TUTORIAL ANSWERS FOR TUTORS

Principles of Economics (ECON 1008)

Study Period 2, 2014

Tutorial Time: ________________________ Tutorial Room: __________

Tutorial Time: ________________________ Tutorial Room: __________

Tutorial Time: ________________________ Tutorial Room: __________

Tutorial Time: ________________________ Tutorial Room: __________

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Dear Tutor,

This document is a week-by-week guide containing weekly tutorial questions with

suggested answers/approaches, for use by tutors only in SP2, 2014. Below please
find below some handy tips for your reference in delivering the tutorials.

Tutors’ Role

 You are the point of contact/information for most students

 You are sending the message regarding our expectations
 We want you to take a key role in sending our expectations and standards to
students

Please emphasise:

 Student’s individual responsibility for learning

 Active learning (participation in tutes, exercises, extra study)
 Their full participation in the course – they should do all the assignments –
they should do all the tutorials- they must be organized.
 Have high expectations of students from day 1
 Expect them to access the materials from the web;
 Expect them to have the textbooks
 Expect them to be organized and ready to go

 We expect at least 7 hours study per week in additional to the lectures and
the tutorials
 We expect students to ask questions to the tutors and on the discussion
forum
 Tutorials are for asking questions – but not about receiving a lists of written
answers from the tutor
 Treat everyone equally and in a friendly manner.
 Students must regularly check the website and read their emails.

Tutorial processes:

 Tutorial classes are 50 minutes. Please try to be in the class room at least 5
minutes before the start of the tutorial.
 Tutor begins discussing the answer to the weekly exercises as a group.
Please do not feed the students the answers. Please encourage students to
actively participate in class discussion each week.
 If you are ill or there is some other problem that may prevent you from
conducting the tutorials, please try and give us as much notice as possible.

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Assignment/Assessment information:
 Assignment 1a and 1b (week 3 and week13)
o Students must complete the learning inventory online, provide a
benchmark receipt and essay to get the full 2.5%, otherwise they’ll get
zero.
o The students will need to submit this via Assign IT.

 Assignment 2 (due in week 6)

o Writing economics exercise. The exercise will appear on the website in
week 3 for almost three weeks. It will consist of a short reading and
questions to be completed in on a set number of pages.
o Mark and record results. Send the results to the course administrative
staff. Normal turnaround time for assignment two is two weeks. A
marking guide will be supplied.

 Assignment 3: MCQ test

o The test will be conducted online in Week 5, 8 and 11.

Please direct queries regarding assignment extension to Gradebook. Please

direct queries regarding special considerations, deferred exam and
supplementary exam to campus central, as course coordinator is not involved
in making such decisions.

Recording marks:

Both assignment 1 and 2 must be submitted via Gradebook. You are expected to
mark Assignment 2. The turnover time for Assignment 2 is 2 weeks. Please let the
course coordinator know if you have difficulties in meeting the deadlines.

Meetings:

There are 13 weeks of tutorials from week 1.

In addition to these 13 contract weeks, we will have meetings to discuss marking

guide for Assignment 2 and exam. You will be paid for your time.

If you have any questions please don’t hesitate to contact either of us via email
(xin.deng@unisa.edu.au; adam.loch@unisa.edu.au) or my office number
(83020743/83027296).

We look forward to working with all of you to make this course an enjoyable and
challenging learning experience for students.

Adam and Xin

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Assignment 1 Learning-to-Learn

Due date:          March 21st at 11:00pm (1a) and June 13th at 11:00pm (1b). To be completed &
submitted via Gradebook only.
Weighting:       2.5% each.

In the “learning to learn” aspect of this course, you are expected to reflect on the way that you learn
economics.  In order to receive 2.5 marks for both inventories, you need to complete the following
three components:

1. A Learning Inventory
2. A Benchmark Exercise and
3. A short (up to 500 words) essay about your learning profile.

Assignment 2 Applied Writing

Due date:         April 11th at 11:00 pm. To be completed & submitted Via Gradebook only.
Weighting:       25%

Assignment 3 Multiple Choice Test

Due date:          Week 5, 8 and 11. Online (The test will be closed at 11pm on Fridays of the
relevant week)
Weighting:       20%

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Tutorial # 1 (Week 1, Beginning Mar 3rd)

This week gives you a chance to get to know the students in your tutorial, provide some
general information about the course and the importance of economic models. You will be a
given ‘important things to know’ worksheet, which you can provide it your students. Let
them know what you expect from them and what should they expect from you.

Please also take the time to show them the course website and all that it has to offer.

Then we can begin with some basic introductions to the course and the thinking required to
set a firm basis for the rest of the semester. Use these questions to get the process of
economic thinking started:

Look at Graph1 above. It presents a theory about the relationship between the numbers of
drink drivers on the road (where a drink driver is a driver who drives a car with a blood-
alcohol level that is above the legal limit) and the number of road accidents. Answer the
following questions related to this graph:

(a) On the graph which is the dependent variable and which is the independent variable?

Answer: The dependent variable is… A …… and the independent variable

is…… D ……..

(b) In your own words what is the graph postulating about the relationship between the
number of accidents and the number of drink drivers?

Answer: All other than being equal, when the number of drink drivers increases
then the number of road accidents also increases

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(e) What other factors do you think could influence the number of road accidents?

Answer: make students come out with different factors that can cause road accidents,
besides drink driving.

(f) How does interpreting the graph utilise the ‘ceteris paribus’ assumption?
Answer: ‘Ceteris paribus’ means ‘all other things remaining constant’. B captures
‘all other things’ and its value is constant. This also represents the intercept of a
straight line. Give some ideas about slopes and intercepts.

(g) What does the distance B represent?

Answer: Distance B represent the number of accidents even when the number of drink
drivers are zero on the road. (intercept)

(e) Why would the study of economics help in analysing the problem of drink driving? Explain your
answer.

Answer: As can be seen from the answer to these tutorial questions, economics
teaches us to abstract from reality and construct hypotheses about that reality. In
doing this economist are able to gather together all relevant variables,
systematically analyse their importance by identifying independence and
dependence and then hypothesise about the nature and direction of the relationship
between such variables. Economics also teaches students about data sampling and
statistical analysis so that the theories that have been formulated can be tested
against relevant facts gathered from the real world. Once this has been done, policy
makers are able to ascertain the efficacy of various policy prescriptions such as
whether resources should be allocated to greater enforcement of drink driving laws
or to higher levels of education about the dangers of drink-driving or to a myriad
of other policy directions.

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TUTORIAL # 2 (Week 2 Beginning Mar 10th)

March 10th is a public holiday, if you have your tutorial on Monday then please ask
your students to attend any other tutorial that week.

1. “Scarcity is faced only by underdeveloped and developing nations.” Do you agree?

Explain your reasoning. In your answer you should be clear about what is meant by the
term used in the statement.

Answer: No, the given statement is incorrect, unlimited wants and limited resources lead
to the problem of scarcity. Limited resources must be allocated to the production of
goods and services and resulting either to investment or consumption. Since there are
never enough resources available to produce all of the desired goods and services, the
problem of scarcity is directly relevant to all countries and all individuals.

2. What is an inverse relationship? Show how it is graphed, and explain why this is inverse.
Answer: An inverse relationship is where a positive change in the independent variable
results in a negative change in the dependent variable. Use any example(s) you want.
You might use something like the relationship between interest rates and loan demand
(as below) for an example, and get one or more of the class to draw the inverse
relationship on the board. It may also be good to graph a positive relationship so they
can understand these concepts (use any example).

3. Critically evaluate this statement: “The problem with economics is that it is not practical.
It has too much to say about theory and not enough about facts”.
Answer: Students should discuss that in reality economics is best served by a mixture of
facts and theory to answer economic (social) problems. This may allow opportunities to
talk about positive (factual) and normative statements, and again highlight the
importance of market theories in this course for analysing and explaining such
problems. It would be useful to have them discuss their views on economics as a
practical subject and how it relates to their individual courses. Further, the link
between appropriately using facts and theories in the assessment questions in this
course (i.e. assignment 2 and final exam) could help them to appreciate how to better
tackle the tasks ahead of them.
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TUTORIAL # 3 (Week 3 Beginning March 17th)

Assignment 1a is due this Friday at 11pm.

1. TRUE or FALSE: “On a production possibilities curve or frontier, a change from

economic efficiency to economic inefficiency would be indicated by a movement along
the curve.” Explain.
Answer: False, explain the meaning of productive, or economic, efficiency: a point at which the
maximum output is achieved given the society’s scarce resources. What does “more”
economically efficient mean? Economic efficiency is an absolute rather than a relative concept,
an efficient combination of resources is achieved by being on the PPF by comparing output
levels at a point inside versus a point on the PPF. Emphasise the implications of the assumption
of full employment and that all points on the PPF are productively efficient. Also emphasise the
distinction between productive and allocative efficiency. What combination of goods is
productively efficient is determined by technology; what combination is allocatively efficient is
determined by social preferences (that determine marginal benefits) and technology (that
determines marginal costs). At the allocatively efficient point on the PPF, for each good, the,
the marginal cost of producing one unit equals – or comes closest to equalling – the
marginal benefit derived from producing it.
2. You have been asked by the new nation of Tranjikstan to prepare a report about the
production possibilities it faces when its resources are fully employed. The Ministry of
Industrial Planning gives you the following table of (incomplete) combinations of public
sector goods and services (defence, police services, education, hospitals etc) and private
sector goods and services (cars, food, clothing, housing etc) that it feels that Trajikstan is
capable of producing (the figures are in millions of Trajikstan goubles, the local
currency.)
A B C D E
Public sector
goods & services 0 9 27 54 108
Private sector
goods & services 100 92 76 52 4

(a) Plot these combinations on a graph.

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Answer: If you do this you will find that the line is linear. Since public goods and
private goods are independent variables, they can be placed interchangeable on any
axis.
(b) The Chief Planning Officer tells you that he is convinced that the figures illustrate the concept of
opportunity cost. Do you agree? Justify your answer.

Answer: Yes. This is the case because the PPF is downward sloping. Get students to
link the concept of opportunity cost to the negative slope by getting them to move
from one point, say C, to another, say B.

3. Explain why opportunity cost is an inevitable part of decision making in all economic
systems at local, national and international levels.

Answer: All economic systems face the problem of scarcity. Thus assuming the
economy is using all resources as efficiently as possible and the best technology
available, it is not possible to produce more of one good without reducing
production of another, this applies at all levels of decision making, local, national, or
even international, because there are never enough resources available to produce
all of the desired goods and services.

4. Look at the figure provided below. What does point D represent? Similarly, what does
point X represent in this diagram? As a slightly more difficult question, what is a key
difference between this diagram and what we graphed earlier?

Answer: Point D is unattainable at the moment. We need an increase in total resources

or an improvement in technology to reach this combination of vehicles and personal
computers. Points lying inside the PPF occur when there are unemployed resources or
when the economy is not making efficient use of the scarce resources available. Point X
is an example of this. We could increase output of both goods by moving towards the
production possibility frontier and reaching any of points C, A or B.

The main difference is between the shape of the frontier—one is linear (straight) while
this one is curved. Do not get too carried away, but perhaps briefly explain that a PPF is
normally drawn as concave to the origin since the marginal productivity of allocating
extra resources to one particular good may fall. In linear curves the slope is constant,
while in the concave curve the slope is non-constant. Each depends on societies’ level of
utility from the two goods in question.
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 TUTORIAL # 4 (Week 4 Beginning March 24th)

1. Assuming the graphs below refer to the Australian sugar market, draw in the
appropriate graphs and fill in the missing spaces in this table.

This effect...... ....shifts the demand or supply .....because

curve (draw in appropriate
shift)......
An increase in wages Increases the cost of
of the employees in production so that
sugar industry suppliers are only
willing to supply
each quantity at a
higher price

An improvement in Decreases the cost of

technology in sugar production so that
processing suppliers are willing
to supply each
quantity at a lower
price

A decrease in the Increases the

price of sweetener quantity demanded
of the substitute and
so reduces (shifts)
the demand for the
other good to the left

Sugar is found to Obesity is

contribute to obesity considered as non-
price determinant of
demand for sugar.
This will lead to
decrease in demand.

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 An increase in sales Increases the cost of
tax for sugar supplying the good
so suppliers are only
willing to supply it
at a higher price

A decrease in income This increases the

tax in Australia consumer’s budget
and hence shifts the
demand curve to the
right.

2. TRUE or FALSE: “In a market where the forces of demand and supply are free to
fluctuate unimpeded, the equilibrium price is the only price that can last.” Explain.

Answer: True. Have students explain thoroughly why above and below equilibrium
prices will not be sustainable. A thorough explanation would proceed as follows,
starting from a below-equilibrium price where there is a shortage or excess demand. As
the competition between buyers forces the price to rise, some consumers drop out of the
market because their reservation prices have been reached (the equilibrating process
involves movement along the demand curve). At the same time, the rise in price also
induces a larger quantity supplied because firms attempt to pursue the higher profits
that come from switching resources from the production of other goods into producing
this good (given its increased market price), and because firms that were previously
unprofitable in producing this good can now produce at a profit, and enter the market
(a move up along the supply curve). This process will continue until all excess demand is
removed. A similar but opposite story can be told starting from an above-equilibrium
price.

3. Assume coffee beans are sold in a purely competitive world market. Describe the
impact, ceteris paribus, of each of the following on a graph.
(a) a severe drought in one of the major coffee-producing nations (Brazil).
(b) a rise in the incomes of consumers.
(c) an expectation of a bumper crop in Brazil
(d) a report that links heart disease to the consumption of caffeine.
(e) a rise in the price of tea.

Answer:
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 (a)A severe drought would shift the supply curve to the left and result in a higher world
price and decrease in quantity.
(b) A rise in the incomes of consumers would shift the demand curve to the right and
result in a higher price and increase in quantity.
(c) An expectation of a bumper crop in Brazil would lead to an expectation of a lower
price so demand in the current market would shift to the left as buyers delayed their
purchases. This result would depend on the level of inventories and the perishability of
coffee. There will be decrease in price and decrease in quantity as well.
(d) The report would result in a reduction in the consumption of coffee and a fall in its
price.
(e) If we assume that tea and coffee are substitutes, then a rise in the price of tea would
lead to an increase in the demand for coffee and a subsequent rise in its price.
Note: In student answers each answer should be accompanied by a graph which is
correctly labelled and described.

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TUTORIAL # 5 (Week 5 Beginning March 31st )

First online test is due this Friday.

1. An increase in supply and an increase in demand will…(select the best option, and
explain your choice):
(a) increase price and increase quantity.
(b) decrease price and increase quantity.
(c) affect price in an indeterminate way and decrease quantity.
(d) cancel each other out and not have an impact on either price or quantity.
(e) affect the price in an indeterminate way and increase quantity.

Answer: (e) is correct. Have students illustrate each case graphically.

2. Assume market for fuel is in equilibrium position. Analyse the impact on the market,
when government imposes retails price ceiling on fuel.

Answer
*Before starting discussing answers, give a quick recall about the concept of Price
ceiling. Discus how shortage is created due to price ceiling and also mention the effect of
shortage on the market. Refer pg 72 of the text book.

3. Illustrate graphically why price support results in surpluses?

Answer:
Refer pg 73 of textbook.

PS: This week we will give a surprise test on demand and supply to students. I will provide
the test along with the answers in week 4. This test is not gradable and is only meant to verify
the understanding of the students.

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TUTORIAL # 6 (Week 6 Beginning April 7th)

Assignment 2 due this Friday at 11pm.

Semester break starts next week.

1. TRUE or FALSE: “Ceteris paribus, recessions benefit companies that sell products
with negative income elasticities of demand.” Explain.
Answer: True. Negative income elasticities suggest that goods are inferior goods. So
when incomes fall, demand goes up. Make sure students understand why inferior goods
have negative income elasticities. You may find it useful to go back to the elasticity
formula (% change of dependent variable/% change of independent variable), ensure
students recognize which is which, and then have them explain how negative and
positive signs for the E coefficient can emerge.

2. TRUE or FALSE? "If an elasticity coefficient is equal to -3.5 then we can conclude
that a 1% change in the independent variable is associated with a 3.5% change in the
dependent variable in the opposite direction." Explain.

Answer: True. You should get students to go through the generalised formula in the text and
then put these figures into the formula. (explain the negative sign).

3. *TRUE or FALSE: “Twinkle and Dazzle are substitute products used in the cleaning
industry. All other things remaining the same, you would expect them to have a
positive cross price elasticity of demand.” Explain.

Answer: True. Use the same teaching methodology as used in explaining the answer to
the previous question (referring now to the formula for the cross-price elasticity of
demand, on EP pg 70) to make sure students understand the implication of negative
sign.

4. Each Monday a restaurant runs a lunch special on vegetarian laksa. On other days of
the week it sells about 250 serves at a price of $7 each during the lunchtime rush. On
Mondays, the restaurant lowers its price to $5 and demand proves to be price inelastic
(i.e. Ped is less than 1.0). The chef argues that even 250 serves stretches the kitchen
beyond its production capacity. She argues that a price rise would ease the pressure on
the kitchen and would leave the restaurant better off. Use your understanding of
elasticity and revenue to critically examine the chef’s position.

Answer: This is testing that requires students to analyse the impact on TR of a price
change if the Ped is < 1.0. The Monday special price is a generous reduction (28.5%)
but, since demand is price inelastic, the impact is to reduce TR, made worse by the fact
that the kitchen is already over-stretched at 250 serves.
The smart thing to do is to raise the price since TR will increase when Ped < 1.0; i.e. the %
change in Q will be less than the % change in P. The restaurant is better off after a price rise
since less is being sold but at a higher price

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 5. Joe and Bruce sit outside a bar on budget night. Joe eyes his pack of cigarettes with
dismay. “Those darn politicians announced another tax on us poor smokers today”,
he says. Bruce nods with empathy, fingers his smokes and then whines, “They try to
tell us that they do it to reduce the number of cigarettes sold in the market. It’s just
another way for the government to levy more taxes! They should tax the cigarette
companies and leave us poor smokers alone”.

(a) Do you suppose that the demand for cigarettes is price elastic or price inelastic? What is
the elasticity of supply of cigarettes?

Answer: Run through the factors affecting Ped and Pes and students should conclude
that Ped is likely to be < than 1.0, i.e. demand is price inelastic as cigarettes are
addictive and thus a necessity for those who smoke) whereas Pes is most likely > 1.0, (i.e.
supply is price elastic as the product is durable and can be stored)

(c) If your guess about price elasticities is right, then will the burden of the new sales tax be
borne by suppliers or more by consumers?

Answer: Refer FIG 3.7 (b) page 75. The tax burden is borne more by consumers in this
case since the demand for cigarettes is relatively price inelastic.

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TUTORIAL # 7 (Week 7 Beginning April 28th)

Assignments to be returned to students in tutorial this week.

The following activity is designed to illustrate the average and marginal concepts.
Divide your class into two groups, and get the group members to find out the age of each
member, and fill the table below and present the information in the table as a graph. Then
each group will choose a representative to report their result to the whole class.

Student Age Average Age Marginal Age

1
2
3
4
5
6
7
8
9
10

Average
Average Age
Age
Marginal
Marginal Age

No. of Student

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1. The following table outlines the wheat production per year of a small wheat farm on the
Yorke Peninsula. Each worker on the wheat farm was paid an identical wage of $375 per
week for one year.

Numbe TP AP MP TVC AVC TFC TC ATC MC

r of of labour of labour Per
workers year

0 0 0 0 0 - 750 750 - -
1 3 3 3 19500 6500 750 20250 6750 6500
2 10 5 7 39000 3900 750 39750 3975 2785.71
3 24 8 14 58500 2438 750 59250 2469 1392.86
4 36 9 12 78000 2167 750 78750 2188 1625
5 40 8 4 97500 2438 750 98250 2456 4875
6 42 7 2 117000 2786 750 117750 2804 9750
7 42 6 0 136500 3250 750 137250 3268 19500
8 40 5 -2 156000 3900 750 156750 3919 -9750

(a) Fill in the blank columns in the table above

(b) Plot the firm’s short run total, average and marginal product curve.

Answer: Should look like FIG 4.1 (a and b) on page 88. Also discuss that diminishing
returns set in after 3rd work. NOTE: while drawing this you MAY want to take the
students briefly back to question 4 week 3 (curved PPF diagram) and discuss how
these curves are representative of production opportunity cost rather than utility
opportunity cost.

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 2. The following statements refer to Graph 1 above. In each case identify which
statement is True and which is False by circling your choice. In each case, justify that
choice in the space provided.

T F a) In Graph 1, the distance 0A measures normal profits.

Explanation:

False: You cannot ascertain profits without knowing price (=average revenue
or AR) which is not given. Even if A were the price, it would not measure
normal profits because they would be measured by an area. In this case
normal profits would have a zero area.

T F b) In Graph 1 assume that the market price is 0B. A firm producing an output of
0Q5 would make a normal profit.
Explanation:

True: Total revenue = OBx0Q5 = Total Cost = OBxQ5, so that TR-TC = 0

which is the definition of normal profit

T F c) In Graph 1, if we assume that 0Q5 is the profit maximising level of output,

then average revenue must equal 0C and profit per unit will be CB.
Explanation:

True: The profit is maximised when MC = MR. For pure competition MR =

AR =P. Since average revenue equals 0C and ATC equals 0B at an output of
Q5, profit per unit will be AR-ATC = CB.

3. In the long run, we can expect average total costs to…..(choose the best answer):
a) rise if economies of scale are present.
b) fall if diseconomies of scale are present
c) rise if there are increasing returns to scale present.
d) fall if economies of scale are present.
e) fall if there are constant returns to scale present.

Answer: Option d is correct. See Figure 4.7 of EP on pg 98

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TUTORIAL # 8 (Week 8 Beginning May 5th)

The second online test due this Friday at 11pm.

1. TRUE or FALSE: “The output of any one purely competitive firm is so small relative
to market output that it has to accept the output desired by customers in that market.”
Explain.
Answer: This is false. The firm must accept the price, not the output; the decision
regarding output is up to the firm, based upon the cost curves it faces and the marginal
revenue it can expect, given the price structure it faces – which in a competitive market
is simply price itself. See Figure 5.7 on EP pg 122.

2. Use marginal and average cost and revenue curves for a perfectly competitive firm to
show
(a) a short-term loss situation;
(c) an economic profit situation;
(b) a normal profit situation

Answer: Explain Figures 5.3 (showing the curves for a firm making economic profits,
on EP pg 116), 5.4 (showing the curves for a firm making a loss, on EP p 118) and the
normal profit situation, in which average revenue=MR=price equals average total cost.
Have students flesh out the meaning of “normal” profit by asking them to explain why
TR =TC = 0 measures a “profit” (because total costs includes the entrepreneur’s
opportunity cost, and the opportunity cost of all other inputs to production).

3. Discuss graphically the long run position of pure competitive firm?

Answer: Refer pg 121 – 124 of text book.

4. “Competitive market economy will allocate the limited resources available to society
in such a way as to maximise the satisfaction of consumers”. Explain the above
statement using the concept of Productive and Allocative efficiency.

Answer: Refer page 126-127 of text book.

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TUTORIAL # 9 (Week 9 Beginning May 12th)

1. Give three reasons regarding how monopoly power may arise?

Answer: Refer pg 129 of text book.

2. Why the price of a monopolist’s does exceeds its marginal revenue?

Answer: Refer pg 131- 132 of text book.

3. Explain “At a level of output where MR exceeds MC, the profit-maximising monopolist could
increase profits by lowering price”.

Answer: This is true. MR is greater than MC to the left of the profit maximising
level of Q. By lowering price, MR will fall, and MC will rise. While this may seem
like something the firm would like to avoid, profits will not be maximised when MR
exceeds MC, because the additional quantity sold that is yielded when price is
lowered adds to total revenue more than it adds to total costs, thereby boosting
profits.

4. TRUE OR FALSE: “The monopolist is the quintessential capitalist: exploiting consumers

and employees while always turning a tidy profit.” Explain.

Answer: While the image of the rich and exploitative capitalist may be comfortable to many
students, this statement is strictly false because of the claim that a profit will always be had.
Some discussion should ensue about whether the capitalist “exploits” consumers and/or
employees. Monopolists’ ability to choose where on the demand curve to produce, which
implies that to some degree consumers are at their mercy, sounds something like exploitation
(although this interpretation implies that a “wrong” is being done; it would be helpful to point
out that there is no moral component to this argument, or indeed to economic arguments
generally). As employees are inputs to production, and as in a monopolistic firm there is less
pressure to be productively efficient, it may be that employees will in fact have an easier time
working for monopolistic firms than for perfectly competitive firms: employees may not have
to be as productive as they would otherwise. Students may make the connection between this
and their experiences of, for example, customer service employees at monopolistic firms.

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TUTORIAL # 10 (Week 10 Beginning May 19th)

1. “The demand curve facing the monopolistically competitive firm lies somewhere
between the one facing a monopolist and the one facing a perfectly competitive firm.
This is explained by differences in the nature of competition and barriers to entry. It
also results in differences in the degrees of allocative and productive efficiency for
each market form.” Discuss this statement fully.

Answer: Students need to discuss the extremes between pure competition (flat AR = MR
curve) and the relatively steep AR and MR curves associated with monopoly. The
former is associated with products that are perfect substitutes and the latter by barriers
to entry and no substitutes. Monopolistic competition is somewhere in between where
there is some substitutability brought on by product differentiation and some barriers
to entry. It may pay to show that the gap between P and MC gets larger the steeper the
AR curve. This points to differences in allocative efficiency as well where the ideal is
P=MC under pure competition and increasingly greater divergence between P and MC
as the AR gets steeper.
Productive efficiency is ensured in pure competition by the P = min LATC condition
produced by the entry and exit of firms. In monopoly, barriers to entry suggest that
firms can earn economic profits because AR can remain above LATC indefinitely. In
monopolistic competition it is conceivable that AR could touch LATC so that only
normal profits are realized into the long run. However this result can only produce a
tangency point on LATC which is above min LATC (see panel (c) of Figure 6.2 on page
177 of the text).
It may pay to discuss the non-price competitive elements that characterize monopolistic
competition e.g. fruit stalls in the Central market. Ask students to name the non-price elements
such as location, variety of fruits offered, presentation etc. On the issue of excess capacity
suggested by the tangency point discussed above, you can point out that a fruit stall offers many
more fruit than it can hope to sell in a given day because it wants to ensure choice for its
customers. So, its holding or inventory costs make its LATC higher than could be attained at
min LATC where it would be able to exactly match the supply of each fruit with predicted
demand for that fruit. Excess capacity here means keeping more fruit on display than is strictly
necessary.

2. Paulo’s Pizzas is a small pizzeria located in a busy city street frequented by people
anxious to buy a lunch-time snack from one of many snack bars and bistros. The food
sold in the street is quite varied both in terms of its type (e.g. noodle bars, hamburger
joints, sushi bars etc) and ambience (e.g. take-away, table service etc) but it costs
between $10 to $20 per serve. Paulo even has some direct competition from non-
specialist Pizza suppliers but they serve pizzas as part of a wider, more general menu.
Paulo (and his brother Enzo) boast of original recipes and claim Italian authenticity
for their pizzas.

(a) What kind of competitive market does Paulo’s Pizzas operate in? Explain your
choice.

Answer: Monopolistic competition. See text page 155. Make sure students relate text to
the Paulo Pizza example.

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Graph 1 below shows the ‘share of market’ demand curve available to Paulo’s Pizzas and his
business’ ATC and MC curves.

(b) Based on the information in Graph1 above, answer the following questions:

How many pizzas does Paulo’s produce to maximize profits?...100................

What is the profit maximizing price? $15
What is the cost per pizza at the profit maximizing level of production$12.50
What are total profits at the profit-maximising level of production?
15x100) – (12.50x100) = $250.

(c) Graph 2 above shows the change in market conditions that result from new entrants
into the ‘lunch-time snack’ market (which we can assume is not growing). AR2 and MR2
now represent the new share-of-market demand and MR curves faced by Paulo’s Pizzas.
In the space below describe the new conditions prevailing in the market and discuss the
new outcomes suggested by Graph 2. Does the graph suggest that Paulo should expand
his business or close down?

Answer: Students should discuss the following:

The shift in AR1 from to AR2 (and associated MR curves) is caused by the lower share of the
market now enjoyed by Paulo’s Pizzas given that existing market demand has to be shared by
more suppliers. Notice that the market is for snack meals rather than pizzas specifically.
A lower profit maximising price and quantity sold brought on by competition (Q = 75 to 80 and
P = about $9).
Normal profits would be earned since AR2 equals ATC (or even maybe a slight loss given a
strict reading of the graph with ATC slightly above AR2).
Would this drive Paulo out of business? This would provide a useful opportunity to discuss the
meaning of normal profits. If normal profit is earned economic theory would suggest that
resources are earning the income they could in some alternative use and so they would stay in
business. In the real world such businesses probably have to keep a constant look out for this
type of condition. Though strictly not required by the question, this might give you a chance to
raise the issue of product promotion and the revenue implications of elasticity in such situations
as businesses struggle to survive. e.g. price promotions (elastic demand and a rise in revenue).
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 3. * The likelihood of a cartel being successful is greater when
a. cost and demand curves of various participants are very similar.
b. firms are producing a differentiated, rather than a homogeneous, product.
c. the number of firms involved is relatively large.
d. the economy is in the recession phase of the business cycle.

Answer: A. Refer PAGE 170 of the text

4. TRUE or FALSE? “If the prisoner’s dilemma is played once only, the dominant
strategy equilibrium is both prisoners confessing to the robbery.”

Answer: True. Try and get the students to explain the nature of the ‘dilemma’ in terms
of game theory and how it is appropriate to use this notion to understand how
oligopolists might behave. In the textbook example, the prisoners confessing is
analogous to ‘Giant’ and ‘Big’ independently adopting a low price strategy to ensure
that they don’t miss out on market share because the other firm cheated. Thus, the
prisoners opt to minimize gaol time by confessing whereas the firms opt for the
maximin strategy to maximize their expected minimum pay-offs.

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TUTORIAL # 11 (Week 11 Beginning May 26)

3rd MCQ test due this Friday at 11pm.

1. What is meant by the term “spillovers”? Explain why positive and negative “spillovers”
are seen as reasons why competitive markets “fail”. Conclude your analysis with a comment
on how such failure could be corrected.

Answer: Discuss the concept of spillover cost and spillover benefit, using fig 7.1 on page
184 of text. Also discuss the resource over- and under-allocation implications of
spillover effects as an explanation of why competitive markets fail. The correction of
market failure is covered on pages 187 - 188 of the text.

2. “Government influence in the economy is widespread. It has a role as a market regulator,

as a supplier of public goods and services and in stabilising the macro economy.” Discuss
this statement fully giving examples where appropriate.

Answer: The role of public sector was discussed as a regulator in imperfect competition.
Given that allocative and productive efficiency are achieved through competition, there
are strong arguments in favour of governments actively promoting greater competition
and preventing mergers that increase monopoly power in markets. Governments also
have a role in protecting consumers from deceptive and unconscionable behaviour in
cases where firms compete through non-price competition.

The public sector is also involved in the provision of public goods and services in
situations where markets are unable to provide such goods and services. These goods
and services are characterised by indivisibility and non-exclusion. There may also be a
role for government in the provision of public goods and services in cases where a
spillover effects are thought to be large. There is also a role here for government in
correcting such spillover effects.

Finally, governments undertake demand management policies at the macroeconomic

level when they use monetary and fiscal policy in an attempt to control unemployment
and inflation. Other macroeconomic policies relate to the balance of payments, income
distribution and promotion of economic growth.

3. Discuss the possible approaches to tackle pollution. What are the major problems associated with
each these policies?

Answer: Refer to page 193 to 195. Possible solutions:

- the allocation of property rights and the use of liability rules and lawsuits. Problem: could be too
costly for the individuals and groups affected by pollution.

- legislated controls and standards. Problem: standards could be difficult to establish due to
incomplete and disputed technological information. The enforcement of legislated controls and
standards could be complex and costly.

- emission fees. Problem: Difficult to determine the value of emission fee.

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- markets for pollution rights. Has some advantages over other approaches, but setting up the market
and ensure the market work efficiently could be very complicated.

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TUTORIAL # 12 (Week 12 Beginning June 2nd)

1. How do you measure Economic Activity? What are the two ways of measuring GDP?

Answer: GDP measures the value of final goods and services produced within the
borders of the country in a given period of time. However, GDP excludes
1) Activities that do not result in a product or service e.g. old age pension. 2) Goods and
services that do not go through markets e.g. criminal activities, home-keeping activities.
3)
Second hand goods and services. 4) Financial activities e.g. Value of shares purchased –
although some financial services are part of GDP.

There are two ways of measuring GDP

1) Expenditure method: Add up all spending on final goods and services produced
within the borders of the country in a specified period.

GDP = C + I + G + X – M

Personal consumption expenditure (C): Durables e.g. clothes, cars; Non-durables e.g.
food, drinks; Services e.g. hairdressers, restaurants.

Gross private investment expenditure (I): Final purchases of machineries & tools,
equipment, All building and construction, Change in stocks or inventories.

Government purchases (G): Final government consumption expenditure (e.g. Labour

services, army, paper used in govt. offices etc); Final government fixed capital
expenditures (e.g. roads, govt buildings etc); Change in stocks of govt entities (e.g.
public marketing and entities)

Net Exports (X – M): All exports of goods and services produced in the current period,
Minus all imports purchased in the current period.

2) Income method: Add up all the incomes generated producing the final goods and
services in a specified period.

Compensation of employees; Gross operating surplus; Tax less subsidies on production

and imports.

2 (a) .what are the different types of Unemployment?

Answer: 1) Frictional unemployment: workers ‘between jobs’, temporarily laid off due
to seasonality (e.g. bad weather in construction); Workers who are voluntarily
switching jobs; inevitable and partly desirable because allows movement of labour
from non-desired jobs to desired jobs or low to high productivity

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2) Structural unemployment: Occurs due to changes in the structure of the consumer
demand; Unemployment occurs because the composition of the labour force does not
respond quickly to the new structure of job opportunities.

3) Cyclical unemployment: unemployment caused by the business cycle, or due to

insufficient aggregate demand or total spending

(b). Distinguish between Demand-Pull and Cost – Push inflation?

Answer: Demand-Pull Inflation: caused by excess demand for output.

Cost-Push Inflation: rise in prices arising from increased cost of production due to:
Rising production costs e.g. oil prices; wage push; profit push

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TUTORIAL # 13 (Week 13 Beginning June 9)

Assignment 1b due this Friday at 11pm.

1. What is fiscal policy? What kind of fiscal policy should be used to tackle recession and
demand-pull inflation? Why the effectiveness of fiscal policy is influenced by the way
government finances its deficit and dispose its surplus?

Expansionary fiscal policy: The use of increased government spending and/or lower
taxes to increase the government budget deficit in order to stimulate economic activities
and move the economy out of recession or depression.

Financing deficit:
Borrowing from the public (selling bonds): compete with private bond, crowd out some
private investment spending and interest sensitive consumer spending. Not as expansionary
as money creation.
Money Creation: reserve bank issuing new money and accommodating the inflow into the
system of new funds. Spending can be increased without any adverse effect on investment or
consumption. Potential inflation.
Contractionary fiscal policy: The use of reductions in government spending and/or high
taxes, thereby reducing the deficit or increasing the surplus in the government budget, to
control demand pull inflation.

Disposing of a surplus:
Debt reduction: Retiring debts, the government transfers its surplus back to households, thus
potentially stimulate consumption expenditures and reduce interest rates in the markets for
investment and longer term funds, thus increase investment expenditures.
Impounding: allow the surplus fund to stand idle. The funds are not re-injected into the
economy, there is no possibility of the surplus being spent, thus create inflationary pressure to
offset the deflationary impact of the surplus/

2. What are built-in stabilisers? How do they work? Why do we still need discretionary fiscal
policy even if built-in stabilisers may produce similar outcome?

A built-in stabiliser is anything that tends to increase the government’s deficit (or reduce its
surplus) during a recession and to increase its surplus (reduce its deficit) during inflation
without requiring explicit action by policy makers.
Tax revenue tends to increase during inflation and decrease in recession (mining tax).
Progressive rate tend to have even stronger stabilising effect.
Welfare payments: unemployment benefits, family tax benefits.
Issues associated with built-in stabilisers:
Amelioration: all the stabilisers do is to reduce the magnitude or severity of economic
fluctuations. Discretionary fiscal action is still required to correct the inflation or recession.
Fiscal drag: 1) tend to reduce the impact of discretionary fiscal policy. E.g. increased
government spending partially translate into increased tax revenue. 2) Drag economic growth
in the long term.
Cyclically adjusted budget deficit: indicates what the budget deficit (or surplus) would be if
the economy were to operate at potential output throughout the year. Deficit can occur as a
by-product of fiscal inaction as the economy slides into a recession, without any positive
counter-cyclical fiscal actions by the government.

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3. What are the problems associated with applying fiscal policy?
Timing: Recognition lag, Administrative lag, Operational Lag
Political problem: Fiscal policy is not a pure economic decision.

Crowding-out Effect: where the government competes for the funds with private industry,
its debt issue will increase the costs of investment funds and reduce the level of private
investment.
Other Goals:
Expansionary bias: Tax reduction and increase in spending tend to be politically popular.
A political business cycle: politicians might manipulate fiscal policy to maximise voter
support.

4. What is the basic objective of monetary policy? Discuss the operation of monetary policy
in detail and how it works towards achieving the objectives.

Basic objective of monetary policy: To assist the economy to achieve a full-employment,

non-inflationary level (2-3 percent) of total output.
Monetary policy tools:
Cash rate: RBA sets up the cash rate – the price or interest rate, charged for exchange
settlement account funds – in line with its view of inflationary pressures within the economy.
Flow of Monetary Policy:
Change in cash rate – change in other short-term interest rates, as well as the amount of credit
that banks are willing to provide, by influencing their decisions on the holding of the excess
reserves – impact on the spending decisions of society, particularly on investment decisions,
and therefore on the level of output, employment, income and price.

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