AIOU Solved Assignments 1 & 2 Code 402 Autumn & Spring 2024. Solved Assignments code 402 econimics 2024. Allama iqbal open university old papers.
Course: Economics
Code: 402
Level: B.A Autumn & Spring 2024
Questions are may be some changed but answer are same.
Assignment No: 01
Q NO: 1 Explain different definitions of economics. Also differentiate micro and macroeconomics.
There are a variety of modern definitions of economics. Some of the differences may reflect evolving views of the subject itself or different views among economists.
The branch of knowledge concerned with the production, consumption, and transfer of wealth.
The condition of a region or group as regards material prosperity.
-Ahmedul.
The earlier term for ‘economics’ was political economy. It is adapted from the French Mercantilist usage of économie politique, which extended economy from the ancient Greek term for household management to the national realm as public administration of the affairs of state. Sir James Steuart (1767) wrote the first book in English with ‘political economy’ in the title, explaining that just as:
Economy in general [is] the art of providing for all the wants of a family, [so the science of political economy] seeks to secure a certain fund of subsistence for all the inhabitants, to obviate every circumstance which may render it precarious; to provide every thing necessary for supplying the wants of the society, and to employ the inhabitants … in such manner as naturally to create reciprocal relations and dependencies between them, so as to supply one another with reciprocal wants.
Economics can be confusing and finding a clear definition of economics can be a challenge. Most simply put, economics is the analysis of how people use the resources that are available to them.
According to the American Economic Association, those resources include the time and talent people have available, the land, buildings, equipment and other tools on hand and the knowledge of how to combine them to create products and services.
Economics is the social science that studies the choices that individuals, businesses, governments, and entire societies make as they cope with scarcity and the incentives that influence and reconcile those choices.
The word ‘Economics’ originates from the Greek work ‘Oikonomikos’ which can be divided into two parts:
(a) ‘Oikos’, which means ‘Home’,
b) ‘Nomos’, which means ‘Management’. Thus, Economics means ‘Home Management’. The head of a family faces the problem of managing the unlimited wants of the family members within the limited income of the family. In fact, the same is true for a society also. If we consider the whole society as a ‘family’, then the society also faces the problem of tackling unlimited wants of the members of the society with the limited resources available in that society. Thus, Economics means the study of the way in which mankind organises itself to tackle the basic problems of scarcity. All societies have more wants than resources. Hence, a system must be devised to allocate these resources between competing ends.
Economics is the science that deals with production, exchange and consumption of various commodities in economic systems. It shows how scarce resources can be used to increase wealth and human welfare. The central focus of economics is on scarcity of resources and choices among their alternative uses. The resources or inputs available to produce goods are limited or scarce. This scarcity induces people to make choices among alternatives, and the knowledge of economics is used to compare the alternatives for choosing the best among them. For example, a farmer can grow paddy, sugarcane, banana, cotton etc. in his garden land. But he has to choose a crop depending upon the availability of irrigation water.
What’s the difference between microeconomics and macroeconomics?
Macroeconomics and microeconomics, and their wide array of underlying concepts, have been the subject of a great deal of writings. The field of study is vast; so here is a brief summary of what each covers. Microeconomics is generally the study of individuals and business decisions, while macroeconomics looks at higher up country and government decisions.
Microeconomics
Microeconomics is the study of decisions that people and businesses make regarding the allocation of resources and prices of goods and services. This means also taking into account taxes and regulations created by governments. Microeconomics focuses on supply and demand and other forces that determine the price levels seen in the economy. For example, microeconomics would look at how a specific company could maximize its production and capacity, so that it could lower prices and better compete in its industry. (Find out more about microeconomics in How does government policy impact microeconomics?
Micro and Macro
While these two studies of economics appear to be different, they are actually interdependent and complement one another since there are many overlapping issues between the two fields. For example, increased inflation (macro effect) would cause the price of raw materials to increase for companies and in turn affect the end product’s price charged to the public.
Microeconomics takes what is referred to as a bottoms-up approach to analyzing the economy while macroeconomics takes a top-down approach. In other words, microeconomics tries to understand human choices and resource allocation, while macroeconomics tries to answer such questions as “What should the rate of inflation be?” or “What stimulates economic growth?”
Regardless, both micro- and macroeconomics provide fundamental tools for any finance professional and should be studied together in order to fully understand how companies operate and earn revenues and thus, how an entire economy is managed and sustained.
Microeconomics is the study of particular markets, and segments of the economy. It looks at issues such as consumer behaviour, individual labour markets, and the theory of firms.- Macro economics is the study of the whole economy. It looks at ‘aggregate’ variables, such as aggregate demand, national output and inflation.
Microeconomics vs. macroeconomics
The difference between micro and macro economics is simple. Microeconomics is the study of economics at an individual, group or company level. Macroeconomics, on the other hand, is the study of a national economy as a whole.
Microeconomics focuses on issues that affect individuals and companies. This could mean studying the supply and demand for a specific product, the production that an individual or business is capable of, or the effects of regulations on a business.
Macroeconomics focuses on issues that affect the economy as a whole. Some of the most common focuses of macroeconomics include unemployment rates, the gross domestic product of an economy, and the effects of exports and imports.
Does this make sense? While both fields of economics often use the same principles and formulas to solve problems, microeconomics is the study of economics at a far smaller scale, while macroeconomics is the study of large-scale economic issues.
Aiou Solved Assignments code 402 Autumn & Spring 2024
Q NO: 2 (a) Explain the measurement of utility and its different concepts.
(b) What are the assumption and exceptions for law of diminishing marginal utility.
What are the different ways that utility is measured in economics?
It’s difficult to measure a qualitative concept such as utility, but economists try to quantify it in two different ways: cardinal utility and ordinal utility. Both of these values are imperfect, but they provide an important foundation for studying consumer choice.
In economics, utility simply means the satisfaction that a consumer experiences from a product or service. Utility is an important factor in decision-making and product choice, but it presents a problem for economists trying to incorporate it into microeconomics models. Utility varies among consumers for the same product, and it can be influenced by other factors, such as price and the availability of alternatives.
Cardinal utility is the assignment of a numerical value to utility. Models that incorporate cardinal utility use the theoretical unit of utility, the util, in the same way that any other measurable quantity is used. In other words, a basket of bananas might give a consumer a utility of 10, while a basket of mangoes might give a utility of 20.
The downside to cardinal utility is that there is no fixed scale to work from. The idea of 10 utils is meaningless in and of itself, and the factors that influence the number might vary widely from one consumer to the next. If another consumer gives bananas a util value of 15, it doesn’t necessarily mean that he likes bananas 50% than the first consumer. The implication is that there is no way to compare utility between consumers.
One important concept related to cardinal utility the law of diminishing marginal utility, which states that at a certain point every extra unit of a good will provide less and less utility. While a consumer might assign his first basket of bananas a value of 10 utils, after several baskets the additional utility of each new basket might decline significantly. The values that are assigned to each additional basket can be used to find the point at which utility is maximized or to estimate a customer’s demand curve.
An alternative way to measure utility is the concept of ordinal utility, which uses rankings instead of values. The benefit is that the subjective differences between products and between consumers are eliminated and all that remains are the ranked preferences. One consumer might like mangoes more than bananas, and another might prefer bananas over mangoes. These are comparable, if subjective, preferences.
Utility is used in the development of indifference curves, which represent the combination of two products that a certain consumer values equally and independently of price. For example, a consumer might be equally happy with three bananas and one mango or one banana and two mangoes. These are thus two points on the consumer’s indifference curve.
What is the concept of utility in microeconomics?
Utility is a loose and controversial topic in microeconomics. Generally speaking, utility refers to the degree of removed discomfort or perceived satisfaction that an individual receives from an economic act. For example, a consumer purchases a hamburger to stop the discomfort of hunger and to enjoy eating.
All economists would agree that the consumer has gained utility by eating the hamburger. Most economists would agree that human beings are, by nature, utility maximizing agents; human beings choose between one act or another based on each act’s expected utility. The controversial part comes in the application and measurement of utility.
Cardinal and Ordinal Utility
The development of utility theory begins as a logical deduction. Voluntary transactions only occur because the trading parties anticipate a benefit (ex ante); the transaction wouldn’t happen otherwise. In economics, “benefit” means receiving more utility.
Economists also say that human beings rank their activities based on utility. A laborer chooses to go to work rather than skip it because he anticipates his long-run utility to be greater as a result. A consumer who chooses to eat an apple rather than an orange must value the apple more highly, and thus anticipates more utility from it.
The ranking of utility is known as ordinal utility. It is not a controversial topic; however, most microeconomic models also use cardinal utility, which refers to measurable, directly comparable levels of utility.
Cardinal utility is measured in utils to transform the logical to the empirical. Ordinal utility might say that, ex ante, the consumer prefers the apple to the orange. Cardinal utility might say that the apple provides 80 utils while the orange only provides 40 utils.
Even though no economist truly believes that utility can be measured this way, some still consider utility a useful tool in microeconomics. Cardinal utility places individuals on utility curves and can track declines in marginal utility across time. Microeconomics also performs interpersonal comparisons with cardinal utility.
Other economists argue that no meaningful analysis can come out of imaginary numbers, and that cardinal utility – and utils is logically incoherent.
Aiou Solved Assignments code 402 Autumn & Spring 2024
Question No.3:-
- What is meant by point elasticity and arc-elasticity? Explain with the help of diagram and formula
- With the increase in price of tomato from Rs 50 per kg to Rs. 100 per kg in blue market, the demand for tomato has gone down from Rs. 40 per kg to Rs. 30 per kg. Calculate the demand elasticity.
Answer:-
a)
When calculating elasticity of demand there is two possible ways:
- Point elasticity of demand takes the elasticity of demand at a particular point on a curve (or between two points)
- Arc elasticity measures elasticity at the mid point between the two selected points:
Point Elasticity
Formula for point elasticity of demand is:
PED= % ? Q / Q
————
-% ? P / P
To get more precision, you can use calculus and measure an infinitesimal change in Q and Price ( where ð = very small change) This is the slope of the demand curve at that particular point in time.
Arc Elasticity
Arc elasticity measures the midpoint between the two selected points:
Example of Difference between Point and Arc Elasticity A to B
Point elasticity A to B
Quantity increase from 200 to 300 = 100/200 = 50%
Price falls from 4 to 3 = 1/4 = -25%
Therefore PED = 50/ -25 = – 2.0
Mid Point Elasticity A to B
Mid point of Q = (200+300) / 2 = 250
Mid Point of P = (3+4) / 2 = 3.5
Q % = (100/250) = 40%
P % = 1/3.5 = 28.57
PED = 40/-28.57 = – 1.4
(or ( 3.5/250) * 100/1 = – 1.4)
Using Arc elasticity of demand
we get a different elasticity of demand
Firstly we find the midpoint of Q and P. For Q This is (10+20)/2. For P this is 1(0+5)/2 = 7.5
QD = 10/15 = 66% increase in quantity
Price = 5/7.5 = 66% fall in price.
Therefore PED = 66/66 = 1.0 This explains why the revenue remained the same.
Elasticity and Revenue
The thing with a straight line is that the elasticity varies. At the top left, quantity is showing a big % increase, compared to price.
Therefore, it makes a big difference whether we use point elasticity of arc elasticity.
………………………………………………………………………………….
b)
Price Elasticity of demand = % change in Q.D. / % change in Price
Calculating a %
The price increases from Rs. 50 to Rs 100. Therefore % change = 50/ 50 = 1
1 = 100% (0.1 *100)
Quantity fell by 10 / 40 = – 0.25 (25%)
Therefore PED = 25 / – 1
Therefore PED = -25
Therefore Demand is elastic. Elastic demand occurs when % change in Quantity is greater than % change in price; when PED >1
Aiou Solved Assignments code 402 Autumn & Spring 2024
Question No.4:-
- Differentiate between average cost and marginal cost with the help of a table and diagram
- Differentiate between the concepts of average revenue and marginal revenue in case of perfect competition and imperfect competition with the help of a table and diagrams.
Answer:-
a)
A producer or seller of good is also very much concerned with the demand for a good, because revenue obtained by him from selling the good depends mainly upon the demand for the good.
He is, therefore, interested in knowing what sort of demand curve faces him. The demand curve of the consumers for a product is the average revenue curve from the standpoint of the sellers, since the price paid by the consumers is revenue of the sellers.
Average Revenue:
Price paid by the consumer for the product forms the revenue or income of the seller. The whole income received by the seller from selling a given amount of the product is called total revenue. If a seller sells 15 units of a product at price Rs. 10 per unit and obtains Rs. 150 from this sale, then his total revenue is Rs. 150.
Thus total revenue can be obtained from multiplying the quantity of output sold by the market price of the product (P.Q). On the other hand, average revenue is revenue earned per unit of output. Average revenue can be obtained by dividing the total revenue by the number of units sold. Thus,
Average revenue = total revenue/total output sold
AR = TR/Q
Where AR stands for average revenue, TR for total revenue and Q for total output produced and sold. In our above example, when total revenue Q equal to Rs. 150 is received from selling 15 units of the product, the average revenue will be equal to Rs. 150/15 = Rs. 10. Rs. 10 is here the revenue earned per unit of output.
Marginal Revenue:
On the other hand, marginal revenue is the net revenue earned by selling an additional unit of the product. In other words, marginal revenue is the addition made to the total revenue by selling one more unit of a commodity. Putting it in algebraic expression, marginal revenue is the addition made to total revenue by selling n units of a product instead of n – 1 where n is any given number.
If a producer sells 10 units of a product at price Rs. 15 per unit, he will get Rs. 150 as the total revenue. If he now increases his sales of the product by one unit and sells 11 units, suppose the price falls to Rs. 14 per unit. He will, therefore, obtain total revenue of Rs. 154 from the sale of 11 units of the good. This means that 11th unit of output has added Rs. 4 to the total revenue. Hence Rs. 4 is here the marginal revenue.
Total revenue when 10 units are sold at price of Rs. 15 = 10 x 15 =Rs. 150
Total revenue when 11 units are sold at price of Rs. 14 = 11 x 14 = Rs. 154
Marginal revenue = 154- 150 = Rs. 4
The word net in the first definition of marginal revenue given above is worth noting. The full understanding of the word ‘net’ in the definition will reveal why the marginal revenue is not equal to the price. The question is, taking our above numerical example, why the marginal revenue due to the 11th unit is not equal to the price of Rs. 14 at which the 11th unit is sold. The answer is that the 10 units which were sold at the price of Rs. 15 before will now all have to be sold at the reduced price of Rs. 14 per unit.
This will mean the loss of one rupee on each of the previous 10 units and total loss on the previous 10 units due to price fall will be equal to Rs. 10. The loss in revenue incurred on the previous units occurs because the sale of additional 11th unit reduces the price to Rs. 14 for all.
Average and Marginal Revenue under Imperfect Competition:
The meaning of the concepts of total, average and marginal revenues under conditions o’ imperfect competition will become clear from Table As has been stated above, when imperfect competition prevails in the market for a product, an individual firm producing that product faces a downward sloping demand curve. In other words, as a firm working under conditions of imperfect competition increases production and sale of its product its price falls.
Now, when all units of a product are sold at the same price, the average revenue equals price. How marginal revenue can be obtained from the changes in total revenue and what relation it bears to average revenue will be easily grasped from looking at Table.
Table; Total, Average and Marginal Revenues:
It will be seen from the Col. Ill of the table that price (or average revenue) is falling as additional units of the product are sold. Marginal revenue can be found out by taking out the difference between the two successive total revenues. Thus, when 1 unit is sold, total Y revenue is Rs. 16. When 2 units are sold, price (or AR) falls to Rs. 15 and total revenue increases to Rs. 30.
Marginal revenue is therefore here equal to 30-16 = 14, which is recorded in Col. IV. When 3 units of the product are sold, price falls to Rs. 14 and total revenue increases to Rs. 42. Hence marginal revenue is now equal to Rs. 42-30 = Rs. 12 which is again recorded in Col. IV.
Likewise, marginal revenue of further units can be obtained by taking out the difference between two successive total revenues. Marginal revenue is positive as long as total revenue is increasing. Marginal revenue becomes negative when total revenue declines. Thus when in our table 23.3 quantity sold is increased from 9 units to 10 units the total revenue declines from Rs. 72 to 70 and therefore the marginal revenue is negative and is equal to -2.
It may be noted that in all forms of imperfect competition, that is, monopolistic competition, oligopoly and monopoly, average revenue curve facing an individual firm slopes downward as in all these market forms when a firm lowers the price of its product, its quantity demanded and sales would increase and vice versa.
The case, when average revenue (or price) falls when additional units of the product are sold in the market is graphically represented in Fig.. In Fig. it will be observed that average revenue curve (AR) is falling downward and marginal revenue curve (MR) lies below it.
The fact that MR curve is lying below AR curve indicates that marginal revenue declines more rapidly than average revenue. When OQ units of output are sold, AR is equal to QH or OP and MR is equal to QS. When OM units of the product are sold, marginal revenue is zero. If the quantity sold is increased beyond OM, marginal revenue becomes negative.
Average and Marginal Revenue under Perfect Competition:
When there prevails perfect competition in the market for a product, demand curve facing an individual firm is perfectly elastic and the price is beyond the control of a firm, average revenue remains constant. If the price or average revenue remains the same when more units of a product are sold, the marginal revenue will be equal to average revenue.
This is so because if one more unit is sold and the price does not fall, the addition made to the total revenue by that unit will be equal to the price at which it is sold, since no loss in revenue is incurred on the previous units in this case Consider the following table:
TABLE Average and Marginal Revenues under Perfect Competition:
In the above table, price remains constant at the level of Rs. 16 when more units of the product are sold. Col. Ill shows the total revenue when various quantities of the product are sold. Total revenue has been found out by multiplying the quantity sold by the price.
It will be found from taking out the difference between two successive total revenues that marginal revenue in this case is equal to the price i.e., Rs. 16. Thus, when two units of the good are sold instead of one, the total revenue rises from Rs. 16 to Rs. 32, the addition made to the total revenue i.e. marginal revenue will be equal to Rs. 32 -16 = Rs. 16.
Similarly, when three units of the product are sold, the total revenue increases to Rs. 48, and the marginal revenue will be equal to Rs. 48 -32 = Rs. 16 Likewise, it will be found for further units of the product sold that marginal revenue is equal to price. The case of perfect competition when for an individual firm average revenue (or price) remains constant and marginal revenue is equal to average revenue is graphically shown in Fig. 23.2 Average revenue curve in this case is a horizontal straight line (i.e., parallel to the X-axis).
Horizontal-straight-line average revenue curve (AR) indicates that price or average remains the same at OP level when quantity sold is increased. Marginal revenue (MR) curve coincides with average revenue (AR) curve since marginal revenue is equal to average revenue.
………………………………………………………………………………………
b)
Marginal Cost
In economics, marginal cost is the change in the total cost when the quantity produced changes by one unit. It is the cost of producing one more unit of a good. Marginal cost includes all of the costs that vary with the level of production. For example, if a company needs to build a new factory in order to produce more goods, the cost of building the factory is a marginal cost. The amount of marginal cost varies according to the volume of the good being produced. Economic factors that impact the marginal cost include information asymmetries, positive and negative externalizes, transaction costs, and price discrimination. Marginal cost is not related to fixed costs. An example of calculating marginal cost is: the production of one pair of shoes is 40. The marginal cost of producing the second pair of shoes is $10.
Marginal cost is the cost of producing one extra unit of output. It can be found by calculating the change in total cost when output is increased by one unit.
| OUTPUT | TOTAL COST | MARGINAL COST |
| 1 | 150 | |
| 2 | 180 | 30 |
| 3 | 200 | 20 |
| 4 | 230 | 10 |
| 5 | 250 | 40 |
| 6 | 320 | 70 |
| 7 | 450 | 130 |
| 8 | 740 | 290 |
It is important to note that marginal cost is derived solely from variable costs, and not fixed costs.
The marginal cost curve falls briefly at first, then rises. Marginal costs are derived from variable costs and are subject to the principle of variable proportions.
The significance of marginal cost
- The marginal cost curve is significant in the theory of the firm for two reasons:
- It is the leading cost curve, because changes in total and average costs are derived from changes in marginal cost.
- The lowest price a firm is prepared to supply at is the price that just covers marginal cost.
Average Cost
The average cost is the total cost divided by the number of goods produced. It is also equal to the sum of average variable costs and average fixed costs. Average cost can be influenced by the time period for production (increasing production may be expensive or impossible in the short run). Average costs are the driving factor of supply and demand within a market. Economists analyze both short run and long run average cost. Short run average costs vary in relation to the quantity of goods being produced. Long run average cost includes the variation of quantities used for all inputs necessary for production.
Average total cost (ATC) is also called average cost or unit cost. Average total costs are a key cost in the theory of the firm because they indicate how efficiently scarce resources are being used. Average variable costs are found by dividing total fixed variable costs by output.
| OUTPUT | AVERAGE FIXED COST (£000) | AVERAGE VARIABLE COST (£000) | AVERAGE TOTAL COSTS (£000) |
| 1 | 100 | 50 | 150 |
| 2 | 50 | 40 | 90 |
| 3 | 33.3 | 33.3 | 67 |
| 4 | 25 | 27.5 | 52.5 |
| 5 | 20 | 30 | 50 |
| 6 | 16.6 | 36.7 | 53.3 |
| 7 | 14.3 | 50 | 64.3 |
| 8 | 12.5 | 80 | 92.5 |
Average total cost (ATC) can be found by adding average fixed costs (AFC) and average variable costs (AVC). The ATC curve is also ‘U’ shaped because it takes its shape from the AVC curve, with the upturn reflecting the onset of diminishing returns to the variable factor.
Differentiating Total Cost and Marginal Cost
Average total cost and marginal cost are connected because they are derived from the same basic numerical cost data. The general rules governing the relationship are:
- Marginal cost will always cut average total cost from below.
- When marginal cost is below average total cost, average total cost will be falling, and when marginal cost is above average total cost, average total cost will be rising.
- A firm is most productively efficient at the lowest average total cost, which is also where average total cost(ATC) = marginal cost (MC).
Aiou Solved Assignments code 402 Autumn & Spring 2024
Q NO; 5 Write note the following;
- Income effect on price changed.
- Law of equi-marginal utility
- Can substitution effect be positive
- Relation between production and cost
Income substitution effect
If the price of a good increases, then there will be two different effects – known as the income and substitution effect.
If a good increases in price.
- The good is relatively more expensive than alternative goods, and therefore people will switch to other goods which are now relatively cheaper. (substitution effect) –
- The increase in price reduces disposable income and this lower income may reduce demand. (income effect)
The substitution effect states that an increase in the price of a good will encourage consumers to buy alternative goods. The substitution effect measures how much the higher price encourages consumers to buy different goods, assuming the same level of income.
The income effect looks at how the price change affects consumer income. If price rises, it effectively cuts disposable income, and there will be lower demand.
For example:
- If the price of meat increases, then the higher price may encourage consumers to switch to alternative food sources, such as buying vegetables.
- However, with the higher price of meat, it means that after buying some meat, they will have lower spare income. Therefore, consumers will buy less meat because of this income effect.
If a good like a diamond increases, there will be little substitution effect because there are no alternatives to diamonds. However, a higher price of diamonds will lower demand because of the income effect.
Income and substitution effect for wages
Law of Equi Marginal Utility:
The law of equi marginal utility was presented in 19th century by an Australian economists H. H. Gossen. It is also known as law of maximum satisfaction or law of substitution or Gossen’s second law. A consumer has number of wants. He tries to spend limited income on different things in such a way that marginal utility of all things is equal. When he buys several things with given money income he equalizes marginal utilities of all such things. The law of equi marginal utility is an extension of the law of diminishing marginal utility. The consumer can get maximum utility by allocating income among commodities in such a way that last dollar spent on each item provides the same marginal utility.
Definition:
“A person can get maximum utility with his given income when it is spent on different commodities in such a way that the marginal utility of money spent on each item is equal”.
It is clear that consumer can get maximum utility from the expenditure of his limited income. He should purchase such amount of each commodity that the last unit of money spend on each item provides same marginal utility.
Assumptions of the Law of Equi Marginal Utility:
- There is no change in the prices of the goods.
- The income of consumer is fixed.
- The marginal utility of money is constant.
- Consumer has perfect knowledge of utility obtained from goods.
- Consumer is normal person so he tries to seek maximum satisfaction.
- The utility is measurable in cardinal terms.
- Consumer has many wants.
- The goods have substitutes.
- The substitution effect is both positive and negative for consumers. It is positive for consumers because it means that they can afford to keep consuming products in a category even if their incomes decline or some products rise in price. It is also negative because it can limit choices. The substitution effect is negative for most companies that sell products, since it can prevent them from raising their prices and earning higher profits.
- The substitution effect is a concept holding that as prices increase, or incomes decrease, consumers replace more-costly goods and services with less-expensive alternatives. When used in analyzing price increases, it measures the degree to which the higher price spurs consumers to switch products, assuming the same level of income.
- For example, if the price of a premium brand of fruit cocktail rises, consumer spending will increase for supermarket house brands of fruit cocktail. The substitution effect also applies to buying patterns across brands and even across categories of consumer goods and services. If the price of all fruit cocktail brands goes up, some consumers will buy a less-expensive type of canned fruit instead, such as peaches. If the prices on all canned fruit start to soar, some consumers will switch to fresh fruit.
- It is positive for consumers that they can continue to enjoy fruit if they lose their jobs or a major producer in the category raises its prices. However, in testing the substitution effect, a company might be dissuaded from going to market with an innovative new canned mixed fruit product. This would be negative for consumers because it would limit their choices. Moreover, sometimes but not always, lower-priced alternatives are lower in quality, also limiting consumer choices.
- The substitution effect is negative for companies that sell products except for certain types of businesses, such as discount retailers and manufacturers specializing in low-end merchandise. During years when the economy is lean, discount retailers often tend to hold up relatively well.
In the short run we are interested not just in costs, but in average costs of production (AC) and shape of AC curve, which depends on the shape of AVC curve (note: AFC always diminishes). However, dynamics of AVC depends on the relationship between average and marginal products of labor (variable factor).
So, we should consider three cases:
- Constant return to variable factor: MPL = APL, then AVC stays constant, hence AC decreases as Q increases. We have negative dependence between production and average costs.
- Decreasing return to variable factor: MPL < APL, then AVC increases, hence AC decreases at small Q and increases at large Q. We have undefined dependence.
- Increasing return to variable factor: MPL > APL, then AVC decreases, hence AC decreases as Q increases. We have negative dependence.
Aiou Solved Assignments code 402 Autumn 2024
