EXERCISES Why will the price elasticity of demand for a particular brand of a product (e.g. Shell) be greater
than that for the product in general (e.g. petrol)? Is this difference the result of a difference in the
size of the income effect or the substitution effect?
The price elasticity of demand for a particular brand is more elastic than that for a product in general
because people can switch to an alternative brand if the price of one brand goes up. No such switching
will take place if the price of the product in general (i.e. all brands) goes up. Thus the difference in
elasticity is the result of a difference in the size of the substitution effect.
Will a general item of expenditure like food (or clothing) have a price-elastic or inelastic demand?
Discuss in the context of income and substitution effects.
The income effect will be relatively large
over a particular price range?
a) No goods fit into this category, otherwise price could rise to infinity with no fall in demand – but
people do not have infinite incomes!
b) Over very small price ranges, the demand for goods with no close substitutes, oil, water (where it
is scarce) may be totally inelastic.
What will the demand curve corresponding to the following table look like?
c. There would be infinite demand!
Referring to the following table, use the mid-point (arc) formula to calculate the price elasticity of
demand between (a) P = 6 and P = 4; (b) P = 4 and P = 2. What do you conclude about the elasticity
Which are likely to have the highest cross elasticity of demand: two brands of tea, or tea and
coffee?
Two brands of tea, because they are closer substitutes than tea and coffee.
Supply tends to be more elastic in the long run than in the short run. Assume that a tax is
imposed on a good that was previously untaxed. How will the incidence of this tax change as time
passes? How will the incidence be affected if demand too becomes more elastic over time?
As supply becomes more elastic, so output will fall and hence tax revenue will fall. At the same time
price will tend to rise and hence the incidence will shift from the producer to the consumer.
As demand becomes more elastic, so this too will lead to a fall in sales. This, however, will have the
opposite effect on the incidence of the tax: the burden will tend to shift from the consumer to the
producer.
If raising the tax rate on cigarettes raise more revenue and reduce smoking, are there any conflict
between the health and revenue objectives of the government?
There may still be a dilemma in terms of the amount by which the tax rate should be raised. To raise the
maximum amount of revenue may require only a relatively modest increase in the tax rate. To obtain a
large reduction in smoking, however, may require a very large increase in the tax rate. Ultimately, if the
tax rate were to be so high as to stop people smoking altogether, there would be no tax revenue at all for
the government!
You are a government minister; what arguments might you put forward in favour of maximising
the revenue from cigarette taxation?
That it is better than putting the taxes on more socially desirable activities. That there is the beneficial
spin-off from reducing a harmful activity. (You would conveniently ignore the option of putting up
taxes beyond the point that maximizes revenue and thus cutting down even more on smoking.)
You are a doctor; why might you suggest that smoking should be severely restricted? What
methods would you advocate?
That the medical arguments concerning damage to health should take precedence over questions of
raising revenue. You would probably advocate using whatever method was most effective in reducing
smoking. This would probably include a series of measures from large increases in taxes, to banning
advertising, to education campaigns against smoking. You might even go so far as to advocate making
smoking tobacco illegal. The problem here, of course, would be in policing the law.
Why is the supply curve for food often drawn as a vertical straight line?
It is because; the supply of food is virtually fixed in the short run. Once a crop is grown and harvested,
then it is of a fixed amount. (In practice, the timing of releasing crops on to the market can vary, given
that many crops can be stored. This does allow some variation of supply with price.)
The income elasticity of demand for potatoes is negative (an ‘inferior’ good). What is the
implication of this for potato producers?
Potato producers would expect to earn less as time goes past, given that national income rises over time.
Thus if the incomes of individual potato producers are to be protected, production should be reduced
(with some potato dairy farmers switching to other foodstuffs or away from food production altogether).
0 Comments