Change In The Conditions Of Non Price Determinants Economics Essay

Demand defined as a consumer’s desire and willingness to pay for a good or service. On the other hand, quantity demanded is the amount of goods which would be demanded at a certain price. If non-price factors that could affect demand are removed, then the higher the price of a good the lower the quantity of that good will be demanded. It is the inverse of the law of supply, and is directly related to the law of demand.

A change in demand refers to an increase or decrease in demand brought about by a change in the conditions of non-price determinants. For example, the price of substitute and complement goods, the income and the taste of fashion of consumers and also the expectation. The demand curve will usually shift from right to left if there is a decrease in demand. For example, the price Horlicks which is the substitute good for Milo drops from $2 to $1.50, the demand of the Milo will decrease. This is because the Milo is more expensive compared to Horlicks which the price had dropped. More consumers are willing to buy Horlicks and it results in a decrease in demand of Milo. Figure 5.1 shows the demand curve of Milo shift from D0 to D1 when there is a decrease in demand.

Price of Milo

D1

D0

Figure 5.1

Quantity demanded

Qd0

Qd1

D: Demand curve

A: point A

B: point B

Qd: Quantity demanded

$5

$10

Quantity demanded of olive oil

Price of olive oil

B

A

DOn the other hand, a change in quantity demanded represents the reaction of consumers to changes in the prices of goods, ceteris paribus. When the price increases, the quantity demanded decrease, and vice versa. For example, price of the olive oil increases from $5 to $10. Figure 5.2 shows the movement along the demand curve when there is an increase in price of the olive oil.

Figure 5.2

From Figure 5.2, when the price of the olive oil increases from $5 to $10, the quantity demanded of olive oil decrease from Qd0 to Qd1, which results in a upwards movement on the demand curve from point A to point B.

PART B

The percentage change in quantity demanded Income Elasticity of Demand (YED) shows the balanced change in the demand for a good in reaction to a change in income. It shows how people change their consumption habits with changes in their income levels. In a growing economy which where income levels are rising, highly income-dependent demand goods will sell more than the not income-dependent demand goods. For example, demand for staple food items usually do not increase with higher income levels; but demand for gourmet food or restaurant food does increase as individual’s income grows. This is also called the income sensitivity of demand, it is mathematically expressed as percent change in quantity demanded ÷ percent change in income as written below.

The percentage change in household’s income YED =

There are different of degree in YED. The first degree of YED is the positive YED. The value of the income elasticity will always be positive in this case. It means that an increase in income will leads to an increase in demand. There are two groups in positive YED, the income inelastic and the income elastic.

Income inelastic shows the value between 0 to 1 (0 < YED < 1). In this case, the percentage change in quantity demanded is slightly more than the percentage change in household’s income and the good is known as normal good when the income is inelastic. Examples of the normal goods are pants and shoes.

However, the income elastic shows the value of YED which is more than 1 (YED>1). In this case, the percentage change in quantity demanded increases by large percentage than the percentage change in household’s income. The good is called the luxury good if the income is elastic. The example of luxury goods are branded pants, branded bags and branded shoes.

The second degree of YED is the negative YED, the value of income elastic will always be smaller than 0 (YED < 0). As the income increases, the demand falls if the YED is negative. The good is known as inferior goods. The example of inferior goods are second hand goods.

YED which is exactly zero is the third degree of YED (YED = 0). It happens when quantity demanded does not change as the income changes. All the goods in this case are called necessary goods. The example for necessary goods are rice and petrol. No matter the household’s income increases or decreases, the consumers still need rice and petrol on their daily life, so the changes in income do not affect the demand.

References:

www.investorwords.com/6633/quantity_demanded.html

http://www.investopedia.com/terms/q/quantitydemanded.asp

http://simple.wikipedia.org/wiki/Quantity_demanded

QUESTION 2

PART A

Price elasticity of supply (PES) is an elasticity defined as a numerical measure of the responsiveness of the supply of a given good to a change in the price of that good. Per the law of supply, there is an expectation that, in a given market, when price increases, supply will also increase. PES is also a numerical measure (coefficient) of by how much that supply is affected. It can apply using the formula:

The percentage change in price

The percentage change in quantity supplied

PES =

The main factor of supply elasticity is the time period. The shorter the time period, the more inelastic the supply, It also depends on the capacity of the firm. For example, when there is a drop in the price of olive oil, in a short period (short-run), the suppliers or the producers will still continue to produce olive oil in the market although the products give them a lesser profit compared to last time. Supply is said to be inelastic in this case. However, in long-run period, if there is still a drop in the price of olive oil, the suppliers or the producers are given a longer time period to think about producing a substitute product of olive oil, so they will probably stop the production of olive oil and begin to produce coconut oil which is the substitute of olive oil to earn more profits. In this case, supply is said to be elastic.

If stocks of raw materials and finished products are at a high level, the firm is said to be able to respond to changes in demand quickly by supplying these stocks. Hence,the market – supply will be elastic. However, when stocks are low, decreasing supplies force prices to rise up higher. If stocks can be restock, supply will be inelastic in response to a change in demand.

PART B

Price elasticity really helps a lot when it comes to pricing strategy for a producer or company to earn more profits. There are three kinds of price elasticity, Price Elasticity of Demand (PED), Cross Price Elasticity of Demand (XED) and Price Elasticity of Supply (PES). PED observes the responsiveness of consumer demand to a change in price. This is very important as we will know whether its more profitable to increase or decrease the price. XED is the responsiveness of consumer demand to a change in a competitors price. This helps economists in understanding whether goods are complements (demand for one leads to demand for another) or substitutes (demand for one cause less demand for another). On the other hand, PES is the responsiveness in terms of supply with a change in price which helps economists understand the ability of suppliers to increase stocks. For example, electronic goods producers have a low price elasticity of supply because if demand increases, they have limited capacity to increase supply because of the long time period it takes to produce this supply.