Normal And Inferior Goods And Examples Economics Essay

A microeconomic law that states that, all other factors being equal, as the price of a good or service increases, consumer demand for the good or service will decrease and vice versa. 

Law Of Demand

This law summarizes the effect price changes have on consumer behavior.

For example, a consumer will purchase more pizzas if the price of pizza falls. The opposite is true if the price of pizza increases.  people generally buy more of a good when the price is low and less of it when the price is high. This is a general rule that applies to most goods called normal goods. As the price of a normal good increases, people buy less of it because they are usually able to switch to cheaper goods.

Normal and Inferior Goods and Its Examples

Normal goods can be defined as those goods for which demand increases when the income of the consumer increases and falls when income of the consumer decreases, price of the goods remaining constant.

Examples of normal goods are demand of LCD and plasma television, demand for more expensive cars, branded clothes, expensive houses, diamonds etc… increases when the income of the consumers increases.

To the opposite side of normal goods are the inferior goods. It is defined as those goods the demand for which decreases when the income of the consumer increases.

Examples of inferior goods are consumption of breads or cereals and since the income of the consumer increases he moved towards consumption of more nutritious foods and hence demand for low priced product like bread or cereal decreases.

Another example can be of use of public transportation, when income is low people use more of public transportation which is not the case when their income increases.

Hence from the above one can see that other things remaining constant as the income of consumer increases demand for normal goods will increase and demand for inferior goods decrease and vice versa.

GIFFEN GOODS

In economics, a giffen good is an inferior good with the unique characteristic that an increase in price actually increases the quantity of the good that is demanded.  This provides the unusual result of an upward sloping demand curve. This phenomenon is notable because it violates the law of demand, whereby demand should increase as price falls and decrease as price rises.

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For example-consumption of bread increased as its price increased.as bread is a staple food for low income consumers.A rise in its price would not stop people from buying as much as before.But poor people would now have so little extra money to spend on meat or other luxury foods that they would abandon on their demand for these and instead buy more bread to fill up their stomachs.the result was that a rise in the price of bread led to a rise in the demand for bread.

This happens because of the interactions of the income and substitution effects. 

SUBSTITUTION EFFECT : if the price of a good rises, consumers will buy less of that good and more of others because it is now relatively more expensive than other goods. If the price of good falls, consumers will buy more of that good and less of others. These changes in quantity demanded due to the relative change in prices are known as substitution effectof a price change.

INCOME EFFECT : If the price of a good rise, the real income of consumers will fall. They will not be able to buy the same basket of goods and services as before.Consumers can react to this fall in real income in one of the two ways.if the good is a normal good,they will buy less of the good. If the good is an inferior good, they will buy more good.these changes in quantity demanded caused by a change in real income is known as income effect.

For an inferior good, the substitution effect and income effect work in opposite directions.A rise in price leads to a fall in quantity demanded because the relative price of the good has risen.but it leads to a rise in quantity demanded because consumers real income have fallen. However, the substitution effect outweighs the income effect because overall it is still true for an inferior good that a rise in price leads to an overall fall in quantity demanded.

A Giffen Good is a special type of inferior good. A rise in price leads to a fall in quantity demanded because of the substitution effect but a rise in quantity demanded because of the income effect.However, the income effect outweighs the substitution effect, leading to rises in quantity demanded.

Depending on whether the good is inferior or normal, the income effect can be positive or negative as the price of a good increases.

.The interesting thing about a giffen good, is that when the price of a giffen good rises, the income effect is greater than the substitution effect.  So if a good is inferior, the income effect will be positive and larger than the negative value from the substitution effect.

 A giffen good faces an upward sloping demand curve because the income effect dominates the substitution effect, meaning that quantity demanded increases as price rises

C:UsersadminDesktopassignmentWhat is a giffen good, an example with graphs_filesgiffen+good.png

Type Of Good

Substitution Effect

Income Effect

Total Effect

Normal good

Fall

Fall

Fall

Inferior Good

Fall

Rise

Fall because substitution effect > income effect

Giffen Good

Fall

Rise

Rise because substitution effect <income effect

Q2 MONOPOLY

 Pure monopoly exists when a single firm is the sole producer of a product for which there are no close substitutes.  They are very desirable from the point of view of a company and, usually, not very desirable for consumers.  Three characteristics define pure monopoly:

 

1.    There is a single seller.

2.    There are no close substitutes for the firm’s product.

3.    There are barriers to entry.

 

Whereas the perfectly competitive firm was a price taker, the monopolistic firm is a price maker. That is, it has control over the price.

 

Examples of monopoly are public utilities such as gas, electric, water, cable TV, and local telephone service companies,  professional sports teams, DeBeers, and Alcoa. Also, monopolies may exist at the local level because of geographic location. Barriers to entry are the main line of defense for incumbent monopolies and may be of different types. Economies of scale constitute one major barrier.  They occur where decreases in unit costs depend on output size. In this case, because a large firm with a large market share is most efficient, new firms cannot afford to enter the market and gain market shares. Public utilities are known as natural monopolies because they possess such economies of scale. Barriers to entry also exist in legal forms as patents or licenses. Patents grant the inventor the exclusive right to produce a product for 20 years (new worldwide patent period established with a 1995 GATT agreement). Licenses are granted by the government and allow only one or few firms to operate in a given market. Finally, barriers to entry may arise from the exclusive ownership or control of essential resources. 

Since there is only one company, the monopolist is a price maker. That is, the company controls output or price – though not both.  Even the monopolist has to deal with its market context.  Ultimately, its profits depend on its ability to sell, that is, on the market demand for its product. How does a monopolist decide how much to produce and at what price to sell?  As for perfect competition, crucial information is summarized by the demand curve. Since there is only one firm, in the case of the monopolist, the market and the company’s demand curves are identical.  A monopoly demand is the industry (market) demand and is, therefore, illustrated by a downward sloping curve.

As in perfect competition, the profit maximizing solution for the monopolist is obtained when MC = MR. Unlike perfect competition, however, monopoly price exceeds marginal revenue because the monopolist must lower its price in order to increase sales. For each price cut, revenue increases by an amount equal to the price of the last unit sold minus the sum of the price cuts which must be taken on all prior units of output. Everything works in reverse if we consider a price increase. The trade-off between price and sales is the reason why the marginal revenue is always below the demand curve. Finally, since the monopolist produces where MR = MC and  P > MR, then P > MC is also true.  A monopolist charges a higher price than would competitive producers selling in the same market. 

Profit Maximization Under Monopoly

Q

MC

ATC

MR

P

Profit

 

Clearly, the price elasticity of demand plays a crucial role in monopoly price setting. As long as demand is elastic, total revenue will rise when the monopoly lowers its price, but this will not be true when demand becomes inelastic. Therefore, the monopolist will expand output only in the elastic portion of its demand curve.

As monopoly is a form of imperfect market organization, there is no difference between firm and industry. A monopoly firm is said to be an industry. Thus monopoly means the absence of competition. There are strong barriers to entry into the industry. As a result, seller has full control over the supply of the commodity.

Features of Monopoly:

1. One seller and large number of buyers:

Monopoly is a form of imperfect market structure where there is only one seller of a product. A monopoly firm may be owned by a person, a few numbers of partners or a joint stock company. The characteristic feature of single seller eliminates the distinction between the firm and the industry. A monopolist firm is itself ‘the industry. Under monopoly there are large numbers of buyers although the seller is one. No buyer’s reaction can influence the price.

2. No close substitute:

Under monopoly a single producer produces single commodities which have no close substitute. As the commodity in question has no close substitute, the monopolist is at liberty to change a price according to his own whimsy. Monopoly can not exist when there is competition.

A firm is said, to be monopolist only when it is the single producer and supplier of the product which have no close substitute. Under monopoly the cross elasticity of demand is zero. Cross elasticity of demand shows a change in the demand for a good as a result of change in the price of another good.

3. Strong barriers to the entry into the industry exist:

In a monopoly market there is strong barrier on the entry of new firms. Monopolist faces no competition. As there is one firm no other rival producers can enter the market of the same product. Since the monopolist has absolute control over the production and sale of the commodity certain economic barriers are imposed on the entry of potential rivals.

4. Nature of demand curve:

In case of monopoly one firm constitutes the whole industry. The entire demand of the consumers for a product goes to the monopolist. Since the demand curve of the individual consumers lopes downward, the monopolist faces a downward sloping demand curve.

A monopolist can sell more of his output only at a lower price and can reduce the sale at a high price. The downward sloping demand curve expresses that the price (AR) goes on falling ns sales are increased. In monopoly AR curve slopes downward mid MR curve lies below AR curve. Demand curve under monopoly la otherwise known as average revenue curve.

5. Homogeneous Product

A monopoly firm manufactures a commodity that has no close substitute and is a homogeneous product. With the absence of availability of a substitute, the buyer is bound to purchase what is available at the tagged price. For instance: there is no substitute for railways as the ‘bulk carrier’. Thus, to be the sole seller, in the monopolistic setup, a unique product must be produced

6. Price Discrimination

Price discrimination can be defined as the ‘practice by a seller of charging different prices from different buyers for the same good or service’. A monopolist has the leverage to carry out price discrimination as he is the market and acts as per his suitability.

7. Price Elasticity

With regards to the demand of the product or service offered by the monopolizing company or individual, the price elasticity to absolute value ratio is dictated by price increase and market demand. It is not uncommon to see surplus and/or a loss categorized as ‘deadweight’ within a monopoly. The latter refers to gain that evades both, the consumer and the monopolist.

Advantages of monopoly

Monopoly avoids duplication and hence wastage of resources.

A monopoly enjoys economics of scale as it is the only supplier of product or service in the market. The benefits can be passed on to the consumers.

Due to the fact that monopolies make lot of profits, it can be used for research and development and to maintain their status as a monopoly.

Monopolies may use price discrimination which benefits the economically weaker sections of the society. For example, Indian railways provide discounts to students travelling through its network.

Monopolies can afford to invest in latest technology and machinery in order to be efficient and to avoid competition.

Disadvantages of monopoly 

Poor level of service.

No consumer sovereignty.

Consumers may be charged high prices for low quality of goods and services.

Lack of competition may lead to low quality and out dated goods and services.

MONOPOLIST EQUILIBRIUM WITH ZERO MARGINAL COST 

Under certain exceptional cases, the cost of additional units of output, i.e., marginal cost (MC) may be equal to zero. With constant value ‘zero’ of marginal cost, the value of average cost is also constant and is equal to zero. With zero cost of production, the monopolist has only to decide at which output, the total revenue will be maximum. And total revenue is maximum, at the output level at which marginal revenue is equal to zero. Further, with zero marginal cost, the condition of profit maximization, i.e., the equality of marginal cost (MC) and marginal revenue (MR) can be achieved, where the latter is also equal to zero. 

Fig.  shows the equilibrium of the monopolist, where marginal cost is equal to zero. ‘E’ is the point of monopolist equilibrium, where MC cuts MR from below. The equilibrium price and the equilibrium quantity at this equilibrium are OP and OQ respectively. Here, total revenue and hence total profits (area OPBE in  fig. ) of the monopolist are maximum. Beyond OQ level of output, MR becomes negative and total revenue starts declining. As explained in Chapter 16 on Market Structure, under heading’ Relation among AR, MR and Price Elasticity of Demand’, Page 485 elasticity of demand on the AR curve corresponding to zero marginal revenue is equal to one. Therefore, with zero cost of production, monopolist equilibrium will be established at a level, where elasticity of demand is unitary.

Description: Zero Cost of Production.JPG                       

Fig. : Monopolist Equilibrium with Zero Cost of Production

It is important to note that the monopolist will never produce the output at any level, where MR is negative. If he does so, his total revenue will fall as output increases. He can increase total revenue by reducing the output. In other words, the monopolist can earn larger profits by restricting the output. Further, since MC cannot be negative, equality of MC and MR (equilibrium condition) cannot be achieved, where MR is negative.

We know from the relationship among average revenue (AR), marginal revenue (MR) and elasticity of demand7 that when marginal revenue is negative, elasticity of demand is less than one. Therefore, no rational monopolist will produce on that portion of the demand curve, where MR is negative, i.e., the elasticity of demand is less than one? That is why; no monopolist ever operates on the inelastic portion of the average revenue curve or the demand curve.

With the positive marginal costs (which is most usually the case), the monopolist fixes his level of output for which MR is also positive, i.e., total revenue rises with increase in the level of output. In other words, the equilibrium will always lie, where elasticity of demand is greater than one.

In  fig. , if the price is fixed at point ‘B’ (middle point of the demand curve), where the elasticity of demand is equal to one, the MC (whether straight line or U-shaped) curve will pass through the MR curve at zero point. Here, both the MC and the MR are zero. It is a rare possibility. Further, below the middle point ‘B’ of the demand curve, elasticity of demand is less than one. If the price is fixed in this inelastic portion of the demand curve, both the MC and the MR assume negative values, as the point of intersection between them is below point ‘E’ on the MR curve in  fig. . However, MC can never be negative. Given positive costs, MC curve must cut the MR curve from below at a point, where both the MC and the MR are positive. The equilibrium in this case will be established at a point above ‘E’ on the MR curve in the figure and the price will be fixed in the elastic portion of the demand curve, i.e., above the middle point of the AR curve in  fig.

(source: transtutors.com)

Q3)World Economic Outlook

The global recovery is threatened by intensifying strains in the euro area and fragilities elsewhere. Financial conditions have deteriorated, growth prospects have dimmed, and downside risks have escalated. Global output is projected to expand by 3¼ percent in 2012 (Table 1 and Figure 1)-a downward revision of about ¾ percentage point relative to the September 2011 World Economic Outlook (WEO). This is largely because the euro area economy is now expected to go into a mild recession in 2012 as a result of the rise in sovereign yields, the effects of bank deleveraging on the real economy, and the impact of additional fiscal consolidation. Growth in emerging and developing economies is also expected to slow because of the worsening external environment and a weakening of internal demand. The most immediate policy challenge is to restore confidence and put an end to the crisis in the euro area by supporting growth, while sustaining adjustment, containing deleveraging, and providing more liquidity and monetary accommodation. In other major advanced economies, the key policy requirements are to address medium-term fiscal imbalances and to repair and reform financial systems, while sustaining the recovery. In emerging and developing economies, near-term policy should focus on responding to moderating domestic growth and to slowing external demand from advanced economies.

Financial risks escalate, global growth decelerates

Global growth prospects dimmed and risks sharply escalated during the fourth quarter of 2011, as the euro area crisis entered a perilous new phase. Activity remained relatively robust throughout the third quarter, with global GDP expanding at an annualized rate of 3½ percent-only slightly worse than forecast in the September 2011 WEO. Growth in the advanced economies surprised on the upside, as consumers in the United States unexpectedly lowered their saving rates and business fixed investment stayed strong. The bounce back from the supply-chain disruptions caused by the March 2011 Japanese earthquake was also stronger than anticipated. Additionally, stabilizing oil prices helped support consumption. These developments, however, are not expected to sustain significant momentum going forward.

By contrast, growth in emerging and developing economies slowed more than forecast, possibly due to a greater-than-expected effect of macroeconomic policy tightening or weaker underlying growth.

Description: Figure 1

Table 1. Overview of the World Economic Outlook Projections

(Percent change unless noted otherwise)

 

 

Year over Year

 

 

 

 

 

 

 

Projections

 

Difference fromSeptember 2011 WEOProjections

 

Q4 over Q4

 

 

 

 

Estimates

Projections

 

2010

2011

2012

2013

 

2012

2013

 

2011

2012

2013

 

World Output 1

5.2

3.8

3.3

3.9

 

-0.7

-0.6

 

3.3

3.4

4.0

Advanced Economies

3.2

1.6

1.2

1.9

 

-0.7

-0.5

 

1.3

1.3

2.1

United States

3.0

1.8

1.8

2.2

 

0.0

-0.3

 

1.8

1.5

2.4

Euro Area

1.9

1.6

-0.5

0.8

 

-1.6

-0.7

 

0.8

-0.2

1.2

    Germany

3.6

3.0

0.3

1.5

 

-1.0

0.0

 

1.8

0.7

1.6

    France

1.4

1.6

0.2

1.0

 

-1.2

-0.9

 

0.9

0.5

1.3

    Italy

1.5

0.4

-2.2

-0.6

 

-2.5

-1.1

 

-0.1

-2.7

0.9

    Spain

-0.1

0.7

-1.7

-0.3

 

-2.8

-2.1

 

0.2

-2.1

0.6

Japan

4.4

-0.9

1.7

1.6

 

-0.6

-0.4

 

-0.9

1.9

1.5

United Kingdom

2.1

0.9

0.6

2.0

 

-1.0

-0.4

 

0.8

1.0

2.4

Canada

3.2

2.3

1.7

2.0

 

-0.2

-0.5

 

2.1

1.7

2.0

Other Advanced Economies 2

5.8

3.3

2.6

3.4

 

-1.1

-0.3

 

2.9

3.2

3.5

    Newly Industrialized Asian Economies

8.4

4.2

3.3

4.1

 

-1.2

-0.3

 

3.8

4.3

3.8

Emerging and Developing Economies 3

7.3

6.2

5.4

5.9

 

-0.7

-0.6

 

5.9

6.0

6.3

Central and Eastern Europe

4.5

5.1

1.1

2.4

 

-1.6

-1.1

 

3.4

1.4

3.0

Commonwealth of Independent States

4.6

4.5

3.7

3.8

 

-0.7

-0.6

 

3.2

3.5

3.7

    Russia

4.0

4.1

3.3

3.5

 

-0.8

-0.5

 

3.5

2.8

4.0

    Excluding Russia

6.0

5.5

4.4

4.7

 

-0.7

-0.4

 

. . .

. . .

. . .

Developing Asia

9.5

7.9

7.3

7.8

 

-0.7

-0.6

 

7.4

7.9

7.6

    China

10.4

9.2

8.2

8.8

 

-0.8

-0.7

 

8.7

8.5

8.4

    India

9.9

7.4

7.0

7.3

 

-0.5

-0.8

 

6.7

6.9

7.2

    ASEAN-5 4

6.9

4.8

5.2

5.6

 

-0.4

-0.2

 

3.7

7.4

5.0

Latin America and the Caribbean

6.1

4.6

3.6

3.9

 

-0.4

-0.2

 

3.9

3.3

5.0

    Brazil

7.5

2.9

3.0

4.0

 

-0.6

-0.2

 

2.1

3.8

4.1

    Mexico

5.4

4.1

3.5

3.5

 

-0.1

-0.2

 

4.1

3.1

3.6

Middle East and North Africa (MENA) 5

4.3

3.1

3.2

3.6

 

. . .

. . .

 

. . .

. . .

. . .

Sub-Saharan Africa

5.3

4.9

5.5

5.3

 

-0.3

-0.2

 

. . .

. . .

. . .

    South Africa

2.9

3.1

2.5

3.4

 

-1.1

-0.6

 

2.4

3.0

3.7

Memorandum

 

 

 

 

 

 

 

 

 

 

 

European Union

2.0

1.6

-0.1

1.2

 

-1.5

-0.7

 

0.8

0.3

1.7

World Growth Based on Market Exchange Rates

4.1

2.8

2.5

3.2

 

-0.7

-0.4

 

. . .

. . .

. . .

 

 

 

 

 

 

 

 

 

 

 

 

World Trade Volume (goods and services)

12.7

6.9

3.8

5.4

 

-2.0

-1.0

 

. . .

. . .

. . .

Imports

 

 

 

 

 

 

 

 

 

 

 

    Advanced Economies

11.5

4.8

2.0

3.9

 

-2.0

-0.8

 

. . .

. . .

. . .

    Emerging and Developing Economies

15.0

11.3

7.1

7.7

 

-1.0

-1.0

 

. . .

. . .

. . .

Exports

 

 

 

 

 

 

 

 

 

 

 

    Advanced Economies

12.2

5.5

2.4

4.7

 

-2.8

-0.8

 

. . .

. . .

. . .

    Emerging and Developing Economies

13.8

9.0

6.1

7.0

 

-1.7

-1.6

 

. . .

. . .

. . .

Commodity Prices (U.S. dollars)

 

 

 

 

 

 

 

 

 

 

 

Oil 6

27.9

31.9

-4.9

-3.6

 

-1.8

-3.1

 

. . .

. . .

. . .

Nonfuel (average based on world commodity export weights)

26.3

17.7

-14.0

-1.7

 

-9.3

2.2

 

. . .

. . .

. . .

 

 

 

 

 

 

 

 

 

 

 

 

Consumer Prices

 

 

 

 

 

 

 

 

 

 

 

Advanced Economies

1.6

2.7

1.6

1.3

 

0.2

-0.1

 

2.9

1.2

1.3

Emerging and Developing Economies 3

6.1

7.2

6.2

5.5

 

0.3

0.4

 

6.5

5.6

4.8

London Interbank Offered Rate (percent) 7

 

 

 

 

 

 

 

 

 

 

 

On U.S. Dollar Deposits

0.5

0.5

0.9

0.9

 

0.4

0.3

 

. . .

. . .

. . .

On Euro Deposits

0.8

1.4

1.1

1.2

 

-0.1

-0.4

 

. . .

. . .

. . .

On Japanese Yen Deposits

0.4

0.4

0.5

0.2

 

0.2

0.0

 

. . .

. . .

. . 

(Source www.imf.org/external/pubs/ft/weo/2012/update/01/