Price Mechanism & its applications

Question 1

Non-price determinants of DD

Answer 1

TIGERPIE
T- Tastes and Preferences
I- Income
G- Government policies
E- Exchange rates
R- Prices of Related goods
P- Population
I- Interest rates
E- Expectations of future prices

Question 2

Allocative efficiency

Answer 2

Allocative efficiency is the situation in which society produces and consumes a combination of goods and services that maximises its welfare

Question 3

Productive efficiency

Answer 3

Productive efficiency is achieved when all resources are fully and efficiently utilised.

Question 4

PED

Answer 4

Price elasticity of demand (PED) is a measure of the responsiveness of the quantity demanded of a good to a change in its price, ceteris paribus

Question 5

Determinants of PED

Answer 5

SHIT
S- Number and closeness of substitutes
H- Habituality of consumption
I- Proportion of income spent
T- Time horizon

Question 6

PES

Answer 6

Price elasticity of supply (PES) is a measure of the responsiveness of the quantity supplied of a good to a change in its price, ceteris paribus.

Question 7

Determinants of PES

Answer 7

MALTP
M- Mobility of factors of production 
A- Availability of spare capacity
L- Level of stocks and inventories (which is depends on the ease of storing the stocks)
T- Time horizon
P- Length and complexity of production

Question 8

CED

Answer 8

Cross elasticity of demand (CED) is a measure of the responsiveness of the quantity demanded of a good to a change in the price of another good, ceteris paribus.

Question 9

Determinants of CED

Answer 9

1. the relationship between the two goods

2. the closeness of the relationship between the two goods

Question 10

YED

Answer 10

Income elasticity of demand (YED) is a measure of the responsiveness of the quantity demanded of a good to a change in consumers’ income, ceteris paribus.

Question 11

Determinants of YED

Answer 11

1. nature of the good
2. degree of necessity of the good
3. level of income of the consumer base

Question 12

Limitations in the application of elasticity concepts

Answer 12

1. Computation issues
   - Large amount of data collected, errors may be made that undermines the accuracy of the data. Hence, PED would be inaccurate and the use of it may not be reliable
2. Issues with prediction
   - The values of elasticities are calculated based on past data, so that may not be relevant for current use. Given the nature of our present dynamic economy, such estimates may become outdated quickly
3. Ceteris Paribus assumption
   - The statement of ‘ all other things being equal’ is a very strict assumption that cannot hold in reality. e.g. in the application of the PED concept, only the price of good is allowed to change while other factors of demand are assumed to remain constant. This is not true as NPD are always changing.

Question 13

Minimum price (price floor)

Answer 13

A minimum price is a price floor, which is a legally established minimum price to prevent prices from falling below a certain level. The price is not allowed to fall below this level. To be effective, the price floor must be set above the market equilibrium price.

Question 14

Maximum price (price ceiling)

Answer 14

A maximum price is a price ceiling, which is a legally established maximum price to prevent prices from rising above a certain level. Producers are prohibited from selling above a stipulated price. To be effective, the price ceiling must be set below the equilibrium price.

Question 15

Demand

Answer 15

The demand of a good/service refers to the amount that consumers are able and willing to purchase at each given price over a given period of time.

Question 16

Supply

Answer 16

The supply of a good or service refers to the amount of a good or service that producers are able and willing to offer for sale at each given price over a given period of time.

Question 17

PAP ( fall in DD)

Answer 17

1. With a fall in DD, at the original price, there is a surplus of (good) as Qd< Qs , this will lead to a downward pressure on (good) prices as producers will cut prices to attract consumers to buy (good).
2. As price falls, consumers will increase their Qd of (good), and producers will decrease Qs of (good). Prices will continue to fall until the new equilibrium price of P1, and quantity traded of Q1, where the surplus is eliminated.

Question 18

Specific tax

Answer 18

A specific tax will shift the supply curve vertically upwards by the amount of tax ($t). Since the amount of tax is same at all prices, supply curve shifts leftwards from S0 to S1`

Question 19

Ad valorem tax

Answer 19

An ad valorem tax, or a percentage tax, is a tax pegged at a certain percentage of the price of the good. As price rises, the amount of tax to be paid rises. This results in an leftward pivotal shift of the supply curve from S0 to S1

Question 20

Specific subsidy

Answer 20

A specific subsidy will shift the supply curve vertically downwards by the amount of subsidy ($s). Since the amount of subsidy is the same at all prices, supply curve shifts rightwards from S0 to S1

Question 21

Ad valorem subsidy

Answer 21

An ad valorem subsidy is pegged at a certain percentage of the price of the good. As price rises, the amount of subsidy granted rises. This results in a rightward pivotal shift from S0 to S1.

Question 22

Consumer Surplus

Answer 22

Consumer surplus is the difference between the maximum amount that consumers are willing and able to pay for a given quantity of a good and what they actually pay.

Question 23

Producer Surplus

Answer 23

Producer Surplus is the difference between the amount received by producers for selling their good and minimum prices that they are willing and able to accept for supplying additional units of the good.