Section B – Long questions

÷DEMAND, SUPPLY AND ELASTICITY

SAMPLE QUESTION: Distinguish between the economic meanings of a “movement along a demand curve” and a “shift in a demand curve”, with the aid of appropriate diagrams.

Solution:

Movement along a demand curve is caused by a change in the selling price of the good itself (ceteris paribus - all other things being equal.) This results in a change in quantity demanded, at different prices.

SAMPLE QUESTION:

Outline FOUR factors that determine the demand of a good or service.

Sample answer:

1. Changes in the price of other goods: • Substitute goods: (e.g. Lyons and Barry’s Tea) - If the price of a substitute good increases, then the quantity demanded for the good itself will increase, causing a rightward shift in the demand curve.

- If the price of a substitute good decreases, then the quantity demanded for the good itself will fall, causing a

leftward shift in the demand curve.

• Complementary goods: (e.g. cars and petrol)

- If the price of a complementary good increases, then the quantity demanded for the good itself will fall, causing a

leftward shift in the demand curve.

- If the price of a complementary good decreases, then the quantity demanded for the good itself will increase, causing a rightward shift in the demand curve.

2. Changes in consumer incomes:

• Normal goods: (e.g. L’Oréal shampoo)

- If income rises, then the quantity demanded for a normal good will increase, causing a rightward shift in the demand curve.

- If income falls, then the quantity demanded for a normal good will decrease, causing a leftward shift in the demand curve.

• Inferior goods: (e.g. Tesco own-brand shampoo)

- If income rises, then the quantity demanded for an inferior good will fall (as the increase in income is spent on higher quality goods), causing a leftward shift in the demand curve.

inferior If income falls, then the quantity demanded for an good will increase (as there is less money to spend on higher quality goods), causing a rightward

shift in the demand curve. 3. Consumer expectations: • If consumers expect the price of the good to be higher in future (e.g. stocks and shares) or that the good will become scarcer in the future (e.g. oil), then the quantity demanded for the good will increase, causing a rightward shift in the demand curve.

• If consumers expect the price of the good to be lower in the future (e.g. property prices during a recession) or that the good will be in plentiful supply in the future (e.g. fruit after a good harvest), then the quantity demanded will decrease, causing a leftward shift in the demand curve.

4. Change in consumer tastes:

• If consumer tastes change in favour of the good, then the quantity demanded will increase, causing a rightward shift in the demand curve.

• If consumer tastes change against the good, then the quantity demanded will decrease, causing a leftward shift in the demand curve.

SAMPLE QUESTION

If the price of a Giffen product were to fall (all other things being equal) would more or less of the product be purchased? Explain your answer with reference to the substitution effect and the income effect.

Sample answer:

Substitution effect: The quantity demanded for the good increases. This is because the good is now relatively cheaper due to its price reduction, so the consumer is getting increased marginal utility for their good.

Income effect: The quantity demanded for the good

decreases. This is because the consumer now has additional real income due to the reduction in price of the good. As this good is a Giffen good, the quantity demanded for it will decrease and the rise in income will be spent on better quality goods.

Overall, the demand for the good would decrease, as the income effect is much larger than the substitution effect for a Giffen good. This proves the theory that a Giffen good has a positive price effect.

SAMPLE QUESTION

Which figure stated below is most likely to represent each of the following:

• Income elasticity of demand for inner city bus transport

• Income elasticity of demand for Kellogg’s Cornflakes

• Price elasticity of demand for cuts of organic meat. +2.6 -0.2 -3.3

Give reasons for your choice in each case.

Sample answer:

YED for inner city bus transport is -0.2 - Inner city bus transport is an inferior good with regards to income, therefore a negative sign.

- Bus transport is a necessity for those using it to commute, therefore income inelastic (figure less than 1).

YED for Kellogg’s Cornflakes is +2.6

- Kellogg’s Cornflakes are a normal good with regards to income, therefore a positive sign.

- Kellog’gs Cornflakes are a non-necessity and therefore income elastic (figure greater than 1).

PED for cuts of organic meat is -3.3

- Cuts of organic meat are a normal good with regards to price, therefore a negative sign.

- Cuts of organic meat are a non-necessity and therefore price elastic (figure greater than 1).