Symbiosis School for Liberal Arts

Semester End Evaluation (Fresh/Regular/Current Semester) April/May-2021

Course: B.A./B.Sc. Liberal Arts Date: 05th May, 2021

Subject: Principles of Microeconomics
Faculty: Sakshi Juneja
Evaluation Type: SEE (Home Assignment)
Deadline for Submission: 25th May, 2021. 11:59pm
Total Marks: 15 Marks

Instructions:
• Do not submit Hard-copies of the assignments.
• Submit the Soft-copies of the assignment.
• No extension of time will be allowed for any reason whatsoever.
• This question paper must be added in the beginning of your assignment.
• Do not plagiarize.
• Please mention your Name and PRN on the assignment properly.
• Each question carries 5 marks. All are compulsory
• Word Limit: 500 words for each questions. Include graphs wherever necessary.

Questions:

Q.1 Give two examples each of Monopolistic and Oligopolistic market structure explaining their
Features?

Q.2 You decide to shift from auto rickshaw to taxi for your daily commuting from home to
college because of the increase in your income. If the price of auto rickshaw travel decrease
then what will be the change in the demand of auto rickshaw. Explain using the income
Effect and the substitution Effect via taking an appropriate assumptions?

Q.3 Do you agree with the statement that “A binding price floor and non-binding price ceiling
are both greater than the equilibrium”. Give an example of a market and diagram to support
your argument.

Siddhanta Naidu
PRN: 19060322067
Subject: Principles of Microeconomics
Symbiosis School for Liberal Arts
Q.1 Give two examples each of Monopolistic and Oligopolistic market structure explaining their
Features?

A monopolistic market structure is when many firms exist that offer products and services that are similar
but are not perfect substitutes. In a purely theoretical state, Monopolistic market can be considered a middle
ground between monopoly and perfect competition. All firms share a relatively low degree of market power
which makes all of them ‘Price Makers’. In the short run, economic profit in monopolistic competition
firms is positive but approaches zero in the long run due to the tendency to advertise heavily. Demand is
highly elastic in the long run which means that demand is highly sensitive to price changes.

Some characteristic features of a Monopolistic Market are- Large number of sellers, Product
differentiation, Freedom of entry and exit and Non-price competition. In a monopolistic market, one
firm’s decision does not create a chain reaction in the market i.e., there is no price war. All the different
brands try to differentiate their product in an attempt to add an element of monopoly over the competing
products. Several firms can easily enter and exit the market just like in perfect competition. Sellers compete
on other factors than price such as product development, aggressive advertising, distribution and customer
service.

The graph on the left is a diagram for monopolistic competition in the short run which is the same as a
Monopoly. The firm maximizes profit where MR=MC, at output Q1 and price P1 which gives a
supernormal profit. The graph on the right is for the long run where supernormal firms encourages other
firms to enter, reducing demand for existing firms and leading to normal profit.

Examples of Monopolistic Markets:

➢ Fast Food companies like McDonalds and Burger King sell products like burgers, French fries,
ice cream etc. which are similar in nature but there is no congruency between the products sold by
these companies as each one has a slightly different taste and shape.
 ➢ Sports Shoe companies like Adidas, ASICS, Nike sell almost identical products but differentiate
their product through brand uniqueness which allows them to charge different prices in the
market.

In an Oligopolistic Market Structure, there exists a state of limited competition wherein the market is
dominated by a small group of large sellers. There usually exist 2 or more firms which control the market
share and collude (explicitly or tactically) to restrict output and fix prices of their commodity in order to
achieve a good market return. A duopoly is the most basic form of an Oligopoly where two suppliers
dominate the market for a commodity or service.
Oligopolistic companies face a principal problem called the ‘Prisoner’s Dilemma’ in which every firm
has an incentive to cheat. If all the firms in an oligopoly agree to restrict supply and/or keep the prices high,
then every firm will have the opportunity to capture substantial market share and business by undercutting
the others.
Some characteristic features of Oligopolistic Markets are- Fewer sellers who control all or most of the
market, Barriers to entry, Interdependence amongst all the companies within the Oligopoly and
Prevalent Advertising to maintain their share of the Market. Interdependence results in Oligopolies to
showcase a ‘Kinked Demand Curve’

1. When a firm increases its price, rivals will not

follow and gain the majority of consumers due to lower
prices. Initial firm will see a large reduction in
consumers i.e., an elastic demand.
2. When a firm decreases its price, rivals will also
follow suit. The initial firm will see very little change in
quantity demanded i.e., an inelastic demand.

Examples of Oligopolies:

➢ In Big Tech, operating systems for smartphones and computers can be a great example for
Oligopoly. Apple iOS and the Google Android system hold majority market share in smartphone
operating systems, while computer operating systems are dominated by Microsoft windows and
Apple. The internet is also a market captured mainly by three players- Google, Amazon and
Facebook. Their age-old domination and advanced technology make it difficult for other start-ups
to break into the market.
 ➢ Pepsi and Coca Cola also act as an Oligopoly in the Carbonated soft drinks industry. They are
perfect substitutes of each other as they have similar, taste, color and purpose. They also participate
in extensive advertising of their products on holidays and events like Superbowl.

References:

1. https://www.investopedia.com/terms/o/oligopoly.asp

2. https://www.economicshelp.org/blog/311/markets/monopolistic-competition/

Q.2 You decide to shift from auto rickshaw to taxi for your daily commuting from home to
college because of the increase in your income. If the price of auto rickshaw travel decreases
then what will be the change in the demand of auto rickshaw. Explain using the income
Effect and the substitution Effect via taking an appropriate assumption?

Inferior goods are goods whose demand falls with an increase in the consumers’ income. Here, we can
notice a shift from an auto rickshaw to a taxi for daily commuting from home to college when there is an
increase in salary which makes ‘auto rickshaw’ an inferior good. The shift to taxis with an increase in
income may occur due to the need to experience a better, quicker and more comfortable mode of transport.

This graph shows the change in demand of an inferior good (Auto

Rickshaw) due to the change in income. When the income increases from
Y to Y1, the demand for inferior goods i.e., the auto rickshaw decreases
from Q to Q1.
This is known as the Income Effect.

However, when the prices of Auto Rickshaw travel decrease, we can notice a Substitution Effect.
Substitution Effect is the phenomenon in which the consumer switches to a cheaper alternative which
causes a decrease in demand for the better but expensive alternative. For example, if beef prices increase
then consumers will switch too chicken as the next best cheaper alternative. Here, we can notice a drop in
prices of the Auto Rickshaw fare which makes the Taxi service relatively more expensive and thus the
demand for auto rickshaws will increase as people switch to the next best cheaper alternative as per the
substitution effect. The drop in auto rickshaw fare has also increased my real income and purchasing power.
However, since the auto rickshaw travel is considered inferior, a rise in my real income and purchasing
power would reduce my quantity demanded as suggested by the Income Effect.

The consumer is placed at point A initially on the

budget line RS. A drop in the Auto Rickshaw fare
makes the consumer move to the point B on the
budget line RT. The demand for Auto Rickshaws
can be seen in the substitution effect, F1E
(associated with a move from point A to D), and
an income effect, EF2 (associated with a move
from D to B). In this case, Auto Rickshaw is an
inferior good because the income effect is
negative. However, because the substitution effect
exceeds the income effect, the decrease in the fare
leads to an increase in the demand of Auto
Rickshaws.

Here we can notice that since we are dealing with an inferior good, the income and substitution effect move
the quantity demanded in opposite direction having two opposite effects i.e., the demand for auto rickshaws
rising due to the substitution effect and the demand falling due to the income effect. However, in practice,
the substitution effect exceeds the income effect and therefore I will switch back to auto rickshaws due to
the fall in fare prices. Therefore, in case of inferior goods, if we consider the Substitution effect, the quantity
demanded is inversely proportional to the price whereas in Income effect the quantity demanded is directly
proportional to the price of the good or service. Since the substitution effect is much larger than the income
effect, the consumption of inferior goods virtually follows the law of demand which states that the fall in
price of a good or service increases the quantity demanded. Lastly, due to the drop in fare price of the Auto
Rickshaws I will substitute away from the better but more expensive option of a taxi service to the next
best cheaper alternative of auto rickshaws.

References:

1. Pindyck, R. S., & Rubinfeld, D. L. (2014). Microeconomics. Pearson Education.

Q.3 Do you agree with the statement that “A binding price floor and non-binding price ceiling
are both greater than the equilibrium”. Give an example of a market and diagram to support
your argument.

Yes, I do agree with the statement- “A binding price floor and a non-binding ceiling are both greater than
the equilibrium”.
Binding Price Floor

A price floor is the lowest price at which a producer can legally sell his commodity or service. A binding
price floor occurs when the Government sets a required price of a good or service at a price above the
equilibrium. Since the Government requires that the price do not drop below this price, the price is binding
in the market for that good. This is mainly done to give producers the benefit of a higher income for their
goods which will encourage producers to produce their goods or services. If the Government were to set
the binding price floor below the equilibrium price in the market, the demand for the particular good would
be in excess with less supply which would simply push the price back to the equilibrium and thus rendering
the action useless.

Thus, by imposing a binding price floor above the equilibrium, the Government is artificially inflating the
prices which encourages the producers, causing a fall in demand (certain consumers decline to pay the
price) which creates a surplus (excess supply). Further, I would like to explain this phenomenon with the
help of a graph:

The demand and supply curve intersect at E

(equilibrium) where the goods demanded by the
consumers is equal to the supply in the market at
quantity Q and price P. Our Government has to set a
price floor which is the minimum price at which a
producer can sell his product or service. The
Government sets the binding floor price above the
equilibrium which moves the commodities’ new price to
Pf and increased quantity of commodity produced from
Q to Qs.
However due to this increase in price the consumers
demand falls from Q to Qd. However, despite the
quantity of commodity sold decreases, the producer
benefits from selling their product or service at a higher
price.

Many agricultural good have price floors imposed by the Government. For example, the Tobacco sold in
the United States has been subjected to a price floor by the United States Secretary of Agriculture.
Non-binding Price Ceiling

A price ceiling is fixed maximum price at which a producer can legally sell his commodity or service. The
Government fixed this price for essential goods like kerosene, sugar, oil etc. so that they can be affordable
for the common man. A price ceiling is imposed in regulated markets keeping in mind the needs of the
low-income groups in our society. In the case of binding price ceiling, the Government sets the price ceiling
below the equilibrium there is an excess of demand with low supply.

However, a non-binding price ceiling is when a price ceiling does not have an effect on the market prices.
In general, a price ceiling will be non-binding whenever it is equal to or greater than the equilibrium price
of the market. Let’s consider a hypothetical situation of a price ceiling on Coffee Beans, the Government
can impose a non-binding price ceiling of Rs. 1000 (P’) however the equilibrium cost of Coffee Beans is
fixed at Rs. 200 (e) where the producer is ready to sell his beans at Rs.200 and the consumers are ready to
purchase at that price. Here, the price ceiling of Rs.1000 is non-binding since it is way higher than the
equilibrium price rendering it ineffective.
The Equilibrium Price (P) is set at Rs. 200 and Quantity (Q)
is being supplied by the producer at the equilibrium price.
The equilibrium (e) is decided by the producer and the
consumer for the certain commodity. The Government sets
the price ceiling (P’) which is Rs. 1000 (the maximum
amount the coffee beans can be sold for). However, this price
regulation is way higher than the equilibrium price and the
consumers and producers are already satisfied with the
equilibrium price and quantity, the price ceiling will not
affect the market, is rendered ineffective and thus becomes
non-binding. Therefore, the non-binding price ceiling is
greater than the equilibrium.

Hence, it is proved that the binding price floor and a non-binding price ceiling are both greater than the
equilibrium.

References:

1. https://pressbooks.bccampus.ca/uvicecon103/chapter/4-6-price-controls/

2. https://courses.lumenlearning.com/wm-macroeconomics/chapter/price-floors/

3. https://www.thoughtco.com/introduction-to-price-ceilings-
1146817#:~:text=A%20price%20ceiling%20that%20doesn,prevail%20in%20an%20unregulated
%20market.