e cons elasticity trick

JD SM CL A V2 HCI ECONS DD SS ELASTICITY

Basics Definition of Demand

The different quantities of a good or service that consumers are willing and able to buy at various prices over a given period of time, ceteris paribus.

Demand Factors

P rice of related goods (Substitutes/Complements/Derived Demand)

T aste and Preferences (Advertisements/Fashionable/Promotions)

Changes in Consumer I ncome (Normal/Inferior Good)

D emographics (Population/Age/Gender)

Changes in E xpectations (Expected income/prices/speculative demand)

Definition of Supply

The different quantities of a good or service that producers are willing and able to OFFER FOR SALE at various prices over a period of time, ceteris paribus.

Supply Factors

C ost of Production (raw materials, factor of production, technology, efficiency)

P rices of related goods (Competitive Supply, substitutes in production, joint supply)

Number of P roducers

S upply Shocks (Natural disasters, Climate Change, Strikes)

E xpectation Change by Producer (expect price to rise, hold on to stocks)

PED Definition


Measures the degree of responsiveness of quantity demanded to a change in pits own price, ceteris paribus. (>1=price elastic, <1=price inelastic)

PED Factors

Availability of Substitutes (number and closeness, the more substitutes, more price elastic)

Degree of Necessity (Basic/habit good, more price inelastic)

Proportion of Income (Larger the proportion, more price elastic. Smaller income proportion means consumers shouldn’t have much problem paying for it. )

Time Period (Price inelastic in short run and elastic in long run, alternatives may pop up)

PES Definition

Measures the degree of responsiveness of quantity supplied to a change in its own price, ceteris paribus. (>1=elastic, <1=inelastic)

PES Factors

Spare Capacity (Possible to increase production quickly with spare capacity. The more spare capacity available, the more elastic is its supply.)

Nature of Production (factor substitution, length of production period) (If it easy to switch to another product, degree of mobility of product, and does the product take very long to produce? Goods can be produced at short notice.)

Ease of accumulating Inventory/stocks (when demand drop, firms can immediately put them into reserves, the easier it is to do so, the more price elastic.)


Time (price inelastic in short run, price elastic in long run. Since firms have more time to rectify supply problems.)

YED Definition

Degree of responsiveness of demand to a change in the income of consumers, ceteris paribus. (>0<1=inelastic, >1=elastic, <0=inferior goods , >1=luxury goods)

YED Factors

Nature of the good (Necessities/Luxury)

Level of income of consumers (Some basic goods may be considered luxury goods to different people vice versa.)

CED Definition

Degree of responsiveness of demand for one good to a change in the price of another good, ceteris paribus.

What should you have in a market style queston? (15/25marks)

Introduction -Market is determined by the interaction between DD SS

-State the 3 MARKETS you identified

-State the concepts that you are using (E.G PED/PES )

Identify Market 1 -Define Demand

-State Demand Change

- Explain Demand Change using P-TIDE

-Define PES

-State PES

-Explain PES using SNIT

-State price increase/decrease with a more than/less than proportionate


increase/decrease in quantity

-Define Supply

-State Supply Change

- Explain Supply Change using CPPSE

-Define PED

-State PED

-Explain PED using SNIT

-State price increase/decrease with more than/less than proportionate increase/decrease in quantity

-Combine Simultaneous Shifts of both DD SS

-State equilibrium price increase/decrease/indeterminate( dependent on relative shifts ) and equilibrium quantity

increase/decrease/indeterminate

-Give judgement on whether supply/demand shift more

-Explain judgement

-State equilibrium price increases/decreases and quantity

increases/decreases based on judgement

* Always remember to link to your FIGURE (E.g Price increases from P0 To P1)

Identify Market 2 (Complement/Substitute factors)

Similar to structure above, but add in CED

(ADDITIONAL TO ADD) -Define CED

-State CED value

-Explain CED value (weak/strong substitute/complement using judgement)


-Deduce with price increase/decrease of _____, demand for ______ will increase

more than/less than proportionately.

Identify Market 3 (Complement/Substitute factors)

Similar to Above

Evaluation/Limitation (4 marks) -Ceteris Paribus Assumption (Assumes no other factors except own price, income and price of related good changes when PED,

YED AND CED used. In real life, many factors may be changing simultaneously.

For example when price of non-3G phones fall, demand for non-3G subscription plans

unlikely to rise as phone users may be changing to 4G smart phones)

-Short term VS Long term difference (Since elasticity might change in the long term as taste and preferences change over time. E.G fashionable iphone 6 may not always be attractive when Samsung7 comes out!)

* Usually 2 markets required for 15 marks and 3 markets for 25 marks.

YED question? (and mixture of PED, DD, SS)

Discuss whether the combined effect of the rise in incomes and the rise in GST is likely to cause the quantities of different types of goods sold to rise or fall. [15]

Introduction -Link Rise in Income to change in DD (since Income is DD factor)

-Link rise in GST to fall in supply (since GST is ad valorem tax)

-Identify the 3 different types of goods with differing Income Elasticity (YED<0,

0 <YED<1, YED>1)

-Identify also that the goods can be split up into |PED|<1 OR |PED|>1


Good 1 (Para 1) -State you are talking about inferior goods (YED<0)

-State what happens to demand when income increases for inferior goods

(decrease)

-State quantity increases

-Explain

-Go to supply side, state supply decreases due to TAX

-Link to PED>1

-Justify PED

-State final quantity drop

-Compare DD and SS and judge equilibrium quantity change

Good 2 (Para 2) -State you are talking about Income Inelastic Goods (necessities)

-State what happens to demand when income increases (increases less than

proportionately)

-Explain

-State quantity increases

-State what happens to supply when GST increases

-Explain

-PED Statement

-PED explanation

-State quantity change

-State equilibrium quantity change

Good 3 (Para 3) -State you are talking about luxury goods (Income elastic)

-State what happens to demand when income increases (increases more than


proportionately)

-Explain

-State quantity increases.

-State what happens to supply when GST increases.

-PED STATEMENT

-PED explanation

-State quantity change

-State equilibrium quantity change

Conclusion/Evaluation/Limitation -Make a stand that Q definitely↓for inferior goods, likely↓for necessities and

likely↑for luxury goods.

-One person’s inferior good might be another’s luxury.

-Ceteris Paribus might not hold. Multiple factors affecting DD SS, Demographics

might have changed as well….

How to write policy making/Strategy questions? (Firms)

Discuss how a supplier of a product that is currently fashionable might use both of these concepts in making price and output decisions.

Determine the AIM of Suppliers

Identify concepts needed

-Maximise Profit, with given costs

-Achieved through increasing sales revenues

-Increased profits if COST remains constant

-Suppliers need to look at YED (output) and PED (price)

Apply PED (Para 1) -State product fashionable means PED<1

-Demand inelastic explanation (few


close substitutes)

-Explain in Short run, supplier should raise price, since loss in revenue from fall in QD is less proportionate than the

gain in revenue from rise in price.

-In long run, supplier should decrease price, since monopoly profits might

attract other suppliers.

-More substitutes, dd more price elastic.

-Firm should lower price as….to remain competitive

-Other possible strategies (introduce different designs, differentiate product)

(Explain PED, LINK To strategy, propose new strategies, evaluate SR VS LR)

Application of YED (output) -YED depends on Income (define YED)

-Company will have to gauge future economy, whether economy will be

good or bad. (good-consumer income will rise, bad-consumer income will fall)

-Fashionable goods likely normal good. (determine type of good since it affects

YED)

-Therefore income is elastic (YED>1)

-If income likely rise, demand will increase more than proportionately.

-Output decision (Ensure enough stocks to meet demand)

-Order more early

-Increase production capacity by buying more machines, employing more

workers.

-Determine which part of the country to open more retail stores (places where


income most expected to increase)

Application of CED (How to react to a change)

-CED measures the closeness of complements/substitutes

-Determine CED value to rival products (since it is fashionable, probably very

poor substitutes, since very few similar products)

- can exercise rival consciousness in his pricing policy or conduct joint promotions with suppliers of

complementary goods

-When rivals raise price, no need to follow suit as product is differentiated in

the short run.

Limitations/Evaluation - Determination of elasticity values is an informational problem. Firms may not have perfect information.

-Ceteris Paribus

-Market demand cannot be used to analyze an individual firm’s output/pricing policies

-Time to acquire and act on information

Another Simple Essay structure example(without elaboration) on TAX and elasticity

The government proposes to increase tax on petrol. Assess relevance of PED and YED for success of proposal. [15m]

PED: directly relevantTax on petrol – COP increase – supply decrease vertically upwards by amount of specific tax – price of petrol increase (draw diagram to show shift in supply)Demand for petrol price inelastic – no close substitutes

YED: not directly relevant because tax on petrol affects priceYED: changes on incomeGovernment likely to be less successful if they increase tax on petrol in period of economic boom


Boom: incomes rise – demand for cars (luxury good) – increase by more than proportionately – derived demand – increase demand for petrol

Developments in modern technology such as faster internet connections have had major impacts on the demand and supply of e-books and associated products such as e-book readers and mass market paperbacks.

When the question mentions “such as faster internet connections”, do not limit developments in modern technology to just that. The question was just citing AN example.

Question mentions demand and supply, immediately it will be identifying the 3 markets

1. IDENTIFY 3 MARKETS (25MARKS) (2 MARKETS FOR 15 MARKS)

- Individual Analysis of e-book reader market

- E-book and e-book readers complement

- E-book and mass market paperback substitutes

2. Start on the general DD SS factors (first market)

- Developments in modern technology results in the addition of new features in e-books that provides added convenience (e.g annotation features, digital bookmarks)

- Modern technology has also made e-books become fashionable as people craze at the extreme convenience and added features. (faster internet connections in accessing e-books)

- As a result, there is a change in taste of preferences of consumers, leading to an increase in desirability for e-books, therefore resulting in an increase in demand for e-books and a shift in the demand curve to the right.

- (Link to graph) - Demand increases against a price

elastic supply. (as length of production period is short and easy to accumulate inventory/stock) ( price increases and more than proportionate


increase in quantity.)

-Supply will also increase due to a lower cost of production for producers. This is also due to the improvement in modern technology, as new programming languages are rolled out and websites offering e-book services are much easier to code. Supply therefore increases against a price elastic demand (availability of paperback substitutes high) ( price decreases and more than proportionate increase in quantity.)

-Evaluative paragraph (combine shifts of DD and SS), equilibrium price indeterminate and equilibrium quantity increases. Equilibrium price dependant on relative shifts of supply and demand. Price will decrease as supply will shift more than demand due to the relative few barriers of entry, whereas consumers take time to finish reading every single e-book as well, and the habit of reading takes time to inculcate as well.

Market 2 (E-book and E-book readers)

-FROM PARA 1 (MARKET 1), we already deduced that price of e-book decrease.

-E-book readers are complementary to e-book since e-book readers are required to load and read e-books (can be either computers/amazon kindle style tablets) They must be consumed jointly. Therefore, when the price of e-books decrease, the demand for e-book readers will increase, demand curve shifts to the right. Cross elasticity of demand measures the responsiveness of quantity demanded of a particular good, given a change in price of another good, ceteris paribus. Thus cross elasticity of demand of e-book readers that are capable to store the digital e-books with respect to prices of e-books


is possibility of negative and of a high value. Thus, given the fall in prices of e-books, demand for e-book readers will increase more than proportionately, as e-books and e-book readers are close complements to one another.

-Add in PES for DD (price elastic supply as well due to _____) (Price therefore increases with a more than proportionate increase in quantity)

- (supply side) The advancement in technology in recent years has caused the unit cost of production for these e-book readers to be lowered. The advancement in Nano-technology has enabled producers of e-book readers to be able to produce readers that capable of a larger memory space and also a lower unit cost of production. Thus, producers of e-book readers are more willing to produce and supply more e-book readers as it is profitable to do so. Thus, the supply for e-book readers will rise.

- Price elasticity of demand of e- book reader is price-elastic as price of e-book reader could take up quite a significant proportion of income for average consumers. Hence, increase in supply of e-book reader along price-elastic demand will result in decrease in price and more than proportionate increase in quantity.

- Compare Simultaneous effects of DD and SS AGAIN and come to a conclusion using JUDGEMENT

Market 3 (E-books and Paperbacks as -Demand for paperbacks would


substitutes) decrease due to a fall in price of related goods (e-books). However, using XED, we know that it is a negative value but may not be very high (weak substitutes), as there is still a significant proportion of consumers who prefer the traditional touch of books, and some may not want to strain their eyes in staring at digital screens. Thus, given the fall in prices of e-books, demand for paperbacks will increase less than proportionately, as ebooks and paperbacks are weak substitutes to one another.

-Add in PES and come to a conclusion on price and quantity

-Supply of paperbacks will increase as well as more producers will likely switch to technologically advanced markets (due to their expectations of a switch to more technologically advanced society), and due to a lower cost of production offered by technology driven markets.

-PED (Come to a conclusion on price and quantity)

-Combine simulataneous shifts, and make judgement once again.

Last paragraph (Limitation) Talk about limitations of economic analysis (ceteris paribus, other factors, etc) (memorise from NOTES)

GENERAL STRUCTURE GUIDELINE FOR DD SS +ELASTICITY MARKET QUESTIONS

STEP 1

FIND AND IDENTIFY YOUR 3 MARKETS

First market should always be a single one

The second third can be complements/substitutes/etc


DD + PES DEFINE DEMAND IDENTIFY WHETHER DEMAND

INCREASES/DECREASES EXPLAIN WHY USING DD

FACTORS (P-TIDE) DEFINE PES ADD IN PES, IDENTIFY WHETHER

PRODUCT PRICE ELASTIC/INELASTIC

EXPLAIN USING SNIT STATE WHAT HAPPENS TO

PRICE AND QUANTITY FOR THAT SINGLE DEMAND CHANGE

SS + PED DEFINE SS STATE WHETHER SUPPLY

INCREASE OR DECREASE FACTOR EXPLANATION USING

CPPSE DEFINE PED WHETHER PRODUCT DEMAND

ELASTIC OR INELASTIC EXPLAIN USING FACTOR SNIT STATE WHAT HAPPENS TO

PRICE AND QUANTITY FOR THAT SINGLE SUPPLY CHANGE

END OF EVERY DD AND SS POINT COMBINED SHIFTS OF DD AND SS, STATE EQUILIBRIUM PRICE AND EQUILIBRIUM QUANTITY AND MAKE JUDGEMENT

IF MARKET IS ON COMPLEMENT/SUBSTITUTE

BRING IN XED IN MIDDLE OF PARAGRAPH

EXPLAIN WHETHER VALUE LOW OR VERY LOW/HIGH/VERY HIGH (CLOSE/WEAK SUBSTITUTES/COMPLEMENTS)

Evaluate WHY XED price/quantity change (use

the words (more/less proportionately)

ADDITIONAL POINTS IF THERE IS TIME SHORT RUN VERSUS LONG RUN EVALUATION

LIMITATIONS


2 ND

Example of paragraph (N2008, market for MP3 player, a complement of digital music)

Digital recorded music and MP3 players are close complements, as a person who wants to listen to digital music would need a gadget like MP3 player or iPods to listen to it on the go. Cross elasticity of demand measures the responsiveness of quantity demanded of a particular good, given a change in price of another good, ceteris paribus. Thus cross elasticity of demand of products like iPods and MP3 players that are capable to store the digital recorded music with respect to prices of digital recorded music is possibility of negative and of a high value. Thus, given the fall in prices of digital recorded music, demand for MP3 players and iPods will increase more than proportionately, as MP3 or iPods and digital recorded music are close complements to one another. Supply of MP3 player is price-elastic as the production period for such manufactured goods is short. Hence, increase in demand in MP3 player along price-elastic supply will result in increase in price and more than proportionate increase in quantity.

The advancement in technology in recent years has caused the unit cost of production for these MP3 players to be lowered. The advancement in Nano-technology has enabled producers of MP3 players to be able to produce players that capable of a larger memory space and also a lower unit cost of production. Thus, producers of MP3 players are more willing to produce and supply more MP3 players as it is profitable to do so. Thus, the supply for music players like iPods and MP3 will rise from SS3 to SS4. Demand of MP3 player is price-elastic as price of MP3 player could take up quite a significant proportion of income for average consumers. Hence, increase in supply of MP3 player along price-elastic demand will result in decrease in price and more than proportionate increase in quantity.

Therefore, with the increase in demand and increase in supply, equilibrium quantity of MP3 players will definitely increase, but change in price is indeterminate.

The extent of shift of rise in demand for MP3 players would be smaller than that of increase in supply of MP3 players, as there are other substitutes of storing the digital music, like handphones. The equilibrium price will eventually fall from P3 to P4, with equilibrium quantity rise from Q3 to Q4.


Figure 2: Market for MP3 players

However, the magnitude of cross elasticity of demand for MP3 players or iPods with respect to digital recorded music may decrease over time. This is because, the sophistication of technology have made it possible for consumers to be able to listen to these digital recorded music on various other platforms like hand phones (iPhones) or even on their laptops (iPads). Thus, with the availability of various other platforms to enjoy digital music, the cross elasticity for demand for complementary music players like MP3 or iPods may not be significant. Thus, a given fall in price of digital recorded music will result in a less than proportionate rise in the quantity demanded for these music players. However, the demand for MP3 players will still increase from DD3 to DD4 given a lower price for digital recorded music.

e cons elasticity trick

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