You are on page 1of 11

F581 Economics

Demand & Supply Question


Impact depends upon the extent of the shift.
If demand shifts, the impact will depend on elasticity of
supply.
If supply shifts, the impact will depend upon the
elasticity of demand.
Impact of shift also depends upon other factors if they
stay the same (ceteris paribus) or change.
Elasticity Question
It is only an estimate, so may not be accurate and cant
be relied on for future decisions.
Depends upon other factors changing.
Depends upon the time period, e.g. PES more elastic in
the long run.
Factors affecting Demand
Consumer Income
Price, availability of related products
Taste and Fashion
Factors affecting Supply
Costs of production
Size, structure, nature of industry
Government Policy
Other factors (e.g. weather, health scare)
Determinants of PED
Availability and closeness of substitutes. (More
substitutes = more elastic).
Proportion of income it takes up. (If product takes up
small portion of income, then rise in price will cause little change in
quantity demanded).
Time. (over time, as consumer find out about more substitutes,
elasticity increases).
Determinants of PES
Availability of stocks of the product. (Lots of stocks means
more elastic, as firm can increase Supply quickly).
Availability of factors of production. (More capital can increase
output and elasticity, but if new machinery has to be installed first, then
it will be inelastic. More workers (labour) can also increase elasticity).
Time. (Where it takes a lot of time for supply to be adjusted, supply
will be inelastic).
Subsidy
Advantages of Subsidy
+ Encourages producers to supply goods with positive
externalities.
+ Reduces producers costs.
+ Encourages consumption of a merit good.
+ Can correct the level of consumption to reflect Allocative
efficiency.

Disadvantages of Subsidy
- Opportunity Cost to Government
- Hard for government to set right amount of subsidy.
- Effectiveness depends upon PED limited effect if inelastic.
- Time lag
- May fail to pass on the subsidy.

Alternatives:
Increased info provision
(esp. if merit good);
Regulation.
Evaluation: Depends on level of subsidy; if passed on; PED. Most
effective method, although other measures may be useful.
Taxation
Advantages of Taxation
+ Raises revenue for government, which can then be used to
correct market failure.
+ Allows the market to function properly.
+ Polluter is forced to internalise the externality and make the
polluter pay.

Disadvantages of Taxation
- Hard to determine size of tax, should equal externality, but
calculating externality is hard.
- Some of tax burden is passed on to consumer.
- If demand is inelastic, consumption will not fall by as much
as intended.
- Inflationary.
Alternatives:
Increased info
provision; Tradable
Permits.
Evaluation: Depends on if tax is at correct level; if product is inelastic
will be less effective as producer could pass tax on to consumer;
effectiveness depends on level of tax and if combined with alternatives.
Regulation
Advantages of Regulation
+ Easy to understand.
+ Enforced by law.
+ Can modify behaviour to correct market failure.
+ Aim to result in optimum allocation of resources.
+ Especially important if there is a high risk of market failure.

Disadvantages of Regulation
- Must have a high level of public support.
- Opportunity cost to enforce them.
- May lead to a black market.
- Do not compensate those that suffer from market failure.
- Hard to set appropriate standards.
Alternatives:
Increased info
provision; Tradable
Permits; Taxation.
Evaluation: Depends on how well enforced; may be combined with
increased info to gain public support; depends on how much they cost.
Tradable Permits
Advantages of Tradable Permits
+ Fairly easy to implement.
+ Allows the market to help solve the problem and gives
firms the incentive to reduce negative externalities.
+ From governments perspective, achieves desired
environmental outcome.

Disadvantages of Tradable Permits
- Expensive to monitor, so opportunity cost.
- Does not compensate victims of pollution.
- Problems of calculating and distributing permits to
polluters.
Alternatives:
Subsidies.
Evaluation: Opportunity cost means money may be better spent on
subsides; permits may be set at a too high level; so depends upon the
level and how enforced.