BECC 101:

1.
a) A positive production externality occurs when the act of production
leads to lower costs to other agents in the economy. As a result, the
marginal social cost is lower than the marginal private cost. On the
other hand, a negative production externality occurs when the act of
production leads to higher costs to other agents in the economy. In this
case, the marginal social cost of production is higher than the
marginal private cost.
In a free market, firms will ignore external costs and benefits and
produce at a level where their private marginal cost equals their
private marginal benefit. However, this level of production is not
socially optimal because it does not take into account the external
costs or benefits.
To correct inefficient production levels resulting from externalities,
governments can intervene by implementing policies such as taxes,
subsidies, or regulations. For example, a tax can be imposed on firms
that produce negative externalities to internalize the external cost. This
will increase their private marginal cost and reduce their level of
production to the socially optimal level. On the other hand, a subsidy
can be provided to firms that produce positive externalities to
internalize the external benefit. This will decrease their private marginal
cost and increase their level of production to the socially optimal level.
DIAGRAM: Positive and Negative Production Externality Diagrams

b) There are several factors that can distort the ability of competitive
markets to achieve efficiency. These include market power,
externalities, asymmetric information, and government intervention.
Market power refers to the ability of a firm to influence the price of a
good or service. In a perfectly competitive market, firms are price
takers and have no market power. However, when firms have market
power, they can set prices above marginal cost, leading to a
deadweight loss and reduced economic efficiency. Market power can
arise from factors such as monopoly, oligopoly, or monopsony powers
of market participants.
Externalities occur when the actions of consumers or producers result
in costs or benefits that do not show up as part of the market price. For
example, pollution is a negative externality because it imposes a cost
on society that is not reflected in the market price. Without government
intervention, firms will have no incentive to consider the social cost of
pollution.
Asymmetric information occurs when one party in a transaction has
more information than the other party. This can lead to adverse
selection and moral hazard, which can reduce economic efficiency.
Asymmetric information or uncertainty among market participants
can distort the ability of competitive markets to achieve efficiency.
Government intervention can also distort competitive markets. For
example, price controls can create a deadweight loss by reducing
economic efficiency. Almost all types of taxes and subsidies can distort
competitive markets.
In summary, market power, externalities, asymmetric information, and
government intervention are some of the factors that can distort the
ability of competitive markets to achieve efficiency.

2.
a)When the price of a good changes, it affects the consumer’s
purchasing power and relative prices, leading to both income and
substitution effects. The income effect refers to the change in
consumption resulting from a change in purchasing power, while the
substitution effect refers to the change in consumption resulting from a
change in relative prices.
In the case of an inferior good, the income effect will work in the
opposite direction to the substitution effect. When the price of an
inferior good falls, its negative income effect will tend to reduce the
quantity purchased, while the substitution effect will tend to increase
the quantity purchased. The net effect of the price change will then
depend on the relative strengths of the two effects.
For example, let’s say that potatoes are an inferior good. When the
price of potatoes falls, consumers have more purchasing power and
can afford to buy more expensive goods. This is known as the income
effect. However, since potatoes are an inferior good, consumers may
choose to buy less of them as their purchasing power increases. On the
other hand, as the price of potatoes falls relative to other goods,
consumers may choose to substitute away from more expensive
goods and buy more potatoes. This is known as the substitution effect.
DIAGRAM: diagrams illustrating the income and substitution effects of
a price change for an inferior good.

b) In the context of demand and supply analysis, a Walrasian

equilibrium refers to a state in which all markets are in equilibrium, with
no excess demand or excess supply. In other words, the quantity
demanded equals the quantity supplied for all goods and services in
the economy.
The Walrasian stability condition is based on the assumption that
buyers will raise their bids if there is excess demand, and sellers will
lower their prices if there is excess supply. This means that a market is
stable if excess demand diminishes as the price of a good rises, and
increases as the price falls.
For example, let’s say that there is excess demand for apples.
According to the Walrasian stability condition, buyers will raise their
bids for apples, causing the price to rise. As the price rises, the quantity
demanded will decrease and the quantity supplied will increase until
they are equal. At this point, the market for apples will be in
equilibrium.
In summary, a Walrasian equilibrium is a state in which all markets are
in equilibrium, and the Walrasian stability condition describes how
markets adjust to changes in demand and supply to reach equilibrium.

c) Price elasticity of demand is a measure of the responsiveness of the

quantity demanded of a good or service to a change in its price. When
demand is elastic, a small change in price will result in a larger change
in quantity demanded. When demand is inelastic, a change in price
will result in a smaller change in quantity demanded. In Figure 1, the
demand curve D’D’ is more elastic than the demand curve DD because
it has a flatter slope. This means that a small change in price will result
in a larger change in quantity demanded for D’D’ than for DD.

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3.
a)A linear homogeneous production function implies that with the
proportionate change in all the factors of production, the output also
increases in the same proportion. In other words, if the input factors are
doubled, the output also gets doubled. This is also known as constant
returns to scale.
In the case of a linear homogeneous production function, the
expansion path is always a straight line through the origin. This means
that the proportions between the factors used will always be the same
irrespective of the output levels, provided the factor prices remain
constant. This holds true for both the short run and long run.
In summary, a firm experiencing a linear homogeneous production
function will have an expansion path that is a straight line through the
origin, both in the short run and long run.

b)Given that the average fixed cost of producing 2 units of output is Rs.
10, we can calculate the total fixed cost as follows: Total fixed cost =
Average fixed cost * Quantity = 10 * 2 = Rs. 20.
Since total cost is the sum of total variable cost and total fixed cost, we
can calculate the total variable cost for each quantity by subtracting
the total fixed cost from the total cost. For example, the total variable
cost for producing 1 unit of output is 50 - 20 = Rs. 30.
Average variable cost can be calculated by dividing the total variable
cost by the quantity. For example, the average variable cost for
producing 1 unit of output is 30 / 1 = Rs. 30.
Average fixed cost can be calculated by dividing the total fixed cost by
the quantity. For example, the average fixed cost for producing 1 unit of
output is 20 / 1 = Rs. 20.
Short-run average cost is the sum of average variable cost and
average fixed cost. For example, the short-run average cost for
producing 1 unit of output is 30 + 20 = Rs. 50.
Short-run marginal cost can be calculated as the change in total cost
divided by the change in quantity. For example, the short-run marginal
 cost for producing the second unit of output is (65 - 50) / (2 - 1) = Rs.
15.
Here is a table summarizing all these values:

Short-Ru Short-Ru
Total Total Average Average
Total n n
Quantity Variable Fixed Variable Fixed
Cost Average Marginal
Cost Cost Cost Cost
Cost Cost

1 50 30 20 30 20 50

2 65 45 20 22.5 10 32.5 15

approxi approxi approxi

approxi
3 75 55 20 mately mately mately2
mately10
18.33 6.67 5

approxi approxi approxi

approxi
4 95 75 20 mately mately mately2
mately5
18.75 23.75 0

approxi approxi approxi approxi approxi approxi

approxi
5 mately13 mately11 mately2 mately2 mately2 mately3
mately4
0 0 0 2 6 5

approxi approxi approxi approxi approxi approxi approxi

6 mately18 mately16 mately2 mately mately mately mately5
5 5 0 27.5 3.33 30.83 5

4)

a)
MR= Marginal Revenue
MC= Marginal Cost
AR= Average Revenue

b)To find the profit-maximizing price and quantity for a monopoly, we

need to find the point where marginal revenue (MR) equals marginal
cost (MC).
First, let’s find the inverse demand function by solving for P in terms of
Q: P = 30 - Q. The total revenue (TR) function is P * Q = (30 - Q) * Q =
30Q - Q^2. The marginal revenue (MR) function is the derivative of the
TR function with respect to Q: MR = d(TR)/dQ = 30 - 2Q.
The total cost (TC) function is given as C(Q) = 2Q^2. The marginal cost
(MC) function is the derivative of the TC function with respect to Q: MC
= d(TC)/dQ = 4Q.
Setting MR = MC to find the profit-maximizing quantity: 30 - 2Q = 4Q ->
Q = 5. Substituting this value of Q into the inverse demand function to
find the profit-maximizing price: P = 30 - Q = 30 - 5 = 25.
The resulting profit to the monopoly is π = TR - TC = (P * Q) - C(Q) =
(25 * 5) - (2 * 5^2) = 125 - 50 = 75.
In a perfectly competitive industry, firms are price takers and produce
at the point where price equals marginal cost. The equilibrium quantity
would be where P = MC: 30 - Q = 4Q -> Q = 6. The equilibrium price
would be P = 30 - Q = 30 - 6 = 24.
So, in this case, a monopoly would produce less quantity and charge a
higher price than a perfectly competitive industry, resulting in a higher
profit for the monopoly.

5)

a)
(the diagram illustrating the horizontal axis represents the quantity of
labor and the vertical axis represents the wage rate. The
upward-sloping supply curve (S) and downward-sloping demand
curve (D) intersect at point E, which represents the market equilibrium
wage rate (We) and quantity of labor (Le). If the government imposes
a minimum wage (Wm) above We, it creates a surplus of labor equal
to the distance between points A and B.)

When the government imposes a minimum wage that is above the

market equilibrium wage rate, it means that firms are not permitted to
pay less than the amount mandated by the government. This can
result in a situation where the supply of labor exceeds the demand for
labor at the set minimum wage. In other words, there are more people
who would like to work at the minimum wage than there are jobs
available at that wage rate. This can lead to a decrease in
employment as firms may choose to hire fewer workers at the higher
wage rate

b)If the minimum wage is set below the market equilibrium wage rate,
it would have no effect on the labor market. In this case, the minimum
wage would not be binding, meaning that it would not affect the wages
paid by employers or the employment levels in the market. Employers
would continue to pay the market equilibrium wage rate, which is
higher than the minimum wage. The market would continue to operate
as if there were no minimum wage in place. In other words, the supply
and demand for labor would determine the wage rate and
employment levels in the market .

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6. Oligopoly is a market structure where a small number of firms

dominate the market and are aware of each other’s actions. In such a
market, firms can either cooperate or act non-cooperatively.
Non-cooperative behavior refers to a situation where firms compete
with each other rather than cooperating.
In a non-cooperative oligopoly, each firm pursues its own price and
output policy independent of its rivals. Firms try to increase their
market share through competition and may engage in various
competitive strategies such as price wars, advertising, and product
differentiation. This type of behavior can result in lower prices for
consumers but can also lead to instability in the market as firms
engage in aggressive competition.
7. Yes, I agree. The law of diminishing returns applies only in the short
run. This is because in the short run, at least one factor of production is
fixed. As more units of a variable factor are added to the fixed factor,
the marginal product of the variable factor will eventually decrease.
This is known as diminishing marginal returns.
In the long run, however, all factors of production are variable. This
means that firms can adjust all inputs to achieve the optimal
combination of factors and avoid diminishing returns. In the long run,
firms can also change their technology or production processes to
increase productivity and avoid diminishing returns.
8. Under perfect competition, the value of marginal product (VMP) and
the marginal revenue product (MRP) of a factor are equal. The VMP is
the additional revenue generated by employing one more unit of a
factor, while the MRP is the change in total revenue resulting from a
one-unit change in the quantity of a factor used, holding all other
factors constant.
In a perfectly competitive market, firms are price takers and cannot
influence the market price of their product. This means that the
additional revenue generated by selling one more unit of output is
equal to the market price. Therefore, the VMP is equal to the market
price multiplied by the marginal physical product (MPP) of the factor.
Since the market price is constant under perfect competition, the MRP
is also equal to the market price multiplied by the MPP. This means that
under perfect competition, VMP = MRP = Price x MPP.
9. Every economy faces three central problems due to the scarcity of
resources. These are: what to produce, how to produce, and for whom
to produce.
The problem of what to produce involves deciding which goods and
services should be produced and in what quantities. This requires
making choices about the allocation of resources among different
possible uses.
The problem of how to produce involves deciding on the methods and
techniques to be used in the production process. This requires
choosing between different production technologies and combinations
of factors of production.
The problem of for whom to produce involves deciding how the goods
and services produced will be distributed among the members of
society. This requires making choices about the distribution of income
and wealth.
These central problems arise because resources are scarce and have
alternative uses. Every economy must find a way to allocate its limited
resources among competing demands in order to meet the needs and
wants of its population.
10.

On this graph, there are two curves. The downward-sloping curve is the
demand curve, which shows the relationship between the quantity
demanded and the price. The upward-sloping curve is the supply
curve, which shows the relationship between the quantity supplied and
the price.
The point where these two curves intersect is the equilibrium point,
which determines the equilibrium price and quantity in the market.
Now, suppose there is a per unit tax imposed on this good or service.
This tax shifts the supply curve upward by the amount of the tax. This
creates a new supply curve that is parallel to the original one.
The new supply curve intersects the demand curve at a higher price
and a lower quantity than the original equilibrium point. This means
that the tax reduces the quantity traded in the market and increases
the price paid by consumers.
The difference between the new price paid by consumers and the
original equilibrium price is the tax burden borne by consumers. The
difference between the original equilibrium price and the new price
received by producers (which is lower than the new price paid by
consumers by the amount of the tax) is the tax burden borne by
producers.
The tax burden depends on how steep or flat the supply and demand
curves are. When the supply curve is more elastic (flatter) than the
demand curve, it means that consumers bear a larger share of the tax
burden. When the supply curve is less elastic (steeper) than the
demand curve, it means that producers bear a larger share of the tax
burden.