Negative and Positive Slope of Demand Function - Essay Example

?Lesson 4 Question Good Substitutes Complements An airline ticket Train ticket Hotel rooms, cargo service, Metro Cab service A mystery novel Mystery movie, horror stories, entertaining books, other novels More mystery novels or more editions of a mystery novel A floppy disk Flash memory drives as USB and Compact disk (CD) Floppy disk drives (FDD) Question 2 (a) Demand Curve: P-intercept = 800, Q-intercept = 400 Supply Curve: P-intercept = 200, Q-intercept = – 200 800 S 600 400 200 Q -200 -100 0 100 200 300 400 500 Demand and Supply equals at P = 400 and Q = 200 (b) As indicated by the negative slope of demand function and downward sloping demand curve, price and quantity demanded are negatively related to each other. As indicated by the positive slope of supply function and upward sloping supply curve, price and quantity supplied are positively related to each other. These relationships are same as supported by the theory of demand and supply that quantity demanded has negative (or inverse) relationship with price while quantity supplied has positive (or direct) relationship with price. (c) The slope of demand function is – 2. It tells that with the increase in quantity demanded by 1 unit, price of that good or service decreases by $2 (or 2 currency units). (d) The slope of supply function is 1. It tells that with the increase in quantity supplied by 1 unit, price of that good or service increases by $1 (or 1 currency unit). Question 3 Equating the demand and supply functions: 200 + 1 QS = 800 ? 2 QD ? 200 + 1 Q = 800 ? 2 Q ? 2 Q + 1 Q = 800 ? 200 ? 3Q = 600 ? Q* = 200 units Putting this value in either demand or supply function: ? P = 200 + 1 QS ? P = 200 + 1 (200) ? P = 200 + 200 ? P* = $400 Since this is an equilibrium price, it would be same for demand function too: ? P = 800 ? 2 QD ? P = 800 – 2 (200) ? P = 800 – 400 ? P* = $400 OR Directly solving for equilibrium P* and Q* by using the parameters form: a = 800 c = 200 b = 2 d = 1 Q* = a – c = 800 – 200 = 400 = 200 units b + d 2 – 1 2 P* = ad + bc = (800) (1) + (2) (200) = 1200 = $400 b + d 2 + 1 3 These equilibrium values for Price and Quantity are same as obtained graphically in part (a). Lesson 5 Demand for Food Tanzania is a low-income country, thus, the proportion of food expenditure (most basic necessity) of Tanzanian residents out of their income is very high. That’s why any change in prices of food is prominent and significant for them, which makes their food demand flexible in response to its price changes; i.e. with the changes in price, they vary their food consumption accordingly. However, U.S. is a high-income country. Its consumption is diversely distributed to variety of luxury goods in addition to the necessity goods. Thus, food consumption of American people comprises of a smaller portion of their income; in fact it is much smaller if compared with a low-income country as Tanzania. That’s why any change in food prices is not so observed by them which makes their food demand almost irresponsive to price. In short, high elasticity of food demand in Tanzania imply higher level of its foods purchases as compared to that in U.S. where food purchases are not so higher as compared to the purchases of other goods – luxury goods (Parkin n.d., p. 95). Taxes S’ (= S+T) P S D Q With the imposition of tax, supply curve shifts left as tax serves as increasing cost of production for producers. Now, the price paid by the consumer (PD) is not the same as that received by the supplier (PS) as the difference is to be paid as a tax; there would be no equilibrium now (The Impact of an Excise Tax or Subsidy on Price n.d.). It can be illustrated here in the graph that since the customer has to pay more price than before and since suppliers cost increases due to the tax, the market price would be increased and due to the increase in price, there would be leftward movement along the demand curve and thus the quantity demanded would be decreased. (a) Tax revenue would be greater from the good for which price increase would not much affect quantity demanded i.e. the good which demand is relatively price inelastic (Parkin n.d., p. 90). Since the expenditure on gasoline doesn’t cover major portion of an individual’s income and since gasoline is one of the necessity good, the price elasticity of its demand is very low. Thus imposition of tax on gasoline wouldn’t much hurt its consumption level i.e. people will still demand it as much as before with only a minor difference – people would have to purchase it up to the level that can be enough to cater their fuel demand. However the restaurant meals have elastic demand since it has other substitutes (home-cooked food etc.) and they are also narrowly defined. That’s why quantity demanded of restaurant meals would be decreased if their price increases on account of tax. This concludes that in order to maximize its revenue ($t * Q), government should impose tax on gasoline since this wouldn’t decrease its consumption (Q) much, and thus this minor decrease in quantity wouldn’t offset the increased revenue from tax amount ($t). On the other hand, the tax imposition on restaurant meals would decrease their consumption (Q) much enough to more than offset the increased revenue from tax amount ($t) thus decreasing the total tax revenue ($t * Q). Lesson 6 If the existing market mechanism is continued to proceed as it is without taking any action, the result of this even efficient allocation would be unfair as the poorest people who can’t afford the market price will be worse off due to having much lesser water than needed or just nothing. Thus, even though market allocation looks fair from the ‘Rule view’ as allowing the trade at market-determined price makes market efficient, it is unfair (and thus costly) from the ‘Result view’ as in the end the poor people can’t fulfill their need of water at the market price (Parkin n.d., p. 118-120). (a) Any price ceiling below the market price of $8 would reduce the quantity supplied because suppliers would be willing to supply less while it would also increase the quantity demanded. This would further increase the shortage; in fact in that case not only the allocation remains unfair, it would also become inefficient now. (b) Restricting such a use of water will restrict the consumption of those people who are using water more than just drinking it and are using it for watering the lawn or filling the swimming pool too. This restriction will thus serve as a quota on water consumption which would misallocate the resources and thus lead to inefficiency. (c) Since the market-based allocation is leading to unfair allocation of resources, government intervention is required. One of the best actions may be that government purchases all water, pay it for tax, and allocate it to each house equally. This will cause some people with more water allocated to them than they are willing to pay for and some people with less water allocated to them than they are willing to pay. Now after this non-market allocation when water would have been equally distributed, the government can allow trading at the market price. Now people who have been allocated more water than they are willing to pay for will sell water and people who have been allocated less water than they are willing to pay for will buy water (Parkin n.d., p. 121). In this way, efficient market allocation will also be back in to the system, after the fair allocation of resources has been done by the government. Who Pays a Tax? S + T P S D Q Since the demand is perfectly elastic, supplier (having normal price elasticity) can’t pass the tax in form of increased prices because if the price increases supplier would lose the significant level of consumer purchases. Thus, supplier has to charge same equilibrium price to buyers as it was paid by them before the tax. Therefore, all of the burden of the tax will lie on supplier – supplier would have to pay the entire tax. This can also be illustrated in graph that after tax PD (price paid by buyer) remains same but supplier price (price received by supplier) would drop on account of adding, to the equilibrium price, the entire tax to be paid by him. On the other hand, if the demand would be inelastic, the tax burden from the supplier would be shared by the buyers up to the extent to which demand curve is inelastic. Bibliography The Impact of an Excise Tax or Subsidy on Price n.d, accessed 8 March 2011, Parkin, M n.d., Economics, Web version, accessed 8 March 2011 from Archive.org Read More