Question

Assignment 3

BUS 151: Microeconomics

Semester 402

Total Marks=20

Note: Answers should be written with appropriate headings. You may also draw figures to answer your questions more clearly.

Question 1: Explain with your example that how a country with absolute advantage in its production of two goods can gain from trade from another country which has no comparative advantage on the same goods. (6 marks) Chapter 3

Question 2: By explaining law of demand and law of supply show how prices of goods and services are determined in all types of market? What are those forces that move a market towards equilibrium? Why it is not advisable for any government of rely on price floor and price ceiling? (4+2=2= 8 marks) chapters 4&6

Question 3: What are the main influences on the elasticity of demand that that makes the demand for some goods elastic and demand for another goods inelastic? What are the main influences on the elasticity of supply that make the supply of goods elastic and the supply of other goods inelastic?(3+3=6 marks) Chapter 5

Answer 1

Ans1. If a country has absolute advantage in production of two goods as compared to another country which has no comparative advangate on the same goods, it will gain from trade of the goods with the other country as it is able to produce goods by using fewer resources and at a lower opportunity cost. This will allow the people of the other country to purchase the same product at a lower cost. Thus, the country having absolute advantage will be able to sell more and more quantities and thereby increasing its income and profits.

Ans2. Law of demand states that there is negative relation between the price of a good and its quantity demanded, as the price of a good increases, its quantity demanded falls and vice-versa.

Law of supply states that there is a positive relation between the price of a good and its quantity supplied, as the price of a good increases, its quantity supplied also increases and vice-versa.

Market price of a good is determined at the point where the market demand and the market supply are equal.

When the price of a good is above equilibrium price, this is a situation of excess supply as due to increase in the price above equilibrium price, the quantity supplied increases and the quantity demanded falls. Thus, causing a situation of excess supply. The market forces of demand and supply function to take the price back to the equilibrium price.

It is not advisable for the government to impose price floor and price ceiling because price floor and price ceiling creates a situation of excess supply and excess demand. This leads to illegal activities to function in the economy.

Ans3. Determinants of elasticity of demand are:

1) Availability of substitues: More the number of substitues, higher is the elasticity of demand and vice-versa.

2)Habits- If a consumer is habitual in the consumption of a goood, his demand will be inelastic for the product.

3) Necessity vs Luxury- If a good is a necessity, it will have an inelastic demand and luxury goods have elastic demand.

4)Income level of consumers- High income consumers tend to have inelastic demand as compared to lower income groups.

Determinants of elasticity of supply are:

1)Ease of switching- If the production of goods can be varied, supply is more elastic.

2)Factor mobility- When moving resources in the industry is easier, the supply is more elastic.

3)Spare capacity- If there is a spare capacity, it is easy to shift the supply and hence the supply is elastic.

4)Length of production period- Greater the time period of production, more inelastic is the supply,