Is the demand for steel a final or derived demand? Why?

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1 Answer to the BEE Questions (#Chapters 4-8): #Chapter 4 Is the demand for steel a final or derived demand? Why? Demand for steel is likely to be derived demand when bought by producers who demand steel for various purposes in related goods such as cars, ships, household appliances. Therefore, when the demand for related goods (such as cars) increases, the demand for steel will correspondingly increase. Consider the labour market, how would you draw the demand curve for labour and how would you label the axes of the diagram? How do you define the demand for labour? Wages Market for labour Demand for labour refers to the quantity of a labour that producers / firms are willing and able to hire at various wages over a given period of time, ceteris paribus. Dd L Quantity of labour Can you think of some examples of complements and substitutes? Briefly explain why they are complements and substitutes. (The examples must satisfy the definitions. For complements, students must explain how the goods satisfy a want when consumed together, and specify what the want is. For substitutes, students must explain how the goods can be consumed in place of each other, and specify what the same want is.) Examples of Complements: Bread and jam are complements to satisfy the want for a sandwich: When the price of bread increases, the demand for jam is likely to fall. Tablets and tablet apps are complements to satisfy the want of entertainment or to do work: When the price of the tablet increases, the demand for tablet apps is likely to fall.

2 Examples of Substitutes: Music CDs and downloaded Music from I-Tunes (paid) are substitutes as they satisfy the same want for entertainment/ relaxation. When the price of CD increases, the demand for downloaded Music from I-Tunes is likely to rise. Chicken Rice and Duck Rice are substitutes as they satisfy the want for a meal: When the price of Chicken Rice falls, the demand for Duck Rice falls. Note: For some goods like Beef vs Pork/ Chicken/ Mutton, this relationship may not be that clear because even though they are all meat, some may not substitute one for the other because of religion etc. Is a car and petrol joint or derived demand? Why? A car and petrol are in joint demand petrol. Petrol is needed to power the car, hence both goods must be used together for consumers to be able to drive to satisfy their want of getting from point A to B. Therefore, a rise in the price of cars is likely to reduce the demand for petrol. It is not derived demand as petrol is not used in the production of cars. #Chapter 5 Market for labour Supply of labour refers to the quantity of labour that workers are willing and able to supply at various wages over a given period of time, ceteris paribus. With improvement of productivity, existing resources are used more efficiently. This means the same inputs can produce more or the same output can be produced with fewer inputs. This lowers the cost of production of goods and services, which helps increase its supply. The cost saved can be passed on to consumers by giving them a better (lower) price. This in turn lowers the equilibrium price of goods and services, ceteris paribus. In this way, these goods and services can be offered on the market at a lower price than other producers, which makes it more price competitive.

3 Agricultural goods and biofuels will be in competitive supply as both types of goods compete for the same resources for production. As petrol and biofuel are substitutes, lower petrol price will lead to less demand for biofuel hence gov t sees less need to push for production of biofuel. Therefore, if the production of biofuels decreases, resources will be diverted into the production of agricultural goods. Therefore, the supply for food crops will increase. #Chapter 6 When the market is said to be in equilibrium it means the price will neither rise nor fall further. It will remain there unless the equilibrium is disturbed. NB: To ensure this condition holds we make the assumption ceteris paribus. At the equilibrium price the quantity demanded is equal to the quantity supplied. Consider the labour market. Using the above analysis and a diagram, explain how market equilibrium is attained. wage rate (per hour) Surplus Supply 8 7 E Figure 1: Demand and supply curves for labour 6 Shortage Demand Quantity of labour ( 00000) Determination of wages in labour market Similar to the analysis used in the goods and services market, the labour market examines the changes in wages (the price of labour) and the number of people employed/ hired (equilibrium labour quantity). A shortage of labour implies that the quantity of labour demanded (by firms) exceeds the quantity of labour supplied (by people who are searching for jobs). This creates an upward pressure on wages till the equilibrium wage is attained. Conversely, a surplus of labour implies that quantity of labour supplied exceeds quantity of labour demanded, resulting in a downward press on wages. Market equilibrium occurs at w=$7/ hr, Q= labour employed at which the quantity of labour demanded by firms is equal to the quantity of labour supplied. This is shown at point E.

4 The government may intervene in the labour market using policies such as minimum wage to achieve their objective. More details on the labour market can be found in Chapter 8. With the aid of a diagram, indicate what will happen to the price and quantity exchanged in the following situations: (a) Demand falls and the demand curve shifts to the left (b) Supply decreases and the supply curve shifts to the left (a) Explanation of Diagram SS B A P 0 C DD 0 DD 1 0 Q 1 Q 0 Quantity (b) SS 1 P 0 C SS 0 B A DD 0 Q 1 Q 0 Quantity When demand decreases from DD 0 to DD 1, at original price P 0 there will be a surplus as quantity supplied exceeds quantity demanded. There is downward pressure on price and equilibrium price will fall from P 0 to and equilibrium quantity will fall from Q 0 to Q 1. Explanation of Diagram When supply decreases from SS 0 to SS 1, at original price P 0 there is a shortage as quantity demanded exceeds quantity supplied. There is upward pressure on price and the equilibrium price will rise from P 0 to and equilibrium quantity will fall from Q 0 to Q 1.

5 Smartphone market *Analysis is very similar to Figure 4 Demand factors: Rising income level, changing taste and preference Given smartphones are normal goods, a rise in income will increase the demand for smartphones. Similarly, with an increased taste and preference for smartphones, the demand of smartphones rises further. Therefore, the demand curve for smartphones shifts rightwards, increasing equilibrium price and quantity, ceteris paribus. Supply factors: Advancement in technology, increase in number of producers Advancement in technology such as in the process of manufacturing smartphones is likely to increase its supply. A greater number of entrants into the market with brands such as Dell, Huawei and Acer are also producing smartphones leads in an increase in its supply. These factors will result in a rightward shift of the supply curve, which leads to rise in quantity but a fall in price of smartphones. Combined analysis: Quantity traded will unambiguously increase. However, the new equilibrium price is indeterminate as it depends on the relative shifts of demand and supply curves. #Chapter 7 1. What is wrong with the following definition of price elasticity of demand? It measures the degree of responsiveness of demand of a good to changes in its own price. It should be quantity demanded and not demand. The term, ceteris paribus is left out. 2. Why is the sign of price elasticity of demand always negative? Due to the law of demand, quantity demanded of a good is always inversely related to its price. 3. Which example shows the correct use of economic terminology? Why? (1) Xbox 360 Kinect is elastic (2) Demand for Xbox Kinect is price elastic The first implies the good itself is elastic (like rubber bands?) which is WRONG, but the second focuses on the degree of responsiveness of demand, given a change in price of the good. 4. The price of a good falls. Compare the change in quantity demanded of a good that has a price-elastic demand with that of a price-inelastic demand. (Hint: Give a similarity and a difference.) Similarity: Quantity demanded will increase for both due to the Law of Demand.

6 Difference: The quantity demanded will increase more than proportionately and less than proportionately for a good with price-elastic demand and price-inelastic demand respectively. Do you think the demand for rice is more price-elastic in Asia or in Europe? Why? Demand for rice is likely to be more price elastic in Europe than Asia as Asians are more accustomed to consuming rice as a staple due to historical and cultural heritage. Whereas in Europe, potatoes and bread are still the predominant staple items. Compare the price elasticity of demand of skilled and unskilled workers. Explain your answer. The demand for unskilled workers is likely to be price elastic whereas the demand for skilled workers is likely to be price inelastic. This is because there are close substitutes available for unskilled workers especially when they can be replaced by technological-aids, while skilled workers like bio-engineers are hard to replace with other factors such as machinery. (degree of Substitutability) Explain the effect of a fall in own price on total revenue when the demand is relatively price elastic. Draw a diagram. When price falls from to P 2 resulting in quantity demanded increasing from Q 1 to Q 2. At the original price of, the TR is depicted by area 0ABF. When price falls to P 2 quantity demanded increases more than proportionately to Q 2. Total revenue increases to the area 0CEG. Since area ABDC (the loss in TR) is less than area DEGF (the gain in TR), the total revenue has increased as a result of the price fall. SS 1 SS 2 A B P 2 C D E F G 0 Q 1 Q 2 DD Quantity

7 Compare the price elasticity of supply of skilled and unskilled workers. Explain your answer. The supply of unskilled workers is likely to be price elastic whereas the supply of skilled workers is likely to be price inelastic. This is because unskilled workers generally do not have special training or skills. Examples of such occupations generally include general cleaners and security guards. Thus, supply for unskilled worker is priceelastic, given the short training time. However, the years of trainings for skilled workers like bio-engineers are longer in duration, therefore their supply is price inelastic. (Nature of Production length of production ) Comment on the price elasticity of supply of HDB flats in Singapore. The supply of HDB flats in Singapore tends to be price inelastic in the short run and possibly the supply will become more price elastic in the long run. In the short run, the supply-side constraints faced, like land shortages, duration needed to build the flats, labour shortages will cause the supply to be less responsive. In the longer run, the supply would be more responsive as most of the mentioned supply side constraints can be overcome.

8 Using the concept of PED, compare the effect of a decrease in supply on (i) the equilibrium price of oil and luxury cars. (ii) the consumer expenditure on oil and luxury cars Analyse the relative PED of oil and luxury cars: Demand for oil is price-inelastic while demand for luxury cars is price-elastic l Impact of decrease in supply on: Market for oil: Market for luxury cars: AWE-some diagram: AWE-some diagram: S 2 S 1 S 2 S 1 P e P 2 P e D 2 D 1 Q 1 Q e Quantity Effect on equilibrium price: increase Effect on consumer expenditure: increase Q 2 Q e Effect on equilibrium price: increase Effect on consumer expenditure: Fall Quantity Effect on price Similarity: of both oil and luxury cars increases Difference: of oil increases more than proportionately compared to its quantity but price of luxury cars increases less than proportionately compare to its quantity. Effect on consumer expenditure Similarity: no similarity Difference: Consumer expenditure on oil increases while consumer expenditure on luxury cars falls. #Chapter 8

9 Draw the demand and supply diagram for the case of government imposing an ad valorem tax on a good. P 0 + tax SS 1 SS 0 Amount of tax (per unit) = vertical distance between the 2 supply curves P 0 DD Q 1 Q 0 Quantity Can you think of examples where consumers bear most of the burden (higher tax incidence on consumers)? What about producers bering most of the burden (higher tax incidence on producers)? Smoking is an addictive habit demand for cigarettes is price inelastic. Thus, regardless of the rise in price due to high taxes, less than proportionate number of smokers will quit smoking. An increase in price for goods with a priceinelastic demand (such as cigarettes) will mean a rise in total revenue for retailers so they will not fear passing on the high price to consumers. The same applies to alcohol and drugs. For goods and services with many substitutes where demand is price elastic, producers will bear more of the burden. They will not raise the price too much as it will mean Qd will fall more than proportionately and there will be a reduction in revenue. Can you think of examples that producers bear most of the burden (higher tax incidence on producers)? What about consumers bearing most of the burden (higher tax incidence on producers)? Manufactured goods that take a long time to produce such as military weapons, aircrafts, etc are examples where producers bear most of the burden. As they can t react fast to changes in production cost (can t stop production midway!), they will have to bear most of the burden. Similarly, if producers can react fast to a tax, consumers will bear the burden those with many suppliers such as retailers. What is a per unit subsidy? A per unit subsidy is a fixed amount of money given to the producers for each unit they sell. What are some of the more common goods/services the government will subsidise and WHY?

10 Healthcare, education, training healthy and skillful labour will increase the PPC of a country and thus leads to economic growth. Note: Healthcare and Education can be deemed as merit goods which are usually under-consumed if there is no government intervention. In these cases, we will say that market failure exists (you will learn this in C1 under Market Failure). Hence, you will observe that government will usually subsidise such goods/services to encourage consumption or production. In Singapore, hospitalization charges are subsidized (according to mean testing i.e. lower income group will get higher subsidies). Are you aware of countries that have/had minimum wage law? Name a few. UK and some European countries; proposals for min. wage law for some blue collars workers. Malaysia has also introduced a minimum wage for the first time in a move to support low income households. Private sector workers in peninsular Malaysia will receive a minimum salary of 900 ringgit a month. While the move is likely to be welcomed by workers and low income families, some critics believe that smaller businesses may be hurt by it. (BBC News 1 May 2012) What if the price floor is set below the free market price? It will be ineffective because a shortage will arise and price will rise to the equilibrium. What happened if the price ceiling is set above the market equilibrium? It will ineffective because a surplus will arise and price will fall to the equilibrium. Can think of some real life examples of black markets? Illegal sales of ivory in some countries.

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