One of the determinants of price elasticity of supply is the availability of substitutes. The ease with which sellers can find substitutes-in-production affects the price elasticity of supply. The general rule is that goods with a greater availability of substitutes are more sensitive to price changes. With more substitutes available, sellers can easily respond to price changes. For example, a local seller that sells fried rice can easily switch to selling ‘nasi lemak’ because the raw materials are similar. It has a lot of very close substitutes can be sold because the resources used for production can easily switch between different goods. The number of available substitutes makes the price elasticity of supply extremely elastic. (N. Gregory Mankiw, Mark P. Taylor 2006)
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Another determinant of the price elasticity of supply is the flexibility of the seller to change the amount of goods that they can produce. The seller already has a large storage of resources and he can increase in the production of goods anytime he wants. This is the flexibility of his production. For example, a land in the highly populated area is very inelastic because it is difficult to produce more. However, mineral water or leather can be mass produce hence it has a high elasticity. They producer can keep the factories operate longer so that they can produce more.
Part B
With the concept of price elasticity of supply, businessman and businesswoman can price their items right. They can measure the supply goods’ responsiveness to its price. According to the law of supply, when the price of the good increases, the quantity supplied of the good will also increases. This shows a positive relationship between the price of the good and quantity supply of the good.
For example, when price of rice increases, more farmers plant more grain to increase the supply of the rice. Price of elasticity of supply is the percentage change in the quantity supplied divided by the percentage change in price. There are a few types of elasticity of supply which is perfect elasticity, perfect inelasticity, relative elasticity, relative inelasticity and unitary elasticity.
Price of elasticity of supply = Percentage change in Quantity supplied
Percentage change in Price
If the price of elasticity of supply (PES) is higher than 1, the good is relative elastic which means the percentage change in quantity supplied of the good is more than the percentage change in price of the good. If the price of elasticity of supply is lower than 1, the good is relative inelastic where the percentage change in quantity supplied of the good is less than the percentage change in price of the good. If the PES is equal to 1, it is unitary elasticity where percentage change in quantity supplied of the good is the same as the percentage change in price of the good. For perfect elasticity, the price of the good will not change no matter what the quantity supplied is. For perfect inelasticity, the quantity supplied will not change when the price of good changes. This help them to sell know which item to sell and at what price should they be selling. So they can strategize the good or service pricing accordingly. To have a stable revenue, relatively inelastic good are better because the change in supply is not much when the price changes.
Price
Relatively elastic
Relatively inelastic
Unitary elasticity
Quantity Supplied
Types of elasticity
Question 3
Part A
Supply of a product will increase because of the price of the raw materials decreases, price of a compliment good increase, and price of a substitute good decrease (N. Gregory Mankiw 2008). When the price of the raw materials of good A decreases, the cost of production of the good A also decreases. There will be more producers wanting to produce and supply this good because the cost is cheaper. This will bring more revenue to the producers if they supply them. This will lead to a rightward shift in the supply curve. When the price of a compliment good increase, the quantity supplied of the compliment will increases. Then there is an increase of supplier to supply good A because in the market there are a lot of compliment good resulting in an increase in supply of the good A. Thus leads to an increase in supply which will cause a rightward shift of the supply curve. As the price of a substitute good decrease, the quantity supplied of the substitute good will decreases indefinitely. When the substitute good’s value decrease, less producers will produce and supply it because of its low revenue rate. Instead of producing the substitute good, many will switch to good A due to its value. The result of such actions leads to an increase in supply of good A. Hence, the supply of the good will increase. A shift to the right will occur in the supply curve.
Part B
Price floors and ceilings are being symbolized as the border or the boundaries if the price ranges of a certain good. When uncontrolled, prices fluctuated to correct imbalances between the quantity supplied and quantity demanded in a market which also known as the equilibrium point. If the producers find themselves at a particular price where output is more than consumers are willing to purchase, the price will decreases. Likewise, if the market is not offering a good enough prices to satisfy consumer demand, there will be an increase in price. Price floors and ceilings prevent price fluctuations to maintain the equilibrium of supply in demand in the market. When a price is set above equilibrium also known as a price floor, producers will increase in production of goods to make more than the market can support, diverting resources away from other more important uses. Price ceilings result in an under allocation of resources toward a particular good, where the excess demand as known as shortage reveals that consumers value of the good and therefore the resources used to produce more than what the market currently offers.
Question 5
Part A
Law of demand states that the quantity demanded of a good will decrease when price of the good increase (N. Gregory Mankiw 2008). Only the price is responsible for the increase and decrease of quantity demanded of the good itself. A decrease in demand is a totally different concept than decrease in quantity demanded. The determinants of the increase and decrease of demand is preference or taste of the customers, rumours and expectation, price of a substitute good, etc.
When there is an increase in price of good A, the quantity supplied will decrease. In the demand curve the point will move upwards.
P1
P0
D1
Price of Good A
QS0
QS1
D0
Quantity Demanded of Good A
A decrease in price of a substitute good will cause an increase in quantity demanded of the substitute good. Consumers will buy more of the substitute good instead of good A. Less consumer will buy good A and thus a decrease in demand of good A. In the demand curve, the curve will shift leftwards. This phenomenon will occur in several more cases. For example, there is a rumour of the price of good A will decrease in the month. The consumers will wait till next month to save money. This will cause a decrease in demand of good A in the present and the demand curve shift to the left. Quality of good A is lower than of good B. Consumers with higher taste will prefer good B. There will also be a decrease in demand of good A and a leftward shift in the demand curve.
Price
Do
D1
P
QD0
QD1
Quantity Demand
Differences
Decrease in Quantity Demanded
Decrease in Demand
Price of the good itself
Point moves up the curve
Rumours of price of the good increase in the future.
Price of a substitute good decreases
Preferences of customer in a more superior good
The point shifts to the left
Part B
Income elasticity of demand is a measure of how much the quantity demanded of a good respond to a change in consumer’s income (N. Gregory Mankiw 2008). It is shown as the percentage change in quantity demanded of the good divided by the percentage in income.
Percentage change in quantity demanded
Income elasticity of demand =
Percentage change in income
When the income elasticity of demand (YED) is more than 1, it is to be said that the good is relatively elastic which means percentage change in quantity demanded (QD) is more than percentage change in income. When YED is less than 1, the good is relatively inelastic which means that percentage change in QD is less than percentage change in income. When the YED is equals to 1, the good is to be referred as unitary elastic where the percentage in QD and the percentage change in income is the same.
Question 6
Part A
Consumer surplus is the difference between the value a consumer place on units consumed and the payment needed to actually make a purchase of a commodity. There are some consumers in these world will always pay more to get what they want in life (Robert J. Carbaugh 2009). Any good or services like make-up services; a celebrity want to go to a movie premiere and he or she want to look fabulous, he or she will hire one of the best make-up artist or hair stylist even though its overpriced compare to the no name hair stylist or make-up artist. A limited edition football jersey which has no longer in production will be a target of a zealous fan. Just to collect the limited edition jersey he might be willing to pay 2 or 3 times more of the original price of the jersey, 5 or 6 times more if the t-shirt has his favourite footballer hand signature on it. An antique decorative which have been crafted centuries ago by a famous craftsman will attract wealth people who are interested in such investment. For example, the portrait of Mono Lisa painted by the famous Leonardo Da Vinci. This painting is very valuable and a lot of potential investors will buy it even though it is overpriced. All these situations is best described as consumer surplus. Consumer surplus is represented in the area under the demand curve above the price line.
Consumer surplus
E1 Market price
Q1
P1
Quantity demanded
Price
Consumer Surplus
Producer surplus is revenue that the producers receive over and above the minimum amount required to induce them to supply the good. The minimum amount has to cover the producer’s total variable cost (Robert J. Carbaugh 2009). When the price of a good in the market increases, there will be more producers to supply that good because it brings good revenue to the producers. When the price of a good falls in the market, naturally there will less producers willing to supply that particular good thus a decrease in quantity supplied in that good. Producer surplus can be represented by the area above the supply curve and below the price. It is the shaded area between the dotted line price and supply curve.
Producer surplus
Actual Price
QD
P
Price
Quantity demanded
Producer
Surplus
Part B
A production possibilities frontier is a curve that shows the different combination of various goods, any one which the producers can turn out, given the limited resources and technology (William J. Baumol, Alan S. Blinder 2009). The production possibilities frontier is base on three economy concepts which is scarcity, choices and opportunity cost. Scarcity means limited resources. Resources that are scarce are categorized into four types which are land, labour, capital goods and enterprise. Land is one of the natural resources which are limited. The earth only has so many lands to spare and one day it will run out. Land includes the surface of the earth, lakes, rivers and forests. It also includes the mineral deposit below the earth. Because of the limited resources we have, we have make choices on what to produce out of what we have. The optimal or the best choice will be made to maximise the resources we have. It is also known as the maximum combination of products. When a choice is made to produce a certain amount of goods, the resources will be used up and unable to produce other type of good. For example, a producer has 5kg of rice. It can be produce into fried rice or oil rice. But when 3kg of rice is used to produce 3kg of fried rice, 2kg of oil rice can only be produced. The other 3kg of oil rice is known as the opportunity cost. The production possibilities frontier shows the choice of the best available option given the recourses and technology limitation and forgoing the other available options.
Good A
Good B
The area under the curve is the less efficient combinations. The point that runs along the curve is the options of optimize combination. Any point which is outside the curve are option that are unavailable due to the limited resources and technology.
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