1: In the table below an oligopolist firm faces two demand schedules.

The current
price is given as $185.
Competitors
Fixed:
Demanded
20
30
40
50
60
70
(i)

Price
Quantity

Price($)

Competitors
Demanded

200
195
190
185
180
175

35
40
45
50
55
60

follow:

Quantity

What would the demand curve be under the kinked demand curve
hypothesis? Illustrate and explain.
300
250

P
r
i
c
e

250

200

200
190

200

185

165

150

Fixed Price
175

175

Follow Price

140

Marginal Revenue Fixed

115

100

MR2
Follow MC

70
60

50

Price

35
20

0
10

20

30

40

0
50

Fixed MC
60

70

80

Quantity

Fig.1
The above demand graph plots the two demand scenarios.
1) PQ- represents the demand curve when the competitors follow price
2) AB- represents the demand curve when the competitors price is fixed. The
point at which the two curves intersect is O.
The equation of PQ demand curve is- P+Q=235
The equation of AB demand curve is -2P+Q=420
Hence, the kink demand curve is AOQ which has a kink at the point O. Since it is
assumed that price decrease by a firm will be matched by a price reduction by

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the competitors but an increase in the price is not matched by the competitors,
the relevant demand curve is AOQ, which has a kink at O.
(ii) Plot the marginal revenue curve corresponding to the kinked demand curve
and explain.
The Demand Curve for AB has the equation P+Q=235
Total Revenue=P*Q= (235-Q)*Q
Also we know, Marginal Revenue=Change in Revenue/Change in Quantity=
dt(R)/ dt(Q)
Therefore by differentiation we get the AB marginal revenue curve as
MRab=235-2Q
Similarly we get the PQ marginal revenue curve as
MRpq=210-Q
The following has been plotted by AB and PQ in Fig.1
. (iii) Given that Marginal Cost is $150 at every level of output.
Copy the above table and calculate TR and MR. Determine the profit- maximising
level of output and plot on the graph.
From the above table we get the following:
Q1
20
30
40
50
60
70

P($)
200
195
190
185
180
175

TR1($)
4000
5850
7600
9250
10800
12250

MR1($
)
190
180
170
160
150
140

Q2
35
40
45
50
55
60

TR2($)
7000
7800
8550
9250
9900
10500

MR2($
)
165
155
145
135
125
115

(Note: Total Revenue=Price*Quantity, Calculation of Marginal Revenue is

explained in (ii) and we have plugged in the Quantity values for the same)
The equilibrium of the firm is defined by the point of the kink because for any
output level less than 50(kink output), MC is below MR while for any output level
greater than OM, MC is greater than MR. Thus, total profit is maximized at the
kink though the profit maximizing condition (MR = MC) is not fulfilled at the kink
point. This has been marked as a vertical line where Q=50 in Fig.1
2 (a) Give examples and discuss the costs of (i) inflation and (ii) unemployment
on the individual, firm, government and the economy as a whole.

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(i)Inflation:
-It leads to higher pay loads as workers try to maintain their real standard of
living.
-Higher salaries cause a surge in unit labor costs. Businesses increase prices to
maintain their profit boundaries.
-It is can also have an effect on the real value of savings
-The real value of borrowers debt is lessened. Inflation decreases the real value
of income year on year.
-It also causes a disturbance of business planning insecurity about the future
makes planning hard, planning becomes a problem as firms become unsure
about what will happen to their expenses.
-This leads to firms projects to be cancelled or suspended.
-Lower rate of capital investment damages long-run financial growth.
(ii)Unemployment:
Some of the affects are:
-Lost output of goods and services
-Reduction in the long run growth potential of the economy.
-Direct impact on government expenditure, the level of government borrowing
and taxation
-An increase in it results in lower tax revenues.
-Government needs to shell out higher benefit payments
-Burden loss of investment in human capital
-It wastes some of the rare resources used in training workers. Besides, labors
who are jobless for long periods become de-skilled as their skills become
gradually dated in a quickly changing business.
-It is also linked to social and economic scarcity - there is some association
between growing unemployment and growing crime and waning social
displacement.
(b) Illustrate and explain what effect the following will have on the expenditure
line:
(i) An increase in the proportion of peoples income that is saved.
(ii) A fall in exports.
The slope of expenditure line
=Marginal propensity to consume (MPC)
+Marginal propensity to invest(MPI)
+Marginal propensity for government
purchases(MPG-Marginal propensity to import(MPM)
(i)

When this happens Marginal Propensity to save (MPS) increases. But,

MPS+MPC=1.
This implies MPC decreases and hence the slope of expenditure line
decreases.

(ii)

When this happens Marginal Propensity to Export decrease. This

implies MPM to import increase. Hence the slope of expenditure line
decreases

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(c) Using the withdrawals/injections and the income/expenditure approach, show

graphically and explain the effects on GDP, consumption and unemployment of a
substantial rise in:
(i) Exports
(ii) Government expenditure.
(i)

GDP = C + I + G + (EX - IM),where consumption (C), investment (I),

government purchases (G), and net exports (X - M).
If
exports
rises
the
GDP
increases,
If consumption rises the GDP increases
According to Ocuns Law with the increase in GDP the unemployment
rate decreases.

(ii)

GDP = C + I + G + (EX - IM), where consumption (C), investment

(I), government purchases (G), and net exports (X - M).
If G increases the GDP increases
The IS-LM model forecasts that consumption should grow with increase
in government expenditure.
Also when government raises its level of expenditure, it leads to a
sustained economic growth which provides a platform for more jobs.

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