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Question and Answer Microeconomics

OPEN UNIVERSITY UNIVERSITI TERBUKA M A L A Y S I A ————————————————- BBEK1103 Principles of Microeconomics ————————————————- Assignment Abdulla Waheed Imad A153282 +960 962 1214 waheed. [email protected] com Ahmed Mohamed Villa Collage – Faculty of Computing and Business Management JULY 2008 SEMESTER Assignment Statement Fuel is one of the main inputs for many sectors in the world’s economy. Therefore, when a war breaks out in Country A. which is the main producer for fuel in the world it causes fuel supply disruptions in the world.

Question 1 What will happen to the price and quantity equilibrium for fuel following this event? Explain. Answer: Since County A is the main producer of oil in the worlds market; due to the war in country A it will face difficulties in the production of oil. This will result a decrease of oil supply in the worlds market as a result the price of oil will be increased at the same time due the increase of this oil price the demand for oil will fall. However because oil is nearly a necessity it is an inelastic product. The percentage change in quantity emanded will be less than the change in price of oil. Due to the limitation of oil supply in the worlds market the supply curve will shift to the left resulting to the equilibrium quantity to fall and the price to rise which forms a new price and quantity equilibrium point. The below figure illustrates the effect on the equilibrium price and quantity of oil in this market situation. Oil Market Figure 1 Due to the decrease in supply of oil to the worlds market it will result in a shift of supply curve to the left as shown in the figure1 from S to S1.

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Due to the shift of supply curve to the left it will cause an increase in the price of oil from P to P1. This will result in changing the price and quantity equilibrium from P,Q to P1,Q1. As shown in the figure it forms a new equilibrium pint which is from E to E1. Oil is considered as almost a necessity; due to this its demand is inelastic. The percentage change in price is bigger than the percentage change in Quantity demanded. Question 2 Following the price and quantity changes in the above situation, what will happen to the demand and supply for cars.

Note that fuel and cars are complementary products. What will happen to the price and quantity of cars due to the war? Note: Illustrate 2 Graphs (Fuel market and car market). Answer: In order to drive car oil is needed. Due to the war in Country A the supply of oil is decreased, resulting increase of the price of oil. Because cars cannot be drive without oil and the price of oil is higher now the demand for cars will ultimately fall. Due to the decrease in demand of cars the quantity supplied of cars will also fall.

The below figure 2 (Car Market) shows the effect of the demand, supply, price and quantity of cars in this situation. On the other hand Figure 1 shows the Oil Market because of the war. Car MarketOil Market Figure 2 Figure 1 Figure 2 shows the effects in the car market due to the war in country A resulting decreasing the supply of oil to the worlds market. Due to the increase in price of oil the demand for car will be reduced as both the goods are complementary goods. In the figure 2 it shows a shift of demand curve to the left from D to D1 which represents a fall in demand for cars.

With this shift the quantity demanded will be reduced to Q1 as a result the price of cars will also be reduced because it is a shift of demand curve while keeping the supply curve as it is. However the percentage change of price is less the then the percentage change in quantity as cars are considered as a luxury good and the demand is elastic. The equilibrium is changed from E to E1 with a decrease in the equilibrium price from P to P1 and a decrease in the equilibrium quantity from Q to Q1. Figure 1 is the market of oil.

It illustrates due to the decrease in supply of oil to the worlds market because of the war in country A it will result in a shift of supply curve to the left as shown in the figure1 from S to S1, this is because their ability to supply oil is changed or reduced. Due to the shift of supply curve to the left it will cause an increase in the price of oil from P to P1, The new price and quantity equilibrium is changed from P & Q to P1 & Q1. As shown in the figure 1 it forms a new equilibrium pint which is from E to E1.

Since oil is an inelastic product the percentage change in price is bigger than the percentage change in Quantity demanded. Question 3 The government of country A would like to impose tax $x on cars following the above situation illustrate and explain using graphs the impact on the car market due to the taxes (Assuming the elasticity demand for car is elastic) who will beer more of the taxes imposed? The suppliers or the consumers? Answer: Due to the increase of oil price the demand for car has reduced on the previous scenario. Resulting a fall in the price as well.

But in this case when the government imposes a tax on the car the price of car will increase. This is because the tax is an additional amount charged for the car’s original price by the government. Car is a luxury good and it is having an elastic demand curve. Due to this reason when a tex is imposed the tax burden is higher for the suppliers compared to consumers. Below diagram gives a clearer picture of the scenario. Effects of imposing tax Figure 3 Tax involves increase in cost for suppliers; hence, tax will shift the supply curve to the left.

Figure 3 illustrates the effect of tax towards the supply curve and the ratio of tax burden carried by both suppliers and consumers. Without tax, equilibrium is achieved at point E, with equilibrium price and quantity as P and Q respectively. With the additional amount of tax $x added by the government for Cars; the supply curve will shift to left. Meanwhile, the demand curve does not shift. When supply curve shifts from S to S1, market equilibrium will move from point E to point E1.

At point E1, quantity demanded after tax is equivalent to supply quantity after tax, that is, Q1. However, the tax paid by the consumers and the supplies are different. The increase in price that has to be paid by consumers is the tax portion that needs to be borne by the consumers. From Figure 3, the amount of tax collected by the government is depicted by area P1,E1,J&K; amount borne by consumers is the area P1,E1,I&H and the remaining, area P,I,J&K, is the tax borne by the suppliers.

From the analysis of tax burden, it can be summarized that the lower the elasticity of supply, the bigger the tax burden that has to be borne by suppliers; while the higher the elasticity of supply, the larger the burden being shifted to the consumers and also the lower the elasticity of demand, the larger the tax burden transferred to the consumers; and the higher the elasticity of the demand curve, the larger the tax burden that has to be borne by the suppliers.

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