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CODE: AIM 1002

PRINCIPLE OF MICROECONOMICS

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ASSIGNMENT

NAME : WONG MUI SIM

NRIC : 910322085696

H/P NUMBER : +60165335778

AUGUST 2010 SEMESTER

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Table of Content

NO TOPIC PAGES
1.0 ASSIGNMENT 3-4

2.0 COURSEWORK 5-7

ASSIGNMENT

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Please give your answers to the following short questions. You should illustrate your

answers with appropriate graphs and models where appropriate.

Referring to Public policy on Smoking:

Studies indicate that the price elasticity of demand for cigarettes is about 0.3. If a packet

of cigarettes is currently $5.00 and the government wants to reduce smoking by 10%, by

how much should it increase the price of a packet of cigarettes?

If the government permanently increases the price of cigarettes, will the policy have a

larger effect on smoking 1 year from now 3 years from now? Please give reason for your

answer.

Studies also find that teenagers have a higher price elasticity of demand for cigarettes

than do adults. Why might this be true?

Equation for the calculation of price elasticity of demand:

η = Percentage change in quantity demanded

Percentage change in price

Therefore: 0.30 = 0.10/ Percentage change in price

Therefore: Percentage change in price = 0.33 or 33%

The price of cigarettes should rise from $5.00 to $5.00 x 33% or $6.65

The general theory in this part of the question revolves around the inelastic value of

demand. Inelasticity the product is important in the budget of the consumer. Therefore it

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would be expected that the immediate fall will be relatively small as given by the value of

eta. That is for a 1% increase in the price, quantity will fall by 0.3%. However over time

consumers will have an opportunity to revise their budget and spending. A 33% increase

in the price of good is significant and accordingly over time the quantity of cigarettes

consumed will decrease to a greater extent than first indicated. This should also be

viewed in the context of peer group pressure, health warnings, all of which will cause

consumers to reduce the quantity of cigarettes consumed.

In regard to the young the problem of increasing price is affecting them as this group

has no income yet to spend on cigarettes. Therefore as the price rises the options

available to teenagers are very restricted and the opportunity cost is quite high. Available

funds are restricted so choice is limited. Accordingly a price increase will see younger

people choosing to spend their available funds on items other than cigarettes. Therefore

the young will have a higher price elasticity of demand than older consumers. It is true

that peer group pressure, health warning and society to smokers will also affect this

decision.

COURSEWORK

Explain the following news from the Australia Fish Market:

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“The fish market here slumped to what local’s called a `low level` today due to a

lack of potatoes. The potato is one of the main ingredients in a dish that figures in

every café and pub menu in Australia- Fish and chips”.

Answer should make reference to the theory of complimentary goods. Fish and chips

complement each other or one enhances the enjoyment of the other. Therefore as the

supply of potatoes diminishes the price of potatoes will rise, as illustrated in the first

demand and supply diagram.

Demand and Supply of Potatoes

S2

P2 S1

P1

Q2 Q1 Potato Out– Put

Demand and Supply of Fish

D1 S
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D2
P1
 P2

Q2 Q1 Fish Out– Put

Q2

The diagram also illustrates a fall in the quantity of potatoes in the market. Firms who are

unable or unwilling to pass-on the cost increase to customers will leave the market and

remove fish and chips from their menu in the short term (while the shortage exists.) As a

consequence the demand for fish in the Fish Market will fall, as is illustrated by the

second demand and supply curve. Price paid and quantity bought will both fall. This will

result in an oversupply in the market should the fish sellers attempt to hold the price at P1

rather than allow the market to clear by dropping the price to P2 as would be the case in

the efficient market.

Demand and Supply of Fish

Price of Fish
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D1
D2 S
 P1

P2

Quantity of fish
Surplus of fish in the Market

Suppliers will have to look to alternative markets in order the clear this surplus-eg:

exports or lower their price in order to clear the market.