Student ID:

ECO130 - Business Economics Assessment No. 2

Question 1:
The condition where demand and supply interacts is called the equilibrium price and
quantity. At the equilibrium, the price is not affected and there is no shortage and excess. The
price is supposed to stay at equilibrium in the short run, unless there is a change in other
factors that affect the demand and supply, such as income or weather conditions. At the
equilibrium, the price is such that both the buyers and sellers are satisfied, and agree on the
market price (Arnold 2001).

a)
Supply

Price

D1

(Mars)

D2

Quantity (Mars)

In the diagram above, the price of a substitute, Snickers, falls by 20%. As a result, the
demand of Snickers will increase, as per the inverse rule of demand and price. Therefore, the
demand of Mars will fall consequently. Mars will face the substitute effect and will
experience a downward shift in its demand curve, and will move from D1 to D2. Mars will
also have to decrease its price or offer other incentives in order to maintain its demand.

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Student ID:

ECO130 - Business Economics Assessment No. 2

b)

Supply

Price
(Mars)

D2
D1

Quantity (Mars)
If the average income in Australia increases by 20%, their disposable income and
purchasing power parity increases as a result. Therefore, the demand of Mars will increase.
Mars is a normal good with demand elasticity of more than 1. It is an elastic product and its
demand would increase with an increase in average income. The demand curve shifts
upwards from D1 to D2, whereas the price of Mars remains the same. The concept ofceteris
paribus will not be applicable in this situation. It only applies when the price changes and rest
factors remains the same.

c)
S1

Price

S2

Demand

(Mars)

Quantity (Mars)

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Student ID:

ECO130 - Business Economics Assessment No. 2

The Cost Saving Robot Technology will lead to an increase in supply with the
same price. In the confectionary industry, the technology will lead to efficiency in
production, thereby leading to an increase in supply of the Mars product. This technology
will prove to be a success for the product as the revenue will increase. The supply curve will
shift outwards from S1 to S2.

d)

Price

Supply

(Mars) 100
85
Demand

100

130

Quantity (Mars)

In the above diagram, the price of Mars falls by 15%, leading to an increase in the
demand of the product. Since Mars is an elastic good, the decrease in price will lead to a
more than 15% increase in the quantity demanded. Moreover, the decrease in price will also
disrupt the market equilibrium and lead to shortages of the product. This will only be
applicable if ceteris paribus is maintained (Arnold 2001). It means that, all other factors
affecting the demand of Mars, other than price, are kept stable and constant.
Question 2:
Elasticity in economics generally means responsiveness. The basic definition of
elasticity is the change in the demand and supply of a good due to the changes in prices.
There are basically three concepts of elasticity. The basic is the price elasticity of demand,
which shows the changes in the demand of the good or service in response to the price
changes. This elasticity is only accurate once all other factors that affect the good/service are
kept constant. Income elasticity shows the changes in the demand for a good as a result of the
change in an individuals income. Lastly, price elasticity of supply measures the
responsiveness of supply due to the changes in the price of a good (Stretton 1999).
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Student ID:

ECO130 - Business Economics Assessment No. 2

If a decrease in price brings a more than proportionate increase in the demand of the
product, then that product is elastic. On the other hand, if the decrease in price brings less
than proportionate increase in the demand of the product, it is considered as inelastic.
Elasticity is calculated and measured by the percentage change in quantity demanded divided
by the percentage change in price (Stretton 1999). Whenever the elasticity of demand is
greater than 1, the goods are considered to be elastic. When the elasticity of demand is less
than 1, the goods are inelastic.
The designer label goods in the given question are supposed to be price elastic. If the
owner plans to raise the revenue from the sales of these goods, he should decrease the prices
to lead to a more than proportionate increase in the demand of these goods. As a result, the
revenue from the sales of the designer labels will increase (Stretton 1999).This is because as
the prices will fall, more and more consumers will buy these products, resulting in a more
than proportional increase in sales, and therefore revenue. For example, if the price falls by
10% and the demand rise by 20%, the elasticity of demand is 2.
The price elasticity of demand is referred by the slope of the demand curve. If the
demand curve is flatter, it shows higher elasticity of the product, since smaller changes in
price leads to larger changes in the quantity demanded.
The graph below shows a hypothetical situation of the elasticity of demand of the
designer label goods. The red line shows the demand curve that is flat, hence proving that the
product has an elastic demand. As the price increases from P1 to P2, the demand falls from
Q2 to Q1. On the other hand, as the price falls from P2 to P1, the quantity demanded
increases from Q1 to Q2.

P2
P1
Price

Q1

Q2

Quantity Demanded
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Student ID:

ECO130 - Business Economics Assessment No. 2

Question 3:
MR on the X Axis
4

Marginal Revenue

3
2
1
0
-1

10

-2
-3
-4
-5

Quantity (Y axis)

Total Revenue Curve

14.00
12.00

Total
Revenue

10.00
8.00
6.00

Total Revenue

4.00
2.00
0.00
0

10

Quantity Demanded

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Student ID:

ECO130 - Business Economics Assessment No. 2

Price Elasiticity of Demand

6.00

Elastic
5.00

4.00

Unitary
Elastic

3.00

Inelastic
2.00

1.00

0.00
0

10

Question 4:
a)

The condition in which a market operates depends upon its buyers and sellers.

Equilibrium in the market is a situation where the quantity demanded is equal to the quantity
supplied. At the point of equilibrium, there is no inclination for the price to change or move
upwards or downwards (Case & Fair 2002).When the market equilibrium is not achieved,
there will be either shortage or excess of the good. Shortage occurs when the quantity
demand is greater than the supplied quantity. Shortage will lead to increase in the price;
hence equilibrium will result towards the end. On the other hand, excess of the good (when
the supply is greater than demand) will result in price fall, resulting in equilibrium again
(Case & Fair 2002).
In the table given in the question, the equilibrium is achieved when the price is $20,
and the quantity demanded and supplied are both at 65. At this point, the price will not
change and remain stable in the short run.
b)

Government sets the price floor to prevent producers from reducing the price below it.

The price is not able to go below the floor, hence the name price floor. In order to be
effective, the price floor should be higher than the equilibrium price in most cases. It refers to
the lowest price a good or service can be sold at (Blink and Dorton 2007).
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Student ID:

ECO130 - Business Economics Assessment No. 2

If the government sets the price floor at $50, the graph of the above product would
look something like this:

Price

Demand
Supply

50
20
10

Quantity

The blue dotted line in the picture is the price floor, which is set at $50.
At this price floor set by the government, the quantity supplied will be greater than the
quantity demanded, resulting in the excess of the product. The main reason to set the price
floor would be to protect the producers. The government usually deals with the excess by
buying the surplus of the good.
c)

Government decides to set the price floor for a number of reasons. Firstly, it attempts

to raise the incomes of producers of goods and services, especially of the agricultural goods.
This price floor implementation might help them as the prices of certain products are subject
to high fluctuations or a lot of foreign competition. Moreover, many governments put a price
floor on local products to save them from the foreign competition, but also to promote the
local market and economy (Blink and Dorton 2007). Secondly, price flood ensures that
workers get a basic minimum wage and also protects their rights.

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Student ID:

ECO130 - Business Economics Assessment No. 2

References
Arnold, R 2001, Economics, South-Western College Pub., Cincinnati, Ohio.
Blink, J & Dorton, I 2007, Economics, Oxford University Press, Oxford.
Case, K & Fair, R 2002, Principles of Economics, 6th edn.
Stretton, H 1999, Economics, Pluto Press, London.

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