CHP 4: Application of demand, supply and elasticity. Flashcards
What are the effects of shifts in supply with different PED values on price and quantity?
**PED is useful in analysing the extent of change in eqP and qty when there is a change in supply.
A rise in supply results in a surplus which leads to a fall in price and a rise in quantity. However, the extent of this depends on the PED.
Prices will fall more sharply if demand is more price inelastic compared if demand is more price elastic.
There will be a larger rise in quantity if demand is more price elastic.
What is the effect of a shift in demand with different PES values on price and quantity?
PES is useful in analysing the extent of change in EqP and EqQty when there is a change in demand.
A rise in demand results in a shortage, leading to a rise in price and qty.
Prices rise more sharply if supply is more price inelastic compared to if supply is more price elastic.
There will be a larger rise in quantity if supply is more price elastic compared if supply is more price inelastic.
What is the effect of a change in supply with PED>1 on total revenue or total expenditure?
If demand is price elastic, a fall in price will lead to a more than proportionate increase in quantity demanded, causing total revenue to increase.
Overall, total revenue increases
What is the effect of a change in supply with PED<1 on total revenue or total expenditure?
An increase in supply would lead to a fall in total revenue if demend is price inelastic.
An increase in market supply leads to a fall in total revenue if demand is price inelastic.
What is the effect of shift in demand with different PES on TR/TE?
A change in demend will change EqP and EqQ in the same direction and hence the effect on TR/TE can be determined. PES is only useful in determining the extent of the change in TR/TE.
What is the effect of a tax on price and quantity?
The tax leads to a rise in eq price and eq quantity. PED determines the extent to which this price and quantity falls.
What is a subsidy and what are its objectives?
A subsidy is an amount of money given to the producers for each unit of a good they sell.
Obj:
To encourage the consumption or production of certain goods and services that may seem desirable.
To raise the revenue or incomes of producers of essential goods or necessities.
To increase the affordability of essential goods to low income consumers.
What is a price ceiling+objectives?
A price ceiling is a legally established maximum price. It is binding when it is set below the market equilibrium price.
To keep the prices of essential goods or necessities affordable during times of inflation or severe shortages.
To prevent exploitation by producers who may charge high prices in times or shortages.
What are the consequences of the shortage caused by the price ceiling?
Black Markets:
A black market is one that exchanges goods at a price above the legally established maximum price. Shortages of goods may entice consumers who were unable to secure the good to offer prices above maximum price. This can lead to the formation of black markets. At a certain output Q1, consumers may be able and willing to pay up to Pbm.
What are the effects of a price ceiling on allocative efficiency?
The price ceiling leads to a change in consumer surplus from P0EA to PCEDB. This represents a gain of P0COBPC as consumers who can obtain the good are better off due to lower price. However there is a loss of ACD as not all cosumers who are willing and able to buy the good at price Pc is able to obtain the good due to shortage. These consumers may be forced to turn to the black market and pay even higher prices of up to Pbm, rendering them worse off.
Producer surplus falls. There is deadweight loss, which is dependent on PED.
What is a price floor and what are its intended effects?
A price floor is a legally established minimum price usually set above the market eq price.
It is to prevent exploitation of labour through unfair wages.
To protect farmers from a glut in an agricultural market.
What is a quota and what are the objectives?
Quantity controls/quota is an upper limit on the quantity of a good that could be bought or sold.
To keep the quantity of a good at a level that is acceptable. This refers to goods that have undesirable social effects.
To prevent depletion of scarce resources or the extinction of valuable resources.
What should a company do when PED>1?
Firms should lower prices when demand is price elastic. A firm cannot lower prices indefinitely as they have production costs to meet. If the firm raises its price, the quantity demanded would fall by more proportionately, TR falls.
To attract buyers the firm should make the price SALIENT to the consumers by emphasising the % reduction in its price or enable consumers to compare the reduction in price with other substitutes. This would enable the firm to exploit the salience bias in the decision making of consumers, where the consumers attention is drawn to the reduced price rather than other aspects of the good.
Firms could alternatively highlight the limited time of the reduced price as well as stocks being limited.
What are the limitations of elasticities of demand?
- Ceteris Paribus Assumption
In reality, more than one factor affecting demand can change simultaneously. For example, price and tastes and preferences can change simultaneously. So although the use of elasticity concepts are beneficial, they are limited because cetpar is unlikely to hold. - Reliability of elasticity of demand and supply values.
Data from past records may no longer be relevant to calculating elasticises of demand as some of the determinants of demand may have changed. Although data from current market surveys are accurate to calculating elasticises of demand, they may not be reliable as the respondents may not be truthful in their responses on the market demand patterns. - Costs consideration
What are the limitations of elasticities of demand?
- Ceteris Paribus Assumption
In reality, more than one factor affecting demand can change simultaneously. For example, price and tastes and preferences can change simultaneously. So although the use of elasticity concepts are beneficial, they are limited because cetpar is unlikely to hold. - Reliability of elasticity of demand and supply values.
Data from past records may no longer be relevant to calculating elasticises of demand as some of the determinants of demand may have changed. Although data from current market surveys are accurate to calculating elasticises of demand, they may not be reliable as the respondents may not be truthful in their responses on the market demand patterns. - Costs consideration
