NYJC H2 ECONS Q1

1 1 Restaurant owners are now crying woes in Singapore as their profit margin has been hit hard due to rising rental and f ood costs. However, their most pressing issue is the lack of manpower a nd to make things worse, consumers are now tightening their belts due to the negative growth rate for the first quarter of the year. But not all hope is lost, with the rise of online food delivery services, restaura nts owners are now partnering them in the hope of attracting more customers. (a) Explain, using examples, the concepts of price elasticity of demand and income elasticity of demand. [10] (b) Discuss how the combination of the above factors af fect the market for different types of restaurant services in Singapore. [15] Suggested Answers (a) Explain, using examples, the concepts of price elasticity of demand and income elasticity of demand. [10] Command Word: Explain Context: No particular goods/services given. Need to provide examples. Content: PED & YED (Definition, Sign & Magnitude) Introduction: • Elasticity is a measure used to show how responsive one variable is to a change in another variable. • Explanation of PED & YED concepts will be based on definition, sign and magnitude Body: 1: PED • Definition: PED measures the responsiveness of quantity demand ed of a good due to a change in its price, ceteris paribus. • Formula: PED = Percentage Change in Quantity Demanded of Good A Percentage Change in Price of Good A

2 • Sign: Negative The negative sign of the coefficient of PED reflects the inverse relationship between price and quantity demanded (i.e. the law o f demand). The law of demand states that the quantity demanded of a product is inversely related to its price. Hence an increase in price leads to a fall in the quantity demanded, ceteris paribus. Based on the formula for calculating PED, the negative sign is the result of quantity demanded an d prices changing in opposite directions. • Magnitude: The magnitude of the PED value signifies the sensi tivity or responsiveness of quantity demanded due to the price change of the good. Generally the greater the responsiveness of quantity demanded due to price changes, the larger the magnitude If a price change causes a more than proportionate change in quantity demanded, quantity demanded is regarded as very responsive to price changes. Demand for the good is said to be price elastic . In Figure 1, for example, if price decreases by 10% and quantity demanded increases by 30%, the PED coefficient will be 3. If a price change results in a less than proportionate change in quantity demanded, quantity demanded is regarded as not very responsive to price changes. Demand for the good is said to be price inelastic . Price Quantity D % change in price = 10% % change in quantity demanded = 8% 0 Figure 2 Figure 1

3 As illustrated in Figure 2, for example, if price d ecreases by 10%, and quantity demanded increases by 8%, the PED coefficient will be 0.8. • Factors affecting the size of Price Elasticity of D emand for a Good ( pick any 1 of the factors and explain using example ) (1) Number and Closeness of Substitutes in the same price range (2) Proportion of income consumers spent on the good (3) Time period (4) Degree of Necessity of the Good to the Consumers (5) Habit of the Consumers Example: Number and Closeness of Substitutes in the Same Price Range How far a consumer can substitute a good for other goods depends on whether the goods concerned are good or bad substit utes. Whether the substitutes are good or bad depends on how closely related the goods are to the consumers. The more closely related the goods a re, the higher the price elasticity of demand. For example, when the price of coke increases, the quantity demanded of Coke will fall (law of demand). Consumers will then look for other carbonated drinks which are substitutes of coke such as Pepsi and Sprite. As there are many substitutes available for Coke, the demand for Coke is likely to be price elastic. Thus, when the price of Coke rises, it wil l lead to a more than proportionate fall in quantity demanded (PED >1). However, if the consumers deemed other carbonated drinks to be very different from Coke in terms of taste, then they are likely to deem the demand for coke to be price inelastic where the increase in price of coke will lead to a less than proportionate fall in quantity demanded. 2: YED • Definition: YED measures the responsiveness of demand of a good due to a change in consumers’ income, ceteris paribus. • Formula: YED = Percentage Change in Demand of Good Percentage Change in Income

4 • Sign: Positive (Normal Goods), Negative (Inferior Goods) The sign of YED indicates whether a good is normal or inferior . Any good whose demand rises due to a rise in incom e or demand falls due to a fall in income are classified as normal goods . Based on the formula for calculating YED, a normal good has a positive income elasticity of demand because income and demand change in the same direction . Any good whose demand falls due to a rise in incom e or demand rises due to a fall in income are classified as inferior goods . Based on the formula for calculating YED, an inferior good has negative income elasticity of demand because income and demand change in opposite directions . • Magnitude: The magnitude of the YED value signifies the sensi tivity or responsiveness of demand due to income changes. Generally the grea ter the responsiveness of demand due to income changes, the larger the magnitude. YED is concerned with income changes, which is ill ustrated diagrammatically by a shift of the demand curve of the good or service. Hence the magnitude of YED provides an indication of the extent of the shift of the demand curve due to income changes. When Demand for a Good is Income Elastic: 1 <|YED| < infinity ( ∞) If an income change causes a more than proportionate change in the demand for a good, demand is regarded as very respo nsive to income changes. Demand for the good is said to be income elastic . These goods include luxury goods. Examples of luxury goods are meals at fine dining restaurants, cars, luxury homes. For example if a g ood has a |YED| = 5, a 1% change in income leads to a 5% change in demand for the good. When Demand for a Good is Income Inelastic: 0 <|YED| < 1 If income change causes a less than proportionate change in the demand of a good, demand is regarded as not very responsiv e to income changes. Demand for the good is said to be income inelastic . These goods include necessity goods. Examples of necessity goods are ri ce, salt and pepper. For example if a good has a |YED| = 0.5, a 1% change in income leads to a 0.5% change in demand for the good. Factors affecting YED (pick any 1 of the factors and explain using example ): (1) Nature of Goods (2) Level of Income

5 Example: Nature of Goods Necessities have low value of YED as its consumptio n is compulsory and rather stable even with changes in income. For example, when income rises, the demand for necessities such as rice will increa se less than proportionately (Figure 3). On the other hand, luxu ry goods tend have a large YED value as people tend to want to purchase more of these goods to improve their lifestyle as their income increase s. Thus, when income rises, there will be a more than proportionate rise in demand for branded goods such as Rolex and Chanel (Figure 4). Conclusion: • PED and YED of different products are different du e to the different determinants of PED and YED. • This analysis is based on ceteris paribus assumpti on but in reality, the PED and YED values may change over time. • Different gr