Price Mechanism and its Applications Pt II

Question 1

What is price elasticity of demand?

Answer 1

The measure of degree of responsiveness of the quantity demanded of a good to a change in its price.

Question 2

What is the mathematical formula of price elasticity of demand?

Answer 2

PED = (% change in quantity demanded)/(% change in price)

Question 3

What is the sign of PED?

Answer 3

Negative. According to the Law of Demand, an increase in price, which is a positive change in the denominator, will cause a decrease in quantity demanded, which is a negative change in the numerator, and vice versa.

Question 4

What does magnitude of PED indicate?

Answer 4

The sensitivity of consumers to price changes. Higher magnitude means greater sensitivity, lower magnitude means lower sensitivity.

Question 5

What does |PED| < 1 indicate?

Answer 5

Demand is price inelastic, meaning that consumers are less sensitive to price changes, and hence quantity demanded is less responsive to changes in prices. A change in price would lead to a less that proportionate change in quantity demanded. Usually represented by a steep demand curve.

Question 6

What does |PED| > 1 indicate?

Answer 6

Demand is price elastic, meaning consumers are more sensitive to price changes, and hence quantity demanded is more responsive to changes in prices. A change in price would lead to a more than proportionate change in quantity demanded. Usually represented by a gentle demand curve.

Question 7

What does |PED| = 1 indicate?

Answer 7

Demand is unitary price elastic, meaning a change in price will cause an equal proportionate change in quantity demanded. Usually represented by a demand curve that is a hyperbola.

Question 8

What does |PED| = 0 indicate?

Answer 8

Demand is perfectly price inelastic, meaning consumers are willing and able to pay any price for a given quantity of a good, and hence price changes have no effect on quantity demanded. Usually represented by a vertical straight line.

Question 9

What does |PED| = ∞ indicate?

Answer 9

Demand is perfectly price elastic, consumers would buy any quantity of a good at a given price. Any increase in price will cause quantity demanded to decrease to 0 and any decrease in price will cause quantity demanded to increase infinitely. Usually represented by a straight horizontal line.

Question 10

What are the determinants of PED?

Answer 10

Number and closeness of substitutes, habituality of consumption, proportion of income spent on good, time horizon.

Question 11

How does number and closeness of substitutes affect PED?

Answer 11

Consumers are more likely to consider alternatives when the price of a good changes if there a large number of close substitutes available. If the price of the good increases, consumers can readily switch to these alternatives and thus there will be a more than proportionate change in quantity demanded for the good, making demand more price elastic.

Question 12

What does availability of substitutes depend on?

Answer 12

It is dependent on the way the market is defined. Narrowly defines markets have a higher PED compared to broadly defined markets, because it is easier to find substitutes for specific goods.

Question 13

How does habituality of consumption affect PED?

Answer 13

If a good is bought habitually, demand for it is more price inelastic as consumers would continue to buy a similar quantity of a good regardless of price changes, resulting in quantity demanded to be less responsive to price changes.

Question 14

What is a special case of habituality of consumption?

Answer 14

Consumers’ addiction. The greater the degree of addiction, the more consumers will buy a similar quantity of a good regardless of price changes, causing quantity demanded to be less responsive to price changes and thus demand to be more price inelastic.

Question 15

How does proportion of income spent on the good affect PED?

Answer 15

Higher proportion of income spent on the good will force people to reduce their consumption when price increases because small increases in price will take up more available income. Thus, a change in price will cause a more than proportionate change in quantity demanded and demand would be more price elastic.

Question 16

How does time horizon affect PED?

Answer 16

When price rises, consumers will take time to adjust their consumption pattern and find alternatives. The longer the time period, the more likely consumers can switch to other substitutes, causing a more than proportionate change in quantity demanded and hence demand to be more price elastic.

Question 17

How do differences in PED affect the impact of changes in supply on price and quantity?

Answer 17

Increase in supply, |PED| < 1: Large decrease in price, less than proportionate increase in quantity.
Increase in supply, |PED| > 1: Small decrease in price, more than proportionate increase in quantity.
Decrease in supply, |PED| < 1: Large increase in price, less than proportionate decrease in quantity.
Decrease in supply, |PED| > 1: Small increase in price, more than proportionate decrease in quantity.

Question 18

How do differences in PED affect the impact of changes in price on total revenue?

Answer 18

Rise in price, |PED| < 1: Price increases, less than proportionate decrease in quantity, total revenue increases.
Rise in price, |PED| > 1: Small price increase, more than proportionate decrease in quantity, total revenue decreases.
Fall in price, |PED| < 1: Price decreases, less than proportionate increase in quantity, total revenue decreases.
Fall in price, |PED| > 1: Small price decrease, more than proportionate increase in quantity, total revenue increases.

Question 19

How can firms use PED to make beneficial decisions?

Answer 19

1. They can raise prices for goods with price inelastic demand, and lower prices for goods with price elastic demand.
2. They can focus on strategies to make demand for their goods more price inelastic in the long run.

Question 20

Explain why firms will raise the price of a good with price inelastic demand.

Answer 20

For a good whose demand is price inelastic, profits can rise as increase in revenue due to price increase is larger than fall in revenue due to decrease in quantity demanded. Total revenue thus increases. Additionally, with decrease in quantity, cost of production can decrease. Thus, profits can rise.

Question 21

Explain why firms will decrease the price of a good with price elastic demand.

Answer 21

It is more likely profits will increase with a fall in price as the increase in revenue from the rise in quantity is larger than decrease in revenue due to the fall in price. However, with rise in quantity demanded, more goods have to be produced, leading to a rise in costs as well. If rise in total revenue is less than rise in total cost, profits will fall, thus it is rather uncommon for firms to lower price to increase profit.

Question 22

Why do firms want to make the demand for their goods price inelastic?

Answer 22

In the short run, there tends to be a lack of close substitute to a firm’s good. However, in the long run, competitors have the time to replicate and produce close substitutes to the good. As such, demand for the good becomes more price elastic, and the firm will have to reduce prices to increase revenue. However, if they use strategies to keep the substitutability of their products, demand will remain price inelastic and the prices can be kept high. This will allow them to raise prices, with a less than proportionate fall in quantity, leading to a rise in revenue.

Question 23

What is price elasticity of supply?

Answer 23

It is the degree of responsiveness of quantity supplied of a good to a change in its price.

Question 24

What is the mathematical formula for PES?

Answer 24

PES = (% change in quantity supplied)/(% change in price)

Question 25

What is the sign of PES?

Answer 25

It is positive. According to the Law of Supply, as price increases, which is a positive change in the denominator, quantity supplied will increase, which is a positive change in the numerator, and vice versa.

Question 26

What does magnitude of PES indicate?

Answer 26

The sensitivity of producers to change in prices. Higher magnitude indicates greater sensitivity, lower magnitude indicates lower sensitivity.

Question 27

What does |PES| < 1 indicate?

Answer 27

Supply is price inelastic. Producers are less sensitive to changes in price, thus quantity supplied is less responsive as well. A change in price will lead to a less than proportionate change in quantity supplied. Usually represented by a steep supply curve.

Question 28

What does |PES| > 1 indicate?

Answer 28

Supply is price elastic. Producers are more sensitive to price changes, and thus quantity supplied is more sensitive to price changes. A change in price will lead to a more than proportionate change in quantity supplied. Usually represented by a gentle supply curve.

Question 29

What does |PES| = 1 indicate?

Answer 29

Unitary price elastic supply. A change in price will lead to an equal proportionate change in quantity supplied. Represented by a straight supply curve starting from the origin.

Question 30

What does |PES| = 0 indicate?

Answer 30

Perfectly price inelastic supply. Price changes have no effect on quantity supplied. Represented by a vertical straight supply curve.

Question 31

What does |PES| = ∞ indicate?

Answer 31

Perfectly price elastic supply. Price changes have huge effects on quantity supplied, any rise in price will lead to an infinite increase in quantity supplied, any fall in price will lead to quantity supplied to fall to zero. Represented by a horizontal straight supply curve.

Question 32

What are the determinants of PES?

Answer 32

Level of stock or inventory, availability of spare capacity, mobility of factors of production, time horizon, length of production period.

Question 33

How does level of stock affect PES?

Answer 33

It affects how readily producers can respond to price changes. If firms have high levels of stock, if price of the good increases and incentivises producers to increase quantity supplied, they can respond quickly and draw on the stock and offer the goods for sale. Thus quantity supplied is responsive to price changes, making the supply of the good price elastic when there are high levels of stock.

Question 34

What does availability of stock depend on?

Answer 34

Ease of storing the stock.

Question 35

How does availability of spare capacity affect PES?

Answer 35

If firms hold sufficient stock of raw materials and have the physical spare capacity, production can be increased readily in response to price changes. If the firm's capacity is saturated, it will be more difficult to increase production when there is an increase in price. The greater the availability of spare capacity, the more price elastic supply is.

Question 36

How does mobility of factors of production affect PES?

Answer 36

The greater the mobility of FOPs, the faster more goods can be produced, the greater the degree of responsiveness of quantity supplied to changes in price, the more price elastic supply is.

Question 37

What is factor mobility?

Answer 37

It is the ease and speed at which FOPs can move from one industry to another.

Question 38

How does time horizon affect PES?

Answer 38

When the price of good changes, producers need time to respond and adjust their production pattern and thus time is needed for quantity supplied to increase or decrease.

Question 39

How does length of production period affect PES?

Answer 39

Time taken to produce goods affects how fast producers can respond to price change. The shorter the production period, the more responsive quantity supplied is to price changes and vice versa.

Question 40

What is the elasticity of supply in the momentary period?

Answer 40

Supply is perfectly price inelastic because it is impossible for firms to change output as soon as there is a change in price as all FOPs are fixed. Supply is restricted to quantities available in the market at that point.

Question 41

What is the elasticity of supply in the short run?

Answer 41

The short run is the period where production is restricted by at least one FOP. Supply is relatively price inelastic as quantity supplied can be increased to some extent in response to changes in price because some inputs can be varied while others remain fixed.

Question 42

What is the elasticity of supply in the long run?

Answer 42

The long run is the period of time where all FOPs can be varied. There is sufficient time for firms to acquire inputs to expand production and for new firms to enter the market, quantity supplied can be more responsive and supply becomes highly price elastic.

Question 43

How does PES affect the extent to which price and quantity supplied changes when demand changes in a perfectly competitive market?

Answer 43

Increase in demand, |PES|<1: Large increase in P, less than proportionate increase in Q Increase in demand, |PES|>1: Small increase in P, more than proportionate increase in Q Decrease in demand, |PES|<1: Large decrease in P, less than proportionate decrease in Q Decrease in demand, |PES|<>: Small decrease in P, more than proportionate decrease in Q

Question 44

What is cross elasticity of demand?

Answer 44

The measure of degree of responsiveness of the quantity demanded of a good to change in the price of another good.

Question 45

What is the mathematical formula for CED?

Answer 45

CED = (% change in quantity demanded of good B)/(% change in price of good A)

Question 46

What is the sign of CED?

Answer 46

If CED is positive, the two goods are substitutes. An increase/decrease in the price of good A will increase/decrease demand for good B. If CED is negative, the two goods are complements. An increase/decrease in the price of good A will decrease/increase demand for good B. If CED is zero, the two goods are unrelated. A change in price in good A will not affect demand for good B.

Question 47

What does the magnitude of CED indicate?

Answer 47

The strength of the relationship between the goods.

Question 48

What does CED<0 and |CED| is large indicate?

Answer 48

The two goods are strong complements. Consumers of good B are sensitive to the price of good A. Increase/decrease in price of good A will lead to a more than proportionate decrease/increase in quantity demanded for good B. Illustrated by a large shift in the demand curve for good B.

Question 49

What does CED<0 and |CED| is small indicate?

Answer 49

The two goods are weak complements. Consumers of good B are less sensitive to the price of good A. Increase/decrease in price of good A will lead to a less than proportionate decrease/increase in quantity demanded for good B. Illustrated by a small shift in the demand curve for good B.

Question 50

What does CED>0 and |CED| is large indicate?

Answer 50

The two goods are strong substitutes. Consumers of good B are sensitive to the price of good A. Increase/decrease in price of good A will lead to a more than proportionate increase/decrease in quantity demanded for good B. Illustrated by a large shift in the demand curve for good B.

Question 51

What does CED>0 and |CED| is small indicate?

Answer 51

The two goods are weak substitutes. Consumers of good B are less sensitive to the price of good A. Increase/decrease in price of good A will lead to a less than proportionate increase/decrease in quantity demanded for good B. Illustrated by a small shift in the demand curve for good B.

Question 52

What are the determinants of CED?

Answer 52

The relationship between the two goods and the closeness of the relationship between the two goods.

Question 53

How can firms use CED to respond to changes in price of a close substitute?

Answer 53

Price strategy: When price of close substitute falls, the firm has to lower the price of its good to prevent a huge loss of customers. Non-price strategy: The firm should reduce the CED between its product and the substitute by making its good less substitutable.

Question 54

How can firms use CED to respond to changes in price of a close complements?

Answer 54

Non-price strategies: If the price of a strong complement falls, the firm can increase production or release stocks. Businesses producing strongly complementary goods can collaborate

Question 55

What is income elasticity of demand?

Answer 55

The measure of the degree of responsiveness of the quantity demanded of a good to a change in consumers' income.

Question 56

What is the sign of YED?

Answer 56

If YED is positive, the good is a normal good. Demand is positively related to income. Increase in income increase purchasing power of consumers, increasing demand for normal goods. If YED is negative, the good is an inferior good. Demand is negatively related to income, increase in income causes consumers to switch to normal goods, decreasing demand for inferior goods.

Question 57

What does the magnitude of YED indicate?

Answer 57

The strength of the relationship between income and demand for a good.

Question 58

What does YED<0 indicate?

Answer 58

The good is an inferior good. Rise/fall in income decreases/increases demand for it.

Question 59

What does YED>0, |YED|<1 indicate?

Answer 59

The good is a normal good, specifically a necessity. Income is not a strong determinant of demand. Rise/fall in income will lead to a less than proportionate increase/decrease in demand, illustrated by a small shift in demand curve.

Question 60

What does YED>1 indicate?

Answer 60

The good is a normal good, specifically a luxury. Income is a strong determinant of demand. Rise/fall in income will lead to a more than proportionate increase/decrease in demand, illustrated by a large shift in demand curve.

Question 61

What are the determinants of YED?

Answer 61

The nature of the good which determines if YED is positive or negative. The degree of necessity, the more necessary the good is, the lower YED is. Degree of necessity is dependent on the level of income of the consumer base. When income levels are low, only basic necessities have a high degree of necessity. When income levels are high, fewer goods are considered luxuries. Stage of economic development of a country affects what is considered a necessity and what is considered a luxury, which affects YED.

Question 62

How can firms use YED to their advantage?

Answer 62

When the economy is growing and income levels are rising, the firms could benefit more by producing more normal goods, especially luxuries, by channeling more resources to produce luxurious goods. When the economy is going through a recession and income levels are falling, the firms could benefit more by producing less luxuries, and channeling more resources to produce necessities and even inferior goods. The firms can segment markets and produce the appropriate range of products to suit consumer bases.

Question 63

What are some limitations in the application of elasticity concepts?

Answer 63

1. Computation issues as exact elasticity values can be hard to calculate 2. Issues with prediction as estimates may become outdated quickly 3. Cost concerns. Elasticity concepts can be used to predict change in total revenue, but not change in costs, thus we might not know if profit increases or decreases. 4. Ceteris paribus assumption cannot hold in reality.

Question 64

What are taxes?

Answer 64

Compulsory payments to the government and are used by them for various reasons, including raising government revenue and resolving market failure.

Question 65

What are indirect taxes?

Answer 65

Taxes on goods and services and are paid to the tax authorities indirectly by the suppliers of the goods and services. It fall on producers and increases cost of production, causing a leftward shift in supply curve.

Question 66

What are the 2 types of indirect taxes?

Answer 66

1. Specific tax 2. Ad valorem tax

Question 67

What is specific tax?

Answer 67

An indirect tax of a fixed sum per unit sold. It shifts the supply curve parallel upwards by the amount of tax.

Question 68

What is an ad valorem tax?

Answer 68

An indirect tax of a certain percentage of the price of the good. It causes an upward pivotal shift in the supply curve, because as price rises, amount of tax rises.

Question 69

What is the incidence of tax?

Answer 69

The distribution of the burden of tax between sellers and buyers.

Question 70

What is consumers' incidence of tax reflected by?

Answer 70

The extent of the increase in price to be paid.

Question 71

What is producers' incidence of tax reflected by?

Answer 71

The amount by which the rise in price is insufficient to cover the tax.

Question 72

What are the effects of indirect tax on the market?

Answer 72

Consumers pay more, producers receive less after taxation, government receives tax revenue.

Question 73

How does incidence of tax change when PES>PED?

Answer 73

When demand is more price inelastic than supply, buyers are less responsive to changes in the price of the good compared to sellers, therefore buyers bear a greater burden of tax.

Question 74

How does incidence of tax change when PED>PES?

Answer 74

When demand is more price elastic than supply, buyers are more responsive to changes in the price of the good compared to sellers, therefore sellers bear a greater burden of tax.

Question 75

What are the effect of indirect taxes on welfare?

Answer 75

Consumer surplus falls as with the imposition of tax, actual price paid increases and quantity consumed decreases. Producer surplus falls as with the imposition of tax, actual price retained decreases and quantity sold decreases. Part of the losses in these surpluses were transferred to the government as an increase in tax revenue, however, the losses were not fully recouped by the government, and society experiences a deadweight loss.

Question 76

What are direct taxes?

Answer 76

Taxes on income and wealth and are paid to the tax authorities directly by the economic agent. It affects willingness and ability to consume goods, leading to a leftward shift in demand curve.

Question 77

What are the effects of direct taxes?

Answer 77

Reduction in ability to purchase goods due to reduction in disposable income, and hence causes negative welfare effects.

Question 78

What are subsidies?

Answer 78

Cash transfers from the government to the producer or consumer to resolve market failure or as a response to inequity.

Question 79

What are indirect subsidies?

Answer 79

Subsidies granted by tax authorities to the suppliers instead of consumers. It decreases the cost of production for firms and leads to a rightward shift of the supply curve.

Question 80

What are the 2 types of indirect subsidies?

Answer 80

1. Specific subsidies 2. Ad valorem subsidies

Question 81

What is specific subsidy?

Answer 81

An indirect subsidy of a fixed sum per unit sold. It shifts the supply curve vertically downwards by the amount of subsidy.

Question 82

What is ad valorem subsidy?

Answer 82

An indirect subsidy of a certain percentage of the price of the good. It causes an downward pivotal shift in the supply curve, because as price rises, amount of subsidy rises.

Question 83

What is incidence of subsidy?

Answer 83

The distribution of the share of subsidy between sellers and buyers.

Question 84

What is consumers' incidence of subsidy reflected by?

Answer 84

The extent of decrease in price paid.

Question 85

What is producers' incidence of subsidy reflected by?

Answer 85

The excess of the subsidy after the fall in price.

Question 86

What are the effects of indirect subsidy on the market?

Answer 86

Consumers pay less, producers receive more, government expenditure increases.

Question 87

How does incidence of subsidy change when PES>PED?

Answer 87

Consumers enjoy a larger subsidy incidence, and total share of subsidy for consumers is larger than that for producers.

Question 88

How does incidence of subsidy change when PED>PES?

Answer 88

Producers enjoy a larger subsidy incidence, and total share of subsidy for producers is larger than that for consumers.

Question 89

What are the effects of indirect subsidy on welfare?

Answer 89

Consumer surplus rises as actual price paid decreased due to subsidy grant, and quantity consumed rises. Producer surplus rises as actual price received increases due to subsidy grant and quantity sold increases. Part of the government expenditure is transferred to society as gains in surpluses, however the gains did not fully recover the government expenditure and society experiences a deadweight loss.

Question 90

What are direct subsidies?

Answer 90

Subsidies granted by the tax authorities directly to the economic agent. It affects the willingness and ability to consume goods and leads to a rightward shift in the demand curve.

Question 91

What are the effects of direct subsidies?

Answer 91

It raises the ability of consumers to purchase goods and services, creating positive welfare effects.

Question 92

What is minimum price?

Answer 92

A price floor, a legally established minimum price to prevent prices from falling below a certain level.

Question 93

Where should a price floor be set?

Answer 93

Above the equilibrium market price.

Question 94

Why are price floors set?

Answer 94

To protect producers' incomes when prices are volatile, to create a surplus to be stored in preparation for shortages, to set a minimum wage for workers.

Question 95

Why is a surplus created when a price floor is set?

Answer 95

Quantity demanded decreases due to Law of Demand, quantity supplied increases due to Law of Supply.

Question 96

What does the size of the surplus from the setting of a price floor depend on?

Answer 96

The level at which the price floor is set (the higher the price floor, the greater the surplus), the price elasticity of demand and supply (the greater the PED and/or PES, the greater the surplus), changes in demand and supply (if demand increases/supply decreases, surplus decreases).

Question 97

What is the effect of a price floor on a market?

Answer 97

It results in overproduction and thus allocative inefficiency whereby too many scarce resources are allocated to producing the good.

Question 98

What are the effects of a price floor on welfare?

Answer 98

There is a loss in consumer surplus as price consumers have to pay increases and quantity consumed decreases. There is a gain in producer surplus as price received rises and quantity sold increases. It requires government expenditure which comes at the expense of societal welfare since it requires tax revenue. There is deadweight loss in society if the government cannot recover expenses through reselling or redistributing goods.

Question 99

What is maximum price?

Answer 99

A price ceiling, a legally established maximum price to prevent prices from rising above a certain level.

Question 100

Where should a price ceiling be set?

Answer 100

Under the equilibrium market price.

Question 101

Why are price ceilings set?

Answer 101

To achieve some form of equity.

Question 102

Why is a shortage created when a price ceiling is set?

Answer 102

Quantity demand rises due to Law of Demand, and quantity supplied falls due to Law of Supply.

Question 103

What does the size of shortage from the setting of a price ceiling depend on?

Answer 103

The level at which the price ceiling is set (the lower the price ceiling, the greater the shortage), the price elasticity of demand and supply (the greater the PED and/or PES, the greater the shortage), and changes in demand and supply (If demand increases/supply decreases, shortage increases).

Question 104

What is the effect of a price ceiling on a market?

Answer 104

It results in underproduction and thus allocative inefficiency whereby too few scarce resources are allocated to producing the good.

Question 105

What are the effects of a price ceiling on welfare?

Answer 105

Consumer surplus changes as price they have to pay falls, but quantity consumed also decreases. Producer surplus falls as price received falls and quantity sold also falls. There is deadweight loss to society. Non-price rationing is needed as price controls interferes with the price mechanism. An underground market may emerge where people ignore the price ceiling and sell illegally at free market prices.

Question 106

How can governments minimise the problems arising from price ceilings?

Answer 106

Encourage increase in supply through drawing on past surpluses, engaging in direct production, giving subsidies or tax relief to producers, or reduce demand by controlling income or producing alternatives.

Question 107

What are quality controls?

Answer 107

The setting of fixed output level by the government.

Question 108

What is a quota?

Answer 108

A limit on the quantity produced imposed by the government through legislation and regulation.

Question 109

Where should a quota be set?

Answer 109

Below the market equilibrium quantity.

Question 110

What is the effect of a quota on a market?

Answer 110

It results in underproduction and thus allocative inefficiency whereby too few scarce resources are allocated to producing the good.

Question 111

What are the effects of a quota on welfare?

Answer 111

There is a loss in consumer surplus as price paid rises and quantity of good consumed decreases. There is a change in producer surplus as price producers receive rises but quantity of good sold decreases. There is thus a change in overall societal welfare.

Question 112

Who are the sellers in the labour market?

Answer 112

Households.

Question 113

Who are the buyers in the labour market?

Answer 113

Firms.

Question 114

What are the y and x axes in a labour market graph?

Answer 114

Y axis: Wage X axis: Quantity of labour in terms of hours worked or number of workers employed.

Question 115

What are the non-wage determinants of labour demand?

Answer 115

1. Demand for final goods and services 2. Productivity of labour 3. Supply of alternative/complementary FoPs

Question 116

How does demand for final goods and services affect labour demand?

Answer 116

Demand for labour is derived from demand for final goods and services. When demand for good increases, market price increases, marginal revenue also increases. Each unit of labour brings in more revenue, thus labour demand increases.

Question 117

How does productivity of labour affect labour demand?

Answer 117

Productivity is the level of output per employee. When productivity is increased, each unit of labour provides more output and is able to bring in more revenue, increasing demand for labour.

Question 118

How does supply of alternative FoPs affect labour demand?

Answer 118

When supply of alternative FoPs rises, prices of the resources also rises, and this might cause firms to switch to labour inputs from alternative inputs.

Question 119

How does supply of complementary FoPs affect labour demand?

Answer 119

When supply of complementary FoPs rises, prices of the resources also rises, firms will purchase more of these resources as well as the required labour and vice versa.

Question 120

What are the non-wage determinants of labour supply?

Answer 120

1. Immigration 2. Changes in educational attainment/job qualifications 3. Changes in non-wage benefits of jobs 4. Changes in alternative employment opportunities

Question 121

How does immigration affect labour supply?

Answer 121

Movement of workers into a country increases supply and vice versa.

Question 122

How do changes in educational attainment/job qualifications affect labour supply?

Answer 122

With higher educational attainment, workers qualify for higher-skilled jobs, increasing labour supply to that industry. With higher job qualifications, fewer workers qualify for the jobs, decreasing labour supply to that industry.

Question 123

How do changes in non-wage benefits of jobs affect labour supply?

Answer 123

It affects the overall attractiveness of a job and this affects the willingness of people to work at existing wage levels and hence labour supply.

Question 124

How do changes in alternative employment opportunities affect labour supply?

Answer 124

If one job seems relatively more attractive than another, more people will be willing to work at the former, thus labour supply to that market will increase and vice versa.

Question 125

What are the reasons for wage differentials?

Answer 125

1. Workers are not homogenous 2. Jobs are not homogenous 3. Governments may intervene

Question 126

How do workers not being homogenous cause wage differentials?

Answer 126

Difference in skills and abilities affect productivities of different workers, which affects their desirability of labour to firms, which affects their willingness and ability to demand for labour. More productive workers bring in more revenue, and are in greater demand, resulting in higher wages. Price elasticity of supply affects wages, when supply is price inelastic, when there is an increase in demand for labour, a large shortage will be created and a large rise in wages will be needed to increase quantity supplied to clear the shortage and vice versa.

Question 127

How do jobs not being homogenous cause wage differentials?

Answer 127

Jobs have different attractiveness of job scope and work environment. Jobs that require specialised skills will have a limited supply of labour and jobs that carry higher risks or limited career progression will face reduced willingness from workers to provide labour, thus facing a limited supply. This results in higher wages. Price elasticity of demand affects wages, jobs with price inelastic demand are unresponsive to wage changes. Thus, when supply falls and a large shortage is created, a large rise in wages will be required to reduce demand to eliminate the shortage.

Question 128

How does government intervention cause wage differentials?

Answer 128

Minimum wage laws, determination of CPF rates and supply of foreign workers may influence the wage rate.

Question 129

What are the effects of minimum wage policy?

Answer 129

There will be unemployment as quantity of labour demanded decreases but quantity of labour supplied increases as wage rate rises. A surplus of labour rises, thus unemployment results. Illegal employment may occur as some workers work at wages below the minimum wage. Technological unemployment may occur as firms might develop and switch to high-tech production methods which displace labour.