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ECON1001 Microeconomics for Business Decisions

TUTORIAL REVISION EXERCISES Set 3 (Week 4)
Market Allocation Tut Set | | Revision Exercises | 3 | Week 4 Allocation and the market systemJ&McI (Ch. 4) | 1. What important production questions must any economy answer? A socialist state will answer the economic questions of what, how, how much, distribution, where, through government planning. 2. Use supply and demand diagrams for two products to explain how the market decides on what it should produce. Determined by competing buyers and sellers in both resource and product markets (SS/DD) 3. What is the difference between a normal profit and positive economic profit?

PROFIT = Total Revenue – Total Cost
Accounting Profit
Total revenue minus total eplicit costs

Economic profitTotal revenue minus explicit plus implicit costs 4. # Why are economic profits and losses important in determining which industries are expanding and those that are contracting? CH.4, pp. 102-103Economic profits and losses are important in determining which industries are expanding and contracting because economic profits induce new firms to enter the industry, in order to get higher profits or if it is below normal profit this induces firms to leave to get normal profits elsewhere.When new firms are entering the industry this results in an expanding industry, this increases the market supply of the product which causes for prices to drop until the normal profits are restored. The total quantity of a product that will be produced is determined by the market supply and demand situation prevailing when economic profits become zero.

If demand falls for a product, the price will fall and so do profits. This will be the cause of below normal profit which results in a declining industry. As firms exit, supply decreases, and prices increase until normal profit is restored. The market demand and supply that prevail at this point determined the total output of a product of service.

The economic profits and losses are mainly influential to industries that choose to join or leave depending on the profit. This changes the demand and supply which affects the costs and profits from increasing or declining. This can help analyse which industries are expanding or contracting. If a competitive industry is neither expanding nor contracting, we would expect economic profits to be zero. The existence of economic profits attracts entry, economic losses lead to exit, and in long-run equilibrium, firms in a perfectly competitive industry will earn zero economic profit. 5. How does the market ensure that firms are producing the least cost method of production? More profit by least cost 6. How does the market promote technological advance that creates economic growth? Ch4 p107
Price rationing – Prodducts are distributed on the basis of cosumers willingness and ability to pay the existing market price for a product

Technological advances lower productions costs and increase economic profits
Increased profit attracts firms who use and invest in new technology. 7. How is the distribution of goods and services decided within the market economy? 8. How can the market influence where businesses locate? 9. What is allocative efficiency? Ch2 p33 Allocative efficiency is a type of economic efficiency in which economy/producers produce only those types of goods and services that are more desirable in the society and also in high demand. According to the formula the point of allocative efficiency is a point where marginal benefit is equal to marginal cost 10. # What are some of the shortcomings of the market economy model? Ch2 pp110-112 p115 pt.10Some of the shortcomings of the market economy model would be that firms can’t product anything that they wish as they need to focus on making a profit and to meet demand of the customers. Also, the demand decisions of consumers restrict the choice of businesses in deciding what to produce.

There are several criticisms of the market system:-The controlling mechanism, competition, tends to weaken over time, resulting in the introduction of monopoly power and reducing the efficiency of the market as an allocation mechanism.-It results in income inequalities by recognising neither need nor merit in how it allows output to be allocated between households.
- In relying on individual consumers’ willingness to pay, it is unable to register wants.
- In relying on individual consumers’ willingness to pay, it is unable to register wants.Market PowerInequitable Distribution
Market Failure | | |

Instructions

* Working independently, you should prepare written answers to hand in for the questions marked with #. * Answers must be submitted directly to the tutor at the beginning of tutorial. * For your own learning benefit, answers to the other questions should also be attempted on a separate document. * You should keep a copy of your submitted answers, and also use your notes for the non-submitted questions, to contribute to the tutorial discussion and for making notes of correct answers.

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