Question

 

Question 1: The following information is extracted from an article1 about Coronavirus relief measure in Hong Kong. Hong Kong’s embattled leader on Wednesday unveiled her government’s biggest coronavirus financial relief package so far, offering a HK$137.5 billion (US$18 billion) lifeline to save ailing businesses and ensure some 1.5 million workers would continue to get paid in the tough months ahead.

The government would, through employers, pay 50 per cent of salaries for half a year, each worker’s monthly subsidy capped at HK$9,000. Many small businesses are seriously affected by the Coronavirus. For example, some Chinese restaurants revealed that they might close their business in next few months.

1Coronavirus: Carrie Lam unveils Hong Kong’s biggest Covid-19 relief package yet, worth HK$138 billion, to ensure 1.5 million workers still get paid. SCMP. 8th April 2020.

a) Starting with long run equilibrium, show how small business are affected by the Coronavirus. Explain with aid of diagram.

b) The Hong Kong government proposed to subsidize the salaries of business. Discuss why some small business still decide to close in short run. Explain with aid of diagram.

Answer 1

Answer a :-

Before the coronavirus, the economy was at equilibrium at point A where the supply curve S1 was intersecting the demand curve D1 at point A with an equilibrium quantity of Q1 and the price P1. Now due to spread of this flu ,the consumers have changed their buying behaviour and curtailed there expenditure on many of the consumer goods leading to a decrease in demand. This can be represented by shift of demand curve to the leftwards from D1 to D2 which leads to change of equilibrium from point A to point B .This leads to decrease in equilibrium quantity to Q2 and decrease in equilibrium price to P2.

Answer b :-

The cost of the firm can we bifurcated into two parts that are fixed costs like rent , installment for assets etc and variable costs like salaries . In short run the producers chooses to exit the market when the price of the goods Falls below its average variable cost. Now in the above diagram we can see that the the equilibrium point which has shifted to point B has led to decrease in equilibrium quantity to Q2. Now when the government provides subsidy to the producers of the firms, it leads to decrease in the marginal cost of producing goods which will shift the supply curve to the rightwards from S1 to S2. The subsidy will help to to bring the economy to its previous equilibrium output level of Q1, however as we can see in the above diagram that the new supply curve S2 intersects the new demand curve D2 at a much lower price of P3 . Thus it is quite possible that such a low price for the goods makes it impossible for the producer to cover its average variable cost , thus many producers will choose to shut down their firm even after the government provide subsidy.