RVHS H2 ECONS Essay Q1

Essay Question 1 Suggested Answers Increasing affluence and advances in modern technology have contributed to the proliferation of e-reading devices and e-books. In addition, an increasing number of publishing companies have started to produce e-books. Discuss how these developments might affect the revenue earned from the sales of e-books and related products. [25m] ---------------------------------------------------------------------------------------------------------------- The market for e-books consists of consumers who buy digital books online and publishing companies (e.g. Hachette, Har perCollins, and Penguin Random House) which sell e-books to consumers through onlin e retailers such as Amazon, Apple or Google. Associated markets of e-books incl ude its substitute (e.g. print books) and complement (e.g. e-reading devices). T he equilibrium price and quantity in these markets are determined by the intersection of their respective demand and supply. As such, any change in the demand an d/or supply will caus e a change in the equilibrium price and quant ity, and in turn affect total revenue (TR) earned. This is because TR is defined as the amount received from the sale of the good at a given price and is calculated as the price multip lied by the quantity. In this context, the impact on TR earned in the markets involv ed due to increasing affluence, advances in modern technology and increasing numbe r of publishing companies producing e- books will be examined. Due to increasing affluence, the income of the people increased. Income elasticity of demand (YED) measures the degree of re sponsiveness of quantity demanded of a good to change in income, ceteris paribus. Since e-book is considered a normal good where YED>0, an increase in income would lead to an increase in demand for e-books. Furthermore, due to advancement in modern technology, faster broadband speed and internet connecti on have changed consumers’ taste and preference in favour of e-books due to the ability to purchase and download any book title with just a few clicks on the e-reading device. In addition, technological improvements have produced a wide array of attractive feat ures and functions of dedicated e-book devices such as Kindle. They are light-weighted, possessed advanced screen technology and provide support for on-screen handwritten notes and highlights. All these benefits meant to cr eate a comfortable and conveni ent reading experience for readers will change consumers’ taste and preference towards e-books and hence lead to an increase in demand for e-books. When demand for e-books in creases, both equilibrium price and quantity will increase, leading to an increase in TR for e-books publishers. Advancement in modern technology has also resulted in the greater ease of creating e-books. Besides having fast er broadband speed and internet connection that helps to increase the efficiency of creating e- books, the discovery of advanced scanning

technology and software has also made it fast and easy to digitise print text. Hence, the supply of e-books will increase. Besi des, the increasing number of e-books publishers producing e-books in creases the number of se llers and further increase the supply of e-books. With an increase in supply from S 0 to S 1 as shown in Figure 1 below, a fall in price will be accompanied by a rise in its quantity. The extent of this increase in quantity then depends on the price elasticity of demand (PED) for e-books as PED measures the degree of responsiveness of quantity demanded to a change in its price, ceteris paribus. Figure 1: Market for E-books The demand for e-books is relatively price elastic (PED>1) because of its low degree of necessity and the availability of close s ubstitute such as print books. Given an increase in supply from S 0 to S 1, the fall in price from P 0 to P e will lead to a more than proportionate increase in quantity demanded from Q0 to Qe. Hence, the TR of e- books publishers increases from 0P0AQ0 to 0PeBQe. Overall, the combined effect on the mark et for e-books includes a rise in both its demand and supply. As seen in Figure 2 bel ow, this will cause the equilibrium quantity to rise with the change in price being ambiguous as this is dependent on the extent of change in demand and supply.

Figure 2: Market for E-books In this context, it is likely that the in crease in supply of e-books will outweigh the increase in demand for e-books. This is because technological advancement and low cost of production have made it in creasingly cheap and easy to produce e- books. This is why many established pu blishers have chosen to produce more e- books instead of print books. In fact, there has also been a sharp rise in the number of self-publishers. On t he other hand, the increase the demand may not be as significant because print books still hold a strong appeal for many book-lovers who enjoy reading with the physical touch of the boo ks. Hence, there will be a fall in price from P0 to P1 and a rise in quantity from Q0 to Q1. As explained previously, the rise in demand for e-books, keeping supply unchanged, will cause a rise in TR. And the rise in supply of e-books, keeping demand changed, will result in a rise in TR with the PED being more than one. In this case, whether the extent of increase in demand or supply is greater, TR will still see an overall increase. However, in the long-run, as more e-book publishers enter the market due to high profitability and low barriers to entry, increased competiti on will likely reduce the amount of profits enjoyed by each publisher. With changing taste and preference towa rds e-books, the demand for print books which include paperback and hardcover books will fall . In addition, as e-books and print books are substitutes, the cross elasti city of demand (XED) between them is positive. The cross elasticity of demand (XED) measures the degree of responsiveness of quantity demanded of one good to a change in the price of another good, ceteris paribus. Hence, with the rise in supply of e-books, keeping demand unchanged, the price of e-books will fa ll. In turn, there will be fall in the demand for print books since the XED value bet ween the two vehicles is positive. Overall, the fall in demand will cause the pric e and quantity of print books to fall, which decreases TR of print books publishers.

The extent of the fall in demand for print books also depends on the degree of closeness of substitutes between e-books and print book. The closer they are as substitutes, the greater t he fall in demand for print books and the greater the fall in TR received by print books publishers. Lastly, the market for e-reading devices will also be affected. They are devices capable of displaying text on the screen and include dedicated e-readers such as Kindle and Nook, other tablets and sm artphones. Since e-reading devices are required for the display of e-books, they are complem ents in consumption and the XED value between them is negat ive. Hence, a fall in the price of e-books will cause a rise in the demand for e-reading devices. In turn, both the price and quantity of e- reading devices will increase, thus increasing the TR received by producers. Again, the extent of the increase in demand for e-reading devices depends on the degree of closeness of comp lements between e- books and e-reading devices. The closer they are as comple ments, the greater the incr ease in demand for e-reading devices and the greater the increase in TR received by producers of these devices. In conclusion, the TR of e-books and e-reading devices is expected to increase while the TR of print books is expected to fall. Ho wever, it is important to note that when we calculate PED, YED or XED, we assume ceteris paribus. In reality, there can be many factors affecting demand simultaneously. In