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Homogeneous And Differentiated Product In Microeconomics Economics Essay

Paper Type: Free Essay Subject: Economics
Wordcount: 2662 words Published: 1st Jan 2015

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Part of: Microeconomics

The economic issue in this observation involves the concept of homogeneous and differentiated product in microeconomics

According to Lindeman (2002), product homogeneity exists when the products produced by firms are identical, the same. Homogeneous products are also a characteristic of perfect competition market such as wheat, grain, cooper, etc where buyers only aim for the cheapest goods available in the market (Lindeman, 2002).

In our case, petrol and liquefied petroleum gas are homogeneous products despite the petrol station or company (BP, Shell, Caltex, etc) you are buying from. In fact, the method to extract and refine petroleum is almost the same among those companies. Additionally, the consumers perceive petrol as non-differentiated product and they probably choose a cheaper brand to buy which explains why petrol price is more homogeneous because if the firm makes its price higher than the competitors, the drivers will fill their tanks in the competitors’ petrol stations.

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Lindeman (2002, p.86) also suggested “differentiated product exists where you can tell a difference between different firms’ products within the industry”. By differentiating their products, firms are following a non-price competition strategy and also firms can attract more customers and create customer loyalty by enhancing its product or service. This will result in a shift of demand curve to the right (Lindeman, 2002)

In our case, bottled water is perceived as differentiated products. Different firms can charge different prices for their bottled water. In fact, there are around 50 brands of botted water selling in the market, such as Mt Franklin, Fiji water, Pump, H2GO, etc and in a wide range of price. Take fashionable Fiji water as an example; it is differentiated from other brands as the purest spring water, “untouched by man”, “so much more pure and so much healthier than other bottled waters” (Fiji water, 2009). And, this has made it the most expensive spring water sold in supermarket with $2.99/ litre, even more expensive than Mt Franklin water of Coca Cola – best selling brand sold for $2.96/ litre.

The second economic issue emerged in this case is related to the elasticity of both water and petrol.

Gans et al. (2009) pointed out that petrol is considered as relatively inelastic in the short run due to the fact that even when the price of petrol goes up, the quantity of petrol demanded only slightly decreased in the first few months and also petrol is a unique product which has no substitute for it. However, in the long run, within several years, there would be a substantial drop in the petrol quantity demanded since people have bought more fuel-efficient cars, move closer to their workplace or switch to public transports (Gans et al. 2009). This has explained why petrol companies are not motivated to raise up their price (might negatively affect people driving behaviour and hence reduce firms’ profits)

Bottled water on the other hand has a relatively elastic demand curve due to water has many substituted products available in the market such as boiled/tap water, coke, fruit juice, different kinds of soft drinks, etc. This suggests the firms in the industry to be very careful in their pricing strategy (increasing or decreasing both have certain effects on their customer bases)

Question 2+3: What will you tell them about the relative effects of import quotas and equivalent tariffs on the wellbeing of Russian vodka producers, Russian vodka consumers, and the Russian government budget? Can a government always gain revenue by imposing a tariff? Use a diagram to illustrate your answer.

Quota is a type of mechanism to protect local products by setting a physical limit on the quantity of vodka produced bringing into Russia that can be sold domestically in a given period of time. This is beneficial for the vodka producers in domestic economy as all consumers expense the good in that economy. Even, tariff and quota are used to protect oversea goods, but there are some negative effects to a country applies the method for trade restriction as well as it is less economical efficient than other methods. There are relative effects of import quotas and equivalent tariff on the wellbeing of Russian vodka producers, Russian vodka consumers, and the Russian government budget as follows (Gans et al. 2009).

Relative effect on the wellbeing of Russian vodka producers

The Government would set domestic price of vodka above the world price and control the number of quantity of vodka imported into the country when setting up quota instead of imposing tax. Considering the price is increase over the world price, the difference between price with quota and price without quota is added surplus of vodka producer. Therefore, as much as the price with quota is set over world price as much as vodka producers could gain benefit in term of selling product at higher price (Gans et al. 2009).

Relative effect on Russian vodka consumers

While vodka producers gain benefit by shifting domestic supply and limiting number of import quantities leading to reduce the difference between price with and without quota decease. To consider the consumer surplus for this method, as much as the price of vodka is set higher than world price, the buyers are worse off when purchasing vodka (Gans et al. 2009).

Relative effect on Russian government budget

The Government can consider the number of vodka’s quantity to be imported, then licensing to importers who wish to do Russian vodka business as well as provide the custom the power to control the access of vodka products into the country. This can cause a serious corruption problem in the country with import quotas as the importers chosen to meet the quota are the ones who can provide the most favours to the customs officers. To gain revenue the same level as tariff, Government may have to sell import licenses for full value to importers. However, in case of tariff, Government can collect revenue when quantity of vodka increases while import quota Government can gain the exact amount of revenue by selling licenses. In addition, a larger deadweight loss can occur considering to mechanism such as lobbying employed to allocate the import licenses. Additionally, an unreasonable price would cause smuggling issue and it is likely that people may try to bring vodka into the country illegally, just as they would if the import quota is only a small fraction of the demand for the product whereas the limit of quantity and shortages can cause smuggling problem and it would lead to large deadweight loss as well. Even if there are some shortcomings of quota, this can also be used as an argument against tariffs as the government cannot ensure that the number of imports will stay below a certain level and Government continue collect the steady revenue (Gans et al. 2009).

Diagram 1:

(Gans et al. 2009)

A tariff is a tax on goods produced abroad and sold domestically and it can raises the price of imported goods above the world price by amount of the tariff, moreover, tariff is able to reduce the quantity of imports and move the domestic market closer to its equilibrium trade. The tariffs are not only control the price of a goods, they also indirectly control the quantity sold of that good due to the interaction of supply and demand. A Government can gain revenue when the tariff is set above the world price close to equilibrium without trade and numbers of imported products with tariffs are counted. However, tariffs may cause smuggling considering it is set at unreasonable level of amount tariff. Additionally, the high amount set of tariff is likely to cause people trying to bring the products into the country illegally. This can potentially lead to deadweight loss, thus the government may have to set the tariff at a reasonable level. Revenue from tariff is not stable as the products are not limited for a firm to enter. Then by using tariff mechanism considering the demand raises, the number of products sold should be increased, and the Government is able to collect greater revenue, when demand goes down, the Government can collect less revenue vice versa (Gans et al. 2009).

Question 4:

How might a drought that destroys half of all farm crops be good for farmers?

Diagram 2:

A drought that destroys half of all farm crops will reduce the supply of farm goods in the market; shift the supply curve to the left. Given that the demand for farm crops is inelastic (a high change in price results in small change in quantity demanded), the shift to the left of the supply curve leads to an increase in price that will consequently raise the total revenue for farmers who are unaffected by the drought if the price elasticity of demand is less than 1.

If such a drought is good for farmers, why don’t farmers destroy their own crops in the absence of a drought?

No farmer wants to destroy their farm crops intentionally because they are considered as price taker in the market and if only a few of them destroy their crops, it is only a small portion and not enough to shift the supply curve to the left and consequently increase the price of farm goods.

However, only if all the farmers destroy their crops together, like through a government program, it would make the farmers better off. Such program will benefit the farmers, but it achieves the objective at the expense of consumers (Gans et al. 2009).

Question 5: When the free trade treaty CER was signed between New Zealand and Australia, opponents claimed that New Zealand would suffer significant job losses to more efficient Australian producers. Why would you not be surprised to learn that CER did not lift unemployment in either country? Use diagrams and an example in support of your answer?

CER was signed between New Zealand and Australia that did not lift the unemployment in either country.


Firstly, since the Australia-New Zealand Closer Economic Relations Trade Agreement (ANZCERTA) came into effect on 1983, the two economies have become increasingly integrated (Petersen and Gounder, 2002). In this free trade agreement, it is stated that both countries create a conventional free trade area which includes the removal of all border restrictions on trade in goods, and the administrative would be removed for the trading and investment flows such as liberalising. The liberalising trade in both countries help the trade fence can be ignored (Petersen and Gounder, 2002). There can be some interests gaining from ANZCERT thanks to the efficiency by cheaper imports of consumer goods and services within the two countries. As a result, the costs for producers and consumers can be reduced among free trade area. With the increase of producer’s effectiveness and the reduction in export taxes in free trade area, the exporters likely to increase the export goods and services. Those consequent can generate the needs and demands in labour market.

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Furthermore, in ANZCERTA, there is a freedom of travel within the conventional free trade area, for both labour market and social reasons (Department of Foreign Affairs and Trade, 1997). These reasons can help the business in two countries to remove all barriers in trading and avoiding the increasing cost in producing. Besides that, the labour market can develop within both countries due to freedom in travelling. Therefore, there may be a reduction in additional cost for labour market. This means that the employers can have more choices and the employees can easily choose their company within two countries. In other words, the CER can create more opportunities in employment, so the unemployment rate in Australia and New Zealand can be reduced.


Diagram 3:

Assuming the current situation of labour market wool shavers in Australia is in equilibrium. According to Gans et al (2005, pg. 392), “the price of labour depends on supply and demand curve reflects the value of the marginal product of labour, in equilibrium workers receive the value of their marginal contribution to the productions of goods and services.”

In addition, it is supposed that there a number of immigration workers’ willingness to come Australia to shave the wool. When the CER is established, due to freedom of travelling between two countries, there will be an increase of number of shavers who is from New Zealand to Australia. The supply of labour market will be shifted to the right or will increase the number of workers in supply.

Diagram 4:

From the above diagram, there is a shift in Supply curve (increase in number of workers come to Australia), the point of new equilibrium is (L2, W2). It is showed that the L2 is the number of increase in employment.

In case of the labour demand increase, it is assumed that the wool price is increasing. Hence the demand of labour can be increase because the local employers need more workers in shaving wool. Therefore the demand of labour will be shifted to the right or an increase in labour demand.

Diagram 5:

The diagram 5 demonstrates that, there new point of equilibrium is (L3, W3) in term of labour demand is increasing. The quantity of employment is increasing from L1 to L3.

In conclusion, in both cases of increasing in labour demand and labour supply, the number of employment increases in a certain amount, because the CER between Australia and New Zealand create the advantage conditions for both producers in enhance their efficiency in producing and give more freedom of travelling for the employees so that they can have more opportunities in employment in both countries. The CER has allowed many local businesses to go to globalisation and this has been very important for wages and employment prospects in both economies.

Question 6: Identify an example of a tax levied in Australia. Illustrate and discuss the tax incidence using a diagram and the implications for policymakers and business.

The government in Australia imposes about 10 percent tax on supply of services as well as goods. This tax is usually called as Goods and Services Tax (GST or Value Added Tax -VAT) and it is levied on individuals who have registered for. The revenues, which are earned from Goods and Services tax is distributed among the states.

According to Breen et al (2002)’s research paper, they found that some businesses tend to experience increasing costs over the time due to dealing with GST or VAT.


Diagram 6:

With the implementation of the GST on the goods or services, there will be an increase of price, the new price Q2 which is higher than the Q1. Through the diagram, the amount received can be decreased (the amount received on diagram). The government tax revenues will shared by the consumers and producers from two side of the equilibrium point.

The producer surplus is the area which determined that the producers are willing to sell the products at that price. The deadweight loss is where the consumers are to pay at that price. However, that price is taxed, so the people must to pay more for a product and the producers will receive less because of GST. As a result, the welfare for producer and consumer can be reduced, but the government tax revenue can benefit for the public.

Furthermore, when the GST is exercised, the input materials are also taxed, as consequently, the cost in manufacturing can be increased significant. To deal with this problem, it is required for the reduction of the levels they supply because they can avoid paying the raw materials which may be gone up in price.


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