Course Code/Title: MFIN603 / BUSINESS ECONOMICS

Lecturer: Dr. King Salami

1. Given that there is a reduction in income tax and a drop of 20% tariff on
the product, trace the new equilibrium price. Will it be higher, lower or
same as the initial equilibrium price?

Assuming the reduction in income tax is 20% and also a drop of 20% in tariffs.
A reduction in income tax will result in an increase in consumers income since the
deduction on the taxable income will drop. All other things being equal, there will
be a shift in the demand curve or a change in demand. Also a drop of 20 percent
in tariff will reduce production cost. Firms will increase supply based upon how
much the unit cost of the product has reduced. Simultaneously, demand and
supply will increase by the same margin. The resultant effect is that equilibrium
price remains the same but equilibrium quantity will increase.
When the demand for a commodity and supply of that commodity increase by the
same margin, the equilibrium price P0 will remain the same, whilst the
equilibrium quantity Q0 increases to Q1 . From the diagram above, the demand
and supply increase by the same 20%, shifting the demand and supply curve to
the right by the same margin. As a result, equilibrium price P0 remains the same.
This is so because, no surplus nor shortage. However the equilibrium quantity
rises from Q0 to Q1
In effect, an increase in consumers’ income will lead to increase in demand while
a drop in tariff provides an opportunity for firms or suppliers of goods and
services to increase their supplies to meet the new demand.

2. Explain the role of price in the smooth functioning of the economy.

Price is defined as the economic value placed on goods and services on the
market. The price at which goods and services are paid for depends on the
perceived utility they offer.
The price of goods and services play a crucial role in determining an efficient
distribution of resources in the market system. Suppliers of funds will normally
channel their resources where the returns will be worthwhile.
Price acts as a signal for shortages and surpluses which helps firms and consumers
respond to changing market conditions. If there is shortage of goods, there will be
a rise in price which will lead to a fall in demand but will encourage firms to
increase supply. If there is a surplus, price will fall which encourages consumers to
buy more whiles firms will cut supply.
Price helps to redistribute resources from goods with little demand to goods and
services which people value more.

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Price helps to categorize goods on the market due to how consumers respond to
the price changes. Goods can be classified into necessities, normal or luxury.
When price of necessities increase, consumers will solicit for more income to
purchase. The same cannot be said for normal or luxury goods which consumers
can sometimes do without.
Price also helps to forecast revenue in order to budget for expenditure. It helps to
predict how consumers will patronize goods in order to determine future cash
inflows.

3. Use diagrams to distinguish between change in demand and change in

quantity demanded.

Change in quantity demanded

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Change in quantity demanded of goods and services is caused by change in the
price only. When the price of goods and services rises, all other things being
equal; demand will fall. When the price falls, the demand will increase or rise. This
shows an inverse relationship between price and quantity demanded for goods
and services. Change in quantity demanded results in a movement on the
demand curve.

Change in demand

Change in demand result in a shift in the demand curve. This is because it is

caused by other factors other than price. It is evident on the diagram above that
at the same price of GHC 10, demand reduced or decreased from 300 to
200(𝐷1 𝑡𝑜 𝐷2 ).
Factors which accounts for the shift in the demand curve are outlined below.

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 i. Change in consumers’ income
When consumers’ income increase, their demand for goods and services
also increases, all other things being equal. When their income falls,
demand will also fall.
ii. Change in taste and preferences
When consumers taste for goods and services change, the demand will
also change; all other things being equal. For example, if a consumers’
taste for petrol cars falls, the demand for such cars will fall drastically.
The reverse is also true, all other things being equal.

iii. Change in price of substitutes

In situations where there is a change in the price of substitute goods,
the demand for the other goods will be affected. For example; if a tin of
milo is selling for GHC 13 but that of bournvita reduces to GHC 8, all
other things being equal; the demand for milo will fall.
iv. Change in price of complementary goods
Where there is a change in the price of complementary goods, the
demand for the other goods will be affected. For example; if the price of
petrol increases too often, demand for petrol cars will be affected, all
other things being equal.