Resource Allocation in Competitive Markets (Demand & Supply)

Question 1

For questions pertaining to the impact of specific events on a market, we should consider changes to:

Answer 1

Price (aka cost of good to consumers);
Quantity (aka output); and/or
Revenue (aka expenditure)

Question 2

Summarise the FEEBLE framework (impact on a market not specified)

Answer 2

1. Factors affecting demand and supply (from preamble)
2. Elasticity of demand (hold dd, shift ss)
3. Elasticity of supply (hold ss, shift dd)
4. Bigger change in demand or supply (justify)
5. Link to adujstment to equilibrium process (show once)
6. Evaluation (alternative elasticity values or challenge ceteris paribus condition)

Question 3

What is the difference between explaining a “rise” in price versus a “spike” in price? [same for output change]

Answer 3

“Rise” = directional change, hence only dd/ss factors are required.

“Spike” = direction + magnitude, hence PED/PES factors are required on top of dd/ss factors.

Question 4

What are the key terms to include when explaining the relevance of any elasticity concept?

Answer 4

“More than proportionate” or “less than proportionate” changes.

• DO NOT use “hype” in your writing, e.g. “tremendous” rise in output or “collapse” in prices.

Question 5

What are the possible reasons leading to a rise in price?

Answer 5

1) Rise in dd
2) Fall in ss
3) Rise in dd exceeds rise in ss
4) Fall in ss exceeds fall in dd

Question 6

What are the possible reasons leading to a spike in price?

Answer 6

1) Rise in dd with price-inelastic supply
2) Fall in ss with price-inelastic demand
3) Rise in income with YED>1 (luxury good)

Question 7

What are the possible reasons leading to a sharp fall in output?

Answer 7

1) Fall in dd, PES>1
2) Fall in ss, PED>1
3) Fall in income, YED>1 (luxury good)

Question 8

What are the possible reasons leading to a rise in revenue?

Answer 8

1) Rise in dd
2) Fall in ss with price-inelastic demand
3) Rise in ss with price-elastic demand

Question 9

What is the impact on producers of a fall in ss, given price-inelastic demand?

Would the above outcome always benefit producers?

Answer 9

1) Revenue rises

2) Not if the fall in ss is due to higher production cost (e.g. effects of tax hike or higher wages)

Question 10

What are the parachute concepts and their associated methodologies under this topic?

Answer 10

1) Impact on a market - if specified, use TABLE under p.10; if unspecified, use FEEBLE
2) Uses of elasticity concepts - PED (pricing), YED (output), XED (marketing and pricing)
3) Government intervention - help consumers (Pc, s, others); help producers (Pf, s, others)

Question 11

What do we need to note whenever a question invokes a change in income?

Answer 11

Include YED analysis in your answer.

Question 12

When is PES analysis not needed under the FEEBLE approach?

Answer 12

When question pertains to the impact on revenue/expenditure.

• PES value does not affect the impact on expenditure, For example, an increase in demand increases revenue/expenditure, regardless of PES value.

Question 13

For CSQ, what is the difference between explaining the value of PED/PES versus YED/XED?

Answer 13

PED/PES: explain whether value is bigger/smaller than 1.

YED/XED: explain whether value is positive/negative, and whether it is bigger/smaller than 1.

Question 14

For essay questions pertaining to the impact on producers or consumers, which approach should we use?

Answer 14

FEEBLE

• Producers (link revenue change)
• Consumers (link price and output change to consumer surplus)

Question 15

What is the difference in elasticity values between a primary good (e.g. coffee beans) and a secondary good (e.g. Starbucks coffee)?

Answer 15

Primary good: PED is smaller than 1 (necessity; no substitutes) and PES is smaller than 1 (gestation period).

Secondary good: PED is greater than 1 (available substitutes) and PES is greater than 1 (available stocks).

Question 16

What are the relevant steps to consider when assessing the incidence of a tax or subsidy?

Answer 16

i. Assume that tax or subsidy affects production cost, hence shifting the supply curve.
ii. Always evaluate according to NEW equilibrium quantity exchanged, i.e. q2.
iii. Vertical distance between supply curves at q2 represents size of tax or subsidy.
iv. Consumer’s share is indicated by change in equilibrium price.
v. The party with the more elastic curve would have a lower incidence of tax/subsidy.

Question 17

What is an evaluative comment often attached to the concept of YED?

Answer 17

The nature of goods is subjective. For instance, fast food may be a luxury to a poor family, inferior good to a wealthy family and a normal good to a middle-income family.

Question 18

How can PED be of use to a producer?

Answer 18

PED helps with pricing decisions to increase revenue

• Lower price when PED is greater than 1
• Raise price when PED is smaller than 1 (preferred as cost is lower which raises profits)

Question 19

How can YED be of use to a producer?

Answer 19

Increase the output of normal and luxury goods when the economy is booming (income rising)

Increase the output of inferior goods when the economy is performing poorly (income falling)

Question 20

How can XED be of use to a producer?

Answer 20

When XED is positive and high (substitutes), advertising can be adopted to differentiate from rival products, hence reducing XED. Producer can also match price cuts by rivals.

When XED is high and negative (complements), joint marketing can be done.

Question 21

How can PED be of use to a government?

Answer 21

In taxing demerit goods such as cigarettes or alcohol which are addictive, campaigns or education should be introduced to complement the tax (for greater effectiveness). E.g. campaigns such as introduction of nicotine patches help to increase PED value.

Question 22

Evaluate a price ceiling (used to help consumers)

Answer 22

Pros
1) Some consumers can buy the good at a lower price

Cons

1) Some consumers lose access to the good
2) A shortage occurs, leading to an inefficient allocation of goods
3) Black market problem exists

Evaluative comments

1) The shortage is smaller when both PED and PES are smaller than 1.
2) Proper enforcement can prevent the formation of a black market.

Question 23

Evaluate a subsidy (used to help consumers)

Answer 23

Pros:
1) Equilibrium output rises and eqm price falls

Cons:

1) Producers may get a larger share of the subsidy if supply is relatively more price-inelastic
2) Burden on government budget to finance subsidy
3) Opp costs associated with the subsidy

Question 24

Other than a price ceiling and subsidies, how else can governments help consumers grappling with rising prices of necessities e.g. food?

Answer 24

Lower demand (eg: birth control or run campaigns to discourage food wastage)

Increase supply by using more advanced technology

Pros:
1) More sustainable method

Cons

1) Takes time to work
2) The use of more advanced technology requires funding, not feasible for governments with tight budgets

Question 25

Evaluate a price floor (used to help producers)

Answer 25

Pros
1) Some producers can sell their goods at the higher price

Cons

1) Some producers are unable to sell their goods at the higher price
2) A surplus results, hence there is an inefficient allocation of resources, may put pressure on the government to buy up the surplus

Evaluative comments
1) The surplus is smaller when both PED and PES are smaller than 1.

Question 26

Evaluate a subsidy (used to help producers)

Answer 26

Pros:
1) Producers receive a relatively higher price at a higher output level

Cons:

1) Consumers may get a larger share of the subsidy if the demand curve is relatively more price inelastic
2) Burden to finance subsidy

Question 27

Other than a price floor and subsidies, how else can governments help producers dealing with low prices (or workers faced with low wages)?

Answer 27

Lower supply by keeping out imported goods

Increase demand by improving quality of products

Pros
1) More sustainable in the long run

Cons

1) Takes time to work
2) To boost quality of products, advanced technology is required and its use may require funding from governments, which is not feasible for governments with tight budgets.

Question 28

For FEEBLE essays where the market(s) to analyse is not specified, recap the methodology for choosing your markets.

Answer 28

1) If preamble refers to a change in income, link to 3 markets with different YED values (normal, inferior and luxury good)
2) If preamble does not specific a change in income, pick 3 markets with the closest relevance to the developments in the preamble.
3) If question requires students to examine the impact on market A (e.g. oil) and related markets, consider 2 markets from the following selection:

1. Substitutes (e.g. biofuel)
2. Complements
3. Downstream market which relies on good X as a factor of production (e.g. air travel)
4. Joint supply
5. Competitive supply

Question 29

What is the difference between a change in “demand” and a change in “quantity demanded”?

Answer 29

A change in demand is represented as a shift of the curve (due to changes in EGYPT), while a change in quantity demanded is represented as a movement along the curve (due to price change).

Question 30

If a question requires us to explain the difference between PED, YED and XED, what do we consider?

Answer 30

1) All pertain to the demand function, but are TRIGGERED by different factors.

• PED: change in price of good
• YED: change in income
• XED: change in price of related good

2) Differences in DIAGRAMMATIC representation.

• PED: slope of dd curve
• YED/XED: movement of dd curve

3) Differences in SIGN

• PED: always negative
• YED/XED: positive or negative depending on nature of good/relationship between goods

4) Differences in FACTORS affecting them

• PED: PANTS
• YED: nature of good / income level of consumer
• XED: relationship between goods

Question 31

Define PED

Answer 31

Degree of responsiveness of quantity demanded of a good to a change in its own price, ceteris paribus. PED is always negative based on the Law of Demand.

Question 32

Define YED

Answer 32

Degree of responsiveness of demand for a good to a change in income, ceteris paribus. YED is positive in the case of normal goods and negative in the case of inferior goods.

Question 33

Define XED

Answer 33

Degree of responsiveness of demand for a good to a change in the price of another good, ceteris paribus. XED is positive in the case of substitute goods and negative in the case of complementary goods.

Question 34

What is the link between taxes and demand or supply shifts?

Answer 34

Change in personal income tax: affects demand (depends on YED value also)

Change in corporate income tax or GST: affects supply (though GST can be passed on to consumers)

Question 35

Diagrammatically, what is the difference between a specific tax (e.g. on cigarettes) versus an ad-valorem tax (e.g. GST)

Answer 35

Specific tax: parallel shift in supply curve
Ad-valorem tax: pivotal shift in supply curve

• A specific tax is calculated as a fixed amount per unit good, while an indirect tax is calculated as a percentage of the sale price of a good.

Question 36

List the factors that affect PED (PANTS)

Answer 36

PROPORTION of income that the good takes up,
the level of ADDICTION to the good,
the degree of NECESSITY of the good,
TIME period, and
the number/closeness of SUBSTITUTES to the good

Question 37

List the factors that affect PES (TIMES)

Answer 37

The TIME period, 
the nature of the INDUSTRY, 
the MOBILITY of factors, 
the EXISTENCE of spare capacity, and 
the level of STOCKS accumulated

Question 38

List the factors that affect demand (EGYPT)

Answer 38

EXPECTATIONS of income/price change,
GOVT policies,
INCOME (Y) change (link to YED),
PRICE of related goods (substitutes and complements), &
TASTE and preferences

Question 39

List the factors that affect supply (TAPES)

Answer 39

TECHNOLOGY (can link to cost of pdtn too),
ABNORMAL conditions (e.g. weather changes),
PRICE of related goods (joint/competitive supply),
EXPECTATIONS of price change (perishable good?)
SUBSIDIES (plus other factors affecting cost of production)

Question 40

What is the methodology to adopt for questions on whether demand or supply factors play a bigger role in explaining a price/output change?

Answer 40

1. Examine possible supply factors
2. Examine possible demand factors
3. Conclude which plays a bigger role
4. Link to PED/PES analysis (i.e. effects of demand change are affected by PES, while effects of supply change are affected by PED).

Question 41

Define PES

Answer 41

Degree of responsiveness of quantity supplied of a good to a change in its own price, ceteris paribus. PES is always positive based on the Law of Supply.

Question 42

Define a price ceiling

Answer 42

Legally established maximum price which is effective only if set below the equilibrium price.

Question 43

Define a price floor

Answer 43

Legally established minimum price which is effective only if set above the equilibrium price.

Question 44

What is the difference between an indirect tax and a direct tax?

Answer 44

Indirect taxes are imposed on goods and services while direct taxes are usually imposed on income.

Question 45

When a case study question requires students to account for the value of PED, what are the 3 possible ways to achieve this?

Answer 45

1. Factors (PANTS)
2. Formula (%change in qty demanded/% change in price)
3. Application (change in revenue, given specified change in price)

Question 46

When a case study question requires students to account for the value of PES, what are the 2 possible ways to achieve this?

Answer 46

1. Factors (PANTS)

2. Formula (%change in qty supplied/% change in price)

Question 47

When a case study question requires students to account for the value of YED or XED, what should be noted?

Answer 47

Remember to indicate sign and magnitude when assessing YED and XED.

Question 48

When the impact on the market is not specified, when is XED critical to the analysis?

Answer 48

When only two markets are specified in the question.

Question 49

When the impact on the market is not specified, how do you assess the impact on consumers?

Answer 49

Changes in price and output. When price rises or output falls, consumers suffer (can link to smaller consumer surplus).

Question 50

When the impact on the market is not specified, how do you assess the impact on producers?

Answer 50

Changes in revenue (or expenditure).

Question 51

When is YED applicable when assessing the impact on a market?

Answer 51

When the preamble hints at a change in consumers’ income, e.g. a worldwide recession

Question 52

What is the application of YED in assessing the impact on a market?

Answer 52

1) It helps us in determining how the demand for a particular good changes when income changes, depending on whether YED is positive (normal good) or negative (inferior good).
2) It helps us in determining the extent of shift of the demand curve, depending on whether YED is greater than 1 (luxury good) or smaller than 1 (necessity).

Question 53

For taxation or subsidisation, what should we bear in mind when analyzing its incidence?

Answer 53

Whoever has a more price inelastic curve will have the larger share of the tax or subsidy.

For incidence of subsidy, consumer’s share lies below producer’s share.

For incidence of tax consumer’s share lies above producer’s share.

Question 54

Diagrammatically, what is the difference between consumer/producer surplus AND consumer/producer tax/subsidy incidence?

Answer 54

Surplus is always a triangle, while incidence is a rectangle.

Question 55

How can a consumer’s incidence of tax be determined?

Answer 55

It is indicated by the change in equilibrium price multiplied by the new equilibrium quantity

Question 56

What is a general framework for assessing why the price of a good may be rising, albeit at a falling rate?

Answer 56

1) Demand rising at a slower rate (indicate factors that increase and decrease demand)
2) Supply falling at a slower rate (indicate factors that increase and decrease supply)
3) PES is rising (link to 1)
4) PED is rising (link to 2)

Above structure is subject to change, depending on circumstances highlighted in the preamble. For example, if the preamble highlights that supply is RISING, students need to establish that the rise in demand exceeds the rise in supply (in order for prices to rise overall).