Answer to Question #228808 in Microeconomics for Sue

Question

Assume you are the manager of a small South African firm which sells nails, identical to those supplied by many other firms. You are concerned about two eventualities: • That the overall market supply of nails will decrease by 2 percent due to foreign producers’ exit • That the overall market demand for nails will increase by 2 percent due to a growing economy.

2.1 Identify and justify the firm’s market structure. (5)

2.2 With the aid of a diagram, illustrate and explain the firm’s long-run equilibrium position. (10)

2.3 The schedule below shows the quantities of nails demanded at each price:

Price Quantity Old 400 10000 New 380 12000

2.3.1 Calculate the elasticities of demand, using the point method and interpret your result. (6)

2.3.2 List any four (4) factors that could result in the nails having the elasticity calculated in 2.3.1

Answer 1

2.1

The firm sells nails that are identical to nails sold in the market by the other suppliers. This implies there are many sellers of the nails in the market. Also, nails are used by households in daily life for various purposes that imply various buyers in the market. Thus, there are many buyers and sellers in the market. The price is determined on the basis of demand-supply intersections that shows sellers are a price taker. The characteristics of the nail market meet the features of a perfectly competitive market. Thus, we can say that the market structure is competitive in nature. 

2.2

In the above diagram, the X-axis represents the quantity and the Y-axis represents the price. The economy is in equilibrium at point E1 when the demand curve D intersects the supply curve S. Now, due to foreign producers’ exit from the country, it leads to a fall of 2% of the overall supply that shifts the supply curve to the left S1. This implies a growing economy that increases overall demand by 2% that shifts the demand curve to the right D1. Thus, the economy achieves a new equilibrium in the long-term E2 (intersection of D1 and S1) where the price increases from Po to P1 but the level of output remains the same.

2.3.1

Price elasticity of demand measures the responsiveness of change in quantity demanded as a response to change in price.

$Ed =\frac{ percentage\space change\space in \space quantity\space demanded}{ percentage \space change\space in\space price}$

percentage change in quantity demanded$=\frac{ (12000-10000)}{10000}\times100 = 20\%$

percentage change in price$= \frac{(380-400)}{400} \times100 = - 5\%$

Putting the values:

$Ed =\frac{ 20 }{ -5}$

Ed = - 4 where the minus sign denotes the inverse relationship between price and quantity demanded.

Price elasticity of 4 implies that the demand for nails is price elastic.

2.3.2

Four factors that could result in this:

i. availability of substitutes - it could be possible that there are a variety of substitutes available for nails. Therefore, the demand is highly price sensititve implying that in case of an increase in price of nails, consumers will switch to its substitutes.

ii. high number of uses - since nails have a high number of uses in manufacturing, construction, etc, its demand is highly elastic.

iii. nature of good - since nails are not a neccesity, its demand is price elastic. In case of necessities, the demand is inelastic.

iv. postponement of consumption - since postponement of consumption is possible in case of increase in price of nails, its demand is highly elastic.