Economic priciples

Answers are provided for Task 1, Task 2, and Task 3; also, for Task 4 part (a), one example is provided. For these, you are to critically evaluate the answers. Some of them are correct, but some of them are incorrect. If an answer is correct, you are to state that it is correct; if an answer is incorrect, then you are to state why it is incorrect and to provide the correct answer.

An answer may be incorrect due to any of the following three reasons:
(i) the application of the concept or definition is faulty;
(ii) the calculations contain an error that leads to the incorrect conclusion; or
(iii) the conclusion is correct despite the calculations containing an error.

An example of the third would be if the question asked to identify which of two different situations has the greater Consumers’ Surplus; the answer provided could have calculated 100 and 80 leading to the conclusion that the first situation has greater CS, even though the correct calculations are 120 and 80.

The answers for you to evaluate are in blue; write or type your comments and corrections in standard black.

For Task 4, there are two parts, (a) and (b). In part (a), two examples are asked for, but only one is provided. In addition to critically evaluate the first example of this part, you are to provide a second example; you are also to answer part (b).
CORRECT OR INCORRECT ANSWERS

Task 1: Analysis of Supply

There are two types of producers: those that use a labour-intensive technology, and those that use a capital-intensive technology.

Below, QSL represents the quantity supplied by a producer that uses a labour-intensive technology; similarly, QSC represents the quantity supplied by a producer that uses a capital-intensive technology. QS represents the quantity supplied by all producers in the market.

There are 100 firms that have the labour-intensive technology; each has

• a total cost function TC(QSL) = 10 + 2QSL + 0.5QSL2; yielding
• a marginal cost function given by MC (QSL) = 2+QSL.

There are 50 firms that have the capital-intensive technology; each has

• a total cost function TC(QSC) = 100 + 10QSC + 0.25QSC2; yielding
• a marginal cost function given by MC (QSC) = 10 + 0.5QSC.

(a) Determine the market supply. Graph it.
(4Points)

The market supply is the total quantity supplied by all firms, for each different price. Since there are many firms, the market is perfectly competitive. Thus, each firm’s supply curve is its MC curve.

Thus, for a given P:

ifP<2, then each labour-intensive producer produces 0 units, and each capital-intensive producer produces 0 units;
if2=P<10, then each labour-intensive producer produces QSL=P-2 units, and each capital-intensive producer produces 0 units;
ifP=10, then each labour-intensive producer produces QSL=P-2 units, and each capital-intensive producer produces QSC=2*(P-10)=2P-20 units.

For the number of each type of producer, the market supply is:

• 0 for P< 2;
• 100P-200 for 2=P<10; and
• 100P-200+50*(2P-20) = 100P – 200 + 100P -1000 = 200P – 1200 for P=10

(b) Define the productivity of labour. In general, how does it relate to the amount of capital that a producer has? That is, does labour become more or less productive as a producer has more capital? Provide an example.
(2Points)

The productivity of labour is another term for the marginal product of labour. It is the amount of additional output that one more unit of labour input produces. For example, a trained chef can produce a good three-course meal for four persons in one hour; whereas, a mere aspiring cook could produce the same three-course meal for one person in two hours. The marginal product of one hour of labour of the trained chef is four good three-course meals, the marginal product of one hour of labour of the aspiring cook is one-half of a good three-course meal.

Usually, the more productive that labour is, the less capital that the worker needs. Great chefs know how to make a great meal despite using an oven that does not heat evenly, or knives that are dull, or mixing bowls that have cracks that leak. Thus, as producers use less capital, labour is forced to become more productive.

(c) Discuss why a market for a good might have two different types of producers, each using a different mix of inputs to produce the same output. Provide a simple example that shows how the relative productivities of labour and capital, and their relative costs, would induce producers in one economy to adopt a more labour-intensive technology than producers in the other economy adopt.
(3Points)

The choice of how to produce a good at least cost depends upon the relative productivities of each input as well as the relative cost of each input. Either or both the relative productivity and the relative cost of each input can differ between two different areas or economies.

Suppose that in economy A, the marginal product of labour is twice that of the marginal product of capital — that is, labour is twice as productive as capital. In economy B, the marginal product of labour is the same as the marginal product of capital. In addition, the cost of a unit of labour (the wage rate) in economy A is twice the cost of a unit of labour (the rental rate). In economy B, the wage rate and rental rates are the same.

Then economy A will use a more labour-intensive technology and economy B will use a more capital-intensive technology.

(d) Determine the combination of output levels at which the marginal costs are the same. Determine the threshold output level for the industry at which the labour-intensive producers lose their cost advantage — i.e., at what price does each labour-intensive producer and each capital-intensive producer choose the same output?
(3Points)

2+QSL = 10 + 0.5QSC implies that QSL = 8 + 0.5QSC. If QSC = 16, then QSL = 16. This yields a market quantity supplied of 16*100=1600 by the labour-intensive producers and 16*50 = 800 by the capital-intensive producers. Total industry output is 2400, which implies that P=18. For any P>18, each capital-intensive producer chooses a greater output level than each labour-intensive producer chooses.
Task 2: Analysis of Demand and Equilibrium

Let the market demand be given by QD = 8400 – 20P, QD where is the quantity demanded by the market.

(a) Determine the equilibrium market price and market quantity; determine the quantity and profits of each labor-intensive, and each capital-intensive producer.
(3Points)

In equilibrium, demand equals supply. Thus, 8400 – 20P = 200P – 400 if P=10. This is 8800 = 220P or P = 40.

This implies that QSL = P – 2 = 38, and QSC = 2P – 4 = 76. Total quantity supplied is 38*100 + 76*50 = 3800 + 3800 = 7600.

A labour-intensive producer earns revenue 40*38 = 1520; its total cost is: 10 + 2*38 + 382 = 10 + 76 + 1344 = 1430, yielding a profit of 90.

A capital-intensive producer earns revenue 40*76 = 3040; its total cost is 100 + 10*76 + .25*7 = 100 + 760 + 1504 = 2364, yielding a profit of 676.

(b) If the market is perfectly competitive, is it in long-run equilibrium? Explain.
(3Points)

In a perfectly competitive market, each firm produces a homogeneous good and there are many producers. Thus, each firm is a price-taker, so that MR = P. Since there are no barriers to entry, profit in the long-run must equal 0, so P = ATC. Moreover, profit-maximisation requires that MR = MC. Thus, MC = MR = P = ATC implies that MC = ATC, which occurs only at the value where ATC is at its minimum.

Since eachlabour-intensive and each capital-intensive producer earns a positive economic profit and there are no barriers to entry, other producers would enter the market with either technology.

Since there would be entry, the market is not currently in long-run equilibrium.
Task 3: Analysis of Market Interventions

Consider two goods: manufactured clothing, and pharmaceutical development, each of which can be produced in Australia and in Bangladesh. The following table describes the number of units of production that are possible in each country, using the same amount of labour:

CountryGood Clothing Pharmaceuticals
Australia 50 10
Bangladesh 30 2
(a) Which country has an absolute advantage in the production of clothing, and which in the production of pharmaceuticals? Which country has a comparative advantage in the production of clothing, and which in the production of pharmaceuticals? On which concept is trade based? What would each country specialise in and what would each import?
(4Points)

Since Australia can produce 20 more units clothing than Bangladesh can (50-30=20), but can only produce 8 more units of pharmaceuticals than Bangladesh can (10-2=8), Australia has an absolute advantage in the production of clothing; since no country can have an absolute advantage in the production of both goods, it must be that Bangladesh has an absolute advantage in the production of pharmaceuticals.

Comparative advantage is based upon opportunity cost. Australia’s opportunity cost of one unit of clothing is 5 units of pharmaceuticals (50/10 = 5); Bangladesh’s opportunity cost of one unit of clothing is 15 units of pharmaceuticals (30/2 = 15). Since 5<15, Australia has a comparative advantage in the production of clothing.

These opportunity costs of clothing imply that the opportunity costs of pharmaceuticals are 1/5 for Australia but 1/15 for Bangladesh, so that Bangladesh has a comparative advantage in the production of pharmaceuticals.

Trade is based upon the principle of absolute advantage; thus, Australia would produce pharmaceuticals and Bangladesh would produce clothing — they would then trade, Australia importing clothing from Bangladesh, Bangladesh importing pharmaceuticals from Australia.
Suppose that, despite the different advantages, clothing is produced in both countries; moreover, Australia consumes clothing both that is produced domestically and that is imported from Bangladesh. Assume that the relative price of labour-to-capital is much greater in Australia than it is in Bangladesh; for example, if an Australian producer could hire three units of labour for the same wage that it costs him to hire one unit of capital, a Bangladeshi producer could hire eight units of labour for the same wage that it costs to hire one unit of capital.
(b) For clothing, which type of producer is likely to exist in Australia? Which type of producer is likely to exist in Bangladesh?
(2Points)

Since labour is relatively cheap in Bangladesh compared with Australia, Bangladesh is likely to produce clothing using a labour-intensive technology, whereas Australia is likely to produce clothing using a capital-intensive technology.

(c) In the Australian parliament, the MP who represents the township of Lilliput proposes that the government subsidises an input that would favour the producers in Australia. Which input — labour or capital — would this Lilliputian MP want to subsidise in order to help Australian producers of clothing?
(3Points)

As Australian clothing producers are capital-intensive, subsidising the hiring of labour would lower the marginal cost of Australian producers more than subsidising the hiring of capital would.
(d) Another MP, who represents the township of Laputa, states that subsidising the input that theLilliputian MP suggests, is distortionary and will result in an inefficient allocation of inputs. He argues instead in favour of a tariff on imported clothing. Outline the critique by thisLaputian MP of the subsidy proposed by the Lilliputian MP. Which policy — subsidy, tariff, or neither — yields the greatest total welfare for Australia?
(4Points)

The Laputian MP is correct, that subsidising the hiring of labour does create a distortion, inducing Australia’s clothing producers to hire more labour and less capital than is efficient. A subsidy costs the government revenue; whereas, a tariff generates revenue for the government. Moreover, Australia, and the world, are better off by reducing the number of imports since local production uses less fuel and thus produces fewer greenhouse gases. The greatest total welfare for Australia would be if the Australian government imposes tariffs on imported clothing.
Task 4: Other Products
(a) Choose two other products for which the costs of production have changed dramatically over the past 10, 20, 100 years or some other timeframe. For each, describe how the changes in production technology have affected the types of producers that operate, and where those producers operate.
(4Points)

In agriculture, the development of tractors that can replace the horse-and-plow has caused farms to become more capital-intensive and less labour-intensive. Since these tractors operate efficiently on larger scales, farms have also grown in size. In other words, one farmer with one tractor can work many more acres today than 10 farmers each with a horse-and-plow could work 100 years ago. Thus, in the developed world across time, two vastly disparate technologies have been used to produce the same agricultural product.

In poor or developing economies, however, agriculture is still very labour-intensive because they cannot afford to purchase the tractors. Thus, even at the same time, there are two different technologies that are used to produce the same agricultural product.

You are to state whether the example above is correct or incorrect — and if incorrect, to state why and make it correct, and then you are to provide a second example of a product for which the costs of production have changed dramatically over some timeframe.

(b) What do you think will happen to the product of education, given the ability of MOOCs and iTunesU and Kahn Academy to disseminate knowledge around the world at a very low cost.

You are to argue using economics whether or how education will change. You may look at Kahn Academy and iTunesU, and search about the “flipped classroom.”

You can consider elementary or secondary education, or vocational training or university education.
(3 Points)