A Strong Existence of the Law of Demand - Research Paper Example

Basic Economics Assignment “Microeconomics” Table of Contents a. Impact on ‘Law of Demand’ when there is no Scar of Resources 3 b. Efficiency of Price Mechanism in Solving Three Fundamental Problems of a Society and Defects of a Market System 4 2. a. Reasoning 5 2. b. Change in Methods of Production of Australia 6 2. c. Why Do Tourists Pay Higher Prices for Goods and Services in a Foreign City than the Local Residents of That Country? 7 3.0. Complementary Products: Bread and Butter 7 Condition (a) 8 Condition (b) 9 4. a. Price Elasticity of Demand 9 4. b. Short-Run and Long-Run Price Elasticity 12 4. c. Price Elasticity of Demand for a Particular Brand 13 4. d. If Price Elasticity of Demand for Cigarettes Is Inelastic 13 References 14 Bibliography 15 1. a. Impact on ‘Law of Demand’ when there is no Scarcity of Resources According to a theory of ‘Law of demand’, an inverse relationship exists between quantity demanded by customers and price of products and/or services. If there is no scarcity of resources in a given market, the price of a commodity may fall rapidly which in turn will provide rise to demand of the commodity. As stated in the theory, a decrease in price of a commodity increases its demand in market. Moreover, in economic perspective, human nature is termed to be always demanding which depicts that demand of commodity will continue to rise and thereby affecting its price at large. Therefore, it can be stated that whether there is a scarcity of resources or not, the ‘Law of Demand’ will still exist (Baumol & Blinder, 2009). Consequently, price rationing can also be observed in this case due to a fact that demands of human-beings are termed to be never-ending or unlimited. However, on the contrary, resources of goods are limited. Thus, price rationing will be strongly evident (Maddala, 2004). Conclusively, from an economic point of view, it can be stated that resources will be efficiently used when there is no scarcity. It is due to the fact that a strong existence of the ‘Law of Demand’ and the price rationing is likely to regulate the use of these resources. The graphical representation is shown below: 1. b. Efficiency of Price Mechanism in Solving Three Fundamental Problems of a Society and Defects of a Market System In the study of microeconomics, three fundamental problems faced by any society are: What goods and/or services can be produced in a given society and what will be an appropriate quantity of production? How to produce the required goods and/or services? The produced goods and/or services will be targeted to which market segment or customers? (Gabay & Et. Al., 2007). On the similar context, price mechanism is referred to as determining prices of goods and/or services with the influence of various forces of demand and supply in a given society. The theory assumes to have no interference in terms of external factors to the society. According to a theory of economics, producers always tend to produce those commodities which can be sold in market at a high price and apply those production techniques which are cost-efficient in order to maximise their profits. Similarly, customers tend to favour products which are less costly and thus it determines the price of the commodity in a given market. Thus, price mechanism states an interdependent relationship between self-interests of producers and buyers. In other words, actions of producers are regulated by actions of consumers and vice-versa. This efficiently determines quantity of production and price of a commodity, solving the three fundamental problems of a society (Jain & Khanna, 2007). However, there are a few defects that exist in a market which provides rise to various limitations of price mechanism theory. They can be identified as, market competencies, inefficient or wasteful productions, external influences, indolence of commodities, uneven circulation of income and others (Jain & Khanna, 2007). 2. a. Reasoning The aspect of ‘opportunity cost’ can be well identified in this case. It is referred to a cost of a product which is given up by a buyer to consume something else. In this case, council of the university decided to utilise its own plot of land instead of the land that was $3 million. The council, in this context, can also be observed to make the same mistakes in comparing the prices of two similar things as most of the buyers do. For instance, the rejected land could be more appropriate in offering a suitable atmosphere for the playground in comparison to the land owned. However, the decision can prove to be quite supportive in providing a long-term benefit to students, which the rejected tract would not be able to provide at the same cost. 2. b. Change in Methods of Production of Australia The term ‘capital-intensive’ refers to a situation, when an economy comprises of larger proportion of capital in comparison to labour. The term ‘labour-intensive’ is referred to a contradictory situation of ‘capital-intensive’ production. Previously, the Australian economy carried out its production process through labour-intensive approach, which depicts that the economy comprised of a huge proportion of labour than capital. However, to continue with the production method, firms in the economy required spending a certain amount of money in return of efficient labours. However, the production method led to profit maximisation which in turn increased the capital of firms in the economy. Thus, when the firms gained a major proportion of capital it turned to be capital-intensive, as the producers did not require spending extra amount in return of labours. It was also supported by the self-interests of the producers, i.e. to attain extra profit through cost-effective production methods. Here the opportunity cost of the capital-intensive production method was the cost of labour-intensive production method which motivated the producers to bring change in the production methods of the economy. 2. c. Why Do Tourists Pay Higher Prices for Goods and Services in a Foreign City than the Local Residents of That Country? According to the theory of economics, one of the major influencing factors of the opportunity costs is the scarcity of resources. It is due to this scarcity that tourists tend to favour the tourism locations of other countries than their local environment. In other words, tourists visit other countries with an intention to enjoy goods and/or services which are not available in their local region and thus tend to pay higher price than the local residents. The opportunity cost in this case can be referred to as the scarcity of goods and/or services which are available in foreign cities which in turn encourages tourists to pay a large sum of money. 3.0. Complementary Products: Bread and Butter The bread and butter are considered as perfect complements. Two goods are termed to be perfectly complementary when marginal rate of substitutes (MRS) is infinite and indifference curve is formed at a right angle. Another major attribute of two perfectly complementary products is that when price of one product decreases, the quantity of another decreases as well. For example, when the price of butter (bread) will increase the quantity of bread (butter) will decrease as well (Pyndick & Et. Al., 2007). However, the indifference curves for the two products can be presented as follows, Indifference Curves of Perfect Complements Condition (a) In the given condition, equilibrium price of butter has increased and equilibrium quantity of bread has also increased at the same time. Whereas, according to the characteristics of perfectly complementary products, price of one product and quantity of the other are inversely related. Thus, the condition provided is impossible in either of the mentioned situations, i.e. (i) price of milk has increased, and (ii) price of flour has increased. Condition (b) According to the second condition, equilibrium price of butter has increased and equilibrium quantity of bread has decreased. In this case, an inverse relationship between price of butter and quantity of bread can be well-observed which depicts that the situation is possible when the market is perfectly competitive and the products are perfectly complementary. Moreover, in a perfectly competitive market, firms tend to have almost no influence on the market price of product. Thus, an increase in the equilibrium price of butter can be identified as a consequence of the decrease in the quantity of bread. To be illustrated, with the increase in price of flour, the production cost of bread has also increased. In addition, in order to sustain profit, the producers will decrease their quantity of production, as they tend to be ‘price takers’ in a perfectly competitive market. Therefore, it can only happen when the price of flour increases (Pyndick & Et. Al., 2007). 4. a. Price Elasticity of Demand Price elasticity of demand is defined as a percentage change in quantity demanded as a consequence to a percentage change in the price of the product. In this case, it was expected that a price hike in tobacco products would lead to a percentage fall in the consumption of the product. However, fall in consumption was further expected to vary from that of higher-income level customers and lower-income level customers. Linear demand function of the price elasticity of demand in case of high-income countries is presented below: Linear demand function, when the market is elastic, Q= a-bP [Here, a is referred to the old quantity and b to the percentage change in quantity. a and b are both constants while P represents the price of cigarettes]. Given, b= 4% = 0.04 Hence, Ep= -0.04 Therefore, the linear demand curve of the price elasticity of demand for high income countries will be: Again, for the linear demand curve of the low and middle income countries, Q= a-bP Given, b= 8% = 0.08 Thus, Ep = - 0.08 Therefore, the linear demand curve of the price elasticity of demand for the low and middle income countries will be: From the diagrammatic presentations, it is well observed that the price elasticity of demand in high-income countries is less than that of lower and middle income countries. For instance, Ep for high income countries is – 0.04 which is greater than -1 but lesser than – 0.08, i.e. Ep for low and middle income countries. Moreover, the linear demand curves slope more towards the origin in the case of high income countries which depict that elasticity is lesser than the price elasticity of demand in case of low and middle income countries. 4. b. Short-Run and Long-Run Price Elasticity From the provided situation, short-run price elasticity of demand was -0.04 and – 0.08 for high income and low and middle income countries respectively. However, with the increase in time and gradual increase in the price of cigarettes, the price elasticity of demand is likely to increase in a long-run. Moreover, as the cigarettes are termed as inferior products, the elasticity of demand will continue increasing in the long-run (Pyndick & Et. Al., 2007). 4. c. Price Elasticity of Demand for a Particular Brand With a continuous increase in the price of a particular brand of cigarettes, it is most likely that consumers, especially in lower and middle income countries, will switch on to another brand with a lower percentage change in price. Therefore, the price elasticity of demand for a particular brand will be greater than the price elasticity of cigarettes in general. 4. d. If Price Elasticity of Demand for Cigarettes Is Inelastic The price elasticity of demand, Q = a – bP [Here ‘a’ is referred to old quantity and ‘b’ to percentage change in quantity. Both ‘a’ and ‘b’ are constants while P represents the price of cigarettes]. Here, b = -1, as the imposition of $1 tax on the consumption of cigarettes will increase the price of per unit of cigarettes to 1%. Thus, Ep = -1 which depicts that the price elasticity of demand in a short-run will become unit elastic. Due to this fact, a percent change in price will lead to one unit change in quantity demanded. References Baumol, W. J. & Blinder, A. S., 2009. Economics: Principles and Policy. Cengage Learning. Gabay, B. K. & Et. Al., 2007. Economics: Its Concepts & Principles (w/ Agrarian Reform & Taxation) 2007. Rex Bookstore, Inc. Jain, T. R. & Khanna, O. P., 2007. Development Problems and Policies. FK Publications. Maddala, 2004. Microeconomics: Theory and Applications. Tata McGraw-Hill. Pyndick, R. S. & Et. Al., 2007. Microeconomics. Prentice Hall. Bibliography Al Awami, H. A., No Date. The Law of Demand. Documents. [Online] Available at: http://cvlearn.com/Documents/The%20Law%20of%20Demand.pdf [Accessed March 14, 2011]. Read More