Learning outcomes

This assignment assesses the following learning outcomes:

• LO1: Explain the meaning of scarcity and choice in economic decision-making and the nature of the economic problem. Understand and evaluate the underlying assumptions of economic models.
• LO2: Explain how supply and demand determine equilibrium prices in a market economy.
• LO3: Apply marginal principles to determine price and output decisions under perfect and imperfect competition.
• LO4: Explain the reasons why market failure may occur and apply economic concepts to determine methods of minimizing market failure. Analyze the role of government in the economy, explain methods of government intervention and discuss the consequences of such intervention

Question 1: Fundamentals of economics

a. At their grandparent’s 50th wedding anniversary party Chloe and her cousin Simon talked about their studies. Chloe is in the first year of a business studies degree while Simon is in the final year of a mechanical engineering degree. Chloe said that the first thing she had learned in her economics course was that almost all resources are scarce and that this greatly affects the way a country’s economy is structured. Simon said he couldn’t follow this. If more of any product was needed the factory owners could expand production by buying more machinery and materials, employing more staff, and adding another building if necessary. He said that any competent
the mechanical engineer could give sound advice on what was needed to increase output.

i. Simon’s comment showed he did not understand the concept of scarcity. If you were Chloe, how would you explain it to him?

ii. In economics, very few goods are classified as free. Water and air have often been given as examples, though water may be scarce in some localities. Define a free good and identify one free good other than water and air.

b. Chloe’s older brother Lachlan is in his final year of study for a health sciences degree. To keep his student loan as low as possible he has decided to take a part-time job at a large supermarket, which will involve re-filling shelves in the evening. He will receive the adult minimum rate of $20 per hour. Lachlan is yet to agree with the store manager on the number of hours per week he will work. Lachlan has been going to the gym four evenings a week and feels it keeps he fit, and one night a week he meets up with a group of friends.

i. What method should Lachlan use to decide the number of hours he should work at the supermarket?

ii. How would Lachlan apply this method in making this decision?

c. Chloe and Lachlan’s family have farming relatives in both Central Otago and Taranaki. During a family meal one evening, a discussion focusing on the importance of farming to the New Zealand economy and on the changes taking place in the industry. Examine the following two statements and say whether you consider each to be positive or normative. Give your reasons.

Statement 1

Chloe said, ‘New Zealand accounts for over a third of the world trade in dairy exports’.

Statement 2

Lachlan said that ‘Because of the big fall in the demand for wool, all government buildings and schools should have woolen carpets fitted rather than synthetics when re-carpeting is needed’.

d. Angela has been interested in crafts since intermediate school, and she has developed considerable ability in several craft fields. She has found her natural aptitude for creating pleasing designs a big advantage.

Angela’s friend Kristin, who had moved from the city to a rural district three years earlier, developed a business that weaves products from alpaca fibre. Kristin recently married an Australian who had been working in the district and she is moving to Melbourne to live. Before she left, Kristen offered the business to Angela. On the spur of the moment, Angela decided to buy the business and to move to where Kristin had lived. She is now assessing what she should do to make the business a success.

Kristin had arrangements with alpaca owners in the district for the supply of a fixed quantity of fiber, and these owners had agreed to continue to supply the same quantities to Angela. Kristin had produced two products: throws and scarves. From the records Kristin had left, Angela knew the quantities she could produce of each, taking account of the capacity of the loom and the quantity of fiber available. She drew up the following table to help with her decision making

i. Based on Angela’s weekly production possibility schedule, draw a graph with a production possibility frontier curve that shows all combination possibilities.

ii. Calculate the opportunity cost of moving from Combination B to Combination E.

iii. If Angela received an order at short notice from a new retailer in Auckland for 25 throws and order from a retailer in Queenstown for 40 scarves, with both orders being required urgently in one week’s time, would it be possible for her to produce sufficient products to meet both orders? Explain your reasoning.

iv. Describe a situation in which it would be rational for Angela to produce Combination A.

e. After operating the business for ten months, Angela felt she could expand her output by adding baby blankets to the range. She had found a source of the superfine fiber required for this purpose. Her friend Richard was studying for a degree in marketing and was required to prepare a report based on field research. Richard offered to base his study on the market for baby blankets and to give a copy to Angela.

Richard identified 25 New Zealand retailers who expressed interest in adding Angela to their suppliers. Richard’s findings are shown in ‘Quantity demanded’ in the table below and are based on the prices at which the blankets could be offered to retailers.

Angela calculated the figures in the ‘Quantity supplied’ column by considering the additional costs she would face, including materials, equipment and part-time assistants; this is the quantity she would be willing to sell at each price.

i. From the above schedule draw a supply and demand graph that shows the equilibrium price and quantity for alpaca baby blankets. Label the graph fully.

ii. Identify and discuss the economic concept illustrated by the sequence of figures in the ‘quantity supplied’ column of the table.

iii. Assume that television and magazine stories about the Prime Minister giving an alpaca baby blanket to a friend for her new daughter led to a large increase in demand for the product. Richard undertook another study and found the quantity demand for baby blankets has increased by four at each price (per blanket). Complete the table below, and state what the new equilibrium and quantity would be.

iv. Assume that as part of a comprehensive price control program the government imposed a maximum price to retailers of $175 per alpaca baby blanket. How would this affect the market for the product?

Question 2: The Theory of the firm

a. Simon Is a laboratory technician with an annual salary of $65,000. Metalworking has been his hobby for many years, and he has developed a high level of skill with guidance from an uncle who died recently. The uncle’s business was manufacturing a range of metal products for use in house and building construction. Simon is considering resigning from his laboratory position and starting his own machine shop that would make a wider range of products than his uncle did, using modern equipment. Simon calculated that his annual costs for products that could earn revenue of $160,000 would be:
• Raw materials $60,000
• Workshop rent $25,000
• Electricity $4,500
• Accounting services $1,500
• Interest on a bank loan for metalworking machinery $8,000

Simon has been accumulating savings that he had intended to use as a deposit on his first house. With the addition of a $30,000 bequest from his uncle, his savings now total $95,000.

The machinery needed would cost $150,000. Simon could finance this from his savings and a bank loan of $55,000.

Assume Simon could earn 5% on his savings.

i. Calculate the accounting profit or loss that Simon could expect to earn from undertaking this business and the economic profit or loss that would result. (Ignore the fall in the value of the machinery over time.) Show your workings in full.

ii. From your calculations in part (i), and using economic concepts, what advice would you give to Simon on whether he should commence this business, and why?

iii. What opportunity costs and benefits in addition to those included in your calculations in part (i) should Simon consider? Identify one implicit benefit and one implicit cost.

b. Simon found that there were numerous small metalworking businesses throughout New Zealand that made similar products to those he would produce.

There are four types of market structure: perfect competition, monopolistic

competition, oligopoly, and monopoly. What type of market structure would Simon’s firm is operating in, and why would it be classified in this way?

c.
i. Identify two monopoly firms in New Zealand. Briefly outline the nature of their business activities and explain why it is difficult or impossible for competing firms to enter the markets concerned.

ii. Oligopolistic firms are cautious about making price changes. Why is this?

iii. Some oligopolies have a price leader. What does this mean, and what gives the price leader this role?

d. Aotearoa Beverages Ltd produces sparkling soft drinks using mineral water from a spring in Central Otago. These are sold throughout the South Island and in the lower North Island. The company’s costs and revenue are shown in the following table.

ii. What does the table show to be the profit-maximizing output and price? What is the total profit at that point, and what type of profit is it? Why is Is this the profit-maximizing level of output?

iii. In what type of market structure does Aotea Beverages operate? Why is it classified in this market?

iv. After selling his software development business for $4 million, Oscar Wilson bought 25% of the shares in Aotearoa Beverages and became a director of the company. At the first board meeting, he said his experience in software development had convinced him that achieving the maximum quantity of output was the most successful business strategy, and he couldn’t understand why Aotearoa Beverages was producing at well below capacity. He urged the company to increase output to that level. Assess whether it would benefit Aotearoa Beverages to follow his advice and explain your reasoning.

e. Assume that, in a perfectly competitive market, the market price for one kilo of carrots is $1.75. Central Growers Ltd currently produces 400,000 kilograms of carrots and the firm’s owner, Tama Green, has asked for your advice on whether this level of output should be changed to maximize the profit. Complete the table and use marginal analysis to advise Mr. Green on what he should do.

Question 3: Market failure and the role of the government

a. The New Zealand government’s 2020 Covid recovery plan included the provision of $2.8 billion in assistance to those receiving benefits.

Discuss this provision, and include the following points in your answer:

• What increases were made in welfare benefits, and why did the government make this provision?
• What would be the impact of the increased benefits on New Zealand’s Gini co-efficient index measure?
• Which households would be least affected by this provision?

b. A study of the concerns of New Zealanders on the environment found the five main areas of concern to be:

• the state of rivers, lakes, streams, wetlands, and aquatic life
• the state of the oceans and sea life
• plant and animal life becoming endangered or extinct,
• changes in weather patterns
• air pollution.

Select one of these issues, explain whether there was a market failure involved and discuss what role, if any, the government could have in responding to the area of concern.

c. In New Zealand basic dental services are provided free for those under 18. Why is this subsidy provided?

d.
i. With effect from 7 June 2018 the New Zealand government introduced
a ban on certain products that contained plastic microbeads. This was followed by a ban on single-use plastic shopping bags with effect from 1 July 2019. Discuss the market failures that led to these measures.

ii. Identify one other widely used plastic item that is causing plastics pollution. Is this a market failure?

e. In recent years increased attention has been paid to the adverse health impacts of excessive sugar consumption. Several countries have introduced a tax on sugary drinks (for example, Mexico (2014), Portugal (2017), the UK (2018), and Ireland (2018). The possibility of introducing a sugar tax has been discussed in several other countries including New Zealand and Australia.

i. When a government introduces a tax on sugary drinks what type of market failure is it attempting to address? What outcomes might result from such a tax?

ii. Draw a supply and demand graph to show the effect of the introduction of a tax on the consumption of sugary drinks. The graph shows both the initial equilibrium and the equilibrium after the tax. Explain what the graph shows.

iii. Explain one argument against a tax on sugary drinks.

f. For each of the following hypothetical situations explain briefly whether and why the outcome is the result of a market failure, a government failure or has elements of both.

Question 4. Case study: elasticity of demand

The Southside Caravan Park, which is in a region popular with local tourists, provides sites for caravans and camper vans. Each site has an electric power connection, and the daily charge includes the use of the camp kitchen and the showers. There is a laundry with coin-in-the-slot washing machines and dryers.

Chloe and Lachlan’s father Richard, who recently retired as an insurance company branch manager, bought the Park and intends to manage it himself. Because of his lack of experience in the tourist industry, Richard engaged a marketing consultant to advise him on pricing. The consultant estimated the number of caravans and campervans that would use the site each week at a range of prices, and these figures are contained in the two left-hand columns of the table below.

With the assistance of Chloe, Richard drew up a table incorporating the consultant’s figures to allow the price that would produce the highest revenue to be identified.

Using your economic skills and the information above prepare a report for Richard on the daily charge that would maximize the Park’s revenue. Your report should follow the briefing paper layout shown below.

Heading: Possible charges for vehicles using sites at the Southside Caravan Park, [date]. Report by [insert your name].

State the purpose of the report: to evaluate the possible prices that could be charged for sites at the Park, using the midpoint method of calculating price elasticity, and to recommend the price that would result in the highest revenue.

Briefing paper mark allocation

Component

1. Limitations of the briefing paper:

Identify and briefly explain two limitations of the information provided.

2. Complete the table above, using the midpoint elasticity formula.

3. Discuss the price options available:

• Refer to the figures in your completed table as the basis of this discussion.
• Analyse the price options and explain what their effects would be.
• Discuss price elasticity of demand. What does the term mean, and why is it important? What types of price elasticity are shown in the table?

4. Identify factors that might affect the elasticity of demand.

5. Identify three long-term developments that might undermine the proposed entry charge.