Question # 01: What is Micro Economics?

Briefly explain
Macro Economics. Also explain the factors to be studied in
both Micro & Macro Economics in detail.

Answer:

Microeconomics

The field of economics is broken down into two distinct areas of study:

microeconomics and macroeconomics. Microeconomics looks at the

smaller picture and focuses more on basic theories of supply and demand

and how individual businesses decide how much of something to produce

and how much to charge for it. People who have any desire to start their

own business or who want to learn the rationale behind the pricing of

particular products and services would be more interested in this area.

The branch of economics that analyzes the market behavior of individual

consumers and firms in an attempt to understand the decision-

making process of firms and house holds. It is concerned with the

interaction between individual buyers and sellers and the factors that

influence the choices made by buyers and sellers. In particular,

microeconomics focuses on patterns of supply and demand and the

determination of price and output in individual markets.

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 it's production and capacity so it could lower prices and better

compete in its industry.

Macroeconomics
The field of economics that studies the behavior of the aggregate

economy. Macroeconomics examines economy-wide phenomena such as

changes in unemployment, national income, rate of growth, gross

domestic product, inflation and price levels.

Macroeconomics on the other hand, is the field of economics that

studies the behavior of the economy as a whole and not just on specific

companies, but entire industries and economies. This looks at economy-

wide phenomena, such as Gross National Product (GDP) and how it is

affected by changes in unemployment, national income, rate of growth,

and price levels. For example, macroeconomics would look at how an

increase/decrease in net exports would affect a nation's Capital Account

or how GDP would be affected by unemployment rate.

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.
Macroeconomics is focused on the movement and trends in the economy

as a whole, while in microeconomics the focus is placed on factors that

affect the decisions made by firms and individuals. The factors that are

studied by macro and micro will often influence each other, such as the

current level of unemployment in the economy as a whole will affect the

supply of workers which an oil company can hire from.

The bottom line is that microeconomics takes a bottoms-up approach to

analyzing the economy while macroeconomics takes a top-down
approach. 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.

Source:

http://www.investopedia.com/terms/m/microecono
mics.asp

Factors to in Micro & Macro Economics

Balance of Trade

The balance of trade (or net exports, sometimes symbolized as

NX) is the difference between the monetary value of exports and
imports in an economy over a certain period of time. It is the
relationship between a nation's imports and exports. A positive
balance of trade is known as a trade surplus and consists of
exporting more than is imported; a negative balance of trade is
known as a trade deficit or, informally, a trade gap. The balance
of trade is sometimes divided into a goods and a services balance.
Physical balance of trade

Monetary balance of trade is different from physical balance of

trade (which is expressed in amount of raw materials). Developed
countries usually import a lot of primary raw materials from
developing countries at low prices. Often, these materials are then
converted into finished products, and a significant amount of value
is added. Although for instance the EU (as well as many other
developed countries) has a balanced monetary balance of trade, its
physical trade balance (especially with developing countries) is
negative, meaning that in terms of materials a lot more is imported
than exported. (http://en.wikipedia.org/wiki/Balance_of_trade)

Balance of Payment

In economics, the balance of payments, (or BOP) measures the

payments that flow between any individual country and all other
countries. It is used to summarize all international economic
transactions for that country during a specific time period, usually a
year. The BOP is determined by the country's exports and imports
of goods, services, and financial capital, as well as financial
transfer. It reflects all payments and liabilities to foreigners (debits)
and all payments and obligations received from foreigners (credits).
Balance of payments is one of the major indicators of a country's
status in international trade, with net capital outflow.

The balance, like other accounting statements, is prepared in

a single currency, usually the domestic. Foreign assets and
flows are valued at the exchange rate of the time of
transaction.

National Income
A variety of measures of national income and output are used
in economics to estimate total economic activity in a country or
region, including GDP, Gross National Product (GNP), and Net
National Income (NNI).

There are three main ways of calculating these numbers; the

output approach, the income approach and the expenditure
approach. In theory, the three must yield the same, because total
expenditures on goods and services (GNE) must equal the total
income paid to the producers (GNI), and that must also equal the
total value of the output of goods and services (GNP).

However, in practice minor differences are obtained from the

various methods for several reasons, including changes in
inventory levels and errors in the statistics. This is because goods
in inventory have been produced (therefore included in GNP), but
not yet sold (therefore not yet included in GNE). Similar timing
issues can also cause a slight discrepancy between the value of
goods produced (GNP) and the payments to the factors that
produced the goods, particularly if inputs are purchased on credit,
and also because wages are collected often after a period of
production

Per Capita Income

Per capita income means how much each individual receives, in

monetary terms, of the yearly income generated in the country.
This is what each citizen is to receive if the yearly national income
is divided equally among everyone. Per capita income is usually
reported in units of currency per year (e.g. US$20,000 per year).
When comparing nations per capita income reflects gross national
product per capital income, but it is also used to compare
municipalities within nations. When determining the per capita
income of a community, the total personal income is divided by the
population.

If the real per capita income increases over a long period of time, it
will indicate that country is making economic development

http://en.wikipedia.org/wiki/Per_capita_income
Question # 02 (a):
What is inflation? Differentiate between inflation &
hyper inflation, with examples.

Inflation:

The rate at which the general level of prices for goods and services is
rising and subsequently, purchasing power is falling. Central banks
attempt to stop severe inflation, along with severe deflation, in an
attempt to keep the excessive growth of prices to a minimum.
As inflation rises, every dollar will buy a smaller percentage of a good. For
example, if the inflation rate is 2%, then a $1 pack of gum will cost $1.02
in a year.

Hyperinflation
In economics, hyperinflation is inflation that is "out of control," a
condition in which prices increase rapidly as a fiat paper currency loses
its value. Formal definitions vary from a cumulative inflation rate over
three years approaching 100% (Today, many goods exceed the 100%) to
"inflation exceeding 50% a month." In informal usage the term is often
applied to much lower rates. As a rule of thumb, normal inflation is
reported per year, but hyperinflation is often reported for much shorter
intervals, often per month.

The definition used by most economists is "an inflationary cycle without

any tendency toward equilibrium." A vicious circle is created in which
more and more inflation is created with each iteration of the cycle.
Although there is a great deal of debate about the root causes of
hyperinflation, it becomes visible when there is an unchecked increase in
the money supply or drastic debasement of coinage, and is often
associated with wars (or their aftermath - Iraq, Afghanistan), economic
depressions, and political or social upheavals.
http://www.investopedia.com/terms/h/hyperinflation.asp
Question 02 (b)

Inflation can have a number of negative effects on the

economy. Explain at least four of them with some
suggestions to tackle such problems.

Answer:

Inflation can cause a number of negative effects on the economy of a

country. As inflation rises at creeping rate i.e. @ 2-3% per annum, it helps
grow the economy, as the purchasing power of the consumer is
increased, he buys more, when he buys more, new demands are
generated, to meet the new demands production is enhanced to meet the
market demands. Such rate of inflation can lead to a positive growth of
the people as well as the economy on the whole. But unfortunately
negative effects are more than the positive effects. The followings are the
main effects of Inflation:

• High Cost of Goods/Services

• Lower Savings
• Unemployment

High Cost of Goods/Services

When inflation rises at the galloping speed, it decreases the purchasing
power of the consumer. A consumer would buy fewer goods against more
spending. The consumer would not be able to match his income with
expenses. When the purchasing power of the consumer decreases,
demands falls automatically, therefore, production process would also
slow down, and ultimately the growth of the economy drops.

Lower Savings:

Inflation hits indirectly to the savings in one way or the other both on
micro and macro level. When cost of necessary goods increases due to
inflation, purchasing power of the consumer decreases, and to meet
income with expenses, consumer would spend the savings to fill the gap.
Due to inflationary effect on prices, most effected community is of
salaried persons, whose salary does not increase occasionally as
compared to other segments of the community. Salaried person has to
survive within the limits of his fixed income.

Fiscal Policy

Fiscal policy refers to government attempts to influence the direction of

the economy through changes in government taxes, or through some
spending (fiscal allowances). It is the use of government spending and
revenue collection to influence the economy

Fiscal policy can be contrasted with the other main type of economic
policy, monetary policy, which attempts to stabilize the economy by
controlling interest rates and the supply of money. The two main
instruments of fiscal policy are government spending and taxation.
Changes in the level and composition of taxation and government
spending can impact on the following variables in the economy:

• Aggregate demand and the level of economic activity;

• The pattern of resource allocation;
• The distribution of income.

Monetary policy

Monetary policy is the process by which the government, central bank,

or monetary authority of a country controls (i) the supply of money, (ii)
availability of money, and (iii) cost of money or rate of interest, in order
to attain a set of objectives oriented towards the growth and stability of
the economy Monetary theory provides insight into how to craft optimal
monetary policy.

Monetary policy is referred to as either being an expansionary policy, or a

contractionary policy, where an expansionary policy increases the total
supply of money in the economy, and a contractionary policy decreases
the total money supply. Expansionary policy is traditionally used to
combat unemployment in a recession by lowering interest rates, while
contractionary policy involves raising interest rates in order to combat
inflation. Monetary policy should be contrasted with fiscal policy, which
refers to government borrowing, spending and taxation.

Structural change

Structural change of an economy refers to a long-term widespread

change of the fundamental structure, rather than micro scale or short-
term output and employment. For example, a subsistence economy is
transformed into a manufacturing economy, or a regulated mixed
economy is liberalized. A current structural change in the world economy
is globalization.

Fisher (1939) and Clark (1940) look at patterns in changes in sectoral

employment. The logic of their arguments being that patterns of
production are functions of the level of income and that resource and
production shifts are an integral part of development. The major
determinant of these shifts is the income elasticity of demand. Goods or
sectors for which there is a high income elasticity of demand will grow in
importance as income grows. Countries start with their production
dominated by primary production, then secondary activities start to
dominate and finally the tertiary sector dominates.

Structural change can be initiated by policy decisions or permanent

changes in resources, population or the society. The downfall of
communism, for example, is a political change that has had far-reaching
implications on the economies dependent on the state-run Soviet
economy. Structural change involves obsolescence of skills, vocations,
and permanent changes in spending and production resulting in
structural unemployment.

Short-term economical challenges can be managed with short-term fiscal

or monetary policy decisions, and fluctuations are expected to even out
in a few years. Managing structural change requires long-term
investments such as education, and reforms aimed at increasing labor
mobility. The Trade Adjustment Assistance is an example of such a
program

http://en.wikipedia.org/wiki/Monetary_policy
http://en.wikipedia.org/wiki/Structural_change
 Question # 03 (a)

Describe the role of price as rationing device?

Answer:

The invisible hand – the workings of the price mechanism

Adam
Smith,
one of
the
Foundin
g
Fathers
of
economi
cs
famousl
y wrote
of the
“invisibl
e hand
of the
price
mechani
sm”. He
describe
d how
the
invisible
or
hidden
hand of
the
market
operate
d in a
competi
tive
market
through
the
pursuit
of self-
interest
to
allocate
resource
s in
society’s
best
interest.
This
remains
Author: Geoff Riley, Eton College, September 2006

http://tutor2u.net/economics/revision-notes/as-markets-price-mechanism.html
Question # 03 (b)

The Government gains revenue by imposing a sales

tax. Who stands to lose the most, the consumer or the
producer, or both? Quote original examples.

Answer:

Whether a sales tax is levied on buyers or sellers makes no

difference to the price paid by the consumers, the price
received by producers, and the volume of the goods sold. Nor
does it make any difference to the government’s revenue from
taxation; it is the same for both scenarios. The only difference
occurs in the diagrammatic exposition. I a graph of the tax on
sellers, the supply curve shifts up and to the left by the
amount of the tax per unit, whereas in a tax on buyers the
demand curve shifts down and to the left. In both cases, there
will be a wedge driven between the price paid and the price
received.

When the sales tax is introduced, it leaves the demand curve intact
while it raises the supply curve by the amount of the tax, supply
curve represents the quantities that a firm is to offer at alternative
prices. When the tax is levied, the price charged by the sellers
must reflect the tax. Therefore, the supply curve jumps up (a
decrease in supply) by the amount of the tax. This shift is a parallel
shift since the amount of tax is fixed and does not change with the
volume of consumption. The tax-inculsive supply curve reflects the
fact that sellers are willing to supply the same quantities only if
they get paid the tax amount more than before. The added amount
to the price is the sellers’ new obligation to the government. In
other words, sellers are willing to sell as much goods as before at
the same (net of the tax) prices.

Price of
Gasoline
(Per Litre)
B
0.53
 0.50

0.48 A
C

30 40
Quantity (Millions of Litres)

At the new equilibrium, point B, the price has risen and the volume
of transactions has fallen.

However, the equilibrium price of $ 0.53 is the price paid by the

consumers. Note that the price does not rise by the full amount of 5
cents to consumers even though the government has levied a 5
cent tax.

A final point of this analysis is how the burden of the tax is shared
between the two sides. In this example, the consumers’ share of
the new sales tax (3 cents) is greater than the producers’ share (2
cents). In general, who gets to pay a bigger portion of the tax is a
function of the slopes of the demand & supply curve. The steeper
the gasoline demand curve, the greater the portion of the 5 cents
that will be paid by consumers; the flatter the demand curve, the
smaller the consumers’ share. Also, the flatter the supply curve, the
bigger the portion paid by the consumers and vice versa.
Question # 04 (b)

In what respect would you expect determinant of demand for

computers to differ from determinants of the demand for milk?

Answer:

Demand:

In economics the concept of demand is employed to describe the quantity of a good

or service that a household can, or a firm chooses, to buy at a given price.

Market Demand & Individual Demand:

The market demand for a good or service is simply the total quantity that all the
customers in the economy are willing to demand per time period at a given price.

Determinants of Demand:

The amount of a product that consumers wish to buy in a given time period is
influenced by the following variables:

1. Product’s own choice

2. The price of related products
3. Average income of households
4. Tastes & Preferences
5. Income Distribution
6. Population

Difference between determinants of demand for Computers &

Milk:

While determining the determinants for Milk & computers, we would have to
distinguish between needs, wants & demands. Since milk is one of our basic needs,
and does not constitute wants or demand, therefore, it has very limited determinants
as compared to computers are very few. Whereas the determinants of demand for
computers above factors play a role. Computers are not a basic need for every
person, so we can put this product under wants & demands.

As the relationship between price and quantity, is subject to change over time due to
changes in the underlying factors held constant by the static notion of demand.
Changes in demand "shifters" are often included in economic estimation of demand
representing anticipated dynamics in these determinants.
Levels of income
A key determinant of demand is the level of income evident in the appropriate
country or region under analysis. Generally, the higher the level of aggregate and/or
personal income the higher the demand for a typical commodity, including dairy
products. More of a good or service will be chosen at a given price where income is
higher. Thus determinants of demand normally utilize some form of income
measure, including Gross Domestic Product (GDP).

Population
Population is of course a key determinant of demand. Although all dairy products do
not necessarily enter final consumer markets, the actual markets are largely
presumed to be functionally related to population. Growing populations are
positively correlated to dairy products demands in the aggregate, as well as
specifically to individual dairy products. Frequently, population and income
estimators are combined, as in the case of the use of Gross Domestic Product per
capita.

End market indicators

The use of end market indicators as determinants of demand is frequently
incorporated into demand analysis. For example, much of the final use of dairy
products is linked to domestic users..

Availability and price of substitute goods

Consumption choices related to dairy products are also influenced by the alternative
options facing users in the relevant marketplace. The availability of potential
substitute products, and their prices, weigh heavily in determining the elasticity of
demand, both in the short run (static) sense and over time (long run).

Suitability of alternative goods and services is, in part, a question of knowledge as

well as availability. Market information regarding alternative products, quality,
convenience, and dependability all influence choices. Under conditions of increased
scarcity and rising prices for dairy products, for example, users have a positive
incentive to search for and investigate the suitability of alternatives that were
previously overlooked or ignored.

Tastes and preferences

All markets are shaped by collective and individual tastes and preferences. These
patterns are partly shaped by culture and partly implanted by information and
knowledge of products and services (including the influence of advertising). Different
societies use dairy products differently because of these differences in taste and
preferences. For example, markets for milk products in USA are commonly
recognized as requiring very high product quality standards, the importance of visual
attributes of milk, and other preferences not commonly found in many other
markets.

http://www.fao.org/docrep/w4388e/w4388e0t.htm
Question # 05:
Answer:

Definitions of Important Terms:

Explicit cost
An Explicit cost is an easy accounted cost, such as wage, rent and
materials. It can be transacted in the form of money payment and is lost
directly, as opposed to monetary implicit cost.

Implicit cost
In economics, an implicit cost occurs when one foregoes an alternative
action but does not make an actual payment. (For instance, the explicit
cost of a night at the movies includes the moviegoer's ticket and soda,
but the implicit cost includes the pay he would have earned if he had
chosen to work instead.) Implicit costs are related to forgone benefits of
any single transaction

Economic Profit
An economic profit arises when its revenue exceeds the total
(opportunity) cost of its inputs, noting that these costs include the cost of
equity capital that is met by "normal profits." A business is said to be
making an accounting profit if its revenues exceed the accounting cost
of the firm. Economics treats the normal profit as a cost, so when
deducted from total accounting profit what is left is economic profit (or
economic loss).
 a) Total Explicit Costs of running the Variety Store

Store Rent $ 25,000.00

Business Taxes $ 15,000.00

Total Explicit Cost $ 40,000.00

Total Implicit Costs

Profit @ 20% on $ 80,000.00$ 16,000.00

Family annual Wages $ 90,000.00

Total Implicit Cost $ 106,000.00

b) Accounting Profit of the Variety Store

Revenue $
480,000.00
Less Cost of products $ 350,000.00
Store Rent $ 25,000.00
Business Taxes $ 15,000.00
Total Cost $
390,000.00
Accounting Profit $
90,000.00
c) Economic Profit of the Variety Store

Revenue $
480,000.00
Less Cost of products $ 350,000.00
 Store Rent $ 25,000.00
Business Taxes $ 15,000.00
Estimated wages $ 90,000.00
Estimated Profit $ 16,000.00
Total Cost $
496,000.00
Economic Profit/ (Loss) $
(16,000.00)

d) Profit is the factor income of the entrepreneur. The definition may

be explained in the following manner; there are four factors of
production: Land, Labor, Capital & Organization. The corresponding
reward of the factors are rent, wage & salary, interest and finally
profit.

An economic profit arises when its revenue exceeds the total

(opportunity) cost of its inputs, noting that these costs include the
cost of equity capital that is met by “normal profits”. A business is
said to be making an accounting profit if its revenues exceed the
accounting cost of the firm. Economics treat the normal profit as a
cost, so when deducted from total accounting profit what is left is
economic profit (or economic loss).

All enterprises can be stated in financial capital of the owners of

the enterprises. The economic profit may include an element if
recognition of the risks that an investor takes. It is often uncertain,
because of incomplete information, whether an enterprise will
succeed or not. This extra risk is included in the minimum rate of
return that providers of financial capital require and so is treated as
still a cost within economics. The size of that return is
commensurate with the riskiness associated with each type of
investment, as the risk-return spectrum.

Economic profit does not occur in perfect competition in long run

equilibrium. Once risk is accounted for, long-lasting economic profit
is thus viewed as the result constant cost-cutting and performance
improvement ahead of industry competitors, or an inefficiency
caused by monopolies or some form of market failure.
e) Though the business is earning “Accounting Profit” but while
considering the “Economic Profit” the firm incurred loss. The
owner of any business concern calculates his profits keeping in
view both Accounting & Economic profits, therefore, it’s best for my
friend to close down his business to avoid any future loss.