Economics Case

1. Introduction

            In this era of trade and business, economics holds significant importance for human existence. An economic crisis would severely impacted every other aspect of human’s life, as we witness in 1930, when America suffered from the Great Depression and in the recent late 1990’s when some of the Asians countries faced the economic crisis. The difficulties which started with economic irregularities have proven to be very contagious to other aspect of human order.

            Economic researches and observations conducted, resulting profound understandings of natural economic mechanisms hidden inside our everyday lives. It turns out that whether in a larger scope of a nation of in the smaller scope of a single enterprise, proper understanding of economics and its practices are required to build desirable construct of a nation’s economy. Macro Economics elaborates findings within a larger scope of a nation, while Micro Economics describes smaller scopes for a more detailed analysis.

1. Question
2. Production Possibility Curve, which also known as Production possibility Frontier, is a graph that describes the trade-off between two items produced in a particular environment.

Figure 1          Production Possibilities Curve

Source: ‘Production Possibility Frontier’, Wikipedia, [Online] Retrieved May 10, 2005, Available at http://en.wikipedia.org/wiki/Production_possibility_frontier

Areas inside the curve represents the production capacity of an economy, relating to its factors of production, technology and management skills. Areas outside the curve represent the area beyond the economy’s production capacity. It cannot be reach without certain improvement in the three aspects mentioned. The curve itself represent the optimum output of an economy which can only be reached if the economy are effective or there is no slack of existing production capacity in anyway. Most economy operates well inside the PPC.

Some of the PPC’s importance is its ability to provide an undertanding of opporunity cost. In a PPC, if we are to increase the production of an item without any changes of existing factors of production, technology or management skill, then we have to reduce the production of the other product by a certain amount. Or for example, in order to increase certain amount of computers produced in the economy(to move from FB to FA), it is required to reduced the production of a certain amount of food (to move from CB to CA). The final outcome would be the shift from point B to point A.

Below is a few applications of PPC within a few assumptions.

                  A                                                  B                                             C

Coke                                                  Beef                                             Pork

                        Pepsi                                                 Lamb                                             Wheat

Assumptions :

• In table A, there is a perfect substitution betweem the two goods, where each good are valued the same way.

• In table B, dua to existing factors of production, technology and management skills in the economy, to produce a single lamb requires more effort than to produce beef. The Lamb is considered more valuable than the beef, thus the production of a single lamb can be traded-off for comparatively more production of beef.

• In table C, the pork is considered harder to produce in the economy, thus the production of a comparatively more wheat can only be traded-of with production of a single Pork

1. Supply and Demand Model in various cases.

                                    A                                                                             B

Price                                                                            Price                      a

                                    a

                                b                                                                                 b

                        Quantity                                                                     Quantity

C                                                                           D

Price                                                                           Price

                                    a                                                                     a

                                b                                                                                 b

                        Quantity                                                                     Quantity

Directions:

• The red lines describe The Demand Curve,
• The blue lines describe The Supply Curve and,
• The arrows display the movement of the curves.
• Model A displays the Australian Lamb Market

Assumptions :

The Mad Chicken disease in US and Europe market raise a significant question over Australia’s chicken market. Chicken consumer begin to ‘shifted’ to substitutional products, and one of those products is the lamb. The condition resulted the demand for lamb increased and shifted the equilibrum from point b to point a.

• Model B displays the Organic Vegetables Market

Assumptions :

As the technological advancement increase productivity, the supply curve shifted upways, while the increasing health consideration shifted the demand curve rightways, thus the overall condition causes the market equilibrium to shifted from point b to point a.

• Model C displays the Genetic Manufactured Vegetables Market

Assumptions :

The consumer’s increasing health considerations lower the demand for GM vegetables, resulting the demand curve to shift to the left and the equilibriun shifted from point a to b.

• Model D displays the European Horsemeat Market.

Assumptions :

Inefficient processing and the animal rights movements has reduce supply of horsemeat, causing the equilibrium to shift from point a to point b.

III.      Question 2

1. Law of Demand

The law of demand states that buyers of a good will purchase more of the good if its price is lower (and vice versa).For example, Pepsi Cola. Currently, according to Consumerguide.com, “the price of 2-liter bottle of Pepsi cola is $1.89. According to law of demand, if the price of the 2-liter bottle of Pepsi Cola decreases from $1.89 to $1.6, consumers will buy more Pepsi” (“Pepsi”).

According to the author of “Supply and Demand,” he says that the law of demand assumes other relevant variables remain constant. Therefore, it is possible that as the price of 2-liter bottle of Pepsi decreases from $1.89 to $1.6, consumers purchase fewer Pepsi. The reason explaining this phenomenon is that buyers’ real incomes decline, so that, even though the price of a bottle of Pepsi is lower , they just can’t afford  to buy as many as they want.

However, the situation does not infringe the law of supply and demand theory since in the latter example assumes that other variables are not held to be constant. If all variables are constant, then according to the theory we might see that consumers will buy more Pepsi as the result of a price decrease.

There are several factors that influence and determine the demands of any products or services as follow:

1. A Change in Buyers’ Incomes and Wealth

According to Howard Community College, “the demand for most products will go up of buyers’ real incomes or real wealth, i.e., their purchasing power rises”

1. Buyers’ Tastes and Preferences

Another factor that influences the demand for a product is buyers’ tastes and preferences. It makes sense since 1980s, for example, megastars such as Michael Jackson and Lionel Ritchie become a model Pepsi cola that will drive the fans of the two megastars to follow what their idols drink as well, that is Pepsi Cola.

1. The Prices of Related Products or Services

Consider the Pepsi case. The demand for Pepsi will decline (assuming no other changes) if the price of related good, for example, Diet Coke, decrease. It means when the price of substitute fall then the demand of a product will drop as well (and vice versa). In this manner, the price of complement will also affect the price of a product. For example, the drop in the price of Pepsi Blue will increase the demand of regular Pepsi Cola (and vice versa).

1. Buyers’ Expectation of the Product’s Future Price

This factor will play a role when, for instance, the nearest local supermarket announces that the price of Pepsi Cola will increase next month. This will drive consumers to buy Pepsi now (and vice versa). Therefore, this kind of determinants will increase current demand and shift the demand curve to the right.

1. The Number of Buyers (Population)

This determinant influences the increase in the demand of Pepsi Cola if the population of buyers of Pepsi Cola in an area or location increases. This is true by referring to the following table that shows percentage of Pepsi Cola consumptions to population.

1. Elasticity of Demand

Elasticity by nature refers to the change of demand and supply as a response toward various stimuli (‘Supply and Demand’ 2005). For a more specific discussion, we will elaborate Price Elasticity over Demand. Price Elasticity of Demand is the responsiveness measure of quantity demanded to a change in price, with all other factors held constant (‘Price Elasticity of Demand’ 2004).

For example, if the price elasticity of demand is 2, it means that if price is raised from the prevailing level, the percentage change in quantity demanded will be 2 times the percentage change in price.  For example, if price of Pepsi Cola is raised 1 percent, quantity demanded will fall 2 percent.

Price Elasticity of Demand is defined as a measure of the responsiveness of quantity demanded to changes in price that satisfies following formula:

Price E_d =

For example, if the price elasticity of demand is 2, it means that if price is raised from the prevailing level, the percentage change in quantity demanded will be 2 times the percentage change in price.  For example, if price of Pepsi Cola is raised 1 percent, quantity demanded will fall 2 percent.

            Elastic Demand                      Elasticity = 1                          Inelastic Demand

Price  1      a                           Price                a                      Price  1           a

         2                         b                   1                                              2              b

                                                        2                        b                                                                           c                  d                              c           d                                             c  d

          Quantity                                            Quantity                                 Quantity

In an Elastic Demand Model, a change in demand (shift from point 2 to 1) will result a very significant change in quantity demanded (shift from point d to c), on the contrary, in an Inelastic Demand Model, the price change (shift from point 2 to 1) will result only a little change (shift from point d to c) of quantity demanded. Nordhaus (2002) presents some determinants which deferenciate between elastic and inelastic goods are:

1. Primary, secondary or luxury

For goods of primary needs such as food, gasoline and clothing, demand tends to be inelastic. The human nature to be dependent to these goods resulted suppliers to have a little power over price

1. Existance of Substitution Goods.

Goods without substitutions tends to be more inelastic compared to goods replaceable by many substitution products

1. Urgencies of Product (time factor)

If you are riding a large luxurious vehicle consuming a large quantities of gas, and suddenly, the news said that gas prices are increasing, would you just stop buying gas? It would atleast take you one or two weeks to decide to sell your car and get smaller and more efficient car. During that time, you have no choice but to keep buying the more expensive gasoline. These types of goods tends to be more inelastic

1. The Goods’ Economic Significance

Cheap products tends to be more inelastic compared to expensive ones

IV       Question 3

1. The lawn mowing market are not a market of primary goods, therefore, the demand is supposedly quite elastic. In a competitive market, the product is variative and the resources are allocated efficiently to ensure competitive prices.

A perfect monopoli is a condition where there are only one supplier of the industry and there are no other industry producing similar or substitutive goods. Within this condition, the supplier has a vey high degree of price control. Customers have no power over price due to the lack choice of producers. As mentioned before, the products in monopoly are without any competitive substitution, thus allocation of resources are not as efficient as the competitive market

                        Before Takeover                                After Takeover

            Price                                                        Price

                                     Quantity                                                Quantity

As we can observe from the above grapic, the takeover would significantly effect the elasticity of demand (producing kinked demand). Having an inelastic demand market, supplier will most likely to raise prices and obtaining significant profit. The profitable market would then result the industry to be very interesting for competitors. For this reason alone, the monopoli would not survive for very a long time.

1. Monopoly are a condition where the supplier obtains absolute power over market.
2. There are no restraints over its bahavior due to its freedom of determining price. A monopoly firm especially in the primary goods market, can increase prices without significant decrease in quantity demanded, which will eventually resulted pressure toward the weaker part of the society. The Government usualy tries to prevent monopolies from happening in our modern market by applying certain business regulations and conducting the anti monopoly laws (Nordhauss, 1992).

            Another famous example of moompoly is Microsoft dominane in computer software market that ends up in antitrust case. The antitrust case against Microsoft is somewhat similar to other antitrust cases in which Microsoft’s domination in computer software has prevented other software firms to grow and compete fairly.

Therefore, the antitrust case against Microsoft is about restricting consumers to choose a variety of software. However, such action reflects what Americans fear about that Japan and Europe will take over their domination in economy.

According to Mike Ingram in Settlement Reached in Microsoft Antitrust Case, there are a lot of evidence that show how Microsoft had subverted new technologies such as the Java programming language, in order to ensure the dominance of the Windows desktop. The situation obviously reflects a growing feeling that in protecting its dominant place in the market for desktop computers, Microsoft was retarding the development of new technologies emerging around the Internet.

The main reasons of emerging antitrust case against Microsoft lie on the company’s decision to bundle the Internet Explorer browser with the operating system under a project named Marvel. The main purpose of Marvel was to kill off America Online, Compuserve, and Prodigy, who appeared set to dominate the emerging sector of electronic commerce.

1. One of the cruelest examples of monopoly in history is the salt monopoly by “La Gabelle”. Before common, salt producing capacity was subject to climate and environmental conditions. As the sea level wasn’t very encouraging and the location of salt farm is undesirable for transportation, salt became scarce. By that time, everyone was still allowed to purchase salt, but the supplier and distributor was subject of strict control by the few who monopolized the few inland source. The monopoly is this particular case cannot be establish without government interference. As salt are as important as food and water for the human body, the monopoly of salt hold a very significant economic concentration. These kinds of monopoly certainly would have negative impact on society’s welfare and should be addressed immediately (‘Monopoly’ 2005).

Question 4

The meaning of the word Oligopoli is “several sellers”. Oligopoli is a condition where severeal companies producing identical (or almost identical) products obtaining control of most of the market share. One of the most important aspect of determining whether an Oligopoli has been conducted or not is to identify the level of cooperation between the companies. If all of the companies are working together to ensure mutual profit, then a colution has been formed (Nordhaus 1992).

One of famous Oligopoly model is Bertrand’s Oligopoly model. In this model, Bertrand assumes several points that are applicable to any industry in which there are some barriers to entry the market as follows:

1. Few firms serving many customers
2. Firms produce identical or differentiated products
3. Each firm chooses its price to maximize its profits given a conjecture about the prices charged by rivals. Equilibrium obtains when these conjectures are all correct.

i.e. Nash Equilibrium in prices!

4. Perfect information, no transaction costs
5. Barriers to entry exist

In the early years of American Capitalism, companies with mutual goal often combine their company to form a trust or a cartel. To avoid ‘unprofitable’ competition, these companies worked together and increase their prices to ensure mutual profit. By definition, Cartel is an organization of independent companies, producing similar or the same product, increaasing their prices and limiting production output. Explicit or implicitly, the companies had a good chance of obtaining absolute control as displayed by a single monopolist. The government have long realized this possibility and reacted by regulating the antitrust laws within the economy (Nordhaus 1992).

Price leadership is a condition where several dominant competitors lead the way in determining price. After the ‘group’ sets a certain price, others usually follow. Even though price leadership practice could guarantee higher profitability for producers of the industry, such an arrangement has proven to be unstable (‘Price Leadership’ 2005).

The famous and well-known cartel/oligolpoly in the world is OPEC. OPEC is an organization that composes of seven oil-producing countries (Algeria, Indonesia, Iran, Iraq, Kuwait, Libya, Nigeria, Qatar, Saudi Arabia, the United Arab Emirates and Venezuela) which are heavily reliant on oil revenues as their main source of income.

Since oil revenues are so vital for the countries’ income, OPEC aims to bring stability to the oil market by calculating then adjusting their oil output to ensure a balance between supply and demand. Currently, OPEC’s eleven members represent 40 percent of the world’s oil output and possess over three-quarters of the world’s total proven crude oil reserves.

Under such circumstances, OPEC’s members have ability to play around the price of oil by limiting the volume of oil output to increase the oil price in the market. This is done so to ensure that OPE C’s member countries achieve a reasonable rate of return on their investments.

However, since in the current condition, non-OPEC oil producing countries like U.S., China and other countries holds 60% of world’s total oil output, they have ability to counteract once they found the OPEC’s members try to play the oil price. However, in the long run, the non-OPEC oil producing countries will lose their strength since OPEC’s members holds more than 75% of total oil reserves.

In addition to cartel defiition and example, there is another terminology: Kindked demand. Kinked demand is the result of powerful pricing influence hold by one or several producers over primary goods or goods which required by many. If the company / companies increasing price above competitive price, result only little difference in quantity demanded, than a kinked demand has been formed.

Figure 2          Kinked Demand

Source: ‘Oligopoly Kinked Demand I’, OnlineTexts.com, [Online] Retrieved May 11, 2005, Available at http://www.econweb.com/Sample/Oligopoly/KindedDemand1.html

Bibliography

‘About OPEC’, OPEC.org, [Online] Retrieved May 13, 2005, Available at www/opec.org/search

Evers, Joris. 2004, ‘DOJ Critiques EU’s Microsoft Ruling’, Computerworld, [Online] Retrieved May 13, 2005, Available at http://www.computerworld.com/softwaretopics/os/windows/story/0,10801,91607,00.html

‘Functions’, OPEC.org, Retrieved May 13, 2005, Available at www/opec.org/search

Ingram, Mike. ‘Settlement Reached in Microsoft Antitrust Case’, World Socialist Web Site, [Online] Retrieved May 13, 2005, Available at http://www.wsws.org/articles/2001/nov2001/xp-n06.shtml

Nordhaus, William D. & Samuelson, Paul A. 1992, Economics, McGraw-Hill, Inc., New York, 789 p

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            http://consumerguide.bizrate.com/buy/products__cat_id–16031300,keyword–pepsi,search_box–1,sfsk–0.html

‘Price Elasticity of Demand’, QuickMBA, [Online] Retrieved May 10, 2005, Available at http://www.quickmba.com/econ/micro/elas/ped.shtml

‘Price Leadership’ Wikipedia, [Online] Retrieved May 11, 2005, Available at http://en.wikipedia.org/wiki/Price_leadership

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‘Supply and Demand’, Wikipedia, [Online] Retrieved May 10, 2005, Available at http://en.wikipedia.org/wiki/Supply_and_demand