JIMMA UNIVERSITY

COLLEGE OF BUSINESS AND ECONOMICS

DEPARTMENT OF ECONOMICS

Introduction to economics group assignment (20%)

Due date for Submission: 23-1-2023

Instruction

 The assignment will be done by a group having maximum of ten members.

 Each group should try each question and every group member should participate in the
task!

 Coping from each other results in cancellation of your result!

 Submit before or on the due date. Delay/late submission from the specified submission
date will result in cancellation of your result!

 Your work should be neat and clear, neatness has its own value.

 Maximum page for this assignment is 15 pages with the exception of cover page.

1. A consultant works for 200 Birr per hour. He likes to eat vegetables, but is not very good at
growing them. Why does it make more economic sense for him to spend his time at the
consulting job and shop for his vegetables?
Answer:
Growing vegetables for this consultant entail huge opportunity cost. Planting, conserving
and growing vegetables require physical labour, but could be done with less skill.
However, the income that could be obtained per hour from this work can potentially less
than consultancy income within the same time. On the other hand, the consultancy job
earns high income, but requires greater professional skill.

If the individual spends his time on growing vegetables, he loose significant income from
his profession because opportunity cost of the former activity is very high. Instead, to
continue the consultancy job and acquire the vegetable he likes is economically more

1
 feasible. Therefore, if he able to obtain 200 Birr per hour, but cannot do the same thing
when he prefers to grow vegetable, the person would economically be better off when he
works his consultancy job and buy and consume the vegetable he likes by spending from
portion of the income.
2. Suppose the demand function for a commodity X is given by Q= 500 – 10P. Where Q and P
denotes the quantity demanded and price of commodity respectively, then Find:
i. Compute the price elasticity of this demand function.

dQ P
Solution: price elasticity of demand is given as Ep= . =¿ then from the demand function
dQ Q
we can only express the elasticity in terms of price since we are not given price level.

dQ P −10 P Ep/¿/−10 P
Hence, dQ/dP= -10, then Ep= . = then in absolute term ¿ /¿
dQ Q 500−10 P 500−10 P

ii. What is the price elasticity of demand when the price is Birr 30? And comment what type of
commodity (good) X can represent.

dQ P −10 P
Solution: Ep= . from above we have got Ep= =
dQ Q 500−10 P
−10 (30)
=¿−1.5/¿ 1.5 since the calculated elasticity exceed a unit (elastic), the good X is
500−10(30)
normal luxury commodity.

3. Consider the demand for hamburgers. If the price of a substitute good (for example, ground
beef) increases and the price of a complement good (for example, hamburger buns) increases,
can you tell for sure what will happen to the demand for hamburgers? Why or why not?
Illustrate your answer with a graph.
Answer:
Case 1: Though we may not know practically what will happen to the demand of hamburger
when price of its substitutable good (ground beef) increases, theoretically it is natural to
expect a response by consumers. Accordingly, when price of the substitutable good increase,
holding other factors that affect demand of hamburger constant, the demand for hamburger
increases. The reason is that since the two goods are close substitutable for each other,

2
 change in price of one good can affect demand of the other. Hence, it causes the demand
curve of hamburger to be shifted outward. Graphically we can illustrate in the following way.

D2

D1

0 Q

Case 2: When price of complementary good (hamburger bun in this case) increases.

In economic theory we know that if price of complementary good increases, demand for that
particular commodity decreases, ceteris paribus. Therefore, when price if hamburger bun
increases which is complementary to the product itself, the demand for hamburger decreases.
This would happen because the rise in price of the bun triggers price of the main product
(hamburger). This effect in turn discourages the consumers to demand less of hamburger. That is
why we observe negative relationship between price of complementary good and demand.
Graphically we can show it in the following curve.

D1

D2

0 Q

3
4. Suppose you are the manager of a store that carries basic soft drinks. Due to a local
economic boom, your customers’ incomes are forecasted to rise by five percent during the
next month. The income elasticity of demand for these products is estimated to be –2.0.
Estimate the change in the quantity of your soft drink orders required to accommodate the
new demand without a surplus or shortage of inventory (that is, how much will demand for
the basic soft drinks change due to the increased income?).

Solution: Before estimating the percentage change in quantity of soft drink, from sign of the
estimated income elasticity (-2) we should understand that the product is inferior good for
that particular consumers. In essence, there is negative relationship between quantity
demanded of the soft drink and income of the consumers. Hence, an increase in income by
1% decreases quantity demanded by 2%, holding other things the same.
%∆Q
Then, E I= =−2, and% ∆ I =5 % Hence, % ∆ Q=−2∗% ∆ I =−2∗5 %=−10 % .
%∆I
Therefore, quantity of the soft drink must be cut by 10% to accommodate the new
demand without shortage or surplus.
5. Show that the cardinal and ordinal approaches have basically the same equilibrium
conditions.

Answer:
In cardinal utility approach, the equilibrium condition of a consumer that consumes a single good
X occurs when the marginal utility of X is equal to its market price.

MUx = Px. The mathematical proof of this equality is that

dU d (QxPx )
Max (U-QxPx. − =MUx−Px=0then MUx=Px
dQ dQ
For two commodity case, the consumer‘s equilibrium is achieved when the marginal utility per
money spent is equal for each good purchased and his money income available for the purchase
of the goods is exhausted.
MUx MUy MUx Px
Arithmetically, = when we re arrange this expression, =
Px Py MUy Py

4
In Ordinal utility approach, we know that the condition that establishes equilibrium of a
consumer consuming two commodities is tangency point of indifference curve and budget line.

Px MUx Px
At the point of tangency, slopes of the two curves are equal. MRSx,y = , Hence, =
Py MUy Py
Therefore, the cardinal and ordinal utility approaches have the same equilibrium
condition.

6. The production department of a firm reported the following information:

Wage bill = 20,000 Birr Raw materials = 60,000 Birr

Interest = 6000 Birr Fuel = 10,000 Birr

Rent = 4000 Birr Units produced = 2000 Birr

Using the above information; a) Calculate the average variable cost the firm

b) Calculate its average total cost c) Estimate its average fixed cost

Solution: We know that total cost is the summation of total variable and fixed costs. To reach on
average cost of each total cost definitions, we need to identify classification of each cost. In the
theory of cost we know that the fixed costs include: salaries of administrative staff, expenses for
building depreciation, interest expenses and repairs, expenses for land maintenance and the rent
of building used for production. And variable costs may include: the cost of raw materials, the
cost of direct labour and the running expenses of fuel, water, electricity, etc.

Therefore, according to the given costs,

total fixed cost (TFC) = interest + rent+ wage bill = 6000+4000+20,000 = 30,000
Total variable cost (TVC) = cost of raw materials+ fuel = 60,000+10,000 = 70,000
Then TC= TVC+ TFC =70,000+30,000 = 100,000
TVC 70,000
a. AVC = = =35
Q 2000
TC 100,000
b. ATC = = =50
Q 2000
TFC 30,000
c. AFC = = =15
Q 2000

5
7. Consider that the minimum possible supply to the market by a competitive firm is 80 units
when the minimum AVC is Birr 5 per unit, then;
a) Find the minimum price that the firm takes
b) Calculate the average fixed cost at the total cost of 800 Birr
c) Calculate the average total cost the firm incurs
d) Calculate the shutdown output level
e) Determine the level of profit at equilibrium.

Solution:
a. The minimum level of price that a firm can take is equal to AVC. This is because any
firm who minimizes loss by shutting down the business cannot supply at price less than
AVC. Hence, the threshold to shut down is P = AVC. Therefore, the minimum price that
the firm takes Birr 5.
b. To find average fixed cost we should know average total cost (ATC).
ATC= TC/Q = 800/80 = 10
At minimum point we know that AVC= 5 Birr
Therefore, AC= AFC+AVC
AFC= AC-AVC = 10-5 = 5 Birr
c. Since we are not given TC function to derive each total cost and average cost at any level
of output, we can only determine ATC when AVC is at minimum point.
Therefore as we have shown above, average total cost when AVC is at its minimum
level, ATC = TC/Q= 800/80= 10
d. Any firm who faces loss minimize it by shutting down its business. The shutting down
point determined where P=AVC, and AVC is at its minimum level. Therefore, from the
above given we have known that shutdown output level is 80 units.
e. To determine the level of profit at equilibrium, we must be given price and total cost
function. Based on the given information what we can tell about the average cost

6
 minimizing level of output and price. Since the expressions of the two variables are not
given, we can neither determine profit maximizing level of output nor the level of profit
at the equilibrium.

8. What do you think is the objective of macroeconomics in the context of Ethiopia? Do you
think we have different macroeconomic problems as compared to other developed nations?
Why? Support your answer with evidence.

Like other developing countries the major macroeconomics objectives in Ethiopia include:

 To achieve high economic growth

 To reduce unemployment to predetermined percentage level by policy subscription
 To ensure stable general price level
 To reduce poverty
 To shrink budget deficit and balance of payment (BoP) deficit
 To ensure fair income distribution
 To ensure fair access to public infrastructure both in rural and urban areas
 To reduce external debt
 To ensure access to social services such as education, health care etc.

Compared to developed countries which have already experienced saturated economic growth
rate and insignificant inflation rate, developing countries like Ethiopia may not have the same
macroeconomic objective. Even globally emerging countries such as Taiwan, Hong Kong,
Japan, Brazil and other with the same economic status may not have the same macroeconomic
objective. For example, in developed nations inflation is not as high as in the case Ethiopia,
where price growth is severely disappointing the society. Hence what is expected from these
countries is either maintaining the same level of price growth or keeping it at lowest possible
based on reasonable economic justification.

Now let briefly present evidence a few macroeconomic performance i.e. economic growth and
inflation in Ethiopian. Over the last two decades, Ethiopia’s economic growth has gone through

7
various phases of inflation and economic progress. It has been observed that since 2003/04 the
country has continuously performed accelerated real GDP growth than the average growth rate
achieved by other African countries. The maximum economic growth was documented during
2004 and 2011 which are, on average 13.6% 13.2% per annual respectively. Such consistent
performance in real GDP growth made the country among economically better performed
countries in sub-Saharan Africa. Again in 2008/09, 11.2% annual growth rate was attained
though inflation shock was historically highest during the year. According Ethiopian Economic
Association (EEA, 2018), after two years challenges of macroeconomic imbalance which caused
largely by agricultural supply shock, macroeconomic stability was successfully maintained in
2012/13 as observed by declined inflation from double to single digit (UNDP, 2014; Bekele,
2017).

However when we see the macroeconomic policy of developed nations, the goal and problems
are different. For example, in United states, macroeconomic policies are largely emphasize on
how to boost trade competitiveness, improve spending on public education, incentives for private
sector innovation, which can lead to efficient use of human capital, increase its international
economic and political influence and etc. (R. Vietor and Weinzierl, 2021)