Answers to Pause-for-Thought Questions

Part B: Business and the Market

Chapter 4
Do all these six determinants of demand affect both an individual’s demand and the market demand for a
product?
All except the distribution of income. The (national) distribution of income simply affects an individual’s
income and thus is not a separate determinant from income as far as the individual is concerned.

1. How much would be supplied at a price of 70p per kilo?

2. Draw a supply curve for farmer X. Are the axes drawn to the same scale as in Figure 4.4?
1. About 430 000 tonnes per month.
2. The supply curve for farmer X will merely plot the relevant two columns from Table 4.2. The vertical
axis can be drawn to the same scale as in Figure 4.4, but a different scale will have to be used for the
horizontal axis (e.g. tonnes rather than thousands of tonnes).

What would happen to price and quantity if the demand curve shifted to the left? Draw a diagram to
illustrate your answer.
Both price and quantity will fall. Imagine in Figure 4.7 that the original curve were D2 and that it shifted to D1.
Price would fall from Pe2 to Pe1 and quantity would fall from Qe2 to Qe1.

Chapter 5
Think of two products and estimate which is likely to have the higher price elasticity of demand. Explain
your answer.
To answer this, you will need to focus on the determinants of price elasticity of demand for each of the
products. The most important determinant is the number and closeness of substitutes. Thus products where
alternatives are readily available and of similar specifications and quality are likely to have a relatively high
price elasticity of demand. That is why, for example, any one brand of petrol is likely to have a high price
elasticity of demand when other brands are available at nearby petrol stations. Petrol in general, however,
has a relatively low price elasticity as, in the short run at least, there is no alternative for drivers of petrol
vehicles. (In the long run, of course, they could switch to diesel vehicles if diesel entailed a lower cost per
mile travelled.)

If a firm faces an elastic demand curve, why will it not necessarily be in the firm’s interests to produce
more? (Clue: you will need to distinguish between revenue and profit. We will explore this relationship in
the next chapter.)
Even though an increase in production will lead to an increase in revenue for the firm, costs may increase by
more than revenue, thereby reducing the firm's profits. The issue, then, is whether revenue increases more
than costs (in which case the firms will increase its profits by producing more), or less than costs (in which
case the firm would see a fall in profit by producing more).
 Answers to pause-for-thought questions in Economics for Business (3rd edition), John Sloman and Mark Sutcliffe

Two customers go to the fish counter at a supermarket to buy some cod. Neither looks at the price.
Customer A orders 1 kilo of cod. Customer B orders £3 worth of cod. What is the price elasticity of demand
of each of the two customers?
The elasticity of demand for Customer A is zero. In other words, that person's demand for cod is
independent of price. If the price was different from the actual price, Customer A would still buy 1 kilo.
The elasticity of demand for Customer B is –1. In other words, if price were 10 per cent higher than the
actual price, 10 per cent less cod would be bought in order to keep the amount spent constant (at £3).

Assume that you decide to spend a quarter of your income on clothes. What is (a) your income elasticity of
demand; (b) your price elasticity of demand?
(a) Your income elasticity of demand is 1. In other words, a 10 per cent rise in your income would see you
spending 10 per cent more on clothes in order to keep the fraction of your income spent on clothes at a
quarter.
(b) Your price elasticity of demand is –1. To understand this, assume that price changes but that your
income does not. In order to keep your expenditure on clothes at one quarter of you income, your total
expenditure on clothes would have to remain the same, irrespective of price. This will occur when the price
elasticity of demand is unity (–1).

What are the advantages and disadvantages of speculation from the point of view of (a) the consumer; (b)
firms?
Generally, stabilising speculation will benefit both consumers and firms as it will create a more stable market
environment in which it is easier to plan purchases, production or investment. Generally people prefer
certainty to uncertainty. Destabilising speculation, on the other hand, by exaggerating the upswings and
downswings in markets, will make it more difficult to plan – something that will be unpopular with consumers
and producers alike.
Of course, to the extent that the consumers or producers are themselves taking part in the speculation,
they will gain from it, whether it is stabilising or destabilising, provided that they predict correctly. For
example, if you are thinking of buying a house and, correctly, predict that house prices will rise in the near
future, then you will gain by buying now before they do.

The demand for pears is more price elastic than the demand for bread and yet the price of pears fluctuates
more than that of bread. Why should this be so? If pears could be stored as long and as cheaply as flour,
would this affect the relative price fluctuations? If so, how?
The reason for the greater price fluctuations of pears is their greater supply fluctuations according to the
season and the different costs of importing pears from other countries when they are in season there.
Holding stocks of a product can help to reduce price fluctuations, as demonstrated in the text, but the cost of
storage must be reflected in the price. Thus if pears could be stored more cheaply, their price would
fluctuate less. If they could be stored as cheaply as flour (relative to their price), then price fluctuations
would be similar to that of flour. Whether the degree of price fluctuation were identical, however, would
depend also on how much initial supply (before storage) fluctuated, assuming storage costs are not zero.