Markets, elasticity and taxation & subsidies

The exam
Markets
Elasticity

Taxation
Subsidies

1 HOUR 30 MINUTES LONG

- 50% AS
- TOTAL 80 MARKS

Supported choice:

Data question:

8 questions for 4 marks

33% evaluation

each
Total 32 marks
Spend no longer than 36
minutes here

5 questions

Total 48 marks
Spend 54 minutes here

The supported choice:

Definition: 1 2 marks

Diagram: 1 - 2 marks
Annotation: 1 - 3 marks
Application/calculation: 1 2 marks
Further analysis: 1 2 marks
KOs 1 3 marks refer to key!

The data response 5 questions:

4 MARK QUESTION
purely knowledge and application marks
Define the terms in the question (1 2 marks)
remember to apply your knowledge to the extract
6 MARK QUESTION
purely knowledge and application marks
Define the terms in the question (1 2 marks)
remember to apply your knowledge and draw diagrams
if theyre relevant

The data response cont:

10 MARK QUESTION
Definition/knowledge 1 mark
Application, analysis & diagram 5 marks
4 marks for evaluation: (2 + 2)

14 MARK QUESTION
Identification, analysis & diagram 8 marks
6 marks for evaluation: (2 + 2 + 2) safest

Evaluation ideas:
Short versus long-run

Different elasticities
Magnitude of factors use extract or data
Ceteris paribus could other factors be the cause

of these effects
Opposing viewpoints
Put the event in a wider context

You should know:

Factors which shift demand

Factors which shift supply
Consumer & producer surplus
Role of the price mechanism
Application to markets:

Agriculture
Precious metals
Oil
Stock markets
Labour

Factors that shift demand & supply:

DEMAND

SUPPLY

Income

Production costs

Population

Technology

Tastes

Number of firms

Price of substitutes

Weather

Price of complements

Tax

Interest rates

Subsidies

Expectations

Firms objectives

Which of the following is most likely to cause

the price of gold to fall without a shift in the
demand curve?
A An increase in national income.
B A decrease in the price of silver.
C An increase in the wage of gold miners.
D A decrease in the cost of machinery used in goldmining.

Factors that shift labour demand & supply:

LABOUR DEMAND

LABOUR SUPPLY

Demand derived from

changes to product demand

Changes to the working

population, such as net
migration
Change to final products price Changes to wages, income
& so firms revenue
tax, working conditions
Labour productivity
Regulations

Changes to capital prices

Value of leisure time

Qu. (June 2010)

Assess the likely
impact of the decrease
in demand for new cars
on the labour market
for car workers.

Evaluation:

Magnitude extract says 21.8% fall in 1st quarter

Extent to which wages can fall NMW & TUs
Impact of occupational and geographical
mobility of labour
Time short-run sabbaticals?
Impact on related markets mechanics, jobs in
second hand car market

Price elasticity of demand:

You should know:
Definition
Diagrams
Determinants
Relationship with revenue
Relevance to business

Price elasticity of demand is

the responsiveness of quantity
demanded to a change in price

PeD =

Inelastic: a change in
price leads to a
proportionally smaller
change in quantity
demanded.

Elastic: a change in
price leads to a
proportionally larger
change in quantity
demanded.

% in Qd
% in P

PeD is always negative a

demand curve slopes
downwards!

PeD becomes more inelastic as

you move down a demand curve

10,000 jar of jam are demanded per day at a

price of 2 per jar. If the PeD for these jars is
-2 and the price is raised by 20%, the number
of jars demanded will fall to
A
B
C
D

6,000
7,000
8,000
9,000

Habitforming

Luxury
or
necessity

Number of
substitutes

DETERMINANTS
OF PED

Time

Proportion
of income

Answer structure:
Qu. (June 2010)
Assess whether Definition PeD
the demand for
food is likely to Definition of inelastic
be price elastic
Use of data and extract
or price
inelastic.

Determinants

Diagram

Evaluation:

Types of food

Differences between different income groups

PeD & revenue:

Summary:
Revenue will rise

Revenue will fall

If PeD is inelastic:
an increase in price

If PeD is inelastic:
a decrease in price

If PeD is elastic:
a decrease in price

If PeD is elastic:
an increase in price

Type of flight

PeD

Short haul business

-0.70

Short haul leisure

-1.52

The table shows estimated PeDs for air travel for

business and leisure customers of Air Canada. It may
be deduced that:
A Demand is more price elastic for business travellers than
leisure travellers.
B An increase in price for business travellers and a decrease
in price for leisure travellers will increase total revenue.
C Air travel is an inferior good.
D The XeD for business air travel with regard to a change in
price of leisure air travel is negative.

Income elasticity of
demand is the
responsiveness of
quantity demanded to a
change in income
% in Qd
% in Y

YeD =

YeD can be negative and

positive.

Positive YeD: an
increase in income
leads to an increase in
quantity demanded =
Normal good

Negative YeD: an
increase in income
leads to a decrease in
quantity demanded =
Inferior good

Qu. (Jan 2011)

Discuss
whether
chocolate and
other
confectionary
is likely to be
normal or
inferior goods.
10 marks

Answer structure:

Definition YeD

Definition of normal & inferior goods

Use of data and extract

Diagram

Evaluation:

Different types of chocolate/confectionary

Ceteris paribus other factors may have

caused the change in demand

Different income groups

Cross price elasticity of

demand is the
responsiveness of the
quantity demanded of
good A to a change in price
in good B
% in Qd Good A
% in P Good B

XeD =

XeD can be negative and

positive.

Positive XeD: an
increase in the price of
good A leads to an
increase in quantity
demanded for good B =
Subsititute good

Negative XeD: an
increase in the price of
good A leads to a fall in
quantity demanded for
good B =
Complementary good

The diagrams show the effects of an increase in

supply of good X on the demand and price of good Y.
Which of the following is most likely to be represented
by good X and good Y:
A Lamb and chicken
B Bus travel and potatoes.
C Computer game consoles and software
D Leather and beef.

Price elasticity of supply is

the responsiveness of
quantity supplied to a
change in price

PeS =

% in Qs
% in P

PeS is always positive a

supply curve slopes
upwards!

Inelastic: a change
in price leads to a
proportionally
smaller change in
quantity supplied.

Elastic: a change in
price leads to a
proportionally
larger change in
quantity supplied.

Levels of
stocks

Spare
capacity

Ease of
storage

DETERMINANTS
OF PES

Time

Ease of
industry
entry

Qu. (Jan 2010)

Discuss how
the PeS of oil
might differ in
the short and
long run.

Answer structure:

Definition PeS

Definition of short & long-run

Use of data and extract

Short-run:

Long-run:

Evaluation:

Price volatility
Different PeS from different regions
Availability of stocks eg. OPEC
Finite resource so very inelastic in LR
Ceteris paribus impact of possible new
discoveries or extractive technologies

Definitions:

Direct tax
A tax levied directly on an individual or organisation.

Indirect tax

A tax on expenditure collected by the producer on behalf of the

government.

Pigouvian tax

A tax is set on a good so that it equals the marginal negative externality

this internalises the external cost : the polluter pays principle.

Specific tax

An indirect tax which is charged as a fixed amount per unit of that good,
causing a parallel shift in the supply curve to the left.

Ad Valorem tax

An indirect tax which is charged as a percentage of the price of the good,

causing a pivotal rotation of the supply curve to the left.

The diagram shows

the impact of a
specific tax placed on
air travel. Which of the
following is correct?
A Total tax revenue is
PeP1YX
B Producer surplus
increases
C The price of air tickets
rises from Pe to P2
D Consumer surplus
decreases

Price per kilo ()

Quantity
demanded (kilos)

Quantity supplied
(kilos)

500,000

900,000

600,000

800,000

700,000

700,000

800,000

600,000

900,000

500,000

Quantity supplied
after tax (kilos)

If the government introduces a tax of 2 per kilo,

the new equilibrium price will be
A
B
C
D

8
7
6
5

Qu. (June 2010)

Evaluate the
possible
economic
effects of a
decrease in
fuel taxes. Use
an appropriate
diagram in
your answer.

Answer structure:

Definition indirect tax

Diagram (next slide)

XeD cars are complements

XeD public transport as substitute

Other impacts:

Qu. (June 2010) cont.

Show on diagram:

Total expenditure
Tax per unit
Incidence
Demand is price
inelastic

Evaluation:
Magnitude of tax decrease data use
Tax as a proportion of all fuel costs
Discussion PeD fuel
Discussion of XeD
Ceteris paribus impact of other factors on
car ownership
Negative externalities
Impact on government finances

Evaluation to consider:
Argue the opposite view.
How contestable is the market?
Is there evidence that competition can increase?
How do incumbents respond? Price wars or aggressive advertising etc.

Definition subsidy
Government grant to firms in order to lower their

production costs and so increase supply & lower

prices.

Incidence:
Price inelastic demand large fall in price
Price elastic demand smaller fall in price

The diagram illustrates

the effect of a
government subsidy
on a good. The total
government
expenditure on the
subsidy will be:
A
B
C
D

100
150
450
1050

Price per unit ()

Quantity
demanded (units)

Quantity supplied
(units)

16

2000

2800

14

2200

2600

12

2400

2400

10

2600

2200

2800

2000

Quantity supplied
after subsidy (units)

If the government introduces a subsidy of 4 per

unit, the new equilibrium price will be
A
B
C
D

8
10
12
14

Qu. (Jan 2010)

Evaluate the
likely economic
benefits of an
increased
subsidy for bus
and rail travel.
Use an
appropriate
diagram in your
answer.

Answer structure:

Definition subsidy

Diagram (next slide)

Impact on consumer surplus

Impact on producer surplus

Impact on negative externalities

Other benefits:

Qu. (Jan 2010) cont.

Show on diagram:

Total expenditure
Subsidy per unit
Incidence

Evaluation
Magnitude of subsidy
Duration of subsidy
XeD of public transport with respect to
private transport
PeD and consumer incidence
Government failure - promotion inefficiency
& dependency in public transport
Impact on public finances opportunity costs
& changes to tax