Assignment 3. Solution.
Product #1: Natural Gas (used for heating a home) (0.5 points) – Elastic or Inelastic – Circle, highlight, or
bold your answer
Inelastic
Product #2: Cheerios Cereal (0.5 points) - Elastic or Inelastic – Circle, highlight, or bold your answer
Elastic
Explanation.
The market for home heating natural gas has very low responsiveness to price changes due to
its essentiality, especially in the winter season. People required to warm their houses usually
have limited choices, so a price increase would not reduce greatly the quantity being
demanded.
In contrast, Cheerios cereal demand is elastic, as it is an excess of a good with numerous
alternatives. When the cost of Cheerios rises, customers may easily change to different kinds
of breakfast cereals or even other types of breakfast meals making them less desired
therefore more largely shifting the amount wanted.
Part B: Scenario: Taylor is shopping for groceries. Last week, the price of onions was $1.25 per
pound (lbs.), and Taylor was willing to buy 4lbs. Today, the price has gone up to $1.50 per
pound, and Taylor is now only willing to buy 2lbs.
What is Taylor’s elasticity of demand? (0.5 points) - Elastic or Inelastic or Unit elastic – Circle,
highlight, or bold your answer.
Elastic
Calculations
Initial quantity (Q1): 4 lbs.
Initial price (P1): $1.25/lb.
New quantity (Q2): 2 lbs.
New price (P2): $1.50/lb
Price elasticity formula: E = (% Change in Quantity) / (% Change in Price)
% Change in Quantity =
=((2−4)/4)100%=−50%
% Change in Price =
= ((1.50−1.25)/1.25)100%=20%
=−50%/20%=−2.5
Explanation.
Due to the availability of substitutes and their non-essential nature, a small price increase
significantly impacts Taylor's willingness to buy onions.
Q2. Price Elasticity of Supply
Part A:
Consider the quantity supplied of a new electric vehicle increased from 1000 units to 1500 units
when the price increased from $50,000 to $80,000 per unit.
Calculate the price elasticity of supply using the midpoint formula. Show your work. (2 points)
Price Elasticity of Supply (PES)= % Change in Price/% Change in Quantity Supplied
% Change in Quantity Supplied =
((1500−1000)/(1500+1000)/2)*100=(1250/500)*100= 40%
% Change in Price=
((80,000−50,000) / (80,000+50,000)/2)×100= (65,000/30,000)×100≈46.15%
= 46.15%/40%≈0.87
Explain if the price elasticity of supply is elastic or inelastic. (2 points)
The price elasticity of supply is inelastic because the value (0.87) is less than 1. This indicates
that the quantity supplied is less responsive to price changes. A significant change in price
results in a relatively smaller change in quantity supplied.
Q 3: Monopolies vs Competitive Firms (response is limited to one page).
Research a real-world example of a monopoly and provide a brief explanation as to why you
believe it is a monopoly.
De Beers in the diamond industry is a prime example of a monopoly. The company controlled
a considerable portion of the world’s diamond supply throughout most of the 20th century.
Furthermore, it influenced diamond prices and production levels as a result of controlling
diamond mines and distribution channels. This power was enough to deter other firms from
entering the market thereby enabling it to retain its monopoly status.
Explain, how this firm’s behavior would differ if the barriers to entry no longer existed, and the
market became competitive. (1 point)
Were there to be no constraints to entrance into the sector, new companies would rise
against De Beers. It would probably give up its representation in the market and its price-cut
policy decision. The corporation must thus emphasize service delivery, resource
conservation/upgrading, and customer satisfaction functions to keep abreast with other
retailers. Competition will lead to lower prices that will increase consumer agencies at large.
Considering the impact of this monopoly on the consumer, should the government intervene
with price controls, such as a price ceiling? Explain your reasoning. (1 point)
Regulatory measures to control prices like the price ceiling may be rationalized if the
monopoly held by De Beers results in exorbitant prices and limited consumer access to
diamonds. Nevertheless, setting a maximum price could have unexpected effects, for
example, lowering investment in diamond mining or causing possible shortages. A more likely
approach could involve deregulating the monopoly or encouraging competition via
regulations combined with help for start-ups.
Q4: Costs of Production (A Case Study):
Consider the owner of a small woodworking business that specializes in constructing custom-
made furniture and fixtures.
The owner has two woodworkers on staff that assist in fulfilling customer orders. Each
woodworker receives a monthly salary of $3,000. Additionally, the owner purchased raw
materials such as lumber, finish, and hardware, totaling $1,500 per month. The owner owns a
small workshop. However, if they were to rent a similar workshop nearby, it would cost $1,000
per month.
Part A:
Calculate the total explicit costs showing your work: (1 point).
Total explicit costs = Salaries + Raw materials
Total explicit costs = $3,000/worker * 2 workers + $1,500/month = $9,000
Provide a brief explanation of why these costs are explicit.
Explicit costs are directly incurred expenses for production, easily identifiable and measurable
in monetary terms. Salaries and raw materials directly contribute to making the furniture,
hence explicit costs.
Part B:
Considering opportunity cost, what would be the implicit costs of production for the business?
(1 point)
Implicit costs are real opportunity costs that come with employing owned resources.
Accordingly, in human terms, this translates to the following for non-financial purposes:
Lost salary: An owner of a business could be earning money from another job as opposed to
running it.
Ownership of workshops: Instead of utilizing their workshop space, one could rent it out and
receive rent money.
Part C:
Consider this scenario: Each month, the woodworking company generates a total revenue of
$15,000 from commissioned orders. The explicit costs of production amount to $8,000, while
the implicit costs total $1,500.
What is the accounting profit for the company? Show your calculation. (1 point)
Revenue = $15,000
Explicit costs = $8,000
Implicit costs = $1,500
Accounting profit:
Accounting profit = Revenue - Explicit costs = $15,000 - $8,000 = $7,000
What is the economic profit for the woodworking company? Show your calculation. (.5 point)
Economic profit:
Economic profit = Accounting profit - Implicit costs = $7,000 - $1,500 = $5,500
Explain what the economic profit indicates and why it is different from the accounting profit. (.5
point)
Accounting profit only measures a company’s actual costs, so it is a limited view of its genuine
income-producing capacity.
While an economic profit takes into account both explicit and implicit costs that provide a
better estimation of how much an owner receives by putting in his time and money.
