Two Economics papers (or maybe exams) from 1995....

Assignment 1

1. Using theories of cost and perfect competition, explain the effects of the North American Free Trade Agreement on Canada’s economic future. Use appropriate diagrams to illustrate your answer.

The North American Free Trade Agreement (NAFTA) will in the long term have a beneficial effect upon Canada’s economic future. The principle of NAFTA is to bring down the governmental barriers to trade between the countries involved. As Canada is one of the growing number of members of NAFTA we should benefit in the long run. By removing tariffs and restriction to trade Canada will be able to sell more of its products to the United States and at a lower price than we do now. The United States conversely, will be able to sell more of its products to Canada at a lower price than they do now. The theory that supports this is the principle of comparative advantage. To illustrate comparative advantage I will use this example: Florida can grow oranges outdoors efficiently Canada cannot (due to colder temperatures and less sun). British Columbia has a natural abundance of Timber which Florida does not. Canada should import oranges from, and export lumber to Florida. By concentrating on the comparative advantages each country has and not concentrating on the industries in which we are naturally disadvantaged we can increase production of our products, sell them at a lower price (for higher profit) and efficiently allocate our land, labor and capital to the most beneficial areas. In the short term some businesses that operate within the shadow of tariffs and restrictions will go out of business (all the hothouse orange growers in B.C. for example); but because of increased demand for wood new businesses will spring up in the lumber market. Some of the federal government institutions that regulate (restrict) perfectly competitive industries that fall under the powers of the NAFTA are: The Agricultural Stabilization Board, The Canadian Dairy Commission, The Canadian Egg Marketing Agency, and The Canadian Wheat Board. With the elimination of restrictions, quota and tariffs these regulatory bodies will doubtless be closed down, with their demise prices for all the goods produced under them will become perfectly competitive with all the advantages and disadvantages that go along with that.

2. Using the theory of consumer behavior, explain how consumers would allocate their income in buying goods and services to suit their needs.

The theory of consumer behavior assumes that people have limited incomes, individual tastes and preferences and are rational decision makers (to their own utility). Consumers consume that is their function in an economy. In consuming they make decisions. Such decisions are rational in that they suit the consumer's own needs and desires. Of primary importance are necessities, in some cultures these are just food, shelter, water and heat. In our culture necessities can go beyond that. However, all rational consumers will satisfy their necessities before their luxuries. Because all consumers are said to have a limited income, they are only going to be able to purchase a finite amount of goods. A consumer therefore cannot by everything he or she wants, when each purchase exhausts a portion of a limited income. This reality forces consumers to make choices between alternate goods in order to obtain the most satisfying collection of goods and services, with a limited income. A Util (a unit of utility) is the value of measurement used to measure how much consumers are satisfied from consumption of a good or service. Due to human nature, the law of diminishing marginal utility can be applied to consumer behavior, this is: the more of a good that is consumed the less a single more unit of that good is desired. To apply this law we can use Shakespeare’s famous line “A Horse! A Horse! My kingdom for a horse!” to illustrate the law of diminishing marginal utility. At that moment Richard III is offering to exchange England for a horse for two horses he would doubtless pay his kingdom and the Isle of Mann. Likewise there is the story of a man dying of thirst in a desert who after having suddenly come upon the Devil is offered one liter of water for every year off the end of his life in exchange. The dying man needs water badly, so he takes the first 3 liters and drinks it down on the spot but knowing the cost is a year per liter he drinks no more. This is consumer behavior and the law of diminishing marginal utility in action. Little did the man know he would have 300 hundred kilometers to travel before the next oasis and every time he called for water the price would go up (imperfect information).

Assignment 2

1. Perfect competition is said to be able to achieve both allocative and productive efficiencies and therefore is desirable.

a. Explain clearly and logically, with the help of appropriate diagrams, how a perfectly competitive firm can achieve allocative and productive efficiencies.

A perfectly competitive firm is a firm with a very large number of other firms competing in the same market and producing identical products. The fact that so many firms are in competition makes the individual firm a price taker, not a price maker, it also makes it subject to perfect information about market prices and the number of the product available at any given time. Resources in perfect competition are perfectly mobile able to shift if needed in a very short time at a low cost. Finally there are virtually no barriers to entry for a new firm into a perfectly competitive market. In the short run, profits and losses can occur in perfect competition, but in the long run only “normal” profits are made which means no “real” profits above the cost to produce a good.
The realization that in the long run a price of a good is exactly equal to the cost of making that good allows us to see that all of a firm's resources are being fully exploited and that allocative efficiency is achieved. When production of the goods consumers want is achieved allocative efficiency is satisfied. The competitive market (their is none more competitive than the perfectly competitive market) system functions, resources are allocated to produce a total output that best suits a consumers needs for that good. In order to figure out if allocative efficiency is achieved the price of a good must equal the marginal cost to produce that good.
To understand productive efficiency we must examine the average total cost it takes for a firm to produce. In the long run, competition between the very large number of firms in a perfectly competitive market will force firms to produce at the point of minimum average total cost of production and to change the price so that it is equal to those costs. This is very desirable from the consumers point of view because it forces the firms to use the best available (lowest cost) technology in order to stay competitive. When a firm is at its minimum average total cost to produce (fixed cost and variable cost divided by the number of products produced) a firm has achieved a state of productive efficiency.

b. Is perfect competition desirable?

Perfect competition is very desirable for consumers it has the uncanny ability of lowering prices that consumers are so fond of. The business owners in a perfectly competitive market are sure to be somewhat un-thrilled with perfect competition in the long run no real profits can be made after all. There are several primary benefits to perfect competition. With perfect competition economic efficiency is achieved which mean all resources and capital are being used efficiently. The producers and consumers of a perfectly competitive good get their fare share with an equitable distribution of income. Finally with perfect competition there is a semblance of economic stability.