The allocation of resources - Price elasticity of demand (PED) (3)
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1.
Question 1
The demand for a particular brand of organic coffee beans is analysed over the period 2022-2023. In 2022, at a price of £8 per kilogram, the quantity demanded was 100 tonnes. In 2023, at a price of £10 per kilogram, the quantity demanded fell to 70 tonnes. Calculate the Price Elasticity of Demand (PED) using the midpoint formula.
Answer:
The midpoint formula for PED is:
PED = ((Q2 - Q1) / Q1) / ((P2 - P1) / P1)
Where:
- Q1 = Quantity demanded in 2022 = 100 tonnes
- Q2 = Quantity demanded in 2023 = 70 tonnes
- P1 = Price in 2022 = £8 per kilogram
- P2 = Price in 2023 = £10 per kilogram
Substituting the values:
PED = ((70 - 100) / 100) / ((10 - 8) / 8)
PED = (-30 / 100) / (2 / 8)
PED = (-0.3) / (0.25)
PED = -1.2
Therefore, the Price Elasticity of Demand (PED) is -1.2. This indicates that demand is relatively elastic.
2.
Question 1
The price elasticity of demand (PED) is a key concept in economics. Discuss how the PED of a product can influence the decision-making of consumers, workers, producers/firms, and the government. Give specific examples to illustrate your points.
Consumer Decision-Making: Consumers respond to price changes based on PED. Elastic demand (PED > 1) means consumers are very sensitive to price changes; a small price increase leads to a large decrease in quantity demanded. They might switch to cheaper alternatives or reduce consumption. Inelastic demand (PED
Worker Decision-Making: PED can indirectly affect workers. If a product has inelastic demand, the firm is less likely to cut costs by reducing wages, providing more job security. Conversely, if demand is elastic, the firm might be more likely to reduce workforce to control costs.
Producer/Firm Decision-Making: Firms use PED to inform pricing strategies. Elastic demand suggests lowering prices can increase total revenue. Inelastic demand suggests raising prices can increase total revenue. Firms also use PED to make decisions about production levels and investment.
Government Decision-Making: The government considers PED when deciding on taxes. Inelastic demand goods (e.g., essential medicines) are often taxed as they generate significant revenue without significantly reducing consumption. Elastic demand goods (e.g., luxury items) are often exempt from taxes as they might lead to a large decrease in consumption. The government also considers PED when designing policies related to public services and subsidies. For example, subsidies for healthy foods might be more effective if demand for unhealthy foods is elastic.
3.
The demand curve for mobile phones is shown in Diagram 2. (a) Is the demand for mobile phones likely to be elastic or inelastic? Explain your answer. (b) Suppose the government introduces a tax on mobile phones. Using a demand curve diagram, illustrate the effect of this tax on the quantity demanded and the price paid by consumers. (c) Explain how the tax affects the burden of the tax between consumers and producers.
Diagram 2: (Imagine a relatively flat demand curve - indicating inelastic demand)
(a) Elasticity of Demand for Mobile Phones: The demand for mobile phones is likely to be inelastic. This is because mobile phones are considered a necessity in modern society. Even if the price increases, consumers will still need and purchase a mobile phone. The relatively flat demand curve in Diagram 2 visually represents this inelasticity.
(b) Illustration of Tax Effect:
To illustrate the effect of a tax on mobile phones, you would draw a demand curve. The tax will shift the demand curve upwards. This is because the price consumers pay will be higher, and the quantity demanded will decrease. On the diagram, you would show a new, higher price (P1 + Tax) and a lower quantity demanded (Q1) compared to the original equilibrium. The tax will be reflected in the price paid by consumers and the price received by producers. The tax will also lead to a decrease in the quantity traded.
(c) Burden of the Tax:
The tax burden is shared between consumers and producers. The extent of the burden depends on the relative elasticity of demand and supply. Since the demand for mobile phones is inelastic, consumers will bear a larger proportion of the tax burden. This is because they are less responsive to the price increase and will continue to purchase the phone, even at a higher price. Producers will bear a smaller proportion of the tax burden, as the quantity sold will decrease.