Managerial

Economics
ABS-MBA Assignment 2022

Submitted By
ABSMBA22040643 KAISHYAP SHRESTHA
ASCENCIA BUSINESS SCHOOL
SUBMITTED ON 14/10/2022
Abbreviation Used

MR Marginal Revenue
ATC Average Total Cost
MC Marginal Cost
AC Actual Cost
AR Average Revenue
OPEC Organization of Petroleum Exporting Countries
D Demand
S Supply
Q Quantity
Contents
ASSIGNMENT PART-I..............................................................................................................................1

Answer: I.1 (Equilibrium Price & Quantity).............................................................................................1

Answer: I.2 (Opportunity Cost / Accounting Profit & Economic Profit with Example)..........................1

Answer: I.3 Critically Evaluate and Explain.............................................................................................2

a. A firm in a perfectly competitive market should always shut when its marginal revenue is below
its average cost (equivalent to average total cost).................................................................................2

b. The intersection of marginal revenue and marginal cost determines the quantity at which a
business in a perfectly competitive market is profitable........................................................................3

ASSIGNMENT PART-II............................................................................................................................4

Answer: II.1 Crude Oil Market Equilibrium- Supply & Demand and its Impacts on Economy...............4

Introduction..........................................................................................................................................4

Reasons for price fluctuation:.............................................................................................................6

Impact of Crude Oil Price Fluctuation on Logistic Business:.........................................................7

Conclusion:...........................................................................................................................................7

Answer: II.2 Price Ceiling on the Price of Heating Gas in Europe / Analysis of the Situation................7

Answer: II.3 Characteristics of Perfect Competition in Terms of Demand, Price, Quantity and Profits at
Equilibrium................................................................................................................................................9

Bibliography................................................................................................................................................10
 ASSIGNMENT PART-I
Answer: I.1 (Equilibrium Price & Quantity)
The equilibrium price and quantity are found where the quantity supplied equal the quantity demanded at
the same price. As we see from the table, the equilibrium price is $70 and the equilibrium quantity is 140
million.

When the demand curve shift to $15 million less demanded at every price, the new equilibrium price will
be $60 and the equilibrium quantity will be 135 million. When the demand for the patrol is less in the
market, the demand curve shift towards inside in demand and supply curve which leads the price to fall
because of the less demand for a particular item in the market.

Answer: I.2 (Opportunity Cost / Accounting Profit & Economic Profit with Example)
Opportunity cost refers to what you have to give up to buy what you want in terms of other goods or
services. It is the value of the next best opportunity. Opportunity cost is a direct implication of scarcity.
People have to choose between different alternatives when deciding how to spend their money and their
time. For example, I have a flat which I use myself for my office purpose, whereas if I rent it out, I cannot
use it as my office and I need to find a separate flat to rent for it. If the cost of renting myself an office is
more expensive than the rent I am receiving from my flat, then the optimal choice is that I will use my flat
for my office rather than renting it.

Difference between economic profit and accounting profit:

S.N. Accounting Profit Economic Profit

1. Total revenue less expenses is accounting The surplus after deducting opportunity costs and
profit. implicit costs is economic profit.
2. It shows the true financial health of a Because of the element of estimation, it may not
company. give a true picture.
3. This profit tells about the profitability of a This profit tells about the effective allocation of

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 company. the resource.
4. Accounting profit does not include special This may include special items like residual value,
items. inflation level changes, etc.
5. Formulae: Total Revenue – Explicit Cost Formulae: Total Revenue – (Explicit Cost +
Implicit Cost)
6. This is a practical approach as it is based on This is less practical as this is based on
actual aspects. assumption.
7. It is used for a short term e.g.- for a year to It is generally used for long-term purposes and
evaluate the total income of the business decision-making.
during the year.

Example:

An owner of a lumber store reported the following financials for last year. If the owner closed the
store, he would be working at Home Depot earning $ 85,000 a year and be able to rent the store’s
property (building and land) for $ 45,000 a year. Per year, the owner’s revenue is $ 1,000,000, wages paid
to store employees are $ 250,000, utilities (water, electricity, telephones charges) are $ 15,000, and
miscellaneous purchases for the store are $750,000.

Accounting Profit = Revenue – Explicit Costs (the cost that involves spending money)

= $ 1,000,000 – ($ 250,000+$ 15,000+$ 450,000)

= $ 285,000 is accounting profit for a year.

Economic Profit=Revenue- {(Explicit Cost) + (Implicit Cost)}

=$ 1,000,000 -{($ 250,000+$ 15,000+$ 450,000)+( $85,000+$45,000)}

=$ 155,000.00 is economic profit for a year.

Answer: I.3 Critically Evaluate and Explain

a. A firm in a perfectly competitive market should always shut when its marginal revenue is below
its average cost (equivalent to average total cost).
A shutdown point is a level of operation at which a business decides to temporarily — or, in some
situations, permanently — shut down operations since there is no longer any advantage to doing so. It is
the outcome of the interaction between output and pricing when the business generates just enough
money to cover all of its variable costs.

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If a firm in a perfectly competitive market is making its marginal revenue below its average cost
(equivalent to average total cost), then the firm should shut down as losses are greater because it does not
make enough revenue to offset the increased variable costs plus fixed costs.

b. The intersection of marginal revenue and marginal cost determines the quantity at which a
business in a perfectly competitive market is profitable.

In the above Energy Drink example, the marginal revenue and marginal cost curves cross at a price of
$0.50 and a quantity of 9000 gallons produced. If the firm started out producing at a level of 6000
gallons, and then experimented with increasing production to 7000 gallons, marginal revenues from the
increase in production would exceed marginal costs—and so profits would rise. At a level of output of
9000 gallons, marginal cost and marginal revenue are equal so profit doesn’t change. If the firm then
experimented further with increasing production from 9000 gallons to 10000 gallons or 11000 gallons,
the firm would find that marginal costs from the increase in production are greater than marginal
revenues, and so profits would decline and the firm will face loss.

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The profit-maximizing choice for a perfectly competitive firm will occur at the level of output where
marginal revenue is equal to marginal cost—that is, where MR = MC. This occurs at Q = 9000 gallons in
the figure.

** End of Part-I**

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 ASSIGNMENT PART-II
Answer: II.1 Crude Oil Market Equilibrium- Supply & Demand and its Impacts on Economy
Introduction
One of the most essential commodities in the world is crude oil, and changes in its price can have
repercussions on the economy as a whole. Oil price increases are generally thought to increase inflation
and reduce economic growth (Dr. Econ, 2007). The laws of supply and demand are primarily responsible
for determining crude oil prices. Prices are lowered by excess supply or declining demand and prices are
raised by increased demand or insufficient supply (Investopedia, 2022). When oil prices rise, production
and transportation costs rise, reducing supply at a given price. When oil prices fall, so do production and
transportation costs, allowing for more production at a given price. Economist defines the term “Demand”
as the quantity of good or service that any consumers are willing to or able to purchase at each price as
per the consumers’ need and want. Demand always has an inverse relationship with price. When price
rise, demand falls, and vice versa. Likewise, the term “Supply” is the quantity of a good or service that a
producer is willing to supply at any price. Increase in price almost always leads to an increase in the
quantity of supply of the good or service, while a price decrease leads to a decrease in the quantity of
supply. Consumers are less willing to purchase a normal product at a higher price; however, suppliers are
more willing to produce/sell a product if they are receiving a higher selling price for that product (Calum
A. Macdonald CA, 2020).

The above behaviour of the “Demand” & “Supply” can be illustrated in the following chart of gasoline
(STEVEN A. & DAVID, 2011).

Demand Curve of Gasoline Supply Curve of Gasoline

Oil is a commodity, and as such, it tends to see larger fluctuations in price than more stable investments,
such as stocks and bonds (NICK LIOUDIS, 2021).

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Since the 1970s, crude oil prices on the world market have experienced fluctuations, including a sharp
rise during the first and second oil crises, a slump in 1986, a steep rise during the Persian Gulf crisis, a
decline during the Asian economic crisis and an upward trend since 1999 (Ken Koyama, PhD, 2005).

As per an article published on online Open Libraries, “Principle of Macroeconomics” - In 1973, the crude
oil market underwent a dramatic change. Between 1973 and 1974, the price of a barrel of crude oil
quadrupled. Price dropped sharply and stayed low for about 20 years after it had been high until the early
1980s. Oil prices started to rise in 2004 and reached a high of $147 per barrel in 2008. It appeared to be
increasing worldwide demand outpacing producers’ ability—or willingness—to increase production and
with the fluctuation of the price, the equilibrium point also changes. This is illustrated in the following
diagram.

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Reasons for price fluctuation:
 Crude oil prices react to many variables, including supply and demand prospects and the
perceived risk of market disruptions.
 Economic growth can drive up the demand for crude oil, while slowdowns tend to lower demand
and prices.
 OPEC is an international alliance of crude oil exporters that negotiates export quotas for members
in an attempt to influence global supply.
 One reason crude oil prices can be volatile is that supply and demand are relatively inelastic, that
is they're slow to respond to price signals, requiring bigger price moves to bring the market into
balance. Statistics from 2018 show that OPEC is in charge of about 80% of the world's oil
reserves (OPEC, 2022).

 Another reason for the price fluctuation is pandemics like the Coronavirus which outbreak,
initially in China on starting of 2020, then spreading to the rest of the world, and the lockdowns
introduced to control its spread- led to a dramatic cut in demand for crude oil. This fall in demand
led to an oversupply of oil and a rapid build-up of stocks. Prices fell from more than $65 per
barrel in January to $50 in late February and $25 per barrel in mid-March. After a modest rise,
they fell again to below $20 per barrel in April 2020, the lowest since February 2002 (Paul
Bolton, 2022).

Impact of Crude Oil Price Fluctuation on Logistic Business:

The logistics business is continually changing as a result of fuel market price volatility. Rapid fuel price
hikes can have a long-lasting and disastrous impact on transportation management organizations, while a
rapid drop could lead to a spike in profits and increased competition to provide customers with the best
deals. Carriers are compelled to increase pricing or suffer losses as fuel costs rise. The cost of fuel
consequently affects not just the logistics firm but also the shipper and the shipper's source of revenue. It
is a domino effect that spreads outward: If the cost of shipping the freight increases, the shipper will be
charged extra to make up the difference. The receiver will be charged extra if the shipper must pay more
for the cost of moving the freight in order to cover their increased expenses. This means the products are

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going to be sold to consumers at higher costs to make up for the higher transportation and fuel costs.
Basically, higher fuel costs cause product inflation and affect every aspect of production transportation
along the way. When fuel costs fall, it is generally the other way around. As expected, the savings are
passed on to the consumer in the form of lower prices. Demand for shipping services increases when
costs fall. Turnover and profitability are boosted and promote growth. Logistics companies that achieve
the greatest cost savings can redirect their efforts from containing high fuel costs to increasing service
speed and improving other aspects of their operations. The bottom line is: lower fuel costs mean a lower
price passed on to the consumer.

Conclusion:
Oil has long been the engine of the world's economy, and even today—as the search for alternative
energy sources gains ground—it remains an essential commodity. The fluctuation in crude oil prices can
impact decision-making in monetary, fiscal and structural policies. However, the impetus to shift these
policies depends on whether a country is an oil importer or exporter. In the context of oil importers, lower
oil prices can make substantial savings, which will help rebuild these countries’ fiscal space after the
global financial turn-moil. From a structural policy perspective, the fall in crude oil prices certainly
strains the public finances of major oil-exporting countries.

Answer: II.2 Price Ceiling on the Price of Heating Gas in Europe / Analysis of the Situation
Global GDP recorded strong growth of 5.9% in 2021, recovering from the pandemic-related decline of
3.2% in 2020, and the outlook for the global economy at the start of 2022 is one of sustained and robust
growth. But the humanitarian costs are compounded by others, Russia's invasion of Ukraine in February
2022 poses new challenges to the global economy at a time when most markets around the world have
recovered from the economic impact of the pandemic Covid 19 pandemic have recovered. "Russia's
unprovoked war in Ukraine is seriously disrupting gas markets, which were already showing signs of
shortages," said IEA Director for Energy Markets and Security Keisuke Sadamori. "We are now seeing
inevitable price spikes as countries around the world compete for LNG supplies (IEA, 2022)."

Before explaining about price ceiling on heating gas in Europe, let’s understand the price ceiling and what
it does exactly. The price ceiling is a law that government enacts to regulate prices which prevents a price
from rising above a certain level (the “ceiling”) and usually applies to essential goods such as food, rents
and energy sources to ensure that everyone has access to them (Intelligent Economist, 2022).

Price caps can potentially lead to excess demand in the market as it remains in disequilibrium
(BoyceWire, 2021). When a price ceiling is set below the equilibrium price, the quantity demanded will
exceed the quantity supplied, and excess demand or shortages will result. Due to this disequilibrium,
excess demand will cause the price to rise, and as price rises producers are willing to sell more, thereby
increasing output.
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Natural gas prices have skyrocketed in Europe as global demand increases. While this is the case with
most commodities, it is a bigger problem with natural gas.

"Europe is seeing a perfect storm in its natural gas market," explains Simone Tagliapietra, a senior fellow
at the Brussels-based economic think-tank Bruegel, due to a combination of factors on both the supply
and demand sides. Demand has increased for several reasons starting from October 1st with the start of
winter season, so people are heating their homes for longer than usual and this has driven up the need for
natural gas. There are also several issues on the supply side: including less maintenance of oil and gas
fields during the COVID-19 crisis and less investment. Before Russia-Ukraine War, 40% of Europe's gas
came from Russia but now Russia, seemingly in retaliation for being hit with sanctions, is now cutting off
that supply. Supply is tightening while demand continues to rise, causing gas and electricity prices, which
are linked in Europe, to rocket (ECONOMIC NEWS, 2022).

Answer: II.3 Characteristics of Perfect Competition in Terms of Demand, Price, Quantity and
Profits at Equilibrium
Perfect competition is a theoretical market structure in which there are many buyers and sellers, identical
products (also called homogeneous products), perfect information and no barriers to entry.

The characteristics of perfect competition are:

1. Many buyers and sellers

2. Identical product and service
3. Perfect information
4. No barrier to entry or exit

Necessary and sufficient conditions for a firm to be in equilibrium are when MC equals MR or the curve
MC intersects the curve MR from below. In other words, the curve MC must intersect the curve MR from
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below and, after the intersection, lie above the curve MR. In simpler terms, the firm must increase its
production as long as MR > MC. The reason for this is that the additional production brings in more
revenue than costs and increases profits. If MC =MR but the firm finds that increasing its production
makes MC smaller than MR, it must increase its production further.

Productive Efficiency: As we know, the level of productive efficiency of production is where MC =AC.
This means that a firm is said to be productively efficient if it produces at a point where MC =AC,
because MC always intersects AC at its lowest point. In the case of perfect competition, a firm produces
at the productively efficient level of output q, as shown in below diagram

Allocative Efficiency: This is the socially optimal level of production. At this point it is impossible to
make one person better off without making another worse off. There is Pareto optimality.

It occurs when MC = AR

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In other words, a firm produces at the profit-maximising level in a market with perfect competition,
which is MR =AR. This is also the point at which MC =AR. From this we can conclude that under perfect
competition there is allocative efficiency in the long run.

Barriers to Entry Prohibit Perfect Competition: There are some barriers to entry prohibit perfect
competition. Many industries have significant barriers to entry, such as high start-up costs (as in the
automotive industry) or stringent government regulations (as in the utilities industry) that limit the ability
of companies to enter or exit these industries. And although consumer awareness has increased in the
information age, there are still few industries where the buyer is aware of all available products and
prices. There are significant barriers that prevent perfect competition from developing in the economy.
Perfect competition is probably most likely to occur in agriculture, where there are many small producers
who have virtually no ability to change the selling price of their products. Commercial buyers of
agricultural products are usually very well informed, and although agricultural production has some
barriers to entry, it is not particularly difficult to enter the market as a producer.

** End of Part-II**

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 BIBLIOGRAPHY
BoyceWire. (2021, January 9 ). Price Ceiling Definition by PAUL BOYCE. From
https://boycewire.com/price-ceiling-definition/

Calum A. Macdonald CA. (2020, September 11). Oil price fluctuations during COVID-19.
www.icas.com/students/learning-blog/test-of-competence/business-acumen-covid-19-and-oil-
prices.

Dr. Econ. (2007, November). What are the possible causes and consequences of higher oil prices on the
overall economy? www.frbsf.org/education/publications/doctor-econ/2007.

ECONOMIC NEWS. (2022, September 13). From Europe in Crisis as Russia Cuts Supply of Gas:
https://www.investopedia.com/europe-russia-gas-cuts-crisis

Energy crisis. (2022, October 07). From euronews:

https://www.euronews.com/my-europe/2022/10/07/energy-crisis-eu-countries-set-to-debate-price-
cap-on-gas-and-its-potential-risks

IEA. (2022, July 5). From Press Realease - Global natural gas demand : https://www.iea.org/news

Intelligent Economist. (2022, February 2). Price Ceiling by Prateek Agrawal. From
https://www.intelligenteconomist.com/price-ceiling/

Investopedia. (2022, September 23). From https://www.investopedia.com/terms/c/crude-oil.asp

Ken Koyama, PhD. (2005). Trend of Supply. The Recent High Oil Price: Its Background and future
prospects, 1.

NICK LIOUDIS. (2021, August 30). What Causes Oil Prices to Fluctuate? From
https://www.investopedia.com

OPEC. (2022). From Annual Statistical Bulletin 2022:

https://www.opec.org/opec_web/en/data_graphs/330.htm

Paul Bolton. (2022, June 8). Oil Prices. Early 2020 to early 2022: Pandemic price crash, p. 11.

(2022). Q3 Gas Market Report. IEA. From https://www.iea.org/reports/gas-market-report-q3-2022

STEVEN A. & DAVID. (2011). Demand and Supply. In Principles of Micro Economics 2e (pp. 55-57).
OpenStax.

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