Assignment Questions:

Question 1:

The removal of imperfections in the market leads to an increase in efficiency in the allocation of resources. Discuss whether you agree with this view (25 marks)

Question 2:

Explain what is meant by normal and abnormal profit and when such profits might occur (12 marks)

Discuss the three reasons as to why people demand money, according to the liquidity preference theory (13 marks)

Table of Contents (Jump to)

Question 1:

A. Allocative Efficiency and Perfectly Competitive Market

B. Allocative Efficiency and Monopoly

Question 2 (a):

A. Perfect Competition

B. Monopoly

C. Monopolistic Competition

Question 2 (b)

A. Transaction Motive

B. Precautionary Motive

C. Speculative Motive

Referencing

List of Figures (Jump to)

Figure 1: Pure Competition – MSC & MSB Curves

Figure 2: Consumer Surplus & Producer Surplus

Figure 3: The short run and long run in perfect competition

Figure 4: The short run and long run monopoly market

Figure 5: The short run and long run monopolistic competition

Figure 6: Money Demand Curves (liquidity preference theory)

Question 1:

The removal of imperfections in the market leads to an increase in efficiency in the allocation of resources. Discuss whether you agree with this view (25 marks)

A. Allocative Efficiency and Perfectly Competitive Market

Allocative Efficiency occurs when it is not possible to reallocate resources in order to make someone better off without making at least another person worse off. It arises where:

Marginal Social Cost (MSC) = Marginal Social Benefit (MSB).

The MSC refers any extra cost to society of producing one more unit of output. The law of diminishing returns implies that MSC will be upward sloping. On the other hand, the MSB is any extra benefit to society of producing one more unit of output. The law of diminishing marginal utility implies that MSB will be downward sloping.

For example: If the 20^th unit of output is produced, then it costs the society $10, but yields a benefit of $20. Thus, the society’s welfare increases by $10 (i.e. MSB – MSC). Since MSB is greater than MSC, people is better off. On the contrary, it is not in the society’s interest to produce the 40^th unit.

In perfect competition, both consumer surplus and producer surplus is maximised (as illustrated by figure 1), where the price is equal to the marginal cost. The consumer surplus is the total net benefit enjoyed by all consumers buying the product. For instance, a consumer paying $20 for a product whose market price is $15; thus enjoying the benefit of $5 ($20 – $15 = $5).

Producer surplus is the difference between the market price the producer receives and the marginal cost of producing this unit.