Q.
(a) The above diagram shows the demand curve (DD) and the supply curve (SS) for a perfectly competitive industry. Discuss the relationship that occurs with P if D1Q1 switches to D2Q2. (10 marks)
(b) Describe the price elasticity of supply and price elasticity of demand, as well as the differences that exist between them. (10 marks)
(20 marks, 2015 Q6)
(18.09.2015)
A.
(a)
[Factors take caused the shifting of D1 to D2 are factors outside of the firm which increase the demand for the product. These external factors are described with scenario below.
Take for example, tea or coffee being common choices of drinks among a population. People who drinks tea also drinks coffee, however the choice depends on price.
The causes of the shift could be:
1. Higher price of one of the substitutes. For example, coffee price increases will cause the demand of tea to increase as people choose to drink more tea than coffee.
2. Higher disposable income in the choice of drinks. For example, more people can afford a premium price drink - tea over coffee as tea drinking is of higher social status. This change of disposable income can be a result of changes in the government taxes or trade policy. It can be also increase in personal income or general economic condition of population.
3. Market trend of the products. For example, if the market trend of tea is to be of higher demand or becomes scarce - thus higher price trend in the future, people will stock up tea over coffee.
4. Factors like health concern or marketing strategy of perception of product. For example, tea is better as an anti-oxidant than coffee. Hence, more choose to drink tea for health reasons. This surge in demand for tea is may be due to government campaign or product strategy of the tea company.
As a result of increased demand, the quantity sold increases. As there is higher quantity sold (Q1 to Q2), prices will hike (P increases from P1 to P2), firms are attracted to produce more (S increases).
Due to higher supplies, the initially increased pricing (P) of the product will be curbed at a new level where equilibrium is met. This is the new equilibrium point at D2Q2.]
Ref:
[X] Own account.
(b) Price elasticity.
Please refer to earlier posts:
- Elastic or inelastic of demand,
- Price elasticity of demand and supply.
- Elasticity of demand and supply.