Answer to Question #320168 in Macroeconomics for dheeraj

Question

1. (a) The demand (D) and supply (S) equations for a commodity (X) are given by:-

D = 2000 – 20P

S = -500 + 30P, where P = Price (R) per unit

(i) Find the equilibrium price and quantity and show on a suitable diagram. (4 marks)

(ii) Calculate Price Elasticity of Demand (PED) when price rises from R20 to R80. (2 marks)

(iii) A specific sales tax of R30 per unit is imposed on the good. Explain and illustrate the changes to part (i). (3 marks)

(iv) Comment on the burden of the tax. (3 marks)

(b) Discuss the factors affecting: demand for, and supply of a good (18 marks

Answer 1

Solution

1.

(i)Equilibrium price and quantity

Demand equation=Supply equation

$2000 – 20P= -500 + 30P$

Put like terms together

$-20P-30P=-500-2000$

$-50P=-2500$

$\frac{-50P}{-50}=\frac{-2500}{-50}$

P=R50

Therefore,

Equilibrium price will be 50

Equilibrium quantity will be

2000 – 20(50)=2000-1000

=1000

(ii)Price Elasticity of Demand =Percent change in quantity divided by percent change in price.

Percentage change in quantity

Q1=2000-20P

$=2000-(20\times20)$

=2000-400

=1600

$Q2=2000-(20\times80)$

=2000-1600

=400

Percentage change in quantity$= \frac{(400-1600)}{1600}\times100$

=-75%

Percentage change in price

P1=R20

P2=R80

Percentage change in price$=\frac{(80-20)}{20}\times100$

=300%

Therefore,

Price Elasticity of Demand$=\frac{-75}{300}$

$=-0.25$

(iii)Price increase of R30

New price will be R(50 +30)

=R80

The price of the goods will increase from R50 to R80. This will make the equilibrium price to move from PE to P2; thus changing both the equilibrium quantity demanded and quantity supplied to move from QE and PE respectively to Q1 and Q3 respectively. This means that the quantity demanded will decrease as the quantity supplied will increase at that price of R80.

(iv) The price of the goods will automatically increase to curb the extra costs incurred in paying taxes to the government.

(v)

Price Fluctuations

Price fluctuations are a strong factor affecting supply and demand. When a product gets expensive enough that the average consumer no longer feels it is worth it to buy the product, then the demand declines. This leads to cuts in production that will hopefully stabilize the product’s value. Lowering the price of a product may increase demand, indicating that the public feels the product is suddenly a great value. This may also cause changes in production to increase to keep up with the demand.

Consumer income

Changes in income level and credit availability can affect supply and demand in a major way. The housing market is a prime example of this type of impact. During a recession when there are fewer jobs available and there is less money to spend, the price of homes tends to drop. Also, the availability of credit may be less because of the average person’s inability to qualify for a loan. 

Availability of Alternatives or Competition

When an alternative product hits the market, the competition between the existing product and the new one can cause demand to drop for the existing product.

Trends

Demand rises and falls on trends in many cases. Only a few things remain a constant need for society. Even food and shelter aren’t immune to the effects of changing trends. If widespread media attention is given to the idea that eating bean sprouts is bad for you, then eventually it will affect the demand for bean sprouts. When the attention is focused on something else, the bean sprout market might rebound.

Seasons

The seasons can affect supply and demand drastically. The supply and demand for toys peaks around Christmas and turkeys sell like crazy at Thanksgiving. Fireworks experience a boom at the Fourth of July in America. Meanwhile, it’s difficult to increase demand for bikinis in January in Minnesota.

Tastes and preferences

Consumers can be fickle, particularly when shopping for CPG products. Tastes and preferences can change within a market for a wide array of reasons. Some of these reasons can be intrinsic, while others are external.

Consumer’s expectations

Another reason that anticipating demand can be so challenging is that you have to pay attention to both habits and expectations. Unfortunately, it’s much harder to predict or understand these expectations. Overall, it’s much easier to look at past data to figure out what could happen in the future.

Price of product

One element we should discuss is the price elasticity of demand (PED). As a rule, when the price of a good goes up, demand goes down. Price elasticity is usually a negative number, like -0.5. So, with that example, if the price of a product goes up by five percent, its volume will go down by 2.5 percent.