Markets, elasticity and taxation & subsidies

The exam

Markets

Elasticity

Taxation

Subsidies

1 HOUR 30 MINUTES LONG- 50% AS- TOTAL 80 MARKS

Supported choice:

8 questions for 4 marks each

Total 32 marks

Spend no longer than 36 minutes here

Data question:

33% evaluation

5 questions

Total 48 marks

Spend 54 minutes here

The supported choice:

Definition: 1 – 2 marks

Diagram: 1 - 2 marks

Annotation: 1 - 3 marks

Application/calculation: 1 – 2 marks

Further analysis: 1 – 2 marks

KOs – 1 – 3 marks – refer to key!

The data response – 5 questions:

4 MARK QUESTION

▪ purely knowledge and application marks

▪ Define the terms in the question (1 – 2 marks)

▪ remember to apply your knowledge to the extract

6 MARK QUESTION

▪ purely knowledge and application marks

▪ Define the terms in the question (1 – 2 marks)

▪ remember to apply your knowledge and draw diagramsif they’re relevant

The data response cont:

10 MARK QUESTION

▪ Definition/knowledge – 1 mark

▪ Application, analysis & diagram – 5 marks

▪ 4 marks for evaluation: (2 + 2)

14 MARK QUESTION

▪ Identification, analysis & diagram – 8 marks

▪ 6 marks for evaluation: (2 + 2 + 2) safest

Evaluation ideas:

Short versus long-run

Different elasticities

Magnitude of factors – use extract or data

Ceteris paribus – could other factors be the cause of these effects

Opposing viewpoints

Put the event in a wider context

You should know:

Factors which shift demand Factors which shift supply Consumer & producer surplus Role of the price mechanism Application to markets:

Agriculture

Precious metals

Oil

Stock markets

Labour

Factors that shift demand & supply:

DEMAND SUPPLY

Income Production costs

Population Technology

Tastes Number of firms

Price of substitutes Weather

Price of complements Tax

Interest rates Subsidies

Expectations Firms’ objectives

Which of the following is most likely to cause the price of gold to fall without a shift in the demand curve?

A An increase in national income.

B A decrease in the price of silver.

C An increase in the wage of gold miners.

D A decrease in the cost of machinery used in gold-mining.

Factors that shift labour demand & supply:

LABOUR DEMAND LABOUR SUPPLY

Demand derived from changes to product demand

Changes to the working population, such as net migration

Change to final product’s price & so firm’s revenue

Changes to wages, income tax, working conditions

Labour productivity Regulations

Changes to capital prices Value of leisure time

Qu. (June 2010)Assess the likely impact of the decrease in demand for new cars on the labour market for car workers.

Evaluation:

Magnitude – extract says 21.8% fall in 1st quarter Extent to which wages can fall – NMW & TUs Impact of occupational and geographical

mobility of labour Time – short-run sabbaticals? Impact on related markets – mechanics, jobs in

second hand car market

Price elasticity of demand:

You should know: Definition Diagrams Determinants Relationship with revenue Relevance to business

Price elasticity of demand is the responsiveness of quantity demanded to a change in price

PeD = % in Qd% in P

PeD is always negative – a demand curve slopes downwards!

PeD becomes more inelastic as you move down a demand curve

Inelastic: a change in price leads to a proportionally smaller change in quantity demanded.

Elastic: a change in price leads to a proportionally larger change in quantity demanded.

10,000 jar of jam are demanded per day at a price of £2 per jar. If the PeD for these jars is -2 and the price is raised by 20%, the number of jars demanded will fall to

A 6,000

B 7,000

C 8,000

D 9,000

DETERMINANTS

OF PED

Habit-forming

Number of substitutes

Proportion of income

Time

Luxury or

necessity

Qu. (June 2010) Assess whether the demand for food is likely to be price elastic or price inelastic.

Answer structure:

Definition PeD

Definition of inelastic

Use of data and extract

Determinants

Diagram

Evaluation:

Types of food

Differences between different income groups

PeD & revenue:

Summary:

Revenue will rise Revenue will fall

If PeD is inelastic: an increase in price

If PeD is inelastic: a decrease in price

If PeD is elastic: a decrease in price

If PeD is elastic: an increase in price

The table shows estimated PeDs for air travel for business and leisure customers of Air Canada. It may be deduced that:A Demand is more price elastic for business travellers than

leisure travellers.B An increase in price for business travellers and a decrease

in price for leisure travellers will increase total revenue.C Air travel is an inferior good.D The XeD for business air travel with regard to a change in

price of leisure air travel is negative.

Type of flight PeD

Short haul business -0.70

Short haul leisure -1.52

Income elasticity of demand is the responsiveness of quantity demanded to a change in income

YeD = % in Qd% in Y

YeD can be negative and positive.

Positive YeD: an increase in income leads to an increase in quantity demanded = Normal good

Negative YeD: an increase in income leads to a decrease in quantity demanded = Inferior good

Qu. (Jan 2011) Discuss whether chocolate and other confectionary is likely to be normal or inferior goods. 10 marks

Answer structure:

Definition YeD

Definition of normal & inferior goods

Use of data and extract

Diagram

Evaluation:

Different types of chocolate/confectionary

Ceteris paribus – other factors may have caused the change in demand

Different income groups

Cross price elasticity of demand is the responsiveness of the quantity demanded of good A to a change in price in good B

XeD = % in Qd Good A

% in P Good B

XeD can be negative and positive.

Positive XeD: an increase in the price of good A leads to an increase in quantity demanded for good B = Subsititute good

Negative XeD: an increase in the price of good A leads to a fall in quantity demanded for good B = Complementary good

The diagrams show the effects of an increase in supply of good X on the demand and price of good Y. Which of the following is most likely to be represented by good X and good Y:A Lamb and chickenB Bus travel and potatoes.C Computer game consoles and softwareD Leather and beef.

Price elasticity of supply is the responsiveness of quantity supplied to a change in price

PeS = % in Qs% in P

PeS is always positive – a supply curve slopes upwards!

Inelastic: a change in price leads to a proportionally smaller change in quantity supplied.

Elastic: a change in price leads to a proportionally larger change in quantity supplied.

DETERMINANTS

OF PES

Levels of stocks

Ease of storage

Ease of industry

entryTime

Spare capacity

Qu. (Jan 2010)Discuss how the PeS of oil might differ in the short and long run.

Answer structure:

Definition PeS

Definition of short & long-run

Use of data and extract

Short-run:

Long-run:

Evaluation:

Price volatility Different PeS from different regions Availability of stocks eg. OPEC Finite resource so very inelastic in LR Ceteris paribus – impact of possible new

discoveries or extractive technologies

Definitions:

Direct taxA tax levied directly on an individual or organisation.

Indirect taxA tax on expenditure collected by the producer on behalf of the government.

Pigouvian taxA tax is set on a good so that it equals the marginal negative externality – this internalises the external cost : the polluter pays principle.

Specific taxAn indirect tax which is charged as a fixed amount per unit of that good, causing a parallel shift in the supply curve to the left.

Ad Valorem taxAn indirect tax which is charged as a percentage of the price of the good, causing a pivotal rotation of the supply curve to the left.

The diagram shows the impact of a specific tax placed on air travel. Which of the following is correct?A Total tax revenue is

PeP1YXB Producer surplus

increasesC The price of air tickets

rises from Pe to P2

D Consumer surplus decreases

If the government introduces a tax of £2 per kilo, the new equilibrium price will beA £8

B £7

C £6

D £5

Price per kilo (£) Quantitydemanded (kilos)

Quantity supplied (kilos)

Quantity supplied after tax (kilos)

8 500,000 900,000

7 600,000 800,000

6 700,000 700,000

5 800,000 600,000

4 900,000 500,000

Qu. (June 2010) Evaluate the possible economic effects of a decrease in fuel taxes. Use an appropriate diagram in your answer.

Answer structure:

Definition indirect tax

Diagram (next slide)

XeD – cars are complements

XeD – public transport as substitute

Other impacts:

Qu. (June 2010) cont.

Show on diagram: Total expenditure Tax per unit Incidence Demand is price

inelastic

Evaluation: Magnitude of tax decrease – data use Tax as a proportion of all fuel costs Discussion PeD fuel Discussion of XeD Ceteris paribus – impact of other factors on

car ownership Negative externalities Impact on government finances

Evaluation to consider:Argue the opposite view.How contestable is the market?Is there evidence that competition can increase?How do incumbents respond? Price wars or aggressive advertising etc.

Definition subsidy

Government grant to firms in order to lower their production costs and so increase supply & lower prices.

Incidence:

Price inelastic demand – large fall in price

Price elastic demand – smaller fall in price

The diagram illustrates the effect of a government subsidy on a good. The total government expenditure on the subsidy will be:A £100

B £150

C £450

D £1050

If the government introduces a subsidy of £4 per unit, the new equilibrium price will beA £8

B £10

C £12

D £14

Price per unit (£) Quantitydemanded (units)

Quantity supplied (units)

Quantity supplied after subsidy (units)

16 2000 2800

14 2200 2600

12 2400 2400

10 2600 2200

8 2800 2000

Qu. (Jan 2010) Evaluate the likely economic benefits of an increased subsidy for bus and rail travel. Use an appropriate diagram in your answer.

Answer structure:

Definition subsidy

Diagram (next slide)

Impact on consumer surplus

Impact on producer surplus

Impact on negative externalities

Other benefits:

Qu. (Jan 2010) cont.

Show on diagram: Total expenditure Subsidy per unit Incidence

Evaluation Magnitude of subsidy Duration of subsidy XeD of public transport with respect to

private transport PeD and consumer incidence Government failure - promotion inefficiency

& dependency in public transport Impact on public finances – opportunity costs

& changes to tax