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Question - 1
In case of economics income elasticity of demand is the gradation of reactivity of the amount required of a good due to change in the buyer’s income, keeping other factors stable (Varian, Bergstrom and West, 2005).
According to the “income elasticity of demand”, goods can be classified into the categories like:
Now, in case of the “normal goods”, the “income elasticity of demand” is positive. This idea can be explained as the earning increases, the goods requirement also get increased per “price-level” (Nerlove, 2013).
The goods belonging to the range of 0-1 of “income elasticity demand” is considered as “necessity products”. Now, these are merchandized, whose consumption does not fluctuate with respect to the variation of the income of the consumer. This category can include “water”, “electricity” or “tobacco” (Corden, and Neary, 2008).
Inferior goods have a negative value of “income elasticity of demand”. With the increment in income of the buyers, the rejection of these types of goods happens. In this case the example is the rejection of “margarine” and usage of “butter” with the increase in income.
“Cross price elasticity of demand” or “cross-elasticity of demand” has its salient role in the field of microeconomics. It’s a concept of assessment of the responsiveness in the amount required of one good when a variation in the price of another product takes place.
Products having 0-coefficient are considered as “unrelated-items”. When the value of “cross-elasticity of demand “is negative, then the products are determined as the “complementary goods”. In simpler words, if the cost of one article gets increased, then the consumption of the good which is closely associated with the former one also gets dropped. For example “if the price of coffee increases, the quantity demanded coffee stir sticks drops as consumers are drinking less coffee and need to purchase fewer sticks. In the formula, the numerator (quantity demanded of stir sticks) is a negative figure and the denominator (the price of coffee) is positive. This results in a negative cross elasticity.”
But in case of “substitute goods” the value of the “cross elasticity of demand” is positive. Now, the relation between the two related products is that, if the cost of one item gets increased, the requirement of “the related one with the former item” also gets increased in a direct proportion. Here the example can be given as “if the price of coffee increases, the quantity demanded for tea (a substitute beverage) increases as consumers switch to a less expensive yet substitutable alternative. This is reflected in the cross elasticity of demand formula, as both the numerator (percentage change in the demand of tea) and denominator (the price of coffee) show positive increases” (Rybczynski, 2011).
Production possibility curve is drawn to show the relation between two non-identical items or services. This is quiet important in macroeconomics. From this curve the priority of the product is analysed and determined with respect to a fixed amount of capital for the goods production (Andreyeva, T et al, 2010). As the resource get limited, the increase in production of one item will results in the decrease in the manufacturing of the other one in respect to the quantity
This production possibility frontier has been explained by various models and examples. The bowed down shape of “PPC” is unique, that’s why it has been termed as “law of increasing opportunity cost”. From this graphical representation, it is clear that when the economy afford majority of its resources to the production of one type of goods, it loses its proficiency. For this reason the graph got flattened at the two extremes but appreciably curved in the middle portion.
Now this concept can be well explained by an example. Let the two non-identical product of this example be “gun” and “drainpipe “and the production resource is common and limited.
The comparative advantage of the company denoted by the green curve is greater than that of the company denoted with the violet curve.
To explain the given question, first of all, the learner has to have a good idea about the “perfectly competitive market”. It has some unique features which includes that the market comprise of a large numbers of companies of same product. Here, both the consumer and the seller are “price taker”. All the companies maximize their profits in this market. A perfect competitive market is controlled by “the marginal cost curve”. This is also known as “supply curve” in the terms of microeconomics. I9t can be defined as the supply curve of the company above the level, where the “average variable cost” is get over-shoot by the price (McCloskey, 2005).
This curve indicates the competitive organizations, about its productivity at a fixed price. Long run competitive equilibrium cannot predict the profit & loss of a competitive firm. In this case profit promotes the entry of the new firms in the market, but the loss compels an organization to leave the Market. But at the point when, the profit comes to zero, the entry and exit of any firm get stopped. This situation helps the competitive market to achieve a long run equilibrium status. Now, it should be understood clearly that, 0-profit does not signifies that the company is getting nothing at the end of the day. To explain this condition properly, the concept of “normal –profit” and “economic-profit” should be mentioned.
Normal profit can be said as the sum that would obtained by the owner of the company in the succeeding alternative. Economic profit can be expressed as the profit obtained over the “normal profit”. In the “long run” the company obtains 0-profit which makes the examination of the “competitive market” significant to the real market. The analysers have a prior vigilance over the “entry-exit” mark to identify a competitive business. A market can be said as a “constant cost industry”, when the “long run supply curve” is optimally constant. Without this, there may be two types of cost industries which are known as “increasing cost industry and “decreasing cost industry”. With the appearance of the new companies in the competitive market, “factor prices” goes up .this results in the expansion of the capacity of the existing companies in the market. This situation is actually related with the supply curve.
Question - 4
Actually price ceiling is the amount, that has been fixed by the government and, this is certainly lower than that of the “equilibrium price” of the market.
Now, this is a kind of imposition done by the government over the business organisation. But there are also certain reasons behind this act of the state. This is an initiative to stop the products from being exorbitantly high priced. “Rent control after the second world war” is a classic example of price ceiling (McCloskey, 2005). But sometimes “price ceiling” may give birth to a condition of the scarcity of commodities, whose price has been lowered down by the state. Emergence of the black market takes place due to this action of the government. In this context, the concept of price floor should be mentioned. It is the lower limit of the price of a product set by the government. But this must be greater than that of the “equilibrium price” of the market, in the benefit of the business-man. As various business taxes and duties are imposed by the government, this price ceiling is also like that, from the perspective of the producers and company owners (Dixit, 2012).
But there are some factors due to that, both the price ceiling and the price floor differ from taxes. In case of tax, a sum has to be paid to the state as the duty of carriage of the business as a whole, but in case of price controlling, there is no Involment of payment of money to the state. With the lowering down of the price of certain goods or services, the rate of consumption get increased which will results in the profit of the business. Price flooring prevents the companies to run in loss. That’s why this differs from tax.
McCloskey, D.N.,2005. The applied theory of price. New York: Macmillan.
Varian, H.R., Bergstrom, T.C. and West, J.E, 2005 Intermediate microeconomics (Vol. 4). New York: Norton.
Andreyeva, T., Long, M.W. and Brownell, K.D., 2010. The impact of food prices on consumption: a systematic review of research on the price elasticity of demand for food. American journal of public health, 100(2), pp.216-222.
Corden, W.M. and Neary, J.P., 2008. Booming sector and de-industrialisation in a small open economy. The economic journal, 92(368), pp.825-848.
Dixit, A.,2012. Irreversible investment with price ceilings. Journal of Political Economy, pp.541-557.
Fuchs, V.R.,2010. Income elasticity of demand. In The Growing Importance of the Service Industries (pp. 8-12). NBER.
Nerlove, M., 2013. Distributed lags and estimation of long-run supply and demand elasticities: Theoretical considerations. Journal of Farm Economics, 40(2), pp.301-311.
Roques, F.A. and Savva, N., 2009. Investment under uncertainty with price ceilings in oligopolies. Journal of Economic Dynamics and Control, 33(2), pp.507-524.
Rybczynski, T.M., 2011. Factor endowment and relative commodity prices. Economica, 22(88), pp.336-341.