contribute to a decrease on prices. Consequently, both prices and economic activities
experience a decrease. This shift represents the decrease in aggregate demand.

The aggregate Supply curve (AS) will also move to the left due to lower demand.

The decrease in consumer spending and reduced business investments would lead to lower production levels.
This would result in a leftward shift of the AS curve, indicating a reduction in the total quantity of goods and
services that producers are willing to supply at various price levels.
Question 4

Question 4A: What type of macroeconomic policy should the Indian government adopt after such a crisis?
Please mention the policy measures to be undertaken clearly with explanations.

Answer 4A: These measures are more transparent and have a direct impact on the government's fiscal deficit.
They include:

Fiscal Policy Measures:

Stimulus Packages: The government should consider introducing further fiscal stimulus packages to support
aggregate demand and revive economic activity. This can involve increased public spending on infrastructure
projects, healthcare, education, and other essential sectors.
Under Pradhan Mantri Garib Kalyan Package valued at Rs. 2.76 lakh crore, free food grain for 80 crore
people, free cooking gas for 8 crore families, and direct cash transfer to over 40 crore farmers, women, the
elderly, the poor, and the needy were provided.

Social Welfare Programs: Continue providing relief measures such as cash transfers and in-kind assistance
to vulnerable households. This helps maintain a basic standard of living and supports consumption.

Employment Generation: Extend or introduce new employment generation schemes, like the Pradhan
Mantri Garib Kalyan Rojgar Abhiyaan, to address unemployment and enhance income levels.

Investment Incentives: Introduce tax incentives or subsidies to encourage private investment in key sectors,
promoting job creation and economic growth.

Industrial and Agricultural Reforms: The structural reforms initiated under the AtmaNirbhar Bharat
Package should be continued and expanded, fostering a competitive and efficient environment for industries
and agriculture.

Question 4B: What type of macroeconomic policy should the Reserve Bank of India adopt after such a
crisis? Please mention the policy measures to be undertaken clearly with explanations.
Answer 4B: After a crisis like the COVID-19 pandemic, the Reserve Bank of India (RBI) should adopt a
combination of monetary and fiscal policies to facilitate economic recovery and stability. Given the extensive
measures undertaken during the crisis, the following macroeconomic policy measures can be considered:

Monetary Policy Measures:

Interest Rate Adjustment: The RBI should continue to monitor the prevailing interest rates and adjust them
as necessary. Lowering the policy repo rate can encourage borrowing and investment, aiding economic
growth. However, this needs to be balanced against inflationary pressures.

Liquidity Management: Maintaining ample liquidity in the banking system is crucial to ensure smooth
credit flow to businesses and individuals. The RBI can employ open market operations, repo operations, and
other liquidity-enhancing measures.

Credit Support: Continue offering targeted refinancing facilities to sectors hit hardest by the crisis, such as
MSMEs and NBFCs, to ensure their access to credit.

Structural Reforms:

Ease of Doing Business: Continue efforts to improve the ease of doing business in the country, encouraging
both domestic and foreign investment.

Financial Sector Strengthening: Enhance the regulatory framework for MSMEs and NBFCs, ensuring their
stability and facilitating their role in the economy.

Inflation and Price Stability:

Vigilance on Inflation: The RBI should closely monitor inflation levels to ensure they remain within a
manageable range. Inflation can erode purchasing power and disrupt economic stability.

Exchange Rate Stability: Maintain a stable exchange rate to provide certainty for businesses engaged in
international trade and investment.

In summary, a comprehensive approach that combines monetary policy adjustments, fiscal stimulus, targeted
relief measures, ongoing structural reforms, and maintaining stability in key economic indicators is crucial for
the Reserve Bank of India to steer the economy toward a robust recovery post-crisis.