asa economics rev guide sample

7/29/2019 Asa Economics Rev Guide Sample

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6

The Price

System

6.1 Individual demand curves

Demand is the willingness and ability to buy aproduct. A demand curve is drawn up rom ademand schedule. It shows the quantity demanded

at dierent prices. Price and demand are inverselyrelated.

A market demand curve shows the total demandor a product. Te market demand is ound byadding up the amount demanded by individualconsumers at dierent prices. Demand or a productis inuenced by changes in its price, disposableincome, the price o related products, tastesand ashion, population size and age structure,advertising and a number o other actors.

A movement along a demand curve can only

be caused by a change in the price o the productitsel. A rise in price will cause a contraction indemand. Tis movement can also be reerredto as a decrease in quantity demanded. A all inprice will cause an extension in demand. Tismovement can also be called an increase inquantity demanded (see Figure 6.1).

A change in any inuence on demand or a product,other than its own price, will result in new quantitiesbeing demanded at each and every price. As a result,

the demand curve will shi its position. A shi tothe right o the demand curve is called an increase indemand, with higher quantities being demanded ateach and every price.

A decrease in demand will lower quantities beingdemanded at each and every price and is illustratedby a shi to the le o the demand curve (as shownin Figure 6.2).

Revision Objectives

distinguish between movements along%and shits in demand and supply curvesdraw demand and supply diagrams to%analyse changes in market conditionsexplain the causes o changes in demand%and supplydistinguish between equilibrium and%disequilibrium

calculate and interpret price elasticity o%demand, cross elasticity o demand, incomeelasticity o demand and price elasticity osupply fguresexplain consumer surplus%outline the role o prices as rationing and%allocative mechanisms.

After you have studied this chapter, you should be able to:

Price

P

D

D

0 Q Q1

P1

Figure 6.1

MTPL0224_Sample_Chapter 6(Blue).indd 28 1/17/2012 2:24


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The Price System 29

Price

D

D

0

D1

D1

Quantity

Figure 6.2

6.2 Price elasticity of demand

Price elasticity o demand (PED) is a measure o theresponsiveness o demand to a change in price. It is

calculated by using the ollowing ormula.

PEDpercentage change in quantity demanded

percentage chang=

ee in price

As price and demand are usually inversely related,PED is normally a minus gure. A PED gure(ignoring the sign) greater than one and less thaninnity means that demand is elastic, with a change inprice causing a greater percentage change in quantitydemanded. A PED gure (ignoring the sign) o lessthan one and greater than zero means that demand is

inelastic. In this case, demand is not very responsiveto a change in price, with a change in price resultingin a smaller percentage change in quantity demanded.

Te three other degrees o PED are perectlyinelastic demand, unitary elasticity o demand andperectly elastic demand. Perectly inelastic demandmeans that demand remains unchanged when pricealters. In this case, PED is zero. Unitary elasticity odemand occurs when a change in price causes anequal percentage change in quantity demanded, givinga PED gure o 1. Perectly elastic demand meansthat a change in price will cause an innite change inquantity demanded, giving a PED o innity.

Unitary price elasticity o demand is illustrated bya rectangular hyperbola, perectly inelastic demandby a straight vertical line and perectly elasticdemand by a straight horizontal line (see Figure 6.3).

Factors aecting PED

Te main actor which inuences the degree o PED isthe extent to which the product has close substitutes.

Te existence o very similar products at a similarprice would make demand elastic. Other actorsthat inuence PED are the proportion o disposableincome spent on the product; whether the product ishabit orming, a luxury or a necessity, and whether itspurchase can be postponed or not. Demand tends tobe more elastic over time as consumers have longer torecognise the price change and to nd alternatives.

I the price o a product takes up a smallproportion o income, demand is likely to be priceinelastic. A relatively large rise in price would nothave much o an impact and so demand would beexpected to all by a smaller percentage.

I a product is habit orming, it will be relativelyinsensitive to price changes. Similarly, i a product isconsidered to be a necessity and its purchase cannotbe delayed, demand will be inelastic PED or the

same products can vary between countries with, orinstance, what is viewed as a necessity in one countrybeing viewed as a luxury in another country.

Implications o PED or revenue andbusiness decisions

I demand is inelastic, a rise in price will cause arise in revenue and a all in price will cause a all inrevenue. In contrast, i demand is elastic, price andrevenue will move in opposite directions.

D

Unitary price elasticity

of demand

D

P1

Price

0 Q1 Q Quantity

P

Price

Perfectly inelastic

demand

Perfectly elastic

demand

P1

D

0 Q Quantity

P

Price

D

0 Q Q1 Quantity

P

Figure 6.3



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30 The Price System

Discovering that demand or its product is elastic,would usually indicate to a rm that close substitutes areavailable. Tis knowledge may make the rm reluctantto raise its price, as it will expect to lose a signicant

proportion o its sales. It may, however, be tempted tolower its price, as it may be able to capture more o themarket. Firms may try to make their products seemunique through, or instance, advertising and brandnames. I successul, this would make demand moreinelastic, giving rms greater market power.

Firms may estimate PED gures by examiningpast changes in price and demand and by carryingout market research. In basing their businessdecisions on PED estimates, however, rms haveto take care. Tis is because the gures are only

estimates and PED can change over time.

6.3 Income elasticity of demand

Income elasticity o demand (YED) is a measureo the responsiveness o demand to a change inincome. It is calculated using the ollowing ormula.

YEDpercentage change in quantity demanded

percentage chang=

ee in income

I YED is greater than one, demand is incomeelastic. Tis means that a change in income will

cause a greater percentage change in demand.A YED o less than one, in contrast, means demandis income inelastic. In this case, a change in incomewill result in a smaller percentage change in demand.

Most products have positive income elasticity odemand. Tis means that a rise in income will resultin an increase in demand and a all in income willcause a all in demand (see Figure 6.4). Productswhich have positive YED greater than one may bereerred to as superior or luxury goods.

Products which have negative YED are calledinerior goods. In the case o these products, incomeand demand are inversely related an increasein income will cause a decrease in demand and a

decrease in income will cause an increase in demand(see Figure 6.5) as shown below.

Factors aecting YED

Products which have substitutes o a higher qualityand a higher price are likely to be inerior goods.Expensive and desirable products may have positiveincome elasticity greater than one.

Implications o YED or revenue andbusiness decisions

As income usually rises, rms are likely to want toproduce mainly normal goods. Producing a ewinerior goods may protect rms rom the risk oa recession; but usually the ear o the consumernding out that they are making inerior goodswill either stop the rms rom producing them orwill result in them trying to change their nature.o achieve the later, rms may try to convinceconsumers that the products have, or instance,health benets.

6.4 Cross elasticity of demandCross elasticity o demand (XED) is a measureo the responsiveness o demand or one productto a change in the price o another product. It iscalculated using the ollowing ormula.

XED

percentage change in the quantity demanded

for another=

product

percentage change in the price of one product

Income

Y1

Y

0 Q1 Q

D

D

Quantity

Figure 6.5

Income

Y1

Y

0 Q1Q

D

D

Quantity

Figure 6.4



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The Price System 31

Positive cross elasticity o demand means that a risein the price o one product will result in an increase indemand or the other product. Similarly, a all in theprice o one product will cause demand or the other

product to decrease. Tis is the case with substitutes(see Figure 6.6).

Price

of tea

P1

P

D

D

0 Q Q1 Quantity of coffee

demanded

Figure 6.6

Negative cross elasticity o demand occurs whenthe change in the price o one product results in a

change o the opposite direction in demand or theother product. Complements have negative XED.For instance, a rise in the price o PCs may result ina decrease in demand or printers, which are boughtto be used with PCs (see Figure 6.7).

Factors aecting XED

Te closer two products are as substitutes, thehigher the positive XED gure will be. Te higher

the negative XED gure is, the closer the twoproducts are as complements.

Implications o XED or revenue andbusiness decisions

Firms have to be aware o the extent to which theirproducts have close substitutes. he existenceo close substitutes provides both a threat anda challenge or a irm. It has to be aware thatraising its price may lose some o it customers. Itmay, however, be able to attract customers awayrom rivals by lowering price.

Knowledge about the existence o complementscan help a rm to increase its revenue. A rm mayoer one product at a lower price i it is purchasedwith a more expensive complement. For instance,a rm may seek to sell more Vs by oering tosell a CD player at a reduced price with everyV purchased.

6.5 Firms supply curves

Supply is the ability and willingness to sell a product.

A supply curve is drawn rom a supply schedule.Price and supply are directly related. Market supplyis the total supply o a product. It is ound by addingup the supply curves o the individual rms in themarket.

Supply is inuenced by a range o actors includingprice, costs o production, advances in technology,indirect taxes, subsidies, and in the case o primaryproducts, weather conditions and diseases.

A movement along a supply curve can be causedonly by a change in the price o the product itsel.

A rise in price will cause an extension is supply.Tis movement can also be reerred to as a decreasein quantity supplied (see Figure 6.8).

A change in any inuence on the supply o aproduct other than its own price will result in newquantities being supplied at each and every price.As a result, the supply curve will shi its position.A shi to the right o the supply curve is called anincrease in supply. Higher quantities are supplied ateach and every price (see Figure 6.9).Figure 6.7

Price

of PCs

P1

P

D

D

0 QQ1 Quantity of

printers demanded



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32 The Price System

A decrease in supply with lower quantities beingsupplied at each and every price is illustrated by ashi to the right o the supply curve.

6.6 Price elasticity of supply

Price elasticity o supply (PES) is a measure o theresponsiveness o supply to a change in the price o theproduct. It is calculated by using the ormula below.

PESpercentage change in quantity supplied

percentage chang=

ee in price

As price and supply are directly related, PES is apositive gure. A PES gure greater than one and

less than innity means that supply is elastic, with achange in price causing a greater percentage changein quantity supplied. A PES gure o less than oneand greater than zero indicates inelastic supply. Inthis case, supply is not very responsive to a changein price, with a change in price resulting in asmaller percentage change in quantity supplied.

Supply may also be perectly inelastic, unitaryelastic and perectly elastic. Perectly inelasticsupply means that a change in price has no eecton the quantity supplied. Unitary elasticity occurswhen a change in price causes an equal percentagechange in supply. Perectly elastic supply means thata change in price will cause an innite change inquantity supplied (see Figure 6.10).

he main actors that inluence PES arewhether the products can be stored, the time ittakes to produce it and time itsel. A product will

Price

P1

P

S

S

0 QQ1 Quantity

Figure 6.8

Figure 6.10

Price

Perfectly inelastic supply

P1

P

S

0 Q Quantity

P1

P

0 Q Q1 Quantity

Price

Unitary elasticity of supply

S

P

0 Q Q1 Quantity

Price

S

Perfectly elastic supply

Figure 6.9

Price

S1

S1

S

S

0 Quantity



6/18

The Price System 33

have an elastic supply i it can be stored and isquick to produce. In this case, supply can be easilyadjusted to changes in price. Over time the supplyo most products become more elastic as there

is more opportunity to make adjustments to theactors o production employed.

Te supply o manuactured products is usuallymore elastic than agricultural products. Plantstake time to grow and livestock to mature. Firmsbenet rom making the supply more elastic. Teirprots are likely to be higher i they can easily raisethe quality supplied when the price rises and caneasily withdraw supplies rom the market whenprice alls.

6.7 Interaction of demand and supply:equilibrium price and quantity

A market is in equilibrium when demand andsupply are equal. In this situation, there will be noreason or price or quantity to change. Te marketwill clear, with no surplus or shortage as shown inFigure 6.11.

Disequilibrium occurs when demand and supplyare not equal. I demand exceeds supply, a shortagewill occur. Tis shortage is likely to result in pricerising until demand and supply are again equal (seeFigure 6.12).

In contrast, i supply is greater than demand, asurplus will result. Te surplus will put downwardpressure on price, until equilibrium is restored asshown in Figure 6.13.

Eects o changes in supply and demandon equilibrium price and quantity

An increase in demand will result in a rise in priceand an extension in supply. A decrease in demandwill cause a all in price and a contraction in supply.An increase in supply will result in a all in priceand an extension in demand. A decrease in supplywill push up the price which, in turn, will cause a

contraction in demand.Applications o demand and supply

Demand and supply analysis enables economists tomake predictions about changes in market conditions.

Governments apply demand and supply analysisto consider the eects o taxes and subsidies. Forinstance, the imposition o an indirect tax eectivelyincreases rms costs o production. Tis will causesupply to decrease. Te decrease in supply will cause

Price

P

D

D

S

S

0 Q Quantity

Figure 6.11

Price

P

PZ

QS

D

D

S

S

0 QDQ Quantity

Figure 6.12

Figure 6.13

Price

P

P2

D

D

S

S

0 QQD QS Quantity



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34 The Price System

price to rise and demand to contract. How much o theprice rises and the quantity bought and sold alls, willbe inuenced by the size o the tax and PED and PES.

Firms use demand and supply analysis to decide

on their production and prices.

6.8 Consumer surplus

Consumer surplus is the dierence between whatconsumers are willing to pay or a product and theamount they actually do. For instance, one person maybe prepared to pay $20, another person $18, a third$15 and a ourth $11. I the actual price charged is $11,the rst person would enjoy $9 consumer surplus, thesecond person $7, the third $4 and the ourth zero. Ona diagram, consumer surplus is the area above the priceline and below the demand curve (see Figure 6.14).

A all in price will increase consumer surplus while arise in price will cause a decrease in consumer surplus.

Prices as rationing and allocative mechanisms

Prices signal to producers changes in consumersdemand. I consumers want more o a product andare prepared to pay or it, the price o the product

will rise. Higher price will provide an incentive orrms to respond by supplying more o the product.

I demand exceeds supply, price will rise and theproducts will be sold to those who can aord thehigher price. Changes in price should ensure thatthe market clears with no products being unsold andno consumers who are willing and able to pay themarket price, being unable to purchase it.

Figure 6.14

Price

P

D

0 Q Quantity

= Consumer surplus

6.9 Mind maps

Mind map 6.1 Demand

Willingness andability to buy a

product

Definition

Demand

Schedule

Price Disposableincome

Influences

on

Substitutes

Complements

Price ofrelated

products Tastes andfashion

Population

Size

Agestructure

Advertising

Shift in

demandcurve

A list ofquantitiesdemandedat different

prices

Curve

Plots differentquantities at

different prices

Movementalong a

demand curve

Caused bya change inthe price of

the product

Right

Left

IncreaseDecrease



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The Price System 35

Mind map 6.2 Supply

Willingness andability to sell a

product

Definition

Schedule

PriceCosts of

production

Influenceson

Shift insupply curve

A list ofquantitiessupplied

at different

prices

Curve

Plots differentquantities at

different prices

Movement alonga supply curve

Caused by a change

in the price of theproduct

Right Left

Increase Decrease

Advances intechnology

Indirecttaxes

Subsidies

Supply

Mind map 6.3 Price elasticity of demand 1

PED =%p

%QD

Formula

Measurements

TotalRevenue

Same direction

as price

Inelastic Inelastic

Oppositedirectionto price

Constantas pricechanges

Unity

Users

Entrepreneurs/Firms

Economists

Governments

Examples of uses

of the conceptEstimating effectsof a change in the

value of the currency

on the current accountof the balanceof payments

Estimating effectsof the imposition of a

tax or the grantingof a subsidy

Estimatingeffects of pricechange on total

revenue

Influences

Existenceof close

substitutes

Proportion ofincome spent on

the product Degree ofnecessity

Whether habitforming or not

Time

Price elasticity of demand



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36 The Price System

Mind map 6.4 Price elasticity of demand 2

>1 0 1

Superior/luxury

goods

IncomeelasticZero income

elasticity

Income

elasticity

% y resultsin a smaller

% qD

% y resultsin a greater

% qD% y resultsin no change

in qD

% qd

% yYed =

Income elasticityof demand



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The Price System 37

Mind map 6.6 Cross elasticity of demand

Formula

Substitutes

Positive xed

Demand forgood A is directly

related to changesin price of good B

Upwardsloping

xed curve

Example

Chickenand turkey

Independent goods

Zero xed

Demand for goodA does not change

when price ofgood B changes

VerticalXed

curve

Example

Chocolateand

insurance

Demandfor good A is

inversely

related tochanges in

price of good B

Downwardsloping xed

curve

Example

Complements

Negative xed

Paint andpaint brush

Cross elasticity of demand

Close

substitutes

High positive

Distantsubstitutes

Distantcomplements

Low

negative

High

negative

Closecomplements

Low

positive

Degrees ofxed

% qD of product A

% p of product BXed =

Mind map 6.7 Price elasticity of supply

A measure ofthe responsiveness

of supply toa change in price

Definition

Infinity

Elastic

A changein price causes

a greater %change in supply

Coefficient

Unitary

Coefficient

Coefficient

> 0 1


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38 The Price System

Mind map 6.8 Equilibrium price

Demand and

supply are

equal

No market pressure for

price or quantity

to change

Achieved where

Equilibrium price

Position of

balance

Producers plans to

supply are equal to

consumers plans to buy

No surplus

No shortage

Results in the

market clearing

If market conditions

change

Price and quantity

alter to restore

equilibrium

Mind map 6.9 Disequilibrium price

Demand and supplyare not equal

Market pressurefor price and

quantity to change

Occurs where

Disequilibrium price

Demandexeeds supply

Supply exceedsdemand

Price driven up

Demandcontracts

Supplyextends

Market failsto clear

SurplusShortage

Price driven down

Demandextends

Supplyextends



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The Price System 39

Mind map 6.10 Indirect taxation

Contraction

in demand

Rise in price

Decrease in supply

Effects

Imposition of an indirect tax

Shift in

supply curve

Specific

tax

Parallel

Ad valorem

(%) tax

Ad valorem

Non-parallel

Burden

Elastic demand

Inelastic

demand

Mainly on producer

Mainly on consumer

Examples

Specific

Excise duty

Sales tax/vat

Mind map 6.11 Subsidy to producer

Extension

in demand

Fall in price

Increase in supply

Effects

Shift insupply curveto the right

Specificsubsidy

Ad valorem(%) subsidy

Non-parallel

Benefit

Elasticdemand

Producers

Inelasticdemand

Consumer

Examples

Agriculturalproducts

Productsproduced by

Strategicindustries

InfantindustriesParallel

Subsidy to producers



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40 The Price System

Mind map 6.12 Subsidy to consumer

Extension in supply

Increase in price

Increase in demand

Effects

Shift in demandcurve to the right

Subsidy to consumers

Aim

Examples

Merit goods

To increaseconsumptionof the product

Mind map 6.13 Consumer surplus

The difference betweenthe price consumers

are prepared to pay andthe price they actually pay

DefinitionArea

PED

The more elasticthe supply

The lower theconsumer

surplus

Above the priceline and below

the demand curve

Effect of aprice change

Price

rise

Reduce

consumersurplus

Increaseconsumer

surplus

Pricereduction

Consumer surplus



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The Price System 41

Revision Activities

1. In each o the ollowing our cases, draw a demand andsupply diagram and explain the eect on the market ornewspapers o:(a) an increase in the cost o paper(b) a decrease in the quality o internet news

websites(c) ree gis provided by newspapers(d) the introduction o a more efcient printing

process.

2. A rise in the price o a particular model o car rom

$12,000 to $15,000 results in an extension in supplyrom 500 to 600 a week.(a) Calculate the price elasticity o supply.(b) Is supply, elastic or inelastic?(c) Would the car rm want to change its price

elasticity supply?(d) I the car rm does want to change its PES, how

could it achieve this?

3.

(a) Why might the PED gures seem to be wrong butwhy might they be right?

(b) What should the rm do to the price o each o itsproducts to raise revenue?

(c) What should the rm do to the price o each type ogi tags?

(d) In the long run, which type o wrapping papershould the rm specialise in?

Short Questions

1. Why do demand curves slope down rom le to right?

2. What is meant by derived demand?

3. Explain three actors that inuence demand or airtravel.

4. What is the dierence between a contraction in demandor ice cream and a decrease in demand or ice cream?

5. Explain what type o price elasticity o demand aproduct possesses i it has a perect substitute.

6. Explain two actors that could make demand or aproduct more price inelastic.

7. How does the PED vary over a straight, downwardsloping demand curve?

8. In most countries, services have an income elasticity o

demand which is both positive and greater than one.Explain what this means.

9. How does the cross elasticity o demand between onemodel o car and petrol dier rom the cross elasticityo demand between the model and other model ocars?

10. Explain three actors that could increase the supply orice in a country.

11. A rm produces both blankets and duvets. Explain whateect a all in the price o blankets is likely to have on its

supply o blankets and duvets.12. How does perishability inuence the price elasticity o

supply o a product?

13. Using a demand and supply diagram, analyse the impacto an indirect tax on a product which has inelasticdemand and elastic supply.

14. What moves a market rom disequilibrium toequilibrium?

15. What is meant by the laws o demand and supply?

16. What eect would an increase in supply and a decreasein demand have on the price and the quantity boughtand sold?

17. What is the dierence between joint demand andcomposite demand?

18. Why does the amount o consumer surplus receivedrom the purchase o a product dier betweencountries?

19. How does the price mechanism ration products?

20. Why may the market price dier rom the equilibriumprice?

Data on a frm producing wrapping paper

Luxury wrappingpaper

Standard wrappingpaper

PED =-0.5 PED =-2.0

YED = 2.5 YED = 0.5

XED in relation to rivalbrand = 0.2

XED in relation to rivalbrand = 1.5

XED in relation to ownbrand o luxury gi tags=-0.1

XED in relation to ownbrand o standard gitags =-2.0



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42 The Price System

1. What causes a movement along a demand curve?A A change in income

B A change in population sizeC A change in priceD A change in tastes

2. What would cause the demand curve or cinema ticketsto shi to the right?A A all in the price o cinema ticketsB A rise in the price o transport to cinemasC Te removal o a tax on cinema ticketsD Te release o a number o very popular lms

3. A product alls in price by 8% and total expenditureremains unchanged. What type o price elasticity odemand does the product possess?

A ElasticB Perectly elasticC Perectly inelasticD Unitary

4. Te price o a product is initially $10 and 200 unitsare sold per day. Te price elasticity o demand or theproduct is -0.8. By how much would the price have toall to raise sales by 80 units?A $1B $3.2C $5D $8

5. Demand or a product is price inelastic. What eect will

a all in price have on demand and total revenue?

Demand otal revenueA Contract DecreaseB Contract IncreaseC Remain unchanged DecreaseD Remain unchanged Increase

6.

Figure 6.15

Price

P

D

D1

D

X Y

D1

0 Quantity

Figure 6.15 shows two demand curves. How does priceelasticity at point X compare with the price elasticity o

demand at point Y?A Demand is more elastic at point X than at point Y as

consumers are less sensitive to price changesB Demand is more elastic at point X than at point Y as

consumers are more sensitive to price changesC Demand is more inelastic at point X than at point Y

as consumers are less sensitive to price changesD Demand is more inelastic at point X than at point Y

as consumers are more sensitive to price changes

7. What is likely to cause a high price elasticity o demandor a product?A Te product is habit ormingB Expenditure on the product orms a small

proportion o total spendingC Te product is considered to be a necessityD Tere are close substitutes to the product

8. A demand curve or a product is a downward slopingdemand curve. What can be deduced about the priceelasticity o demand or the product?A It decreases as the quantity demanded decreasesB It increases as the quantity demanded decreasesC It is innity along the curveD It is unitary along the curve

9.Price o

Product X ($)

Quantitydemanded o

Product X

Quantitydemanded o

Product Y10 200 500

15 180 600

20 120 800

What is the cross elasticity o demand or Product Ywhen the price o Product X rises rom $10 to $15?A 0.2B 0.4C 0.6D 0.8

10. What does a cross elasticity o demand igure o 0.2

indicate about the relationship between two products?A Close complementsB Distant complementsC Close substitutesD Distant substitutes

11. Which types o products have negative income elasticityo demand?A ComplementsB Demerit goodsC Goods in joint supplyD Inerior goods

Multiple Choice Questions



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The Price System 43

12. What would make the supply o a product moreelastic?A An increase in the number o substitute productsB An increase in the speed o production

C A reduction in the durability o the productD A reduction in the spare capacity in the industry

13. Te price elasticity o supply o a product is 0.8. Initiallythe price o the product is $20 and the quantity sold is2,000. Te price then rises to $30. What will now be therms revenue?A $36,000B $40,000C $84,000D $108,000

14. Supply o a product exceeds demand. What does thisindicate about the market?

A Tere is a shortage with the market price exceedingthe equilibrium priceB Tere is a shortage with the market price being

below the equilibrium priceC Tere is a surplus with the market price exceeding

the equilibrium priceD Tere is a surplus with the market price being below

the equilibrium price

15. Te market price o a product rises but the quantitybought and sold remains the same. What change inmarket conditions could explain this impact on priceand quantity?A A decrease in demand and an increase in supply

B A decrease in demand with supply conditionsremaining unchangedC An increase in demand and a decrease in supplyD An increase in demand with supply conditions

remaining unchanged

16. Figure 6.16 shows the demand and supply curves olaptops. Te initial equilibrium position is X.

Figure 6.16

Price

D

D1

DS2

A

B

C

DX

S

S1

S

S2

S1

D2

D2

D1

0 Quantity

What will be the new equilibrium position i incomesrise and advances in technology reduce the cost oproducing laptops?A A

B BC CD D

17. Figure 6.17 shows the eect o imposing a tax on aproduct.

Figure 6.17

Price$ D

1

2

50 70

3

4

5

6

7

10

8

9

11

D

S

S

S1

S1

0 Quantity

What is the all in producers revenue?A $50B $100C $150D $190

18. What eect would the granting o a specic subsidy toproducers have on a market?A It would cause a parallel shi to the right o the

demand curveB It would cause a non-parallel shi to the right o the

demand curveC It would cause a parallel shi to the right o the

supply curveD It would cause a non-parallel shi to the right o thesupply curve

19. Figure 6.18 shows the initial demand and supply curveso a product. Te supply curve then shis to S1. What isthe change in consumer surplus?A XYZB PWZC PP1XZD Q1YZ



17/18

44 The Price System

20. In which circumstances would consumers bear most butnot all o an indirect tax?

Data Response Questions1. Te Department o Finance o Canada examined twenty

one studies o demand or air travel. Tese were mainlybased on behaviour in the US. It produced a summaryo what it thought were the most accurate estimates oelasticities or dierent segments o the market. Some othese ndings are given in able 1 and 2 below.

Table 6.1

Income elasticity o demand (YED)or air travel

YED value

otal market 1.1

Table 6.2

Price elasticity o demand (PED)or air travel

Market segment PED value

Long-distance internationalbusiness ights

0.3

Long-distance internationalleisure ights

1.0

Short-distance business ights 0.7

Short-distance leisure ights 1.5

(a) (i) State the ormula used to calculate incomeelasticity o demand. [2]

(ii) What can be concluded about air travel romable 1? [2]

(b) Using able 2, explain a likely reason or thedierent price elasticity values or:(i) business ights compared with leisure

ights. [3]

(ii) long-distance ights compared with short-distance ights. [3]

(c) Explain the signicance o the price elasticity valuesin able 2 or an airline considering a policy o arecutting. [4]

(d) Discuss the costs and benets o an increaseddemand or air travel. [6]

Q1, Paper 9708/21 Oct/Nov 2009

2. Prices o agricultural products can uctuatesignicantly. wo recent examples are changes in theprices o cotton and spices.

Aer a all in prices between 2008 and 2009, globalcotton prices trebled between 2009 and 2010. Tisreversal was, in part, caused by a all in the globaloutput o cotton rom 107m bales in 2009 to 101m balesin 2010. While output rose in India and Brazil, it ellin China, Brazil and Pakistan. Supply in Pakistan wasparticularly badly aected by devastating oods. Teollowing table shows the output o the major cottonproducers.

Table 6.3

Output o cotton in 2010

(millions o bales)China 31.5

India 26.0

USA 18.9

Pakistan 9.3

Brazil 7.0

Unusual weather conditions and ooding alsocontributed to a trebling o the price o spices

Figure 6.18

Price

P

P1

S

D

S1

W

X

YZ

Q1 Q0 Quantity

Price elasticityo demand

Price elasticityo supply

A 0 0.2

B 0.2 2.0

C 1.2 0.2

D 2.0 2.0



18/18

The Price System 45

produced in Asia a year later. Te price also rosebecause people not only in Asia but also in the US andEurope are using spices in their cooking; and spicesare increasingly being used or other purposes. Teseinclude using them in health products and in naturalcolouring.

Te higher prices were encouraging more armersin 2011 to devote more o their land to spices but itwas expected that it would take some time or this toincrease the quantity supplied. For instance, it takesve years to grow nutmeg.(a) What was Pakistans share o the global cotton

market in 2010? [1](b) What might cause a all in the price o cotton? [2](c) What eect would the rise in the price o spices

have on the price o natural colouring? [2](d) Does the inormation suggest that the supply o

spices is elastic or inelastic? Explain youranswer. [3]

(e) Analyse with a demand and supply diagram, whythe price o spices rose in 2011. [6]

() Discuss whether armers always benet rom a risein the price o their products. [6]

3. yre problems or the mining industry. In 2005, large-scale economic growth in China had

increased the demand or minerals to record levels. As aresult, 2005 was a boom year or mining worldwide, andoutput expanded rapidly.

Te huge earth-moving trucks used in mining needmassive o-the-road (OR) tyres. Tese tyres cost

$20,000 each and take a day to manuacture. By 2006,a major tyre producer, Bridgestone, estimated that

mining companies required 50%more OR tyres thanin the previous year, but the tyre producers struggledto meet this demand rom the mining companies. yreproducers stocks o tyres were very low, while xedproduction capacity meant that output had remainedsteady since 1999. It was not technically possible toswitch rom car tyre production to making OR tyres.

otal planned production or all o 2006 hadalready been sold and no new actories were due tostart producing beore the end o 2007. Another tyreproducer, Michelin, intended to spend $85m in itsactory in the US, and Bridgestone intended to raise itsactory capacity in Japan in 2008.

Rio into, one o the worlds largest miningcompanies, usually spent $100m on 5,000 tyres eachyear but instead aced the prospect o having to stoptrucks working while they had expensive tyre checks

and tyre repair. Te company predicted that this wouldlimit uture exploration or new sources o minerals andcause a rise in mineral prices.(a) Why can the demand or OR tyres be described as

a derived demand? [2](b) Explain why the supply o OR tyres was highly

inelastic in 2006. [4](c) Analyse with a demand and supply diagram,

the change in the market or OR tyres during2006. [5]

(d) How might a shortage o OR tyres aect theproductivity o mining companies? [3]

(e) Discuss whether the shortage o OR tyres required

government intervention. [6] Q1, 9708/2 Oct/Nov 2008

Essay Questions

1. (a) Explain with examples, the signicance o the valueo a goods cross elasticity o demand in relation toits substitutes and complements. [8]

(b) Discuss whether the demand or mobile phones(cell phones) is likely to be price-elastic or price-inelastic. [12]

Q2, Paper 9708/2 May/June 20062. (a) With the aid o a diagram, explain how consumer

surplus will be aected by the granting o a subsidyto producers. [8]

(b) Discuss whether a all in the price o a productwill always be accompanied by a reduction in thequantity traded o that product. [12]

3. (a) Explain how an equilibrium price or a product isestablished in a market and how it might change. [8]

(b) Discuss whether a rms revenue would increase, in

response to price and income changes, i the priceelasticity and income elasticity o demand or itsproduct becomes highly elastic. [12]

Q2, Paper 9708/2 Oct/Nov 2007

asa economics rev guide sample

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