Economics and the Business Environment
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Question one
(a)
Profit maximisation in a monopolistic business environment is achieved when the marginal revenue is equal to the marginal cost (MR = MC). The average total cost should come below the market price for the firm to earn an economic profit.
Using the diagram, the marginal Revenue Curve intersects with the Marginal Cost function Curve at a maximising Quantity of 400 Units which gives an optimal demand price of 100. This is the price and quantity the firm should produce to maximise its profits if the firm decided to produce fewer units (240 Units) where the MR<MC this would result in the company losing money as the cost of producing an additional unit I higher and the company is losing money.
On the other hand, if the company decides to produce 680 units where the MR>MC, the company would be making a profit per unit, but this will reduce the demand for the product.
Therefore, the optimal demand price and quantity for this type of market is at 400 Units and a demand price of 100.
(b)
The level of output and prices determined revenue and costs. At the optimal profit-maximising point where the Marginal Cost (MC) = Marginal Revenue (Q = 400 Units, P = 100).
Total cost, on the other hand, is a product of the average cost per unit and quantity of output (Spulber, 2017). Therefore,
(Where 40 is the average total cost of producing a single unit, inclusive of fixed costs.)
(c)
The firm maximises its profit when the MC = MR. The level of profit does not depend on the competition in monopolistic competition since the competition is zero. Therefore, given that the demand (Average Revenue) is above the Average total Costs ( ATC) at the optimal price and quantity of 100 and 400 units respectively the supernormal profit are possible and are represented by the diagram above in the shaded region.
Since there exists no close substitute in the market, the monopolist makes the supernormal profits since the Average Revenue (AR) exceeds the Average Cost (AC).
The profit is 60% of the total revenue, which is significantly high.
(d)
It is highly unlikely that the diagram depicts a long-run equilibrium of a monopolistic market since the demand curve would have been a tangent to the firm’s average cost curve and thus making the firm unable to make profits beyond the break-even point.
Thus the diagram does not depict a long-run equilibrium but instead shows a short-run one. Unlike monopoly and perfect competition markets, monopolistic markets have many sellers and freedom of entry and exit. In the short-run, firms can make supernormal profits. In the long-run, however, these profits would attract more firms into the market, and lower the existing firms’ demand, causing the average cost to be equal to prices (Bertoletti and Etro, 2017). In the short run, the monopolistic market behaves like a monopoly and is subject to supernormal profits; however, in the long-run, many firms are attracted to enter the market reducing the profit for the existing firm leading to normal profits. Equally important to mention is that inefficient ones are highly likely to exit the market (Trading Economics, 2020).
Question two
Policy 1: Banning the consumption of alcohol in public places, i.e. alcohol can only be purchased for consumption at homes but no longer in bars, restaurants etc.
Alcohol consumption
Banning alcohol consumption through government intervention is a positive externality because less alcohol will be consumed, reducing the number of alcohol-related deaths or diseases. In order to put this into perspective, alcohol has many associated ailments which burden the care system financially; second, alcohol has associated issues like accidents and alcohol-related violence. As such, it least to divert investment from other essential issues. Further many nations are burning the use of alcohol in public places in the eave of the novel COVID 19 because it has an adverse health outcome of spreading the virus (Spulber, 2017)
On the other hand, the business that deals in alcoholic beverages will be affected, especially the small vendors who will have to close shop. Although the policy will bring more benefits than costs overall, there is the belief that the government could apply an amendment, and instead of banning the consumption, they could limit the allowance of drinks for each consumer by just a maximum of two glasses; thus, either social and private will have benefits. In this economy without the positive externality, without the ban on alcohol in public places, here will be overconsumption (Qe where private marginal cost = private marginal benefit) because consumers ignore the external costs (Spulber, 2017)
Bunning of consumption of alcohol in public places in the UK will result in an increase in the Social marginal cost since people will order more to drink from their homes while the producers will increase the price of the alcohol to cover the cost of delivery of their products. This will result in an increase in the Marginal Social Cost. The social equilibrium will shift due to an increase in the Social Marginal cost and thus reducing the Social benefits that would have been derived from the creation of the policy. Therefore, the policy would bring more harm than benefit and thus I would recommend looking at restricting the number of hours instead of having a total ban on the consumption in the bars.
Policy 2: Making education free up to undergraduate degrees across the UK for all citizens, i.e. a person would only need to pay for a Master’s level degree or above.
Provision of free education in the UK to undergraduate levels will shift the Social Equilibrium increasing the Social Marginal Benefit since more skilled labour that is productive will enter the market, increasing its output.
Furthermore, Marginal cost will increase since the government of the UK will be using more funds to support the education system than before. Also, the cost of a graduate degree is reduced. The marginal benefit arises since the students no longer have a debt to service after they finish their graduate degree. If they are offered a free university education, they can concentrate more on developing themselves rather than paying students jobs after securing a job (Murphy, Scott, and Wyness, 2017). Free university education significantly contributes to a high-tech economy since students gain innovative skills. (Murphy, Scott, and Wyness, 2017). Although the government may incur a high cost providing free education, I believe the loss can be compensated in future when the students have graduated and used the skills and knowledge gained in economic development (Jungblut, Vukasovic, and Steinhardt, 2020). Improved skills and technology lead to improved productivity which is the major contributor to economic growth and development.
Therefore, holding other factors constant, the marginal social benefit derived from offering free education to undergraduate level outweighs the Social marginal cost of facilitating the policy and thus a great economic policy too for the UK government.
Question three
(a)
For an economy to attain the equilibrium level of income, the aggregate demand must equal aggregate demand.
AD = C + I + G + NX
C = a + b (Y – tY)
Y = AD
Y = a + b (Y – tY) + I + G + NX
Y = 10,000 + 0.4 (Y – 0.25Y) + 15,000 + 20,000 + 5000
Y = 50,000 + 0.4Y – 0.1Y Y – 0.3Y = 50,000 0.7
Y = 50,000 Y = 71,428.57
(b)
If the government increases its spending in the economy by 20,000, the value of G will increase to 40,000.
The new equilibrium income would be;
Y = 10,000 + 0.4 (Y – 0.25Y) + 15,000 + 40,000 + 5,000
Y = 70,000 + 0.3 Y Y – 0.3
Y = 70,000 0,7Y = 70,000
Y = 100,000
Y1 – Y0 = 100,000 – 71,428.57
Y1 – Y0 = 28,571.43
By the increasing of 20,000, the government achieved an increase of 28,571.43; therefore, the government does not achieve the desired increase of 30,000. The government does not achieve the desired increase of 30,000. How much should the government increase their spending to achieve the 30000 increase in national income (to the nearest whole number)? (Hint: consider the what the multiplier in this economy is)
(Y2 − Y1) /∆ G = 100,000 − 71,428.57 20,000
(���2 − ���1)/ ∆ ��� = 28,571.43 20,000
(���2 − ���1) /∆ ��� = 1.4285715
Multiplier = 1.4285715
∆ ��� = 30,000 /1,4285715
∆ ��� = 20,999.99895
The government should increase their spending by 20,999.99895 to achieve a 30,000 increase in national income.
Question Four
The Bank of England is responsible for the management of monetary policy which it uses to control inflation and economic development. It implements the policy by influencing money supply and using interest rates. Conversely, fiscal policy controls activities in the economy through government spending and taxation and also controls the levels of national borrowing (Dosi et al., 2015). Monetary and fiscal policy focus on reducing the level of inflation, strengthening economic development and growth, reducing unemployment, preventing deficits in the balance of payments and maintaining sustainable public finance. Monetary policy controls interest rates. In that, if inflation is predicted to rise above the targeted level, the bank increases interest rates. Increased interest rates lead to decreased demand and hinder faster economic growth.
The monetary and fiscal policies can be used to increase the production capacity of the economy and hence increasing the real national output or income. Those that still have jobs and their aggregate demand and consumption have been affected by the lockdown constraints may be offered tax benefits to increase their disposable incomes. This effort will increase the amount of income available to the consumers in the UK and consequently increase the aggregate demand.
Therefore, the government’s decision on spending and taxation as a fiscal policy generally increases the aggregate demand as the disposable income increases, increasing the consumption levels of the households as shown below.
Using fiscal policy to increase aggregate demand and consumption
Monetary policies, on the other hand, can be used to restart a slowly growing economy by influencing the quantity of money in circulation through credit and interest rates. The interest rates can be reduced to increase the lending by banks and financial institutions. As a result, the banks would lend to SMEs spurring economic growth as a result of low-interest rates. This helps in the revival of the economy, which reduces inflation and boosts economic growth (Issing, 2005).
Furthermore, the government may influence the economy through open market operations. This is changing the reserve requirements by Banks to the Bank of England and providing discounts. Lower reserves and Discount rates will help inject money into the economy, thus increasing the circulation of money in the economy.
Unconventional monetary policy can be applied in exceptional circumstances. For instance, from 2009 to 2017, the Bank of England experienced insufficiency of low-interest rates in restoring the normal levels of economic development. Thus, the bank used quantitative easing, which involved raising money supply and purchasing government bonds. The government of the UK could apply the fiscal policy in the moderation of the economic cycle. A stable inflation rate in the economy tends to eliminate the vital sources of macroeconomic volatility (Dosi et al., 2015). In that, the likelihood that economic blows impacting inflation in the short term become more augmented through a consistent alteration in inflation prospects. In return, the stable nature of the prospects promotes economic welfare by reducing inflation risk, as seen in nominal bond yields. Monetary policy contributes significantly to macroeconomic stability by ensuring price stability. Fiscal policy sustains aggregate demand as well as private sector income to promote macroeconomic stability during the economic downturn. It also moderates economic activities during economic growth. Fiscal policy increases employment by raising aggregate demand, increasing output which leads to more job creation based on Keynesian theory (Paparas, Richter, and Paparas, 2015). Policy conflict may occur since both monetary and fiscal policy can result in contraction or expansion of GDP. By undertaking a reduction in the interest’s rates, there is an effect in the rates of borrowing; this is likely to promote spending and investing, which result in higher aggregate demand (Issing 2005).
Source: (Issing, 2005).
In a situation where the government raises the amount of liability that it issues all through an expansionary fiscal policy, supplying bonds in an open market will result into a competition with the private sector at the same time. That led to crowding out which indirectly increased the rates as a result of the raised competition for borrowed funds. The government is facing a challenging situation during the current COVID-19 pandemic, which would significantly impact the efficacy of monetary as well as fiscal policy in the control of economic growth and employment (Diaz-Bonilla, 2020). The UK is an exhausting monetary policy to moderate the lockdown impact, and other actions have been taken in the attempt to control the spread of the infection such as termination of business and the consequential unemployment. The government may face challenges trying to apply the monetary and fiscal policy in achieving employment and economic growth since most businesses have been closed, productivity has decreased, and most people remain jobless which also reduce the output (Paparas, Richter, and Paparas, 2015). Most industries have been significantly affected, which reduce the tax and revenues corrected by the government. The government may also be required to spend more on supplying food and medical services to the citizens (Diaz-Bonilla, 2020). The pandemic has affected the national and global economy, which may make it challenging for the government to apply the fiscal and monetary policy in increasing economic growth and employment. However, by implementing price stability households and firms would be able to make informed decisions regarding savings and investment for sustainable economic growth (Paparas, Richter, and Paparas, 2015)
Question Five
Pound Sterling
The significant reduction in confidence within the UK will mean that the Pound Sterling is likely to result in a devaluation of the Pound Sterling (£). Further, the local investors also as a result of the uncertainties of the economy would tend to invest overseas (capital flight) (Trading Economics 2020). This means that the money demand curve will shift to the left since investors are least attracted to invest in the Pound Sterling (£)
Source: (Trading Economics, 2020).
Euro
Quantitative easing is a method deployed by central banks to help spur economic growth lowering long-term interest rates making it easier for banks to lend, the central banks act by increasing the supply of money into the economy directly. The European Central Bank is likely to deploy this tool. As a result, there is a likelihood of increased investment owing to the low-interest rates, which would mean increased borrowing. As a result of the increased supply of money, the supply curve would shift to the left, creating an increased demand for money, but a fall in the interest rate (Togoh 2019).
Source: (Togoh 2019.)
Canadian Dollar
There would be a likely demand for the Canadian dollar leading to an increased foreign direct investment. The value of the currency will, therefore, appreciate because it will be the currency of choice for investment. As a result, the demand curve experiences a shift to the right due to increased demand for the Canadian dollar (Smith, 2020).
Source: (Smith, 2020).
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