Price Elasticity of Demand
1. Crude oil is the most essential product that is required in all the sectors of the economy. From manufacturing to transport the whole world is dependent on the different derivatives that are derived from crude oil. In the present context crude oil is necessary good. The price elasticity of demand measures the sensitivity or the responsiveness of the demand for crude oil with respect to the changes in price. The price elasticity demand is calculated by the following formula,
Where, q is the quantity demanded and p is the price level of the commodity. The value of is calculated in mod values. The short-run price elasticity of crude oil is very low in absolute terms. This means that it is highly price inelastic in short run. However, in the long run the price elasticities are much higher than the short run values. This means that in the long run the price elasticity is less inelastic than the short run (Baumeister & Peersman, 2013). The graphical analysis is provided below.
The demand and the supply curve are having less slope in the long run as compared to that in the short run. The main reason for a more steeply sloped demand curve in the short run is that in the short run people do not have close substitutes to oil. However, in the long run due to technological advancement, substitutes like solar energy may reduce the over dependence on crude oil. A slight change in price level may lead to huge changes in the quantity demanded for crude oil. Thus, relatively more elastic in the long run and inelastic in the short run. Similarly, for the supply curve in the short run even if the producers are making losses they will keep on producing. However, in the long run producers might think of alternate choices and leave the business making an elastic supply in the long run.
2. Consider the market of ice cream. The demand and supply of the ice cream market are the traditional downwards sloping demand and upwards sloping supply curve. The equilibrium price of the market is at P and Q, where P is the price and Q is the quantity demanded. Now, suppose that the government decides to put a binding price ceiling on the ice cream market. Consider that the binding price is below the equilibrium price level. This will create an excess demand of ice creams in the market. This phenomenon will result in various malpractices. The suppliers will tend to give the produced goods to their near relatives and friends and the consumers in need of the good may miss out. Another effect may be that the sellers might lower the quality of the goods produced. The graphical analysis is provided below.
From the above diagram it can be clearly observed that the Qs is the quantity supplied and Qd is the quantity demanded. Qd – Qs is the excess demand that is prevailing in the market. The equilibrium price and quantity is at P and Q respectively.
Price Elasticity of Supply
Now consider for the welfare of the sellers the government decides to set a binding price floor. Suppose that the price set by the government is more than that of the equilibrium price. This will create an excess supply in the market for ice creams. The supply will be more than the demand. This will lead to improvement in the quality of the ice creams produced and increase the efficiency of the producers. The graphical analysis of the above said explanation is provided below.
From the above the equilibrium price and quantity is at P and Q respectively. Qd is the quantity demanded at price level P* and Qs is the quantity supplies at P*. Qs – Qd is the excess supply in the ice cream market.
3.
|
Quantity of soap sold per hour |
Total cost ($) |
Fixed cost ($) |
Variable cost ($) |
Average |
Average |
Average |
Marginal cost ($) |
|
fixed cost ($) |
variable cost ($) |
total cost ($) |
|||||
|
0 |
15 |
15 |
0 |
0 |
0 |
0 |
0 |
|
1 |
15.5 |
15 |
0.5 |
15.00 |
0.50 |
15.50 |
0.50 |
|
2 |
15.6 |
15 |
0.6 |
7.50 |
0.30 |
7.80 |
0.10 |
|
3 |
16.7 |
15 |
1.7 |
5.00 |
0.57 |
5.57 |
1.10 |
|
4 |
17 |
15 |
2 |
3.75 |
0.50 |
4.25 |
0.30 |
|
5 |
17.1 |
15 |
2.1 |
3.00 |
0.42 |
3.42 |
0.10 |
|
6 |
17.2 |
15 |
2.2 |
2.50 |
0.37 |
2.87 |
0.10 |
|
7 |
17.3 |
15 |
2.3 |
2.14 |
0.33 |
2.47 |
0.10 |
|
8 |
18.3 |
15 |
3.3 |
1.88 |
0.41 |
2.29 |
1.00 |
|
9 |
19.3 |
15 |
4.3 |
1.67 |
0.48 |
2.14 |
1.00 |
|
10 |
20.3 |
15 |
5.3 |
1.50 |
0.53 |
2.03 |
1.00 |
Figure 4: Cost Curves
Source: Author’s own creation
According the above diagram, the conventional cost curve properties are not met. To some extent, it can be argued that there exist economies of scale, which can be identified by the falling average cost.
4. Unemployment is a situation when people belonging to the labour force are actively searching for a job but are unable to find a job (Fujita &Moscarini, 2017). Unemployment can be broadly classified into three categories.
- Cyclic Unemployment: This type of unemployment occurs due to fluctuations in the business cycle. When there is an economic downturn there is a reduction in the demand for various goods and services this result in a severe lack of jobs. When there is a cyclic unemployment, the economy operates below the potential level (Diamond, 2013).
- Structural Unemployment: This type of unemployment occurs when there exists a mismatch between the number of available jobs and the number of job seekers. This occurs mainly because of the fact that the employees might not possess the desired level of skills for the job. In some cases, it might be that the employees need to develop new skills in order to meet the requirements of the employer. In this case, the employee may be structurally unemployed (Diamond, 2013).
- Frictional Unemployment: Labourers move from one firm to the other in order to find the suitable job. However, the workers require investing time in order find the job. During this period of transition time the workers are frictionally unemployed. This type of unemployment occurs for a short period of time (Pigou, 2016).
5. There are primarily three ways of measuring Gross Domestic Product (GDP) namely the product Method, expenditure method and income method. All these three methods are discussed in details (Kennedy & Prag, 2017).
1. Product Method: One way to calculate the value of the final goods and services produced is the value added method. In this method the gross domestic [product is simply calculated by adding up the value added at each stage of the production procedure.
Value added = value of the firm’s output – value of the intermediate goods
In an economy, the sum of the total value added is always equal to the value of the final goods and services.
2. Expenditure Method: In this method, the gross domestic product is calculated by the sum of all the final goods and services purchased in an economy. The total output is found using the total amount of money spent. The major components of expenditure in this model are private consumption, investment, government expenditure, net exports. The mathematical equation relating to this method is,
Y = C + I + G + (X-M)
Where C is consumption, I is investment, G is government expenditure, X is exports and M is imports.
3. Income Method: In this method, the total output is calculated by calculating the total factor income that is received by the residents of the nation. These total factor incomes include, employee compensation, interest received net of interest paid, rental income (net of expenses paid to land owners), royalties paid. These when summed together gives the gross national product of the nation.
A contractionary monetary policy shift the LM curve to the left, this reduces the level of output and an increase in the interest rate. As shown in the figure below, LM shifts from LM0 to LM1 reducing output from Y0 to Y1 and increasing interest from r2 to r1.
Figure 5: Contractionary Monetary Policy
(Source: Mankiw, 2014)
Figure6: Expansionary Monetary Policy
(Source: Mankiw, 2014)
The above diagram shows that the LM curve shifts rightwards from LM1 to LM2. The output level increases from Y1 to Y2 and interest rate decreases from r1 to r2.
There is an inverse relationship between the quantity of money supplied and the interest rate. When there is an increase in the interest rate then the cost of borrowing will be lower. Therefore people will draw out money from their saving and spend them. Thus increasing the supply of money. However, when there is an increase in the interest rate then the cost of borrowing money increases, people will spend less and thus reduction in the supply of money(Walsh, 2017).
References
Baumeister, C., &Peersman, G. (2013). The role of time?varying price elasticities in accounting for volatility changes in the crude oil market. Journal of Applied Econometrics, 28(7), 1087-1109.
Diamond, P. (2013). Cyclical unemployment, structural unemployment. IMF Economic Review, 61(3), 410-455.
Fujita, S., &Moscarini, G. (2017). Recall and unemployment. American Economic Review, 107(12), 3875-3916.
Kennedy, P. E., &Prag, J. (2017). Macroeconomic essentials: Understanding economics in the news. MIT Press.
Mankiw, N. G. (2014). Principles of macroeconomics. Cengage Learning.
Pigou, A. C. (2016). Keynes’s General Theory-A Retrospective View. Read Books Ltd.
Walsh, C. E. (2017). Monetary theory and policy. MIT press.
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