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One of the determinants of price elasticity of supply is the market period of a specific good or product. The market period means that a certain time period is needed to let producers adapt to the market situation. Which means no matter how much the price of the product increases or how much product the producers want to produce, there is a specific time period needed unless the producers has ready extra unsold stocks or stored stocks. For example, the price of grapes increase and the grapes supplier can only supply 3 tons of grapes every 6 months and only 3 tons can be sold no matter how much increase or decrease in price as the grapes only ripens every 6 months and in this time period when the producers wants to sell more grapes to earn more, he cannot do that because grapes do not ripen in 1 day. Therefore, a market period is needed for the producer to grow more grapes and get a higher profit in future. The second determinant of price elasticity of supply is The Long Run concept. The Long Run concept states that there is a time period long enough for the producers to upgrade or expand their plants and also for new producers to enter the same business or for existing producers to leave the business. For instance, an electronic appliances manufacturer has time to upgrade their equipments, facilities, machineries and research to increase their products’ quality. Other than that, other future entrepreneurs would want to join into the electronic appliances industry over the long period of time due to the increased demand and higher pricings for appliances.
Question 3 Part A
Explain any three (3) reasons why supply of a product increases.
One of the most important reason why supply of a product increases is price. If the price of a product in the market increases, the producer would definitely increase the supply or production of that particular good or product and if the price of that product decreases, the supply for that product would be cut down by the producers. The second reason why supply of a product increases is the demand for that product. If the demand for the product increases, the producer would increase the production and if the demand of the product decreases, the producer would decrease the production. The third reason why supply of a product increases is technology because allows the producers to mass produces a particular good or product.
Question 3 Part B
What do economists mean when they say that “price floors and ceilings stifle the rationing function of prices and distort resource allocation”?
Price floor is the minimum value or price that is set and limited by the government. A price that is equal to the price set by the government or higher than the price set by the government is legal but any price that is lower than what is set by the government is illegal. Price floors that are higher than the equilibrium prices are normally invoked by the society when they feel that the free functioning of the market system is not providing enough income for certain parties, resource suppliers or producers. The agricultural products and current minimum wages are supported and these are examples of price floors. For example, house developers would have to develop flats as requested by the government and a price floor is set by the government so that people of a certain income can be able to purchase a house. For one flat, the price will be set by the government at RM80,000 and any price lower than that is illegal.
Price ceiling is the maximum price set by the government that is legal for a seller to charge for a product or service. A price that is equal to the price set by the government or lower than the price set by the government is legal but any price higher than what is set by the government is illegal. The use of price ceiling is to enable consumers that cannot afford the product or good or service at the equilibrium price. For example, the price ceiling per packet of rice is RM20.00. The price of a packet of rice cannot be more than RM20.00 but it can be lower than RM20.00
Price floors and price ceilings stifle the rationing function of prices and distort resource allocation because their profit is limited and the freedom of price increment or decrement is unavailable. For example, the producer expects to earn RM200,000 a month but once the government sets a price ceiling or price floor, the producer cannot achieve the expected profit.
Question 5 Part A
Explain and illustrate the difference between a decrease in demand and decrease 3in quantity demanded.
A decrease in demand refers to a decrease in the number of consumers that are willing and able to buy a certain product at a particular level of prices during a particular period of time. For example, the demand by our consumer is at 15 loafs of bread per week when the price per loaf is RM2.50 which means our consumers are willing and able to buy this 12 loafs of bread. When the price per loaf increased by RM0.50 from RM2.50 to RM3.00, the demand by our consumers decreased from 15 loafs to only 10 loafs per week and so on. The table below shows the decrease in demand.
Demand for Bread
Price Per Loaf
Quantity Demanded Per Week
A decrease in quantity demanded states that an increase in price will decrease the quantity demanded of a certain good or product. For example, the quantity demanded for petrol by our consumer is 50 litres per week and the price per litre is RM1.80. If the price of petrol were to increase to RM2.40 per litre, the quantity demanded for petrol by our consumers will be decreased to 45 litres per week. The quantity demanded for petrol by our consumers will continue to decrease if the price of petrol keeps increasing.
Question 5 Part B
Define income elasticity of demand. Describe any three (3) degrees of income elasticity of demand.
Income elasticity demand refers to how consumers adapt to the increment or decrement of their income. It is either they purchase more or less products according to their income increment or decrement. The first level of income elasticity of demand is referred as normal goods. Income elasticity must be positive if the good is a normal good. Positive is referring to the increase in consumer demand when their income is increased. In positive income elasticity, there are two categories which are called normal goods and superior goods. As for income elasticity which is a negative, it refers to the response from the consumers when their income is higher, the demand for specific goods is still the same as before. This means that consumers prefer to save money even though their income has increased but they don’t buy more of a certain product. The good that has a negative elasticity of demand is called inferior goods. The last category is necessity goods. The income elasticity for this category is zero. No matter how much the income rises or decreases, the quantity demanded for this category of goods is still the same as it is necessary in daily life.
Question 6 Part A
With the aid of appropriate diagrams, explain the concepts of consumer surplus and producer surplus.
The consumer surplus means the differences of a consumer or consumers who are willing to pay the maximum price for a certain good or product and the actual price of the good or product. The surplus arises due to the consumers who pay the equilibrium price even though many consumers are willing to spend more than the price obtained from the product. For example a consumer would want to pay RM8 for 1kg of oranges but the equilibrium price is only RM5 and therefore a RM3 is extra and is considered as a consumer supply.
Price per 1kg of Orange
– – – – – Equilibrium Price = RM 5
The producer surplus means the difference between the original price that a producer will receive or collect and the minimum expected and acceptable price. The sellers would normally get producer surplus in the markets because most sellers would accept a lower-than-equilibrium price without hesitation if the product is required to be sold. For example, a producer produces a bottle with the minimum acceptable price of RM1 but the sellers would be willing to pay and accept a price lower-than-equilibrium price if they were supposed to sell the products which is at RM0.80.
Question 6 Part B
Explain the three (3) economic concepts using the production possibilities frontier.
In production possibilities frontier (PPF) there are three categories which is scarcity, choice and opportunity cost. Scarcity refers to limited resources to produce goods that are demanded by consumers. Because of scarcity we are unable to produce and satisfy the consumers’ unlimited wish and demands. Because we cannot fulfill the demands of consumers, in the production possibilities frontier, there will be an inwards curve or a shift to the left because of scarcity. Choice is a cause of scarcity because when there is scarcity, people must make a choice based on which good is more important. Opportunity cost refers to two things that you desire but you are only able to purchase one good out of the two goods on the list. When opportunity cost concept is applied, we have to make a choice of purchasing one good and sacrificing the other but we must not regret the choice we have made.
Type of Production
For example, restaurant that can produce twenty steaks but can only produce ten burgers because of scarcity which forces the restaurant to not produce that many burgers. If the restaurant decided to produce thirty steaks, the restaurant can only produce 20 burgers due to scarcity. Finally, if the restaurant decides to produce 40 steaks, the restaurant can only produce the maximum of 30 burgers. Therefore, the restaurant can draw a production possibilities frontier graph referring to the three economics concept according to the table above.
McConnell, Brue and Flynn 2009, Economics (Eighteen Edition), McGraw-Hill, New York.
Tutor2u 2006, Price Elasticity of Supply, online, retrieved on 3rd May 2010. http://tutor2u.net
TAYLOR’S BUSINESS SCHOOL
Taylor’s Business Foundation
MARCH 2010 INTAKE
(Lecturer : Ms. Rabiah)
(Tutor : Ms.Marina)
(Tutorial Group – 1.1)
Student ID No.
Ling Kar Weng
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