Essay Plans Flashcards
Q: Using the concept of price elasticity of demand, explain why increasing the price of the product is:
(i): a bad idea for a firm producing a product that constitutes a large proportion of household income, and
(ii): a good idea for a firm producing a product that constitutes a small proportion of household income. [8]
AO1: PED Knowledge
- Price elasticity of demand refers to how responsive quantity demanded is to changes in price
- This is evidenced by the formula for PED - Formula: PED = %change in quantity demanded / %change in price
- The PED figures also tell us important information about a product
- If it is less than one, then we know that the quantity demanded will be fairly unresponsive to changes in price, (price inelastic)
- If it is greater than one, then we know that the quantity demanded will be fairly responsive to chanegs in price, (price elastic)
Q: Using the concept of price elasticity of demand, explain why increasing the price of the product is:
(i): a bad idea for a firm producing a product that constitutes a large proportion of household income, and
(ii): a good idea for a firm producing a product that constitutes a small proportion of household income. [8]
AO2: Explain and Analyse i and ii
i:
* The greater the proportion of household income a good occupies the more price elastic it will be, meaning it is sensetive to changes in price
* For example, if you purchase a loaf of bread for £1.00 and you go back in a week later to buy the bread and it is £1.50, then the quantity you demand is unlikely to change, as the increase occupies such a small proportion of income
ii:
* However, if you are trying to purchase a car for £10,000 and the price, like the loaf of bread increases by 50% of it’s original value, then the car’s elasticity is likely to change
* As £5,000 is a large proportion of income, compared to 50p
Q: Using the concept of price elasticity of demand, explain why increasing the price of the product is:
(i): a bad idea for a firm producing a product that constitutes a large proportion of household income, and
(ii): a good idea for a firm producing a product that constitutes a small proportion of household income. [8]
AO3 + Conclusion
*However, if a firm produces luxury goods that occupy a large proportion of income, then in some instances they may actually benefit from increasing the price
* For example: If a firm is a veblen good, then it means that due to factors such as rarity, the quantity demanded increases as the price increases
* Meaning that if a firm charges higher prices on a veblen good that occupies a large proportion of income, then they will actually benefit from higher revenues
*Revenue = Price x Quantity Sold
* It is also important to note that the ceteris paribus assumption has been used, as there are other factors other than proportion of income, which determine whether it is a good idea for firms to change their prices, (Such as amount of substitutes or addictiveness of the product)
Q: Explain two factors that will determine the price elasticity of demand for a particular brand of car and how this price elasticity of demand may change over time. [8]
AO1: PED Knowledge
- Price elasticity of demand refers to how responsive quantity demanded is to changes in price
- The formula: PED = %change in quantity demanded / %change in price
- The PED figures tell us whether a good is price elastic or price inelastic
- If the good has a PED that is less than 1, then it is price inelastic and the quantity demanded will be relatively unresponsive to changes in price
- Whereas if the PED is greater than 1, then the quantity demanded will be responsive to changes in price
Q: Explain two factors that will determine the price elasticity of demand for a particular brand of car and how this price elasticity of demand may change over time. [8]
AO2: Talk about two factors that will influence the PED
Factor No.1: Proportion of income spent on the car
* Ex: If a car is price inelastic and costs £5,000 and the price increases to £5,500 then the car should still remain relatively price inelastic, as the small change in the price of the car shouldn’t lead to a large change in quantity demanded
* However, if a car costs £50,000 and also increases by 10% of it’s original value, making the car now worth £55,000 then the elasticity is more likely to change
* As £5,000 is a larger proportion of income than £500
* Meaning the greater of the proportion of income spent on the car, the more price elastic it is likely to be
Factor 2: Amount of substitutes available
* The amount of substitutes is vital at determining PED
* However, amount of substitutes can differ within a market
* For example, if someone wants to purchase a fuel car, then it is more likely to be price elastic, as there are lots of substitutes
* However, if someone wants to purchase an exclusively hybrid car, then they have less substitutes to chose from, making the hybrid cars produced by this brand more price inelastic
Q: Explain two factors that will determine the price elasticity of demand for a particular brand of car and how this price elasticity of demand may change over time. [8]
AO3 + Conclusion
- An important thing to note is that in this question, I have used the ceteris paribus assumption, as there are multiple other factors that could all be influencing PED of a car company
- These factors may be unlikely to change in the short-run as companies may not be able to produce competing substitute goods in a short period of time
- However, in the long-run, more firms will be expected to enter the market, making the PED more price elastic as there will be more substitutes available
- In the long-run the proportion of income spent on goods is also likely to increase, due to inflation
Q: Explain how the concept of cross-elasticity of demand can be used to distinguish between goods that are substitutes, those that are complements and those that have no relationship. [8]
AO1: XED Knowledge
- Cross-elasticity of demand refers to how responsive the quantity demaned of good X is to changes in the price of good Y
- Formula: XED = %change in quantity demanded of good X / %change in price of good Y
Explain how the concept of cross-elasticity of demand can be used to distinguish between goods that are substitutes, those that are complements and those that have no relationship. [8]
AO1 / AO2: substitutes, complements and no relationship
Substitutes:
* If a good has a positive XED, then the two good are substitutes
* Meaning that the goods can be used for the same use
* However, the strength of the substitute does depend on the figure
* If it is between 0 and 1, then it is a relatively inelastic substitute, which means the quantity demanded of good X is fairly unresponsive to changes in demand of good Y, meaning consumers are unlikely to change their preference even if the price of good Y decreased
* And if it is greater than 1, then it is an elastic substitute
* Which means the quantity demanded of good X is responsive to changes in the price of good Y
Complements:
* If a good has a negative XED, then the two goods are complements
* Meaning that the two goods are often used together, Ex: Milk and coffee
* However, the strength of the complements, depends on XED
* If the XED is between 0 and -1, then the goods are inelastic complements, meaning that they are weak complements
* Ex: The price of milk won’t strongly affect the quantity demanded of coffee
* If the XED is less than -1, then the goods are strong complements and are therefore elastic complements
* Meaning that if the price of good Y changed, then the quantity demanded of good X would be responsive
No relationship:
* If the figure produced by XED is = 0, then there is no relationship between the quantity demanded of good X and the price of good Y
Q: Explain how the concept of cross-elasticity of demand can be used to distinguish between goods that are substitutes, those that are complements and those that have no relationship. [8]
AO3: Conclusion + Evaluation
- XED can distinuguish the difference between goods that are complements, substitutes and those that have no relationship with each other
- These figures can be extremely useful for firms, especially those who produce goods that are complements or those in competitive markets
- The information provided by XED, can allow firms to make pricing decisions that will allow them to maximise revenue in the long run
- These figures also assume ceteris paribus, as there are other factors that could influence the quantity demanded of good X, other than the price of good Y
- These figures may also change overtime due to firms differentiating products
Q: Explain how economists use the concept of elasticity to distinguish between inferior goods and necessary goods when consumer income changes. [8]
AO1: Elasticity Knowledge
- The type of elasticity used to distinguish between inferior and normal goods is known as income elasticity of demand
- YED refers to how responsive the quantity demanded of a good is, compared to changes in income
- Formula: YED = %change in quantity demanded / %change in income
- The figures can also tell us important information about YED
Q: Explain how economists use the concept of elasticity to distinguish between inferior goods and necessary goods when consumer income changes. [8]
AO2: How does YED distinguish between the two goods?
Inferior goods:
* If the YED of a good or service is negative, then it means that the good is an inferior good
* If YED is less than -1, then we are dealing with an inferior good that is elastic, meaning that if income changes, the quantity demanded will be responsive
* If the YED is between -1 and 0, then we are dealing with an inelastic inferior good, meaning the quantity demanded will be fairly unresponsive to chanegs in income
* This means, that if YED is inferior, then it means that as incomes rise, the quantity demanded of inferior goods should fall, as there are higher quality alternatives, which consumers with higher incomes will be incentivised to buy
Necessary goods:
* If the YED is between 0 and 1, then we are dealing with an inelastic normal good, also known as a necessity
* If a good has a YED between 0 and 1, then this means the quantity demanded will be fairly unresponsive to changes in income
* This applies to necessities - For example: If incomes in an economy rise, the quantity demanded of toothpaste is unlikely to change because consumers already purchase the amount they need as it is fundamental for living and their quality of life
* However, the reason why necessities have a YED between 0 and 1 and not just 0, is because the quantity demanded may increase slightly
* Ex: If people earn higher incomes then they may be more likely to bulk buy toothpaste, meaning the quantity demanded will increase in the short run
Q: Explain how economists use the concept of elasticity to distinguish between inferior goods and necessary goods when consumer income changes. [8]
AO3 + Conclusion
- If YED is below 0, then it is an inferior good
- However, if the YED is between 0 and 1, then it is a necessity
- Necessities may have a surge in quantity demanded in the short run, as consumers now feel richer and are more likely to bulk buy
- We have also assumed ceteris paribus, as there are other factors that may influence the quantity demanded of a good, as opposed to incomes
- For example if incomes went up due to wage inflation, the quantity demanded of certain goods may still fall even though there are higher incomes, as the goods have become more expnesive, meaning consumers have a lower marginal propensity to consume
Q: Use examples to illustrate the difference between private goods and public goods, and explain why only private goods will be supplied in a free market economy. [8]
Introduction
- Private goods are excludable and rivalrous
- Public goods are non-exculadable and non-rivalrous
- Free market - An economic system where prices are determined by market forces and there is no government intervention
Q: Use examples to illustrate the difference between private goods and public goods, and explain why only private goods will be supplied in a free market economy. [8]
Public goods and Private goods
Public:
* Non-rivalrous means the consumption of the good doesn’t reduce the quantity available for others
* Non-excludable means the benefits provided by the good cannot be limited to those who pay for it
* Ex: Street light –> Anyone walking near the light can enjoy the good even though they don’t pay
Private:
* Rivalrous means the consumption of the good reduces the quantity available for others
* Ex: Buying tickets for a football match
* Excludable means the provider of the good can prevent people from enjoying the good, (Ex: By charging a higher price)
Q: Use examples to illustrate the difference between private goods and public goods, and explain why only private goods will be supplied in a free market economy. [8]
Conclusion + Private goods only supplied in free market
- Only private goods are supplied in a free-market economy due to the free rider problem
- This is when people enjoy a good they don’t pay for and overconsume it
- Because these public goods are non-excludable and non-rivalrous people aren’t willing to pay for it
- No profit incentive for firms –> Therefore only private goods are supplied
- However, firms may be incentivised to supply some, ‘public goods,’ especially quasi public goods like roads –> As they could profit from them
Q: Show the difference between a movement along, and a shift in a production possibility curve. Explain what might cause each to occur. Use diagrams to support your answer. [8]
Shift
- A shift in a PPC is due to an increase or decrease in the quality or quantity of an economy’s factors of production
- If the quality or quantity increases, then there is an outward shift
- This could be due to supply side policies such as training
- This could make workers more productive, leading to an outward shift of the PPC to PPC1
- However, the extent at which the quality improves in this example, depends on the effectiveness of the supply side policy
- An inward shift is caused by a decrease in the quality or quantity of our factors of production
- [Show on a diagram]
Q: Show the difference between a movement along, and a shift in a production possibility curve. Explain what might cause each to occur. Use diagrams to support your answer. [8]
Movement
- A movement along the PPC means an economy has reallocated it’s resources to produce more of one good and less of another
- This may be due to an increase in the demand for a specific good
- If an economy produces good Y and Good X but moves from point A to point B, then resources have been allocated to produce more of good X and less of good Y
- Meaning an economy is now producing more of good X
