Question

Please try to answer as soon as possible. Thanks in advance.

Answer the questions true, false or uncertain and provide a brief explanation or a graph to defend your answer.

1 a) A change in relative prices will always change a utility maximizing consumer’s marginal rate of substitution.

1b) Competitive firms shutdown production when price falls below the minimum of the average total cost curve.

1c) An increase the price of firms output will always increase the use of an input.

1d) An import tariff on a commodity will increase the price for the producers of the commodity producers in the exporting country.

1e) When ending stocks are large, prices tend to be very unstable.

Answer 1

1a. The maximum amount of one good a consumer would be willing to give up in order to obtain an additional unit of another is called the marginal rate of substitution (MRS), which is equal to the absolute value of the slope of the indifference curve between two points. "The Marginal Rate of Substitution" shows that as Ms. Bain devotes more and more time to horseback riding, the rate at which she is willing to give up days of skiing for additional days of horseback riding—her marginal rate of substitution—diminishes.

1b. Shutdown price is equal to a firm’s minimum possible average variable cost. It is because the firm will never be able to achieve an average variable cost lower than this and if the market price is less than even the lowest-possible average variable cost, there is no output level at which the firm will earn positive contribution margin. It doesn’t make sense for a firm to keep producing if the sales revenue will not cover even the variable costs at a firm’s optimal output.

1c. Marginal Rate of Technical Substitution (MRTS) The MRTS captures the rate at which substitution between inputs is possible. The idea is essentially identical to the MRS in consumer theory. The MRTS captures the amount of one input a firm could give up when it increases another input, while keeping the amount of production the same. The MRTS can be measured as the (absolute value of) slope of a production isoquant. For example, MRTSLK, the MRTS between labour and capital, measures the amount of capital that a firm could give up when it adds one more unit of labour. MRTS K L LK = −∆ ∆ Note that ∆ ∆ Q L MP = ⋅ L and ∆ ∆ Q K MP = ⋅ K . So if K is decreased and L is increased so as to keep Q the same, we have, ∆ ∆ L MP K MP L K ⋅ =− ⋅ So, MP K L MRTS L K = LK − = ∆ ∆ That is, the ratios of the marginal products is equal to the MRTS.

1d. Tariffs increase the prices of imported goods. Because of this, domestic producers are not forced to reduce their prices from increased competition, and domestic consumers are left paying higher prices as a result. Tariffs also reduce efficiencies by allowing companies that would not exist in a more competitive market to remain open.

The figure below illustrates the effects of world trade without the presence of a tariff. In the graph, DS means domestic supply and DD means domestic demand. The price of goods at home is found at price P, while the world price is found at P*. At a lower price, domestic consumers will consume Qw worth of goods, but because the home country can only produce up to Qd, it must import Qw.

1e. There are three chief reasons why commodity prices move higher or lower. The first is the fundamental state of a commodity market. If current inventories exceed demand, the oversupply tends to drive prices lower. But if the demand is greater than supplies, the inventory deficit tends to push prices higher. Secondly, commodity prices fluctuate due to the technical condition of the market. Price charts often drive the behaviour of investors, traders, and other market participants. Since everyone studies the same data, a herd mentality of massive group buying or selling consequently influence prices.

Finally, commodity prices are sensitive to changes in the global macroeconomic and geopolitical landscape.