Supply and Demand and Budget Line

TASK 1 Consider the following equation: MRSXY < PX/PY where MRS = marginal rate of substitution x and y are two goods P = price < = is less than {draw:frame} The graph above shown us the indifference curve budget line diagram which explaining the equation MRSXY < P X / PY. There are two ways to measure the consumer preferences or what the consumer wants. The first one is by trying to put a ‘value’ on the satisfaction a consumer obtains from consuming a ‘unit’ of a good. Consumers are assumed to be able measure utility in terms of a ‘util’. However, we cannot find the total utility by using this method. So we can use another way which is by ranking the product. We can say that the consumer is preferred good Y compared to good X. the indifference curve is a curve that shows consumption bundles that give the consumer the same level of satisfaction. So this means that the consumer is satisfied at any point if the indifference curves above. The slope of the indifference curves are downward sloping. For example, the consumer will satisfy when he buys 3 good X and 4 good Y. The meaning of the term budget constraint is what the consumer can afford to buy. The income of the consumer will determine how much he can buy in the market. So, the budget line in the graph above is showing how much good X and Y that the consumer affords to buy. If the slope of the budget line is higher, this means that the consumer afford to buy good X compare to good Y. While if the slope of the budget line is lower, the consumer afford to buy good Y compare to good X. From the graph, we can see that the consumer is not maximizing the satisfaction. This is because the indifference curves are inside the budget line and it intersect at two points which are a and b. At point b, the slope of the indifference curve (MRSxy ) is less than the slope of the budget line (Px/Py). While, at point a, the slope of the indifference curve (MRSxy ) is greater than the slope of the budget line (Px/Py). So the consumer does not maximizing the satisfaction for both point a and b. In order to maximize the satisfaction, the slope of the indifference curve must equal to the slope of the budget line. So at point b, the consumer should reduce the consumption of good X and increase the consumption of good Y until both slope of indifference curve and budget line will become the same. By switching spending away from good X towards good Y, the consumer will be able to reach a higher indifference curve. {draw:frame} From the graph, we can see that the indifference curve has shift and meet the budget line at the point c. at this point, the slope of the indifference curve and the budget line are the same. So the equation will change to [MRSXY = PX / PY]. At point c, the consumer satisfaction is at the highest place. The consumer choice is the product which been sold in the market. While, the individual demand for a product is the demand of a consumer on that product. The demand on a product will be higher if there are only small choices in the market. People tend to demand more for the product as they cannot find other product. TASK 2 *Definition of Price Elasticity of Demand (PEoD*) The price elasticity of demand is the measure of how responsive is the quantity demanded to a change in price. There are many types of elasticity in demand which will stand for different types of product in the market. In order to differentiate between them we need to state the definition and the ratio of the elasticity. Relatively Elastic Demand The relatively elastic demand is a demand relationship in which the percentage change in quantity demanded is large in absolute value than the percentage change in price. In other words the percentage change in quantity demanded is larger than the percentage change in price. {draw:frame} The ratio for the relatively elastic demand is 1< PEoD < Infinity Relatively Inelastic Demand The relatively inelastic demand is a demand that responds, somewhat, but not a great deal to change in price. In other words, the change in percentage change in price is larger than the percentage change in quantity demanded. {draw:frame} The ratio for the relatively inelastic demand is 0 < PEoD < 1 Unit Elastic Demand The unit elastic demand is a demand relationship in which the percentage change in quantity demanded is the same as the percentage in change of the price. {draw:frame} The ratio for the unit elastic demand is PEoD = 1 Perfectly Elastic Demand The perfectly elastic demand is a demand in which the quantity demanded drops to zero at the slightest in price. In other words, the quantity demanded will become zero if the seller increases the price of the product. While they will never reduce the price as it will reduce their normal profit. {draw:frame} The ratio for the perfectly elastic demand is PEoD = Infinity Perfectly Inelastic Demand The perfectly inelastic demand is a demand in which quantity demanded does not respond at all to the change in price. {draw:frame} The ratio for the perfectly inelastic demand is PEoD = 0 Calculating the Price Elasticity of Demand The formula to determine the price elasticity of demand is: PEoD = (% Change in Quantity Demanded)*/(*% Change in Price) Price (OLD) =9 Price (NEW) =10 Q Demand (OLD) =150 Q Demand (NEW) =110 Calculating the Percentage Change in Quantity Demanded [QDemand(NEW) – QDemand(OLD)] / QDemand(OLD) [110 – 150] / 150 = (-40/150) = -0. 2667 Calculating the Percentage Change in Price [Price(NEW) – Price(OLD)] / Price(OLD)] [10 – 9] / 9 = (1/9) = 0. 1111 PEoD = (% Change in Quantity Demanded)/(% Change in Price) PEoD = (-0. 2667)/(0. 1111) = -2. 4005 TASK 3 The product that I choose is tobacco. Both of the elasticity of demand and supply of tobacco is relatively inelastic. This is because the product will has an inelastic demand if the item is habit forming. As tobacco is a habit forming, it is relatively inelastic in demand. So if there is increase in price, the quantity demanded will not respond too much. While, the supply of the tobacco is relatively inelastic is because of the time period. As the tobacco is the agriculture product, it will take some times to grow it and get the product. So the producer cannot increase the quantity of supply although there are many demands for the tobacco. TASK 4 {draw:frame} The graph above has shown a market of tobacco with the relatively inelastic demand and supply curves. As we can see, the total surplus has reduced since the implementation of the tax. The benefit received by buyers in a market is measured by consumer surplus. The consumer surplus is the amount buyers are willingly to pay for the good minus the amount they actually pay for it. So the consumer surplus before the tax are (a + b + c). However, after the implementation of tax on the tobacco, the consumer surplus is only a. This means that the consumer needs to pay more after the implementation of tax. P in the graph stands for the price of tobacco before the tax. While, P*B* is the price that buyers need to pay after the tax has been implemented. The benefit received by sellers in a market is measured by producer surplus. The producer surplus is the amount of sellers received for the good minus their cost. So the producer surplus before the implementation of tax is (d + e + f). But, the producer surplus change after the implementation of tax, which became only f*. * This means that the seller received less profit after the tax implemented. **P*S in the graph is the price that seller received after the implementation of the tax. So this means that, the consumers and producers have to bear the tax burden after the tax has been implemented. Tax burden is the amount of tax suffered by individuals or organization. The tax burden for the consumer and seller may vary depends on the elasticity of the demand an d supply curves. Although the consumer and sellers seems to be burden by the tax, there is one party that gains benefit from it. It is the government because it has gain revenue from the tax. The tax revenue is the (b + d) in the graph above. From the revenue, the government can use it for other investment. However, the tax has also brought another disadvantage which is the deadweight loss. The deadweight loss is the reduction in total surplus that results from a tax. The deadweight loss in the graph is (c + e). The size of deadweight loss also depends on the elasticity of the demand and supply curves. If both of the curves become more elastic, then the size of the deadweight loss will become smaller. So in the conclusion the tax has given benefit to the government but brought disadvantages to the consumer and producer. REFERENCE LIST Mankiw, N. G. (2008). Ten Principles of Economics. In J. W. Calhoun, A. V. Rosenberg, M. Worls, J. Tufts, J. E. Thomas & K. Yanos (Eds. ), Principles of Economics. Canada: SOUTH-WESTERN CENGAGE Learning. Moffatt, M. (2010). Price Elasticity of Demand. _ _Retrieved April 26, 2010, from http://economics. about. com/cs/micfrohelp/a/priceelasticity. htm Webster, N. (2007). Economics_ _(3rd ed. ). Adelaide: Greg Eather and Associates, Publication Division.