PJC_H1_ECONS_P1_Q3

Pioneer Junior College (Economics Department) 1 PJC 2017 H 1 Prelim Exam Paper 1 Question 3: (a) Explain what might cause price elasticity of de mand to be different for different products. [10] (b) Profits are earned when revenue exceeds costs o f production. Discuss whether it is both possible and beneficial for producers to change th e price elasticity of demand for their products. [15] Price elasticity of demand (PED) measures the degre e of responsiveness of quantity demanded due to a change in the price of the same good, ceteris paribus. Demand for some products are price elastic when a change in the price causes a more than proportionate change in the quantity demanded. This means that the value of PED (ignore the negative sign) is more than one. For products that have price inelastic demand, the valu e of PED is between 0 and 1 as a change in the price causes a less than proportionate change in the quantity demanded. The value of pric e elasticity of demand tends to be different for diff erent products due to factors such as availability of close substitutes, proportion of income spent on the good and nature of the good. The value of price elasticity of demand tends to be different for different products due to availability of close substitutes. The greater the number of substitutes and the close r the substitutes for the good, the more price elastic will be the demand for the good. The presen ce of close substitutes enables consumers to respond and switch to other substitutes when the pr ice of the good rises. This causes the quantity demanded of the good to fall significantly when pri ce rises. For example, the demand for Nike shoes will tend to be price elastic as there are many clo se substitutes available in the market such as Adidas, Reebok and New Balance shoes. On the other hand, demand for petrol is price inelastic as there are no close substitutes available in the mar ket.Hence, the more close substitutes a good has, the more elastic will be its demand. The value of price elasticity of demand tends to be different for different products due to the proportion of income spent on the good. The higher the proportion of income spent on a good, the more price elastic will be the demand for the good. For example, if the price of ballpoint pen increases by 20% (from $1 to $1.20 per pen), consumers are unlikely to cut down the use of ballpoint pen significantly since expenditure of ballpoint pe n is only a very small proportion of consumers’ income. In contrast, if the price of a winter holiday package increases by 20% (from $2000 to $2400), it is likely to affect the consumer’s spending abil ity to a large extent as expenditure on a winter holiday package takes up a much larger proportion of consumers’ income. Thus, a consumer is more likely to be more responsive to a change in price f or goods when consumer expenditure takes up a large proportion (%) of h