1.2.2-1.2.4 - Demand, PED/IED/XED & Market Supply

Question 1

what is the ‘substitution effect’?

Answer 1

• price dec. in good X makes it cheaper compared to substitutes
• consumers may switch to good X → higher demand (depends on whether products are close substitutes)

Question 2

what is the ‘income effect’?

Answer 2

• fall in price -> inc. real income of consumers
• allows people to buy more w/ a given budget. For normal goods, demand rises w/ an inc. in real income.

Question 3

what are the causes of shifts in the demand curve?

Answer 3

• seasonal factors
• changes in size + age structure of population
• changes in real income
• changing prices of substitues + complements
• effects of advertising + marketing

Question 4

factors of PED

Answer 4

• no. of close substitutes available for consumers → more close substitutes = more price elastic
• price of product in relation to income → high % -> demand = more price sensitive
• cost of substituting between diff. products → switching costs = high, demand = price inelastic
• brand loyalty + habitual consumption → high levels of brand loyalty - less price elastic demand; persuasive advertising can make demand price inelastic.
• degree of necessity/ luxury → necessities have a lower PED whereas luxuries are an optional spend
• addictiveness of the product
• time + price of the product as a proportion of income

Question 5

limitations of elasticities

Answer 5

• problems w/ inaccurate or incomplete data collection
• consumer price sensitivity changes overtime
• elasticity of demand varies by region/time
• not all businesses are profit maximisers
• elasticity varies within product ranges e.g. economy + premium products

Question 6

factors of PES

Answer 6

• spare production capacity → if there’s plenty of spare capacity then a business can inc. output without a rise in costs + supply will be elastic in response to a change in price
• stocks of finished products + components → if stocks = high, a firm can respond to a change in demand -> supply = elastic. perishable goods are harder to store
• ease + cost of factor substitution/factor mobility → capital + labour = occupationally mobile, PES is likely to be higher -> resources can be mobilised to supply the extra output e.g. the reallocation of workers to new tasks
• time period + production speed → supply = more elastic -> the longer the time that a firm is allowed to adjust its production levels

Question 7

what’s the coefficient of XED when the goods are unrelated?

Answer 7

0

Question 8

what’s the coefficient of XED when it’s a complement?

Answer 8

less than 0 (-ve)

Question 9

what’s the coefficient of XED when it’s a substitute?

Answer 9

more than 0 (+ve)

Question 10

what is meant by ‘composite demand’?

Answer 10

where goods have more than one use → inc. demand for one product, dec. the supply of the other

e.g. milk is used for cheese, butter, yoghurt, etc.