The Demand Curve and Factors Affecting Demand
Answer to question 1
Demand curve depicts the relationship between price and quantity demanded of a goods. Following an inverse relation between price and demand of a particular good, demand curve slopes downward. The upward sloping demand curve indicates a positive relation between demand and price. For this is to be the case, demand should rise with a rise in demand. Behavior towards demand however depend on number of other factors in addition to price.
Sales of beef increases along with a rise in beef price. Price is not the only factor that influence beef demand. Different substitute of beef like chicken, lamb and others are available in the market (Hildenbrand 2014). People increases the demand for substitute when this seems relatively cheaper. It might be possible that price of substitute increases by a larger magnitude than prices of beef. If this is the case, then despite increase in beef price people continue to purchase beef, as it remains relatively cheaper. This however does not imply beef demand curve to slope upward. Without knowing, the state of other demand influencing factors it cannot be concluded that demand curve for beef is upward sloping.
Answer to question 2
a)
Poor harvest of wine grapes reduces supply of wine grapes. In preparing wine, the primary input is wine grapes. An interrupted input supply affect production of final goods as well. The reduced supply of wine grapes reduces production of French wine. Supply of French wine reduces shifting the supply curve upward (Baumol and Blinder 2015). As supply contracts, the available supply falls short of demand. Shortage of supply in the French wine affects the equilibrium price and quantity. Under new equilibrium condition price increases while equilibrium quantity reduces. Figure 1: Poor harvest and French Wine market
In the French wine market, the supply curve S0S0 to the left to S1S1. As a result, the equilibrium shifts up to E1. Equilibrium price in the market increases to P1 while equilibrium quantity declined to Q1.
b)
Australian wine is a substitute of French wine. In case of substitute goods, price of one good affects the demand for its substitute. Increased price in the French wine market reduces demand for French wine. People tend to substitute French wine with Australian wine. As the demand for Australian wine increases, demand curve shifts to the right (McKenzie and Lee 2016). A new equilibrium is achieved at a higher price and quantity demanded.
Supply and Factors Affecting Supply
Figure 2: Equilibrium in Australian wine market
In response to higher demand, demand curve for Australian wine shifts right to D1D1. Equilibrium shifts up to E2 with a higher price and higher equilibrium quantity.
Answer to question 3
Under free market, equilibrium price and quantity is determined from demand and supply conditions. Changes occur in either demand or supply or both lead to a change in equilibrium price and quantity. Given a decrease in apple juice, demand for apple juice increases. With a decline in price of apple juice, orange juice becomes relatively expensive (Friedman 2017). Orange juice being a substitute of apple juice experiences a decline in demand. Besides, demand side shocks, changes has also occurred in the supply of orange juice. As the rate of wage paid to orange grove workers increases, cost of production for orange juice increases.
The increasing wage cost reduces the supply of orange juice decreases. Because of the change in demand and supply in the orange juice market, equilibrium price and quantity in the market change. Decline in demand and supply both create a downward pressure in equilibrium quantity. At the new equilibrium, quantity declines. The impact on equilibrium price is however ambiguous. Decrease in demand cause a decline in equilibrium price. The supply shortage caused by contraction in supply causes an increase in price. Demand and supply thus have two opposing effect on price (Carlton and Perloff 2015). Direction of price movement depends on dominating effects of demand and supply. If demand force dominates, then price decreases. If supply force dominates, then price increases. The equilibrium quantity declines as usual. Depending on magnitude and extent of demand and supply, there are three possibilities. Figure 3: Impact of dominating demand force
Figure 4: Impact of dominating Supply force Figure 4: Equivalent changes in demand and supply
Market Equilibrium and Changes in Equilibrium
Answer to question 4
a)
Total revenue is the receipts receive by an organization from sales of goods and services. Revenue of a firm depends on both price and volume of sales. As price and quantity change in opposite direction, changes in revenue following a change in price depends on the elasticity of demand. Therefore, before taking any decision regarding price assumption need to be made about elasticity. Revenue increase with an increase in price only with inelastic demand. In case of inelastic demand, proportionate change in demand is smaller than the changes in price (Nocco, Ottaviano and Salto 2014). Henceforth, demand cannot fall largely when price increases. Firm therefore benefits from a higher price. With elastic demand, decrease in price is beneficial as this raises revenue by increasing quantity demanded to a greater proportion. The tax drivers/owners can be confident that an increase in price will increase revenue only when the assume demand to be relatively inelastic.
b)
Demand elasticity depends on a number of factors. Demand is inelastic when least number of substitutes are available (Mahanty 2014). Taxi rides provide a comfortable journey as compared to public transport. People can avoid hefty crowd in public transport by choosing taxi rides. Because of comfortable and time saving journey, preference for taxi rides increases. Because of increasing preference and availability of less perfect substitutes to taxi rides, demand for taxi rides is inelastic in nature.
Answer to question 5
a)
Therefore,
The firm is making loss. Figure 6: Short run equilibrium in monopolistically competitive market
b)
Despite loss, firms should not change the output level as output corresponds to profit maximizing level of output. At this level of output marginal revenue = marginal cost = $3.00. Operating at this level of output, the firm incur a loss, as price is less than average total cost of $5.00. The firm though may continue its operation in the short run until price above or equals average variable cost (Sloman and Jones 2017). The loss-making firm in the long-run should leave the industry in long run if the loss persists.
Reference list
Baumol, W.J. and Blinder, A.S., 2015. Microeconomics: Principles and policy. Cengage Learning.
Carlton, D.W. and Perloff, J.M., 2015. Modern industrial organization. Pearson Higher Ed.
Friedman, L.S., 2017. The microeconomics of public policy analysis. Princeton University Press.
Hildenbrand, W., 2014. Market demand: Theory and empirical evidence. Princeton University Press.
Mahanty, A.K., 2014. Intermediate microeconomics with applications. Academic Press.
McKenzie, R.B. and Lee, D.R., 2016. Microeconomics for MBAs. Cambridge University Press.
Nocco, A., Ottaviano, G.I. and Salto, M., 2014. Monopolistic competition and optimum product selection. American Economic Review, 104(5), pp.304-09.
Sloman, J. and Jones, E., 2017. Essential Economics for Business. Pearson.
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