Elastic and Inelastic Prices - Coursework Example

 Assesment 2 Question 1: Why do necessities tend to have demand that is price inelastic, while luxuriestend to have demand that is price elastic? Answer: When demand is elastic, an increase in price will result is a decrease in sales. The price elasticity of demand is the percentage change in quantity demanded divided by the percentage change in price. Put another way: The price elasticity of demand is a measure of the degree of sensitivity of demand to changes in the price. Luxury goods fall within the domain of price elasticity. An increase will lead to lower demand, and therefore, lower sales. Similarly, when demand is inelastic, an increase in price will hardly make a noticeable difference. For examples, cereals or salt. These are so basic to life that irrespective of the price increase, people will buy them. What Determines Elasticity * Necessities versus luxuries Eating at restaurants Groceries Those good that are regarded as necessities tend to have lower price elasticity, whereas demand for luxury goods is more price elastic. As consumers’ incomes go up the classification of certain goods may change. A good that is considered a luxury at lower income levels may be considered a necessity at higher income levels. * Availability of substitutes Chicken versus beef Those goods (and services) that have more substitutes are more price elastic. * Salt versus Nike Sneakers Generally, the demand for a good that takes a larger proportion of our income is more price elastic than for a good that absorbs a smaller proportion of our income. Question 2: Under what circumstances might a government price ceiling lead to the development of a black market? Answer: Price ceilings are government restrictions on prices. Usually these ceilings stipulate the legal maximum price a producer can charge for a particular good or service. Governments impose such controls normally to stop a rapid rise in the cost of a good or service during a shortage, in an attempt to benefit a favored constituency, or to hold down a general increase in inflation. Usually ceilings are applied to specific goods and services such as on oil during the Arab oil embargo of 1973-1974. But selective price controls usually end up harming the very constituency the government is trying to help. For example, rent ceilings destroy incentives to build and maintain low-income housing, resulting in less housing for the poor—the very ones who were supposed to benefit from the controls. The governments of some Third World countries impose price ceilings on farmers to win favor among the urban population by providing them cheap food. Ironically, the effect of such a policy is to reduce farm income and drive farmers off the land and into poverty in the cities—where at least they can get cheap food! Of course, fewer farmers means less food and thus increasing discontent among the now growing urban population. Question 1: Give some examples of opportunity cost. Answer: Opportunity cost is the cost incurred (sacrifice) by choosing one option over the next best alternative. Thus, opportunity cost is the cost of pursuing one choice instead of another. For example, someone who invests $10,000 in a stock denies oneself the interest that one can easily earn by leaving the $10,000 dollars in a bank account instead. Opportunity cost is not restricted to monetary or financial costs: lost time, pleasure or any other benefit that provides utility should also be considered. Opportunity cost is a key concept in economics because it implies the choice between desirable, yet mutually exclusive results. Another example: An 18-year-old graduating high school can attend a university for a cost of $25,000 per year. However, if he chooses not to continue his education, he can take a full-time job and make $35,000 during that same year. While he is only paying $25,000 to go to school, his opportunity cost would actually be $60,000, because in addition to what he is paying he is also passing up the opportunity to earn $35,000. Question 2: Why is the relationship between marginal product and marginal cost an inverse one? Answer: The reason why the relationship between marginal product and marginal cost is inverse is that the cost per unit of output is in a sense the inverse of output per unit of inputs (productivity): one uses lower quantity of inputs to produce an unit of output means higher productivity of inputs and thus lower costs per unit. Total fixed costs do not change, but the average fixed cost falls as one increases output because total fixed cost divided by the output quantity gives the average cost. Question 1: Why should anyone bother to study perfect competition, since it seldom or never exists in reality? Answer: Perfect or pure competition corresponds essentially to the supply and demand model. Perfect competition does not actually exist. Economists invented this concept so that they could more easily explore the logic of supply and demand, just as physicists need to explore what would occur at absolute zero even though they cannot produce absolute zero in their laboratories. It is observed that the perfect competition model defines a kind of ideal in which rational self-interest leads to an allocation of resources in which the efficient quantities of outputs are produced by enterprises of an efficient cost-minimizing scale. Thus, to determine the most efficient quantities of output to be produced, a study of perfect competition is necessary. This remarkable finding is a modern counterpart to Adam Smith's conception of the ‘invisible hand’. This makes it imperative to study perfect competition. Question 2: If all firms in perfect competition have the same average revenue and pay the same price for inputs such as labor and materials, why do they not all have the same profit? Answer: 1. In a perfect competition, following elements apply: Price-takers, Product Homogeneity, Perfect Mobility of Resources, Perfect Information In a perfectly competitive market, firms' only goal is to make as much of a profit as possible, profit being (revenue) - (cost). To maximize profit, they must get to a point when marginal cost, the cost of each additional unit of output, equals marginal revenue, the income of each additional unit of output. The reason why they do not have the same profit is due to variable costs, as opposed to fixed costs, that they have to spend on production as well as the availability of key knowledge procured through market intelligence about the existing or ensuing market conditions. Question 1: Why can a monopoly not sell all that it desires at any given price? Answer: The monopoly can sell at a given price only in the short term. Suppose the monopoly was allowed to run its course. If the consumers saw that it needed regulating, then they already know that the monopoly is taking advantage of them. The monopoly will get more and more inefficient and cost the society money. Rational consumers will soon stop purchasing the product that the monopoly has to offer or more likely someone will start up competition of the monopoly and the consumers will buy from them. Since the consumers already dislike the once monopoly, they would purchase from the new competition instead. This in turn would encourage others to compete in the market, thus ending the monopoly on the industry. Thus, the monopoly will not be able to sell all that it desires at a price determined by it. Question 2: How can an oligopolist make a profit at a given price, whereas a firm in perfect competition might suffer a loss at that same price? Answer: In oligopoly there aren’t very many competing companies, since there are high barriers to entry (expensive electronics, aircraft, microprocessor, car manufacturing industries) so competition cannot be easily created. Hence, they can sell their products at a price determined by them and make profit. However, the same can't be applied in a perfect competition. Let’s understand through an example. Suppose there are a lot of apparel stores, but none of the stores are substitutes for each other because they each have distinctive styles. Customers will be able to obtain good prices because while there are no perfect substitutes, the substitutes are close enough that if one store raised its prices exorbitantly, they would lose business. Question: 1. With an economic analysis from your readings as well as your personal stance, what will you do if gasoline goes to $15 per gallon? 2. What can you do as citizens to bring gas prices down? Answer: 1 & 2: If, for example, the price of the gas goes up to $ 15 per gallon in a certain city: * In the short run the demand for gas would be less elastic than in the long run. * In the long run, motorists would switch to fuel-efficient cars. * Although gas is considered a necessity, it is only a small part of what it costs to drive, thus demand would probably be inelastic. * For the entire nation, demand would be inelastic, but for a particular city, it would be very elastic since there may be many alternative choices of transportation. For example, some may switch to an alternative form of transportation. This is what any normal person or even I would do to contain the economic adverse effects of gas price escalation. REFERENCES http://personal.ashland.edu/~jgarcia/Microeconomics%20232/Classnotes/6%20elasticities%20Spring%202004.doc http://www.heritage.org/Research/HealthCare/bg929.cfm http://freelanceswitch.com/productivity/opportunity-cost/ http://answers.yahoo.com/question/index?qid=20070813215316AA6TLgR http://william-king.www.drexel.edu/top/Prin/txt/Comp/PC.html http://www.conservapedia.com/Model_Answers http://library.thinkquest.org/C004323/micro2.html Walstad, William B. An International Perspective on Economic Education (1994) London: Kluwer Academic Publishers. Read More