Question

ELEMENTS OF ECONOMICS

v. List the factors that can increase the supply of bread in
Accra.
vi. Identify the key factor that can cause cost-push
inflation and illustrate the
situation with a graph.
vii. Give an example of a ceteris paribus problem.
viii Us a well-labelled graph in show how increase in price of
rice affects the
demand for gari in Nigeria.
ix. Write a paragraph and explain why the balance of
payments report is useful to the
Ministry of Finance in Ghana.
X. What is the difference between price elasticity of demand
and income elasticity of
demand?

Answer 1

v. The factors that can affect the increase in supply of bread in Accra are:

1. Lower cost of production: when the factors of production used are available at a lower cost, production of the good increases and so does the supply.

2. Technological development: If a firm faces technological improvement then its production level increases.

3. Transportation cost: If the transportation cost related to the product decreases, then the cost of the product decreases, and the production increases.

4. The entry of new firms: If there is more entry of firms in the market for the good, then the overall production level increases.

5. Low taxes and increase in government spendings: This gives a boost to the firms to produce more and expand.

vi. Cost-push inflation occurs when the price level of the economy increases due to an increase in the factor prices or cost of production. When this happens, the aggregate supply curve in the economy shifts leftward (decreases), and the average price level rises in the economy

Key factors that cause cost-push inflation:

1. Increase in wages: Increase in wages leads to an increase in the cost of production which further leads to a decrease in the aggregate supply and an increase in the price level.

2. Increase in the price of the factors of production (raw materials used): When the price of the raw materials increases, the cost of production increases, aggregate supply decreases in the economy, and price level increases.

3. Government taxes: Sometimes the government puts taxes on some goods to reduce its production (mainly harmful products). The firm producing the products lowers the production level due to higher taxes. The reduced production level decreases the aggregate supply and increases the prices.

All the above reasons lead to cost-push inflation.

The above diagram represents cost-push inflation. In the AS-AD model, we study the interaction of aggregate supply and aggregate demand to get the real GDP and the price level. Initially, the AD and AS1 curves intersect to achieve the output level Q1 and the price level P1.

Now, due to cost-push inflation, the aggregate supply shifts to the left from AS1 to AS2. The new equilibrium will be at the point where the AD intersects the new supply curve AS2. Here, quantity has reduced from Q1 to Q2 (real GDP decreased) and the price level increased from P1 to P2 which shows the cost-push inflation.

vii.

Ceteris Paribus means 'keeping other things constant'. For example, the law of demand states that ceteris paribus (keeping other things constant) there is a negative relationship between quantity demanded and price of the good. This means that while defining this law, other things that might affect the law of demand like the income of the consumers, the price of related goods and tastes and preferences of the consumers are held constant.

viii.

We know that Gari is a type of flour that acts as a substitute for rice. This means that as the prices of rice increases, the demand for rice will fall and people will switch to Gari. Thus the demand for Gari will increase. Here, since the factor affecting the demand is other than the price of the goods being demanded (but the price of the related good), thus there will be a shift of the whole demand curve of Gari to the right (increase in the demand).

In the below diagram, we can see that D1 shows the initial demand curve of Gari and S1 is the supply curve. Equilibrium is at the point where the equilibrium price level is P1 and the equilibrium quantity is Q1 (by the interaction of D1 and S1). When the demand for Gari increases due to rise in prices of rice, the demand curve of Gari shifts to the right to D2. Now the new equilibrium is at the point where the new demand curve intersects the supply curve and the new equilibrium price is P2 which is greater than P1 and the new quantity of Gari is Q2 which is greater than Q1.