Principle of economics

Question 1


  1. Everything that comes free must be grabbed but while grabbing the free things we may have to lose some other valuable things in life. People must be able to make a choice i.e. selection among alternative goods, services and actions. “There is no such thing as a free lunch!” So to make sensible choices, we should be able to compare the costs and benefits of doing various costs. This process of thinking about choices in small steps is called the “thinking at the margin”. It is also a good idea to choose a particular activity if the marginal benefit of doing so is at least equal to the marginal cost.

    According to this question, a friend is inviting me for the game of cricket between Australia and South Africa because he/she has a free pass and going there won't cost me anything but there are certain things which i'll not be able to do and that costs which is also known as opportunity cost. Opportunity cost is the cost people must make a choice to forgo, or give up, one thing in favour of another (Taylor & Frost 4th edition, p. 5). Here, if I will go to watch a match with a friend then I may have to give up many things such as my work, go shopping, catch up on some sleep or spend the time studying.

  2. The main concern of economics is how people handle with scarcity. Scarcity is the situation where people's resources are insufficient to satisfy their wants and needs (Taylor & Frost 4th edition, p. 5).Resources such as raw materials and labor are finite and limited in the economy but the human wants are not. Scarcity is a fact of economic life for individuals, for families, for universities, for governments, for whole economies and even for the whole world. Scarcity is pervasive and it forces us to pick and choose. For example, Individuals face scarcity for income or for time, student working in a academic year has less time for studying, playing sport, watching television, Similarly, University also faces the scarcity regarding degree of courses it provides. Though university provides a wide range of courses still they cannot cover all the courses because of lack of specialization, division of labour. University must have a resource, such as labour, concentrating on and developing efficiency at providing the various courses at a time. Likewise, University must be able to divide its labour in order to provide a wide range of degree. In order to cope with this problem university need to secure a continuous and sufficient supply of resources and when scarcity of resources exists, higher education organizations compete with each other to secure a continuous and sufficient supply of resources. So to cope with the problem with this scarcity the university.

Question 2


(a) Buyers and sellers are the crucial players in the market. Market equilibrium is a situation in which the price has reached the level where quantity supplied equals quantity demanded. Equilibrium Price is the price at which quantity supplied balances quantity demanded. Equilibrium Quantity is the quantity traded at the equilibrium price. Let's take an example to explain the market equilibrium for a good restored following an increase in demand.

Table 1.1: Finding the market equilibrium



Quantity Demanded


per week)

Quantity Supplied

(thousands per week)

Shortage, surplus or equilibrium

(thousands per week)

Price rises or falls





Price rises




Shortage= 8

Price rises





No change





Price falls

Suppose we take $320, then the quantity demanded by consumers (28000 cars) is greater than the quantity supplied by the firms (8000 cars). Therefore there is a shortage of 28000-8000= 20000 cars. A shortage is a situation where the quantity demanded is greater than the quantity supplied. In this case, the 8000 cars supplied at the price would sell out fast and 20000 people who wanted to buy a bicycle at that price would not be able to get one. As storekeepers start to turn customers away, they will soon realize that they have lost revenue by setting such a low price. With a shortage of cars, the price quickly rise above $320; firms will charge higher prices and consumers who are willing to pay more than $320 for a cars will pay higher prices to firms. Thus, $320 cannot last as the market price. Observe, as the price rises above $320, that the quantity demanded falls and the quantity supplied rises. Thus, as the price rises, the shortage begins to decline. If we choose any price below $400, the same thing will happen: there will be a surplus and the price will fall. The surplus disappears only when the price falls to $400.


Pairs of goods


a)Cars and bicycles

Considerably greater than Zero

b) Metros and Barinas

Slightly greater than zero

c) Cars and petrol

Considerably less than Zero

d) Sugars and cars


e) Cars and trips to Perth

Slightly less than Zero

  1. Cars and bicycles: This is a positive cross-price elasticity of demand as the price in cars goes up, the demand for bikes will go up. Therefore, cars and bicycles have a considerably greater than Zero value.
  2. Metros and Barinas: Metros and Barinas has a positive cross-price elasticity which states that if the price of Metros goes up , then the demand of other private form of vehicles. Therefore, Metros and Barinas have a slightly greater than Zero value.
  3. Cars and petrol: this is a negative cross-price elasticity of demand as if the price of petrol goes up, the demand for cars that are fuel efficient will also go down. Therefore, cars and petrol have a considerably less than Zero value.
  4. Sugars and cars: Since the sugars and cars don't have any relationship, as the price of these goods changes there will be no change in the demand for the good. Thus, there exists Zero value for the cross- price elasticity of demand.
  5. Cars and trips to Perth: Since the effect of price and demand are not much related with each other this Cars and trips to Perth have slightly less than Zero. Because if the cars price goes up then also people will go to Perth by airplanes.

Question 3


  1. In economics, the law of demand states that consumers have a tendency to buy more of goods when its price decreases and less when its price increases. The law of demand says that the higher the price, the lower the quantity demanded in the market and the lower the price, the higher the quantity demanded in the market. In other words, it states that the quantity demanded and its price are inversely related, other things remaining constant such as the income of the consumer, prices of the related goods, and tastes and preferences of the consumer.

    The total effect of a price change is actually combined of two different effects. They are Income effect and Substitution effect.

    1. Income effect: As the price of a commodity rises, it may be considered as if the income of the consumer has declined. Therefore, the income effect of a change in price tells us that as price rises quantity demanded would fall.
    2. Substitution effect: As the price of a commodity rises, it becomes relatively more expensive than the substitute goods. Hence, consumers substitute in the alternative product in for the good whose price has risen. Therefore, the substitution effect of a change in price also tells us that as price rises the quantity demanded would fall.
    3. Producer surplus is the difference between the price received by a firm for an additional item sold and the marginal cost of the item's production. For the market to as a whole, it is the sum of all the individual firm's producer surpluses, or the area above the market supply curve and below the market price(Taylor & Frost 4th edition, p. 129).
    4. The producer surplus can be graphically represented as the area above the individual firm supply curve and below the price line, as in the figure below. The producer surplus is opposite to consumer surplus, the area below the demand curve and above the price line.

Quantity Demanded

The producer surplus in the whole market can be obtained by adding the producer surplus for all producers, or by looking at the area above the market supply curve and below the price. The graphical representation for producer surplus for the market

Quantity demanded

The applications for the producer surplus are similar to consumer surplus. Producer surplus provides a measure of how much a producer gains from the market. There occurs a change in producer's surplus from the government price-control policy. With price controls, producers with relatively lower costs will stay in the market but will receive a lower price for their output, while other producers will leave the market. Both groups will lose producer surplus.

Question 4


The model that is used most often to show how market work is called perfect competition. A market is perfectly competitive if there are large numbers of buyers and sellers, and the products offered for sale are homogeneous. Firms are completely free to enter or exit the market. We can analyze the perfect competition model through a price that will emerge from the interaction of people in the market such that the quantity supplied equals the quantity demanded, known as the equilibrium price. If the price is higher than the predicted market price intersects at the supply curve and the demand curve, then the quantity supplied is greater than the quantity demanded at that price creating a surplus. Whereas, lowering the price will decrease the quantity supplied and increase quantity demanded until the surplus disappears. However, if the price is lower than the predicted market price, then the quantity demanded is greater than the quantity supplied, causing the shortage. Raising the price will decrease the quantity demanded and increase the quantity supplied until the shortage disappears. Thus, if the price falls when there is a surplus and rises when there is a shortage, the price will converge to the equilibrium price.

Whether a purely competitive industry is one of the constant or increasing costs, the final long-run equilibrium position for each firm will have the same basic characteristics.

In the above figure price and marginal revenue will settle at the level where they are equal to minimum average cost. In the figure, marginal cost curve intersects, and is therefore, equal to average cost at the point of minimum average costs. In the long- run equilibrium position everything is equal. That is, MR (=P) + MC = minimum AC.

This triple equality tells that, although a competitive firm may realize economic profits or losses in the short - run, it will breakeven by producing in accordance with the MR (=P) = MC rule in the long run. Similarly, this triple equality suggests that certain conclusion concerning the efficiency of a purely competitive economy

However, the competitive production of any collection of goods does not necessarily mean an efficient allocation of resources. Production must not only be technologically efficient, but it must also involve the; right goods', that is, the goods that consumers most desire. The competitive price system will see to it that resources are allocated so as to result in a total output whose composition best fits the preference of consumers.

Under allocation : P>MC

Under competition, the production of each product will occur up to the precise point at which price equal to marginal cost is shown in the figure above. The profit eeking competitor will realize the maximum possible profit only by equating price and marginal cost. To produce short of the ME (=P) =MC point will mean less than maximum profits to the individual firm and an underallocation of resources to this product from society's standpoint. The fact that price exceeds marginal cost indicates that society values additional units of X more highly than the alternative products that the appropriate resources could otherwise produce.

Overallocation: P< MC

For similar reasons, the production of X should get beyond the output at whichprice equals marginal cost. To do so would mean less than maximum profits for producers and an overallocation of resources to X from the standpint of society. To produce X some point at which marginal costs exceeds price means that resources that society valus more lightly than the units of X.

Assessment item 1 - Part B- Case Study

Australia operates as a very competitive in the world market as a second largest exporter of sugar in the world whereas Brazil is the one of the leader in producing and also exporting the sugar. Australia can produce large number of sugar because they have educated farmers, workforces in the sugar mill. They also grow crops that generally are grown in the third worlds countries. Transportation also plays a vital role for making a sugar industry an efficient one in the Australia. As sugar mills have own railway lines that bring cane to the mills. Therefore, Australia integrates efficient growing, efficient mills and a well integrated marketing system which makes it a second largest exporter and powerful producer of sugar in the world.

In 2006/07, Australian sugar exports were worth $941 million. The major markets for raw sugar in bulk (by volume) are.


1,000,450 tonnes


610,000 tonnes


536,900 tonnes


520,000 tonnes

Chinese Taipei

238,000 tonnes

ABARE, Australian Commodity Statistics 2008.

The sugar industry must be aware of the price control mechanisms of government when determining the equilibrium price and quantity of supply and demand for sugar. Price controls can be seen in certain housing markets, agriculture markets and labor markets throughout the world. Thus, the price control mechanisms are price ceilings and price floors. Price ceiling is a maximum price at which goods can be bought and sold. For example: some cities in India have price controls on rental housing. Landlords are not permitted to charge a rent higher than the maximum stipulated by the rent control law in these cities. Governments impose price ceilings in response to complaints that the market price is too high. As a result, if the government prevents firms from charging more than a certain amount for their products, then a shortage is likely to result. When the maximum price remains below the equilibrium price on the market, there is a persistent shortage; sellers are unwilling to supply as much as buyers want to buy. Another price control that government uses is price floor, a minimum price which helps the suppliers of goods and services. The Australian Government, for example, operated the Wool price Stabilization Scheme until 1991 to prevent the price of wool falling below a certain level. In the labour market, the government requires that firms pay workers a wage no less than a minimum, call the minimum wage. If a government imposes a price floor, then a surplus will occur. When the price above the equilibrium price, suppliers of goods and services want to sell more than people are willing to buy, so there is a surplus.

Price changes whether a sugar industry is a price taker or price maker. Prices change very often. For example: changes in production and demand at different times of a year, prices change. Factors such as weather and plant disease cause the supply of sugar to vary from time to time. Similarly, prices also play an important role on the availability of competing cane. Consumers have a wider choice if there is a different range of competing products Although the quantity of a product may stay the same, the price could go down if the consumer decides to switch to a competing product. The price reduction would occur to hopefully attract consumers.

Prices that are found vary for the different levels of the supply system. We know that at every stage of the supply system there are markets. Each market will typically have a different price. For example there will be the sugar manufacturer's price that sells sugar directly from the farm. There will be the rural merchants buying price and selling price. Buying price means the price that the rural merchant will pay for sugar bought. Then there will be the selling price at which he or she sells to wholesalers or retailers or final consumers There will be the wholesalers buying price and selling price as there will be the retailers buying price and selling price.

Importantly and vitally it must be understood that for sugar industry price for a product is the only source of money i.e. income. Price is the only element that will generate income. Money generated from prices is very important for sugar industry.

To make effective decisions, businesses, governments and public authorities need a way of measuring how much the quantity demanded is affected by changes in the prices and by the changes in consumer's income and the extent to which suppliers are able to respond to increase in price. Thus, elasticity is a measure of how sensitive one economic variable is to another economic variable. There are number of factors that determine the elasticity of demand for sugar. They are as follows:

  1. Substitutes products: the more the products are substitutes the higher is the elasticity, as people can easily switch form one good to another if a little change is made in price.
  2. Percentage of income: The higher the percentage that the product's price is of the consumer's income, the higher the elasticity, as people will be careful with purchasing the good because of its cost
  3. Necessity: The more necessary a good is, the lower the elasticity, as people will attempt to buy it no matter the price,
  4. Duration: The longer a price change holds, the higher the elasticity, as more and more people will stop demanding the goods (i.e. if you go to the supermarket and find that blueberries have doubled in price, you'll buy it because you need it this time, but next time you won't, unless the price drops back down again)
  5. Breadth of definition: The broader the definition, the lower the elasticity. For example, Company X's fried dumplings will have a relatively high elasticity, whereas food in general will have an extremely low elasticity

Brazil is the biggest producers and exporters of sugar among the three countries India and the European Union (EU). Different factors such as natural, economic and political influence the competiveness of sugar production in each country and determine the ability of local production to compete on the world market. It occupies more than 50% of South America and is the fifth largest country in the world comprising different topography like hills, mountains, plains and scrublands. It also occupies area along the shores Atlantic Ocean, with continuous supply of water and acting as hinterland for trade activities. Factors such as different time Zones and location is increasingly playing a global offshore service destination for Brazil. Brazil is rich in natural resources that are why it exports with little effort. Similarly, with huge population base it provides cheap labor which helps in the production of sugar.

Thus, Brazilian sugar producers have a competitive advantage over Australia as they have integrated production systems so that there is a complete ownership from the field, through transport, right through the factory and down to the ports and they have cheap labour. The main reasons the Brazilian came to compete in the world market are:

  • Deregulation of the industry in the late 90 which encouraged the growth of productive efficiency, technology diffusion and adoption of managerial tools in sugar palts and distilleries.
  • State Law of S. Paulo which impose producers to be followed concerning the burning of sugarcane. The law encourages the mechanized cutting of the sugarcane, to reduce production costs and improve the quality.
  • MODERFROTA Program from BNDES which encouraged the mechanization of agricultural operations and of logistics, allowing the technological renovation in agribusiness with interests rates lower than those charged in the market.
  • Program of credit for adoption of information technology which stimulated the acquisition of integration systems of processes of management, production and of distribution
  • Institutes of agronomic research and agribusiness which support the technological training for agricultural and industrial production, and the mechanization of operations of planting and cutting.

Because most sugar is exported and there is no domestic support price or subsidies. If one has a world's best practice in production, handling and marketing and a reputation for quality, supply reliability and service success come in their door. At the farm gate, Australia has maintained export competitiveness by adopting innovative practices, particularly through mechanisation, new farming practices and diversification.

Australia is one of the lowest cost sugarcane and sugar producers in the world. Australian cane growers are world renowned as efficient, innovative producers who have demonstrated a capacity to respond to changing conditions. The productivity on their farms is among the highest in the world. Cost efficiencies have been achieved largely through mechanization and adoption of innovative practices.

Pricing & Marketing Sugar

Australia has no domestic support price, unlike most other countries which regulate prices, often far above world market values. Its success has been built on world's best practice in production, handling and marketing. Many of the world's major sugar importers prefer to source their requirements from Queensland because of its reputation for quality, innovation, reliability and service. The industry's high market share and long-standing customer relationships reflect its efficiency, reliability and cost competitiveness.

Milling& transport

Around 4500 business enterprises around Australia supply more than 35 mt of cane to25 sugar mills. Most mills crush an average 10,000 tonnes of cane daily and employ around 150 people during the season. Cane is transported to the mills on cane railway and road systems. Millers, growers and harvesters determine harvesting and transport schedules that ensure cane is crushed as fresh as possible. Average cut to crush time is less than 12 hours.

Australian cane growers are world renowned as efficient, innovative producers who have demonstrated a capacity to respond to changing conditions. The productivity on their farms is among the highest in the world. Cost efficiencies have been achieved largely through mechanization and adoption of innovative practices.

In recent years growers have sought to maintain viability and world competitiveness in an increasingly tougher export market environment by adopting new farming practices which are more profitable and sustainable. There has been a steady trend towards larger farms and less dependence on labour.

The sugar industry in Australia is growing day by day with knowledgeable, self-reliant, dedicated, confident and technical progress. Productivity is high and all parts of the industry, including research are geared towards furthering efforts to maintain and enhance Australia's competitive position. It maintains its export competitiveness by adopting innovative and efficient practices, particularly through mechanisation, new farming techniques and diversification.


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