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Micro – Economics


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SAJC Prelims 2013
Jun 21, 2017
(a) Explain how the price mechanism allocates resources efficiently. [8] Essay Plan 1) Define Price Mechanism 2) Define “efficient allocation of resources” 3) Explain the adjustment process that allows the market to reach equilibrium price and quantity, hence achieving efficient allocation of resources i. Increase in dd (or decrease in ss) -> shortage -> price mechanism -> eqlb ii. Decrease in dd (or increase in ss) -> surplus -> price mechanism -> eqlb Price mechanism is the system through which producers and consumers interact to determine how scarce resources are allocated to competing uses. In a free market, price is determined by the demand and supply of the good. The efficient allocation of resources is where society’s welfare is maximised and any re-allocation of resources will make society worse off. To achieve allocative efficiency, price must be equal to marginal costs (P=MC), where consumers’ valuation of the good is exactly equal to the cost of producing the last unit of the good. Price mechanism can only help achieve efficient allocation of resources when there is perfect competition and externalities are absent. In the case where there is a change in taste and preferences in favour of a good, like Iphone, there will be an increase in the demand for the good, shifting the demand curve to the right. This creates a shortage at the original price, P1. Recognising the shortage, consumers will signal to producers that they are willing and able to pay higher prices to acquire the good, imposing an upward pressure on the price. As price rises, quantity demanded will fall, as reflected in the graph as an upward movement along the demand curve. At the same time, the higher prices will incentivise producers to increase the quantity supplied, as reflected by the upward movement along the supply curve. This process will continue until the shortage is resolved and a new equilibrium is established at E2. At any output level below equilibrium quantity, Q2, there is inefficient allocation of resources to the production of that good. This illustrates how the price mechanism helps to allocate resources efficiently by serving as a signal system which helps eliminate shortages in the free market, allowing society welfare to be maximised. On the other hand, if there is an improvement in technology which reduces the cost of production for Iphones, there will be an increase in the supply for the good, shifting the supply curve to the right. This creates a surplus at the original price, P3. Recognising the surplus, producers will reduce prices in order to sell off excess stocks, imposing a downward pressure on prices. As prices fall, there will be a fall in the quantity supplied, as reflected in the graph as a downward movement along the supply curve. At the same time, as prices fall, consumers will be willing and able to buy more of the good; the increase in quantity demanded is reflected as a downward movement along the demand curve. This process will continue until the surplus is resolved and a new equilibrium is established at E4. This again illustrates how the price mechanism helps to allocate resources efficiently by serving as a signal system which helps eliminate surpluses in the free market, allowing society welfare to be maximised. It should be noted that price mechanism can only achieve efficient allocation of resources when there is perfect competition and absence of externalities. Market imperfections such as imperfect knowledge as well as positive/negative externalities would result in inefficient allocation of resources and welfare loss to the society. (b) A government imposes taxes on a variety of goods and services which include alcohol, fuel and some imported goods. Discuss whether taxation would lead to a more efficient allocation of resources. [17] Essay Plan Introduction 1) Briefly state the use of taxes Thesis: 2) Explain how demerit goods like alcohol leads to market failure 3) Explain how taxation leads to more efficient allocation of resources Anti-thesis 4) Limitations of taxation 5) Taxation can lead less efficient allocation of resources Evaluation 6) Combination of policies – taxation combined with moral-suasion Market imperfections will lead to an inefficient allocation of resources, for example negative externalities arising from the consumption of demerit goods leads to an over-allocation of resources to the consumption of the good beyond the socially optimal level. To correct the market failure, government may impose taxes on certain demerit goods and services, which increases the marginal private costs borne by undertakers of the activity. If administered appropriately, the taxation should help to correct market failure. This essay will use alcohol as an example of a demerit good to illustrate how taxation is useful in leading to a more efficient allocation of resources. Demerit goods are deemed to be socially undesirable by the government. Such goods generate negative externalities in consumption or production. In the case of alcohol, there will be an over-consumption of it when left to the market forces. The marginal private benefit (MPB) is the satisfaction enjoyed by the undertakers of the activity for every additional unit of alcohol consumed, while marginal private costs (MPC) involves costs to purchase the alcohol and adverse health effects on the consumers. The consumption of alcohol generates negative externalities as there are significant external costs to third parties. The marginal external costs (MEC) involve life danger to third parties due to drunk-driving, higher crime rates and lower labour productivity to the economy. The marginal social costs (MSC) curve will always lie above the MPC curve since MEC causes a divergence between these two graphs; MSC = MPC + MEC. For simplicity’s sake, assume that there is no marginal external benefit (MEB) so MPB = MSB. In a free market driven by self interest, market equilibrium is at QF where MPB = MPC, as consumers ignore the MEC involved in the activity. The socially optimal quantity is at QS, where MSB=MSC. However, at QS, MSC is higher MSB due to the existence of MEC. There is over-consumption of alcohol beyond the socially optimal level, leading to welfare loss to the society. [draw graph] To correct the market failure and bring about a more efficient allocation of resources, the government may choose to impose taxes. The taxes should be equal to the MEC at the socially optimal output level in order to completely eliminate the welfare loss. The tax levied will increase the MPC (MPC’ = MPC + taxes), increasing prices from PF to PS. The new market equilibrium will now be at QS, the socially optimal level, where MPC’=MPB, hence resolving the over-consumption problem. This illustrates how taxes can help lead to a more efficient allocation of resources. However, there remain limitations to taxes which may limit the effectiveness of such policies in achieving a more efficient allocation of resources. In practice, it is extremely difficult and costly to accurately determine the MEC at the socially optimal level. In the case where there is overestimation of the MEC leading to over-taxation, there may be under-consumption of alcohol, where inefficient allocation of resources persists. On the hand, if MEC is underestimated leading to under-taxation, there will still be an over-consumption of alcohol. Nonetheless, it is important to note that having some form of taxation policies to reduce the gap between QS and QF is better than having none. Though welfare loss may not be completely eliminated, having some form of taxes will still lead to a more efficient allocation of resources than in the absence of such policies. There may be cases where taxes, imposed in the form of tariffs on imports, could worsen the efficiency in the allocation of resources instead. The countries from which goods are imported from are expected to possess comparative advantage in the production of such goods, associated with reasons like abundant factor endowment. This means that these countries face relatively lower (opportunity) costs in producing these goods and are expected to be more efficient producers in this case. When tariffs are implemented, price signals are distorted and imports prices are artificially increased. Given that locally produced products are highly substitutable with these imported goods, the demand for imports and domestic goods is expected to be relatively price elastic. The increase in prices of imported goods will lead to a more than proportionate increase in the quantity demand for imports. At the same time, locally produced goods will appear relatively cheaper now, leading to a more than proportionate increase in the quantity demanded for domestically produced goods. This illustrates a situation where there is an over-consumption of domestic goods, produced by less efficient local producers. At the same time, there is an under-consumption of imported goods, produced by more efficient foreign producers. Hence on the overall, tariffs may hence lead to a less efficient allocation of resources instead. In conclusion, whether taxes can help lead to a more efficient allocation of resources depends highly on the government’s ability to accurately determine the magnitude of the MEC involved. An over or under-taxation will fail to completely eliminate the welfare loss brought about by the consumption (or production) of demerit goods, like alcohol. However, some form of tax policies to reduce the gap between QS and QF is superior to having no correcting measures. It is also important that the government recognises the root cause of the problem and implement appropriate policies to address the issues. The government should recognise that apart from taxes, there are other policies which may help lead to a more efficient allocation of resources. The government should hence adopt a combination of policies – taxation as well as educational and awareness campaign. Awareness campaigns can help to increase consumers’ knowledge on the costs to third parties brought about by their activities. For example, the government in some countries like Singapore has widely advertised on the harm and danger to third parties brought about by over-consumption of alcohol and related activities like drunk-driving. These campaigns, accompanied by moral-suasion, may help discourage the consumption of alcohol, correcting the over-consumption problem and leading to a more efficient allocation of resources. However, since the effects of these campaigns may take a long time to set in, the government should combine tax policies with these campaigns for a more lasting outcome and a more efficient allocation of resources on the overall.
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AJC Prelims 2013
Jun 21, 2017
AJC 2013 Suggested Answers Question 3 In Singapore, there are many small home interior design firms in the industry. With low startup costs, these firms, such as Meng Design, usually market themselves as providing exclusive designs or affordable services. On the other hand, in the budget airline industry, Jetstar and Tiger Airways often offer lower-priced tickets. a) Explain why some firms remain small. [10] b) Discuss if Jetstar’s and Meng Design’s strategies are due to the characteristics of the industry they are in. [15] There are many reasons why some firms remain small and this can be explained by both demand and supply-side reasons. Demand-side reasons can include the need for personalised services as well as consumers’ preference for variety and individuality. Supply-side reasons can include the nature of production processes as well as the need for flexibility in fast-changing environment. This essay will elaborate on these reasons to explain why some firms remain small. On the demand side, one reason is that some firms may offer services where personalised attention is an important element. Such firms include hair-dressing salons and dental clinics. Since personalised services are required, the demand for labour per unit of output produced is relatively high and it is difficult for firms to mass produce. Hence, these firms tend to remain small in the industry. Another demand-side reason is that some firms may be selling products or services that require wider variety and greater degree of individuality to appeal to consumers. Such firms include designer fashion shops and home interior designers like Meng Design. These firms have to constantly differentiate their products by coming up with a wide variety of designs to ensure that their products remain unique to their firm. This means that such firms cannot engage in mass production since by doing so, its products will lose the sense of uniqueness and individuality, which are important elements in these fields. Hence, firms each produce a relatively low level of output in relation to market size, explaining why some firms remain small. On the supply side, one main reason why firms choose to remain small is highly associated with the law of diminishing marginal returns (LDMR) in the short run as well as diseconomies of scale (DisEOS) setting in at a relatively low level of output in the long run. LDMR states that as more and more variable factors of production are employed when at least one factor is fixed in quantity, the marginal returns of an additional unit of factor inputs will at some point begin to diminish. For example, a tailoring shop can increase the quantity supplied of their tailor-made clothes by employing more tailors and assistance. However, since the size of the shop is of a fixed size, having increasingly more tailors and assistants will eventually lead to overcrowding in the shop, leading to lower efficiency in the production process. The marginal returns of each additional unit of labour employed will start to diminish and total costs will increase faster than the total output, affecting the profits of the shop (assuming constant prices). This is one of the reasons why firms may choose to remain small. In the long run, all factors of production are variable. Due to the complex nature of production processes, some firms selling products like custom-made cards may experience DisEOS at a relatively low level of output. This is also associated with the personalised services factor explained above. The Minimum Efficient Scale (MES) of such goods is low in relation to market size, hence such firms would choose to remain small before DisEOS sets in, allowing them to keep costs down and remain competitive. Another supply-side reason is the need for flexibility and quick response to changing taste and preferences of consumers. For example, fashion shops and home interior design firms may need to quickly adapt to changing taste and preferences of consumers and alter their production processes to suit their needs. They may hence see the need to remain small, since small firms generally possess greater ability to detect changes in market conditions and have greater flexibility in modifying their production processes. Thus, such firms may choose to remain small to remain viable in a fast-changing environment. The abovementioned reasons hence explain why some firms remain small. b) Discuss if Jetstar’s and Meng Design’s strategies are due to the characteristics of the industry they are in. [15] Regardless of the industries that firms fall in, all of them engage in different strategies to help them achieve their aims; mainly to profit maximise. It is important to clearly identify the type of industries that Meng Design and Jetstar belong to in order to determine if their strategies are indeed due to the characteristics of their industries. The home interior design firms like Meng Design is likely to fall under a monopolistic competition (MC) industry. The preamble stated that there are many small home interior design firms in the industry which is in sync with one of the main characteristics of the MC industry – having a large number of sellers. Secondly, as each designer firm tend to offer designs and concepts unique to their firm, the products sold by these firms are likely to be differentiated, in both actual and perceived qualities, fulfilling another characteristic of an MC industry. Thirdly, the preamble also stated that these firms face low start-up costs, indicating low barriers to entry into the industry. Hence, home designing firms like Meng Design is likely to fall under a MC industry due to the characteristic they exhibit. With low barriers to entry, new entrants can easily enter the industry and compete away any supernormal profits that firms are earning in the short run (SR), thus firms in the MC industry earn only normal profits in the long run (LR). Existing firms would hence have the incentive to engage in non-price competition, with the aim of earning supernormal profits in the short run. By marketing itself as a firm that provides exclusive design and affordable services, Meng Design is trying to differentiate itself from its competitors through non-price strategies. This helps strengthen the perceived quality of their products from the perspective of consumers, hence increasing the demand for their design products. At the same time, these non-price differentiation strategies will also make their products appear less substitutable from rival firms’ products, making the demand more price inelastic. The increase in demand will eventually lead to higher supernormal profits for these home interior design firms. However, these supernormal profits can only be maintained in the short run due to the low barriers to entry into the industry. Hence, firms in a monopolistically competitive industry more commonly engage in non-price product differentiation strategies to capture supernormal profits in the SR. Hence, it can be argued that the strategies Meng Design implemented were due to the characteristic of the monopolistically competitive home interior design industry it is in. Conversely, there are also grounds to argue otherwise – that the strategies undertaken by Meng Design is not entirely due to the characteristic of the industry it is in, instead it could be due to other economic conditions. Take for instance a period of economic recession, Meng Design could have made the decision to market its products as affordable, in order to package its products as value-for-money. This would help maintain their pool of consumers even in times of recession. Similarly, during times of economic boom, there is an increase in the income of consumers, and demand for luxurious goods will increase by more than proportionate. By marketing its products as exclusive, Meng Design in injecting a luxury element into their products, making their products appear to be more upmarket. The demand for their products will also become more income elastic, meaning that a rise in income will lead to a more than proportionate increase in the demand. This will result in a large increase in revenue and eventually increasing profits for the firm. This illustrates that firms like Meng Design could be implementing strategies to tackle changing economic situations, instead of merely doing so due to the characteristics of the industry they are in. Unlike the home interior design industry, the budget airline firms like Jetstar is likely to fall in an oligopolistic industry. The industry is made up of few major players, like Jetstar and Tiger Airways, indicating that each firm has significant market power in the industry. Furthermore, the products offered by each firm are highly substitutable, as most of them offer similar products in terms of their services and the routes offered. This also means that firms in this industry are very mutually interdependent in their pricing an output decisions; a firm’s action can have major impact on their rivals and vice versa. In addition, there are large fixed costs involved in the establishment of a new firm in the industry, such as costs involved in planes purchasing, operational and maintenance. This suggests that there are high barriers to entry into the industry and existing firms can hence maintain their supernormal profits even in the long run. The mutually interdependence of firms in the industry can serve as a plausible explanation as to why Jetstar decided to offer low price tickets. The preamble stated that other firms like Tiger airways also offer low price tickets, this action of Jetstar could thus be in response to actions of its rival firms that have reduced ticket prices. As explained earlier, the products sold by firms in the industry are highly substitutable, this means that the cross elasticity of demand (XED) for Jetstar’s budget tickets is highly positive with that of rival firms. In the case where rival firms like Tiger Airways reduce the price of their tickets, the demand for Jetstar’s tickets will fall by more than proportionate as a large proportion of their consumers will switch to purchase from Tiger Airways. Hence, Jetstar will tend to follow the actions that rival firms have undertaken in order to prevent the loss of market share and profits. Hence, the strategies of Jetstar could be indeed due to the characteristics of the industry like mutual interdependence between firms. However, the strategies of Jetstar could be due to other reasons instead. There are many complementary goods offered by firms in the budget airline industry, such as tour packages, car rental services and inflight dining and products. These products have highly negative cross elasticity of demand with budget air tickets. By offering low price tickets, or reducing the prices of these tickets, Jetstar can increase the quantity demanded of their air tickets, and at the same time, increase the demand for the complementary goods that they offer. Hence, even if Jetstar experience a fall in revenue from lowering the ticket prices, the extra sales revenue generated from their sales of complementary goods will eventually lead to an overall increase in their sales revenue and profits. In conclusion, it is difficult to completely determine if the firms’ strategies are indeed due to the characteristic of the industry they are in. This is because a firm may adopt various strategies due to a wide variety of reasons, be it due to characteristics of the industry, prevailing economic conditions or other factors. For example, firms could implement certain strategies to help them tackle changing economic conditions, like a sudden recession in the economy, or change in taste and preferences unfavourable to the demand of their products. These reasons could however be mistaken to be associated with the characteristics of the industry these firms are in. It is possible to use the time period to help determine the reasons for the strategies implemented. In the short run, economic conditions could be more volatile and dynamic, firms’ decision would then revolve around the need to meet the changing income levels, or demand and supply of their goods, in order to increase their survivability in the market. For example, if there is a sudden change in taste and preferences unfavourable to their products, the demand for these products will fall. Firms would then have to focus their decision making and find ways to increase the demand for their products, by marketing and promotional strategies for instance. On the other hand, in the long run, external shocks average out and there is less volatility involved, it is then highly possible that firms’ decision making as well as price and non-price strategies could be attributed to the characteristics of the industry.
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GCE A Level 2009
Jun 21, 2017
Suggested answer A very popular band is due to play at one concert at a 5000 capacity venue. The plan is to charge different prices according to the area in which the seat is located. a) Explain whether this pricing policy could be considered to be an example of price discrimination. [10] GCE A Level 2009 Essay Plan 1) Define price discrimination 2) Briefly explain the different types of price discrimination (in particular 1st and 3rd deg) 3) Consider the main conditions for third degree PD to occur: i. Seller must possess market power, hence the ability to set prices ii. Each market, or group of consumers, must have different degree of PED iii. Each market, or group of consumers must be segmented and no resale of tickets is allowed iv. Product sold in different markets should be identical. Difference in prices charged should be due to reasons not associated with differences in costs. Suggested Answer Price discrimination (PD) occurs when a good or service is sold at different prices to different groups of consumers for reasons not associated with differences in costs. Types of PD include first, second and third degree PD. First degree PD is where each individual consumer is charged the maximum price he is willing and able to pay. Second degree PD is where the seller charges different prices for different ‘blocks’ of units consumed. The third degree PD is where consumers are segmented into different groups and each group has different degree of elasticity. The group with demand that are relatively more price inelastic will be charged a higher price as compared to the group with demand that is relatively more price elasticity. Using the main conditions for third degree PD to occur, this essay will explain how the abovementioned situation could be considered an example of price discrimination, in particular third degree PD. One of the main conditions for third degree PD to occur is that the seller must possess market power and hence the ability to set prices. In this context, the seller refers to the band and the concert organizers, which are likely to possess substantial market power since the band and the concert organisers are the sole producer/owner of the unique music pieces that the band brings to the audience. As a result, the seller will possess the ability to set their own prices. Price discrimination is thus made possible in this context. The second condition is that each group of consumers identified should have different degree of price elasticity of demand (PED). In this context, different groups of consumers would have varying demand schedules and preferences to where they wish to be seated when they attend the concert. For example, loyal fans with demand that is relatively more price inelastic may wish to be seated in the area of seats nearest to the stage. The concert organisers will hence price discriminate and charge higher prices where demand is more price inelastic, and lower price where demand is more price elastic. Thus, charging different prices according to the different areas where seats are located. Thirdly, each group of consumers and market should be clearly segmented and resale should not be possible. In this context, the markets are clearly segmented as each ticket is tied to a particular seat at the concert venue, hence a consumer who purchased a ticket in the lower-priced area will not be allowed to sit in the higher-priced area. Hence, this condition for third degree PD is also fulfilled. On the other hand, another important condition for PD to occur is that the product must be homogenous and the different price charged should be due to reasons not associated with differences in costs. In this content, the venue rental costs, wages to crew members and relevant workers and marketing costs are generally fixed. Hence, there will not be a difference in costs when providing seats in different areas. The different price charged are not due to cost differences. However, it is clear that the product sold in the different markets, are not considered to be homogenous/identical. This is because at different seating areas of the concert venue, the experience, visibility and sound quality will be different. These issues are highly associated with the distance from the stage and the layout of the venue. Taking into account the difference in quality and visual enjoyment, the different prices charged for different areas may then not be considered a case of price discrimination. On the overall, the abovementioned case has fulfilled most of the condition for price discrimination to occur. However, taking into account the difference in visual and sound quality at different seating areas, one could then argue that this is not a case of price discrimination.
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NYJC Prelims 2013 (modified)
Jun 21, 2017
NYJC Prelims 2013 [modified] Suggested Answers Technological improvement like faster broadband and internet connections has made the production and consumption of e-books more convenient. Such development has major impacts on the demand for and supply of print and non-print materials. (a) Explain how the markets for print and non-print materials might be affected by these developments. [10] With technological improvement like faster broadband and internet connections, the production and consumption of non-print materials, like e-books, have been made increasingly simpler. At the same time, such developments will also affect the market for print materials, like books, magazines, newspapers, to name a few. The effects on the two markets will be discussed in greater detail in subsequent paragraphs. Demand is the willingness and ability of consumers to purchase goods and services at a given point of time. The technological improvement mentioned in the extract has made non-print materials increasingly portable and accessible. This has led to a change in consumers’ taste and preferences in favour of non-print materials, especially so for tech-savvy consumers. The demand for non-print materials hence increases, shifting the demand curve to the right as seen in Graph 1 [See Graph 1 in Images/Photo gallery]. On the other hand, given that print materials are close substitutes of non-print materials, the demand for print materials will experience a fall and the demand curve will shift leftwards, as seen in Graph 2 [See Graph 2 in Images/Photo gallery]. Supply is the willingness and ability of producers to produce goods at a given point of time. Faster internet connections and other technological improvement have helped to make the production process of non-print materials more efficient. This reduces the time involved, and hence the cost of production, to produce the same amount of materials as before. Hence, producers are now more willing and able to produce more non-print materials at each and every price level, represented by the rightward shift in the supply curve as seen in Graph 1. On the other hand, since print and non-print materials are goods in competitive supply, the increase in demand for non-print materials will reduce the supply for print materials, assuming producers produce both print and non-print materials. This is because the increase in demand for non-print materials has imposed an upward pressure on prices leading to an increase in quantity supplied for non-print materials. Given resource constraint, producers will have to channel away resources from the production of print materials, to meet the increase in demand for non-print materials. Hence, the supply curve for print materials will shift to the left, as seen in Graph 2. On the overall, both the demand and supply for non-print materials increase. The magnitude of shift in the demand curve is expected to be larger than that of the supply curve. This is due to the increasing proportion of tech-savvy consumers, which tend to be attracted to non-print materials. On the other hand, although the improvement in technology has made the production process more efficient and reduced the cost of production of non-print materials, this is expected to be of a small extent since marketing, administrative and machinery costs still make up a large proportion of the total production costs. Hence, the equilibrium price increased from P1 to P2, and the equilibrium quantity increased from Q1 to Q2. As for print materials, both demand and supply fell. The fall in demand is expected to be of a larger magnitude than that of the supply curve. This is because in an increasingly technology-friendly environment, consumers are increasingly moving towards high-technology items, like non-print materials. Hence, equilibrium price decreased from P1 to P2, and equilibrium quantity decreased from Q1 to Q2. In the long run, as the environment gets increasingly high-tech and technology-intensive, more consumers will turn towards non-print materials. This will continue to impose a downward pressure on the price of print-materials such that producers may eventually find it worthwhile to cease the production altogether. Hence, it is possible that the non-print materials may eventually completely replace print materials in the long run. (b) Assess how price elasticity of demand, income elasticity of demand and cross elasticity of demand could be of relevance to a publisher of print materials. [15] There are many types of objectives which producers may aim to achieve, including sales maximisation and profit maximisation. To achieve his objectives, a producer has to be clear in his decision making process which usually includes pricing, product innovation and marketing strategies. To facilitate his decision making process, a producer makes use of several economics concepts like price elasticity of demand (PED), income elasticity of demand (YED) and cross elasticity of demand (XED). This essay will explain and assess the relevance of these elasticity concepts to a publisher of print materials, which includes a wide range of products like comics, journals, brochures and textbooks. PED measures the degree of responsiveness of the quantity demanded to a change in the price of the good itself. YED measures the degree of responsiveness of demand of a good given a change in income. XED measures the degree of responsiveness of demand of a good to a change in the price of another related good. Firstly, PED is relevant to a publisher of print materials as it can guide him in his pricing strategies, depending on the price elasticity of demand of the product he is selling, eventually helping him increase his total revenue. Take the case of a producer selling journals, magazines and comic books. The demand of these products is relatively price elastic as there are many close substitutes in the market. In this case, the producer should reduce prices as this will lead to a more than proportionate increase in the quantity demanded, thereby increasing his total revenue. [See Graph 3 in Images/Photo gallery] On the other hand, in the case where a producer sells textbooks and key reference books used in schools or universities, he may adopt the converse strategy instead. The demand for such printed materials is relatively price inelastic. The producer should hence increase price, which will lead to a less than proportionate decrease in the quantity demanded, hence increasing the total revenue of the producer. [See Graph 4 in Images/Photo gallery] Secondly, YED will be relevant if consumers do experience an income change, for example in the case of an economic boom or a recession. A producer with knowledge on YED concept can make better decisions in the type of products to sell as well as marketing strategies when there is a change in income. For example, if the economy is experiencing a boom, the publisher can focus on selling highly luxurious products, like journals and exclusive magazines. These products have highly positive YED values. Given an increase in consumers’ income, there will be a more than proportionate increase in demand for these products, hence increasing the total revenue of the publisher. On the other hand, if the economy is in a recession, the publisher can instead focus on selling either inferior goods, like lower quality or second-hand books, or necessities like textbooks. Inferior goods have negative YED values, which means that a fall in consumers’ income will lead to an increase in the demand for these products, thereby increasing the publisher’s total revenue. Necessities have low YED, so a fall in income will lead to a less than proportionate fall in their demand. At the same time, the producers could consider marketing his products as being value-for-money, for example “buy one get one free” strategies which may appeal to consumers in times of recession. Lastly, the concept of XED is relevant as it helps the publisher better understand the relationship between his goods and other related products, especially substitutes like non-print materials. In addition, the publisher can better recognise the degree of competition he is facing and hence guide him in his pricing and product differentiation strategies. Non-print materials have highly positive cross elasticity of demand in relation to print materials. This means that when publishers of non-print materials reduce prices, it will lead to a more than proportionate fall in the demand for print materials. The publisher of print materials may hence consider reducing the prices of his products, in response to a fall in his rivals’ price, in order to prevent a loss of existing and potential consumers. However, it should be noted that this may eventually result in a price war, which explains why producers tend to avoid using pure pricing strategies. Instead, publishers look to product differentiation strategies as well. The publisher of print materials can engage in product differentiation, through innovation to improve the quality and appearance of his products, and advertising strategies to appeal to the larger mass. This makes the products less substitutable, reducing the XED of the products in relation to other related goods. The publisher will then be less affected by rival firms’ pricing policies. Conversely, there can be situations where elasticity concepts may not be very relevant to a publisher in achieving his objections. The concepts explained above are highly relevant when it comes to maximising sales revenue. However, many producers may aim to profit maximise instead. While raising sales revenue does indeed help a producer increase profit (since Total Profit = Total Revenue – Total Costs), it does not take into consideration the cost structure and factors involved. To profit maximise, firms produce up to the point where MR = MC, while sales revenue maximisation will mean that output is produced up to where MR = 0. Hence, to profit maximise, costs concepts like Economies of Scale may be more relevant to a publisher than elasticity concepts. Furthermore, concepts like YED is highly dependent on the economic conditions, if there is no change in consumer’s income, then YED may not even be relevant at all. On the overall, the concept of cross elasticity of demand may be of greatest relevance to a publisher of print materials. This is because in an increasingly technology-embracing environment, print materials have progressively become more substitutable and replaceable by non-print materials like e-books, resulting in the high XED values between both types of products. It is hence of utmost importance that the publisher understands the concept of XED and recognises the likely impact of rival firms’ strategies on the sales of his products. Only then can he adopt the right decisions to prevent a loss of existing and potential consumers. PED is also of high relevance here, especially so if the publisher sells a wide variety of printed products, ranging from highly substitutable comic books to less substitutable textbook products. Equipped with knowledge on PED concept, the publisher can make appropriate pricing strategies for each type of product, according to their respective price elasticity of demand. However, it should be clear that while elasticity concepts are of relevance, there exists limitation to elasticity information. Firstly, elasticity information are historical figures, which may not serve as a useful predictor to gauge the responsiveness of quantity demanded and demand, especially in fast-changing environment. Furthermore, such information and data are estimates and their reliability is subjected to the strength of the data collection process. These reasons may limit the usefulness of elasticity information, despite that the concepts may be relevant to the publisher.
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A Level Economics Exam 2017 – Microeconomics
Jan 22, 2018
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A Level Economics Exam 2016 – Microeconomics
Jul 14, 2017
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