Complementary Goods: Automobiles and Oil
- In a constant cost industry, the cost of inputs remains constant as the industry varies (Coenen, Mohr & Straub, 2009). The firm supply curve in the long run is at N. the price equals the marginal cost which equals to minimum average cost. The individual firm produces output OP and sells at price OK. Under the industry supply curve, the demand curve D1 shifts rightwards to D2 as the demand for products rises. New firms enter the industry producing at average cost OK. The industry thus produces any given amount of goods at price OK making the supply curve perfectly elastic in the long-run. This is illustrated below:
- For an increasing cost industry the price of the inputs increases as the firms expand their productivity. As the demand for commodities rise, more new firms join the industry. Firms pay high prices to attract more factors. The cost curve of the firm moves up. The minimum average cost equals marginal cost which equals the price at point F which is the long-run equilibrium point for best producing output OT. As the cost of firms increase with increase in output, the supply curve of the industry moves up to equilibrium point R with the output at OT and price at OK. This is shown below:
- A decreasing cost industry involves the fall in price of one or more inputs as the industry expands. The marginal cost and revenue and the minimum average cost shifts downward making the long-run supply to slant downward with a negative slope. The firm in the long-run is at equilibrium point K and produces output OT at price ON. The total supply of all the firms producing commodities at price ON will be OH. As the demand for the commodities increase, new firms enter the market. MC, AC and the price fall. At this low price, the firm at equilibrium point F increases its supply from OT to OH while the industry supply rises from OH to OK. This is illustrated below:
- A rise in the price of margarine does not shift the equilibrium price and quantity. When the price of margarine rises above the equilibrium price, say from Po (equilibrium price) to P1, the quantity of margarine supplied is higher than the quantity of margarine demanded and hence rises from Qo (equilibrium quantity) to Q2 . The quantity demanded decreases from Qo to Q1. This creates excess supply of margarine which is referred to as a surplus. Excess margarine which is not sold will be available in the market. This means that suppliers will have to lower their price back to equilibrium point (Po , Qo)in order to sell all the margarine supplied and hence the equilibrium price and quantity will not change. This is illustrated in the diagram below:
- The rise in demand for yoghurt does not affect the equilibrium price and quantity for margarine. The market equilibrium for margarine (Po , Qo) remains unchanged. This is due to the fact that yoghurt and margarine are not close substitutes and hence cannot be used for the same purpose. The deviation in demand for either the good does not affect the demand and supply for the other and hence the equilibrium point remains unchanged at point (Po , Qo). this is illustrated in the diagram below:
- An increase in the price of bread lowers the demand of margarine. Bread and margarine are compliments. An increase in the price of bread lowers the demand of bread and this means that on the other hand the demand and supply of margarine also decrease. The demand curve of margarine shifts to the left from D1 to D2 while the supply curve shifts from S1 to S2 downwards. The equilibrium price and quantity shifts downwards from Po to P1 and from Qo to Q1 This means the equilibrium point shifts from point (Po , Qo) to point (P1 , Q1 ). This is illustrated in the figure below:
- As discussed above in bread and margarine are complements meaning that they are consumed together. When the demand for bread increases, the demand for margarine also increases. The supply of margarine on the other hand also increases. This means that the demand curve for margarine shifts rightwards from D1 to D2. The supply curve shifts upwards from S1 to S2. The equilibrium price and quantity points moves upwards from the point (Po , Qo) to (P1 , Q1 ). This is illustrated in the diagram show below:
- Future expectations of the price of butter to rise do not affect the demand and supply of margarine. Butter and margarine are close substitutes (Kline & Walters, 2016). Since consumers do not expect any changes in the price of margarine in future, they will maintain their demand even the price of butter is expected to increase in future. Suppliers as well maintain their supply level. This means that the equilibrium price and quantity is not affected and hence remains unchanged at point (Po , Qo) as illustrated in the diagram below:
- A tax on butter production increases the final cost of butter to consumers. Since butter and margarine are close substitutes the increased price of butter due to tax on production of butter raises the demand of margarine. The supply of margarine also increases. The demand curve of margarine shifts towards the right direction while supply curve shifts upwards. The quantity demanded of margarine increases from Qoto Q As a result, the equilibrium price and quantity of margarine moves upwards from point (Po , Qo) to (P1 , Q1 ) as illustrated in the diagram below:
- The invention of the new expensive process of removing cholesterol from butter increases the final cost of butter to consumers. The demand of margarine increases as a result of this compulsory expensive process involved in butter production from Qo to Q1.The supply of margarine also increases as suppliers tend to supply more of margarine due to its comparative advantage in production which means its price is lower than that of butter. As a result of this the demand curve of margarine shifts towards the right direction while supply curve shifts upwards. The equilibrium price and quantity of margarine moves upwards from point (Po , Qo) to (P1 , Q1 ) as illustrated in the diagram below:
Effects of rise in oil prices in Middle East on:
- Demand for automobiles
Automobiles use oil for their operations. This means that automobiles and oil are complementary goods (Economides & Salop, 2012). This indicates that they are used together. When the oil prices increases, the demand for automobiles decreases. The automobiles demand curve shifts to the left from D1 to D2 as illustrated in the diagram below:
- Demand for home insulation
Currently, some of the materials used in home insulation are made from oils. A good example is foam which is actually made from petrochemicals. An increase in the price of oil means that the home insulating materials price will also increase. This price increase will consequently lower the demand for home insulation as the insulating materials become expensive. The demand curve for home insulation shifts to the left from D1 to D2 as illustrated in the diagram below:
- Demand for coal
Oil and coal are close substitutes (Borenstein, 2010). This means that either can be used in place of the other. When the price for oil increases, the demand for coal increases as consumers shift to coal which is less expensive compared to the oil. As a result, the demand curve for coal shifts to the right direction from D1 to D2 as illustrated in the diagram below:
- Demand for tires
Most tires are made from synthetic rubber which is manufactured by use of oil. Increase in price of oil increases the price of the tires. This means that the demand for tires decreases due to the increased prices and therefore the demand curve for tires shifts to the left from D1 to D2 as illustrated below:
- Demand for bicycles
When the price of oil increases, transport cost also increases. Most people who use public and personal transport means tend to use bicycles for transport. This means that the demand for bicycles will increase and the demand curve will shift to the right from D1 to D2 as illustrated:
- Public goods are goods which are non-rivalry and non-exclusive. Every consumer can consume them as they wish whether or not they pay for them. In a free market, the major goal of the private players is to maximize profit. Insufficiency of incentives to the private players means that they will definitely allocate little resources towards the manufacture of the public goods and hence social optimum output in not reached. Due to the less public goods produced, demand for these goods increases. Increase in demand consequently leads to increased prices of the little goods available. Increased prices make the private players to raise their profits adequately as they wish. For this reason, public goods are always scarce in a free market which is occupied by private players.
- I is the Marginal Cost Curve (MC), II is the Average Cost Curve (AC), III is the Average Revenue Curve (AR), IV is the Marginal Revenue Curve (MR).
- The diagram represents the short-run position. During the short-run period, the other firms have not yet entered the market and hence the monopolistic firm is able to sell its goods at a price above the average cost hence making supernormal profit (Yang & Heijdra, 2013).
- Yes, P3is the long-run equilibrium price. This is due to the fact that in the long-run period, the monopolistic firm makes normal profit and can no longer sell its goods at a price which is above the average cost as more firms enter the market due to the supernormal profits made during the short-run period.
- The output that maximizes profit is Q2while the price that maximizes profit is P6.
- The profit made is represented by the shaded area from P4to P6.
- In the long-run period, more firms enter the market and the monopolistic firm can longer sell at a price above the average cost and hence makes the normal profit.
- Marginal cost curve relates to the marginal revenue curve in the long-run as the firm still manufactures its goods where marginal revenue equals the marginal cost. The average cost curve relates to the average revenue curve as the firm sells its goods where the two intersect. This means that the firm cannot sell at a price above the average cost in the long-run. The average cost curve is still above the marginal cost curve in the long-run and this brings about the allocative efficiency (Dixit & Stiglitz, 2014).
- In every economy, resources are scarce. This means that only a specified amount of a certain good is available at a time. Therefore, individuals and the society have to make their best choice on how to utilize the available scarce resources to produce certain amounts of goods. The best choice involved brings about the element of opportunity cost (Raiklin & Uyar, 2016).
Example: suppose only 50 pieces of wood are available and one can either produce 30 tables or 20 cupboards; if one chooses to produce 30 tables, the opportunity cost involved is 20 cupboards (no more pieces to produce cupboards) and if one chooses to produce 20 cupboards the opportunity cost involved is 30 tables (no ore pieces to produce tables). This is illustrated in the diagram below whereby as the quantity of one good produced (table or cupboard) increases the quantity of the other good decreases.
- No, the car is not free. An opportunity cost is involved in order to acquire the car (Pearce & Markandya, 2009). For one to win the car, he/she has to buy more chocolates to increase the chances of winning. The price of the car is paid as consumers purchase more chocolates in order to win.
- The production possibility frontier indicates the maximum amount of a good that can be produced for a given level of production of another good. The two goods are combined in their production. This means that as more of one good is produced the level of production of the other good decreases and hence the production possibility frontier curve is bowed outwards.
References
Borenstein, S. (2010). The long-run efficiency of real-time electricity pricing. The Energy Journal, 93-116.
Coenen, G., Mohr, M., & Straub, R. (2009). Fiscal consolidation in the euro area: Long-run benefits and short-run costs. Economic Modelling, 25(5), 912-932.
Dixit, A. K., & Stiglitz, J. E. (2014). Monopolistic competition and optimum product diversity. The American Economic Review, 67(3), 297-308.
Economides, N., & Salop, S. C. (2012). Competition and integration among complements, and network market structure. The Journal of Industrial Economics, 105-123.
Kline, P., & Walters, C. R. (2016). Evaluating public programs with close substitutes: The case of Head Start. The Quarterly Journal of Economics, 131(4), 1795-1848.
Pearce, D., & Markandya, A. (2009). Marginal opportunity cost as a planning concept in natural resource management. The Annals of Regional Science, 21(3), 18-32.
Raiklin, E., & Uyar, B. (2016). On the relativity of the concepts of needs, wants, scarcity and opportunity cost. International Journal of Social Economics, 23(7), 49-56.
Yang, X., & Heijdra, B. J. (2013). Monopolistic competition and optimum product diversity: Comment. The American Economic Review, 83(1), 295-301.
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