Question

Outcomel Satisfactory Evidence requirements Comments Unsatisfactory explain with an example the basic economic problem explain with an example the concept of opportunity cost identify changes to demand and supply when two determinants for each are altered explain with the aid of a diagram/graphical information the interaction of demand and supply in a given scenario explain the concepts of price elasticity of demand and income elasticity of demand in a given scenario Comments

Answer 1

1.Basic Economic Problem The basic economic problem is the problem of economizing the scarce resources. It is the problem of how to satisfy the unlimited wants with limited means which have alternative uses. In the context of unlimited wants and limited means and the multiple uses of limited resources the economy basically faces three fundamental problems. They are what to producc, how to produce and whom to produce. a) What to produce It is the problem regarding determination of the types of goods and services and their quantity. For example an economy requires consumer goods like cell phones, cloth, butter and bread, capital goods like machines and equipments. The society must decide which goods to be produced and in what quantity b)Ilow to produce The different goods have to be produced by using different techniques. For example in an economy cloth can be produced either by handloom or by power loom. Production with handloom requires more labour and power looms requires more machines. Thus the society is to choose the type of technology in accordance with the availability of resources. c) Whom to produce. It is the problem of distribution of what is produced. In a capitalist economy the goods are distributed to those who pay for them. But in a socialist economy the goods are distributed by the public distribution of system, 2. Opportunity cost. Since the resources are limited the production of one commodity involves opportunity cost. The opportunity cost is the amount of one good the economy sacrifice for the production of another good. Suppose a given society has a limited area of land. The society needs to produce wheat and apple. While producing wheat the amount of apples that can be produced with the land has to be sacrificed. Thus the opportunity cost of wheat production is the amount of apples that the socicly sacrifices. 3. Changes in demand and supply. The demand and supply are two determinants of the price of a good. A change in demand changes the supply and change in supply also change the demand position. For example while supply remaining the same an increase in demand increase the price, this increase in price creates more supply. A decrease in demand while supply remaining the same reduces the price and the fall in price reduce the volume of supply. On the other while the demand is constant an increase in supply decreases the price and the decrease in price creates more demand. A fall in supply while the demand is constant increases the price and reduces the demand. If demand and supply increase and decrease in equal quantity there will no change in price.

4. Interaction of demand and supply. Price DI 1021 Q2 Q Q1 Quantity Suppose the market is in cquilibrium with price P and quantity Q. The increase in demand shifts the demand curve right to DI. The price increase to Pl. The increased price to PI creates an excess supply which reduces the price to P and the market clears. In the other case the decrease in demand shift the demand curve to D2. This reduces the price to P2. The fall in price creates excess of demand over supply. The excess demand rise the price and the market clears with the equality of demand and supply. Price Q2 Q Q1 Quantity Suppose the supply increase and the supply curve shift to the right to Sl. The increased supply reduces the price to Pl. At a lower price more demand is created and the increased demand push up the price to P and the market clcars. A fall in supply shift the supply curve left to S2. The price increase to P2. At a higher price the demand decrease and increase the supply and the market clears by reaching the equilibrium price P. 5. Price clasticity of demand and income clasticity of demand. Price elasticity of demand is the extent to which the quantity demanded changes with a given change in price. It is the ration of percentage change in quantity demanded to percentage change in price. It is calculated by the formula PED= Percentage change in quantity demanded/Percentage change in price.

Suppose the price of apple per bushel is $20 and the quantity demanded at this price is 50 bushels. Again suppose the price of apple increase from $20 per bushel to $30 per bushels and the quantity demanded decrease to 30 bushels. The % AQD= Q1-Q/Qx100 = 30-50/50x100=40% %AP=PI-P/Px100=30-20/20x100=50% Then PED=40/50 0.8 Q and P are initial quantity and price and Q2 and P2 are the new quantity and price. The income elasticity of demand is the responsiveness of quantity demanded to a given change in income of the consumer. It explains how much will be the change in quantity demanded of a good with a given change in income of the consumer. Ei -%AQD/%AY %AQD=Q1-Q/Q x 100 %AY=Y1-Y/YX100 QI and Y1 are new quantity purchased and new income. Q and Y are old quantity and old income. Suppose a person is having income of $1000, and he purchase 20 bushels of oranges. When his income increase to $2000, his quantity demanded increase to 35 bushels. Then income elasticity of demand is Ei =%AQD/%AY "AQD 35-20/20x100 75% %AY = $2000-S1000/$1000=100% Then Ei= 75/100=0.75