Assignment 2 ECON 1006

ASSIGNMENT # 2

Microeconomics-Fall 2023

SBE-Algoma University

QUESTION 1

a. Draw a graph to show how the change affects the welfare of Canadian consumers and

Canadian producers and how it affects total surplus in Canada.

1 of 4
Assignment 2 ECON 1006

𝑇𝑜𝑡𝑎𝑙 𝑠𝑢𝑟𝑝𝑙𝑢𝑠 (𝑇𝑆) = 𝐶𝑆 + 𝑃𝑆

The area below the demand curve and above the market price is the producer surplus. Demand

rises from the third to the fourth quarters. The area above the supply and below the market price

is the consumer surplus. Domestic supply falls from Q1 to Q2. When the price falls from P1 to P2,

the area of ABC decreases and the area of DEF increases.

b. The change in consumer surplus, producer surplus and total surplus due to price reduction.

1
Consumer surplus (area of DEF) = 200,000 × 100 × = 𝟏𝟎, 𝟎𝟎𝟎, 𝟎𝟎𝟎
2

1
Producer surplus (area of ABC) = 200,000 × 100 × = 𝟏𝟎, 𝟎𝟎𝟎, 𝟎𝟎𝟎
2

There is no change in total surplus, because consumer surplus increases by 10,000,000 and

producer surplus decreases by 10, 000,000

c. Government revenue that would be raised and the deadweight loss due to tariff. Would

it be good policy from the standpoint of Canadian welfare? Who might support the policy

(producers or consumers)?

𝐼𝑚𝑝𝑜𝑟𝑡 = 𝑄3 − 𝑄1

𝑇𝑎𝑥 𝑅𝑒𝑣𝑒𝑛𝑢𝑒 = 100 × (𝑄3 − 𝑄1 )

𝑇𝑎𝑥 𝑅𝑒𝑣𝑒𝑛𝑢𝑒 = 100 × (1,200,000 − 400,000) = 𝟖𝟎, 𝟎𝟎𝟎, 𝟎𝟎𝟎

2 of 4
Assignment 2 ECON 1006

The total efficiency loss from consumer and producer surplus after the tax is imposed is referred

to as deadweight loss. Consumers lose because they now have to pay more for televisions. This

loss is proportional to the DEF area. There is also producer inefficiency because domestic

producers are inefficient in producing televisions, despite the fact that domestic production of

televisions increases from Q2 to Q1. Calculating this as an efficiency it is the same as the ABC

area.

∴ 𝑇ℎ𝑒 𝑡𝑜𝑡𝑎𝑙 𝑑𝑒𝑎𝑑𝑤𝑒𝑖𝑔ℎ𝑡 𝑙𝑜𝑠𝑠 𝑓𝑟𝑜𝑚 𝑡𝑎𝑥𝑎𝑡𝑖𝑜𝑛 = 𝐴𝐵𝐶 + 𝐷𝐸𝐹

= 10,000,000 + 10,000,000

= 𝟐𝟎, 𝟎𝟎𝟎, 𝟎𝟎𝟎

The tax is still beneficial to Canada because the revenue generated by the government exceeds

deadweight loss. As a result, overall welfare improves. Television producers will support the tax

because it raises the market price of their product, while consumers will oppose it.

QUESTION 2

a. Equilibrium price and quantity. Compute consumer surplus and producer surplus at

the market equilibrium.

Equilibrium will be achieved when the quantity demanded equals the quantity supplied, i.e.

Qd = Qs

100 − 5P = 5P

10P = 100

P = $10

To obtain the quantity, we will substitute P = 10 in any of the two equations.

Qs = 5P

Qs = 5 × 10

3 of 4
Assignment 2 ECON 1006

Qs = 50 units

∴ The equilibrium price is P = 10 and the equilibrium quantity is Q = 50

1
Consumer surplus = × (20 − 10) × 50 = $𝟐𝟓𝟎
2
1
Producer surplus = × 10 × 50 = $𝟏𝟐𝟓
2

∴ The consumer surplus is $250, and the producer surplus is $250 at the market

equilibrium.

b. The total cost of pollution when the market is in equilibrium.

Total Pollution generated at equilibrium = 50 × 5 = 250 units

Total cost = Cost per unit × Quantity of units

Total cost = $1 per unit × 250 units

= $𝟐𝟓𝟎

c. Suppose that the government restricts emissions to 100 units of pollution. Graph the

market under this constraint. Find the new price and quantity and show them on your

graph.

100 units of pollution implies that only 100/5 = 20 𝑢𝑛𝑖𝑡𝑠 of Negext can be produced. Any

demand above 20 units will build supply pressure, but since supply cannot increase, prices will

increase. For that reason, the supply curve will be a straight (vertical) line at 20 units.

Graphing the market under the conditions

Original demand curve is

Qd = 100 − 5P

Original supply curve is

Qs = 5P

4 of 4
Assignment 2 ECON 1006

Figure 1: Graph showing the market equilibrium under unrestricted conditions

5 of 4
Assignment 2 ECON 1006

Figure 2: Graph showing the market equilibrium under the constraint of restricting emissions to

100 units of pollution

Verical line @ Q= 20 represents the constraint on pollution

The point where the demand curve intersects with the constraint line is the new

equilibrium point.

6 of 4
Assignment 2 ECON 1006

d. Suppose that instead of restricting pollution, the government imposes a tax on

producers equal to $5 for each unit of chemical produced. Calculate the new

equilibrium price and quantity and the cost of pollution.

Equilibrium price will be achieved when we equate 20 units of supply to the given demand

function

∴100 − 5P = 20

5P = 80

P = $16

At the supply of 20units only, price will be much higher i.e., $ 16, much greater than the

equilibrium price without such restrictions.

When government imposes a tax of $5 on producers, then supply function will change but

demand function will remain same as the tax has not been imposed on the consumer.

The new supply function will be

Qs = 5(P − 5)

This is because whatever price they receive, they will have to give $5 to the government as tax.

The demand function will remain as it is.

Equating both we get:

100 − 5P = 5(P − 5)

100 − 5P = 5P − 25

125 = 10P

P = $12.5

7 of 4
Assignment 2 ECON 1006

Quantity, Q

Q = 100 − 5 × (12.5)

Q = 100 − 62.5 = 37.5 units

Total Pollution emitted = 37.5 × 5 = 187.5

∴ Total cost of pollution = 37.5 × 5 × 1$ = $ 𝟏𝟖𝟕. 𝟓

e. Which of the two policies would you recommend? Why?

Taxation, in my opinion, would be a better politics because with taxation, though more pollution

is emissed, there is also more Negext and the government receives tax revenue, which it can use

for other social purpose, while in the case of restriction, quantity is low, prices are extremely

high, and the government receives no revenue.

QUESTION 4

Relationship between ATC, AVC, and MC

ATC (Average True Cost) represents the average cost per unit of output, including both fixed and

variable costs. It is calculated by dividing total cost by the quantity produced.

AVC (Average Variable Cost) represents the average variable cost per unit of output, which

includes variable costs only. It is calculated by dividing total variable cost by the quantity

produced.

MC (Marginal Cost) represents the additional cost incurred by producing one more unit of output.

The relationship between these cost curves is as follows:

ATC is the sum of AVC and AFC (Average Fixed Cost), where AFC is the fixed cost per unit of

output. Mathematically,

ATC = AVC + AFC

8 of 4
Assignment 2 ECON 1006

MC intersects both AVC and ATC at their lowest points. This is due to the fact that MC reflects

the additional cost of producing one more unit, whereas the minimum points of AVC and ATC

correspond to the most efficient level of production.

ATC, AVC, and MC are related in that when MC is lower than ATC, ATC falls. When MC is

greater than ATC, ATC rises. When ATC is at its lowest, MC=ATC. After MC and ATC are

equalized, MC rises faster than ATC, so the MC curve is steeper than the ATC curve in this area.

When MC is less than AVC, AVC decreases; when MC is greater than AVC, AVC increases.

When MC equals AVC, the two curves meet. Following the equalization of MC and AVC, MC

increases at a faster rate than AVC, resulting in a steeper MC curve than AVC in this area. Whether

the firm is profitable or losing money, this relationship remains constant throughout the

manufacturing process.

Relationship between ATC, AVC, and MC for a firm making Loses

Price (P) in a perfectly competitive market is determined by the intersection of the demand and

supply curves.

If P > ATC, the firm is covering its average total cost, but it may still incur losses since P > AVC.

If P < ATC but P > AVC the firm is covering its variable costs (AVC) but not covering its fixed

costs (AFC) resulting inn economic losses.

If P < AVC, the firm is not covering its variable costs and will shut down in the short run.

Short Run Equilibrium (Firm and Market)

Drawings Pending

With a quantity equal to Q1 and a price of P1, the market is in short-run equilibrium. The firm's

equilibrium quantity is q1, where P1 equals MC. P1's short run price is less than the firm's ATC.

As a result, the firm suffers a per-unit loss equal to the difference between P1 and ATC. The short

9 of 4
Assignment 2 ECON 1006

run cost is higher than the average variable cost at R. As a result, the company continues to operate

at a loss.

Long Run Equilibrium (Firm and Market)

Assuming that neither the demand nor cost curves change or if demand and cost conditions do not

change:

Firms that are losing money will eventually leave the industry. As firms leave the market, the

market supply decreases and the market price starts to go up until it reaches the ATC. When the

price reaches ATC, the firms halt production. The decrease in market quantity caused by firm exit

creates less demand for both fixed and variable factors, resulting in a decrease in MC and ATC.

Firms increase output by equating higher P or MR with MC.

In other words, when some firms exit the market, the remaining firms receive a higher price as the

market price (P) rises. As the market adjusts to the new equilibrium, all firms in the market operate

at the minimum point of their ATC curve (P=ATC). Firms make no economic profit as a result of

this long-run equilibrium.

Ultimately, the market finds a new equilibrium with a higher price and a supply quantity that

matches market demand.

QUESTION 5

Demand: P = 10 – Q

Marginal Revenue: MR= 10 – 2Q

Total Cost: TC= 3 + Q + 0.5Q2

Marginal Cost: MC = 1 + Q

Where Q is quantity and P is price measured in Wiknam dollars.

a.

10 of 4
Assignment 2 ECON 1006

i. No of balls the monopolist produces

The number of balls produced at the point where the marginal cost and the marginal revenue are

equal is the quantity of S balls that will maximize profits.

MR = MC

10 − 2Q = 1 + Q

Q = 3 Units

ii. Price at which they should be sold

At this quantity, the price is:

Demand, P = 10 − Q

P = 10 − 3

P = $7

iii. Monopolist profit

The monopolist’s profit is the difference between the total revenue and the total cost. Calculate the

total revenue, total cost, and the monopolistic profit

Profit = TR − TC

TR = P × Q

= $7 × 3

= $21

TC = 3 + Q + 0.5 × Q2

= 3 + 3 + 0.5 × 32

= $10.5

Profit = TR − TC

11 of 4
Assignment 2 ECON 1006

Profit = $21 − $10.5

= $10.5

Therefore, the monopolist produces 3 soccer balls, sells them at a price of $7 each, and earns a

$10.5 profit. (Balls produced = 3 Units, Price = $7, Profit = $10.5)

b. The effect of free trade on:

Domestic Production

Domestic production of soccer balls will change as a result of free trade at a world price of $6. The

firm will no longer be able to sell at the monopolist's price of $7 because the world price will

be lower. As a price taker, the company will adjust its output to maximize profit at the market

price. The net change will be an increase in domestic production.

Domestic Consumption

The difference between domestic production and the world price will determine domestic

consumption. Wiknam will become a soccer ball exporter because domestic production exceeds

world prices.

New Production Quantity

To calculate the new production quantity, we equate MC to the current world price:

MC = 1 + Q = 6

Q= 6−1

Q=5

The enterprise will now produce 5 soccer balls. The difference between domestic production and

the world price will determine domestic consumption. Wiknam will become a soccer ball exporter

because domestic production exceeds world prices.

12 of 4
Assignment 2 ECON 1006

c. In Chapter 9, analysis of international trade, a country becomes an exporter when the

price without trade is below the world price and an importer when the price without trade

is above the world price. Does that conclusion hold based on your answer to parts a) and

b) above? Explain

The conclusion from Chapter 9 analysis does not hold in this case. Without trade, the monopolist's

price was $7, which was higher than the world price of $6. In part (b), however, after free trade

was permitted, the domestic price became equal to the world price. As a result, the conclusion

about becoming an exporter or importer based on price without trade is invalid.

d. Suppose that the world price is not $6 but instead happened to be exactly the same as

domestic price without trade as determined in part a). Now if the country allow trade,

would it change anything in the Wiknamian economy? Explain whether Wiknam

becomes and exporter if the world price is above the domestic equilibrium price and

becomes an importer when world price is below. Include all the relevant information in

your answer.

There would be no incentive for the firm to engage in international trade if the world price was the

same as the domestic price without trade. Because the domestic price would already be at the world

price, allowing trade would have no effect on the Wiknamian economy. This differs from the

analysis in Chapter 9, which shows that trade occurs when the domestic price differs from the

world price.

13 of 4