External Cost and Benefit

a) External cost refers to the cost that is imposed upon third party when products are manufactured and consumed. On the other hand, external benefit refers to positive externality that transaction or other activities provides to party. As external cost is negative externality that is not considered, there occurs more production at higher price, which results to over allocation of the resources. As external benefit is positive externality, it might result in under resource allocation. However, both external cost as well as external benefit influences resource allocation.

b) There are few characteristics of public good including non- excludability, non rejectable and non rival consumption. Public goods are not provided in sufficient amount by the private industry as they do not have the ability to supply these goods for higher profit. Moreover, these goods also provide the example of the failure in market owing to free rider problem and hence it is not produced in larger quantity by private sector.

c)i) Judicial system is public good as its requirement by individuals is not reduced with respect to other product consumption.

1. ii) Pencils are public good as it is non exclusionary and hence it is impossible to exclude any person from consuming this good

iii) Quarantine service is an example of public good as it has been used for separating as well as restricting the movement of individuals.

1. iv) The great wall of China is also another example of public good as it is featured by non rival consumption, which means visiting the place by one consumer does not restrict others from visiting this place.
2. v) Contact lens are also public hood as it is non excludable and non rivalrous. This means when one individual uses it, it does not restrict other persons for utilizing it

1. Both these firms are operating in the short run.
2. Both these firms are operating under imperfect competition
3. Firm A produces at the output level 3 in the short run as MR becomes equivalent to MC at 10. On the other hand, Firm B produces at output level 5 as MC becomes equal to MR at 50.
4. Profit positions of Firm A= TR-TC= -288.

Profit positions of Firm B= TR- TC=61

a) A fixed input refers to the resource or factor of production that cannot be changed by the entity in the short run as it seeks in changing the total quantity of produced output. On the other hand, variable input refers to the resource that can be altered by the firm in short run. While operating a coffee shop, addition of extra machinery can be limited according to store size. Moreover, the total number of laborers employed can be easily changed and hence it is considered as variable input. In addition, other variable inputs include natural resources as well as semi- processed product. While in the long run all inputs used for operation can be easily adjusted.

b) The total fixed cost (TFC) for the plant is $4000 per day and total variable cost is $13000 per day.  The total production of pendants per day is 100.

Average fixed cost (AFC) is estimated by the fixed cost of total production divided by total quantity of produced output. AFC=TFC/Q =$40

Average variable cost (AVC) is calculated by dividing total variable cost to output. AVC= TVC/Q=$130

Average total cost (ATC) refers to the summation of AVC and AFC. Thus, ATC= $170.

Public Goods

Total cost is estimated by summation of TFC and TVC. Thus, TC= $17000

c) The MC (marginal cost) of production refers to the variation in total cost for manufacturing one additional item. On the other hand, ATC is the ratio of total cost to each unit cost. MC has direct relationship with the AC which means MC has been factored into ATC at each unit. As total quantity increases, MC will rise and ATC will reduce. When MC becomes equivalent to AC as highlighted in this case, AC becomes constant. However, the MC curve intersects AC curve at its minimum point. Eventually MC continues to rise, which in turn pulls to ATC upward.

1. a) The economic factors that should exist in the industry under perfect competition, which includes-

• All entities sell identical good
• All entities are price takers
• All firms have small market share
• The industry must be characterized by no barriers in entry and exit

These requirements hardly exist in one industry and hence there is no industry that conforms to the model of perfect competition. This contradicts the fact where agricultural industry comes closest to economist framework of perfect competition as it is featured by fewer producers with no ability in altering selling price of good.

1. b) The firm is in short run equilibrium when it satisfies two conditions including-

• MC=MR
• MC should interest the curve MR curve from below

The figure below illustrates that at price OP determines equality of demand and supply curve at point E, so that AR curve coincides with MR curve. At this price, all entity is in equilibrium at the point L where a) SMC becomes equivalent to MR and AR. B) SMC cuts MR curve from below.

An industry will be in short run equilibrium when total output remains constant and all entity should be earning normal profits. The condition is SMC= MR= AR=SAC. The figure (a) shown below reflects that demand and supply curve cuts at point E. At figure( b), few entities are earning supernormal profits and at figure (c) some entities are incurring losses.

Figure 1: short run perfectively competitive eqauilibrium

1. c) The entity is in long run perfectly competitive equilibrium can raise its output by varying their capital equipment. Moreover, new entity enters the sector for competing with the existing entities. The figure below shows that the entity cannot be in equilibrium if price is larger than OP. Similarly, the entity cannot be in equilibrium at price less than OP. Moreover, the AR and MR curve must lie below AC curve, such that P=MR. However, some entity in this industry moves out as price rises and hence existing firm makes normal profit. The entities continue to leave the industry until P becomes equivalent to AC, such that firms make normal profit. The condition for long run profit maximization is LMC=SMC = MR. This is shown in figure below:

Figure 2: Long run perfectly competitive equilibrium

1. Margarine and butter are considered as substitute product. Rise in price of margarine causes individuals to increase their butter consumption. This shifts the DD (demand) curve to right from D to D1. As a result, this increases the price and quantity of butter.

Figure a

1. As butter and yoghurt are jointly supplied, rise in price of yoghurt shifts the supply curve to right from SS to SS1. As a result, price of butter declines and its quantity rises.

Figure b

1. As bread and butter are complementary product, rise in price of bread leads decline in consumption of butter. This shifts the demand curve to left from DD to DD1. However, both price and quantity of butter falls.

Figure c

1. Similarly, rise in demand for bread also increases demand for butter. This shifts the demand curve to right from DD to DD1. Hence, both price and quantity of butter increases.

Figure d

1. An expected rise in price of butter in future will increase the price of bread but its quantity might increase or decrease based on relative shift size in both demand as well as supply. The demand curve will shift to right as people starts purchasing before its price rise while supply curve will shift to left as manufacturer hold stocks back.

Figure e

1. A tax on butter production shifts the supply cure to left and hence price of butter rises and its quantity falls.

Figure f

1. If new process of removal of cholesterol from butter is invented, then the demand for butter will increase and this will shift demand curve to right but the supply curve will shift to left owing to rise in production cost. Hence, its price rises but quantity might increase or decrease based on shifting size in both demand and supply.

Figure g

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