JC Economics Elasticity Concepts & Total Revenue Essay Model Answers
Are you worried about the essay question on elasticity applications in the Market Mechanism topic question in your ‘A’ Levels H2 Econs? How many of you in JC1 can afford to skip this essay question? Not many actually, as most JC Promos exams do set one question, or it can be easily set in the CSQ paper as well. Worse, if it is set as a compulsory section on its own!
Furthermore, application of PED, PES, YED and XED (or CED) is not that difficult, as one needs to figure how a firms uses these concepts to achieve their business objectives. Here is a full essay example;
(a) Explain, with examples, why different goods and services have different values of PED and YED. (10)
(b) Discuss how a firm, such as Singapore Airlines (SQ), might use the concepts of elasticity of demand in helping it to maximise revenue. (15)
JC Economics Essay – Price & Income Elasticities of Demand
Price elasticity of demand (PED) measures the responsiveness of quantity demanded given a change in the price of the good itself, cp. Demand for a good is said to be price elastic if the value of PED >1, ie. the quantity demanded will change by more than proportionate to a change in its price. On the other hand, if PED <1, demand for the good is price inelastic, le quantity demanded for the good will change by less than proportionate to a change in its price.
There are various factors that will affect the value of the PED, namely, the number of substitutes available, time to find substitutes, proportion of income spent on the goods and nature of the goods. The more substitutes the goods has and the shorter the time to find a substitute, the higher the PED value will be. The reason being consumers will switch to substitutes if the price of a good increase. In addition, the higher the proportion of income spent, the higher the value of PED as people are more responsive to changes in the prices as it will affect them more. Luxury goods will also tend to have a higher PED value as compared to necessities.
Thus, goods such as the Apple I-Phone will have a higher PED value, as there are many other brands such as Samsung, Nokia etc and it is easy to switch to. The IPhone or Samsung Galaxy smartphones are also more expensive and is considered a luxury as compared to non smartphones and other brands. Thus, consumers will respond significantly to a change in price of iPhone. On the other hand, goods like rice is considered as a necessity and has no substitute, thus, consumers will be less responsive to any price changes. PED value will therefore be less than one.
YED measures the responsiveness of demand given a change in the income of consumers, cp. YED is positive if the good are a normal good, i.e demand will increase if income increases, and negative if the good concerned is an inferior good, i.e. demand will fall if income increases. For the normal good, YED is >1 if the good is a luxury good like iPhone and spa, whereas, 0< YED <1 for necessity such as food. Inferior goods such as mobile phones from china may have a YED <0 as consumers will demand less if income increase.
However, it is important to take note that YED is a relative concept. The consumers’ classifications of the nature of goods depend on the absolute income level. For example, spa to the rich may be considered as necessity but for the poorer it will be luxury.
Question by JC Economics Tutor : what kind of diagram can you sketch, to include it as part of the answer?
JC Economics Essay – Applications of Demand Elasticity Concepts
Assuming the objective of SIA is to maximize its revenue by formulating appropriate business strategies, such as price and non price strategies.
A firm needs to consider the value of its PED before deciding if it is going for an aggressive pricing (lowering price) or charging a premium pricing for its products/services. The demand for SIA should be price elastic, ie. PED>1, as SIA has lots of substitutes where consumers can choose to take rival airlines like Qantas, British Airway etc. It also takes a short time to find alternative airlines. Air travel takes up a relatively large proportion of income of consumers compared to other modes of transport. Thus, according to the concept of PED, SIA should lower its fair to increase revenue, as lowering prices will lead to a more than proportional change in the quantity demanded, thus lead to higher total revenue (TR).
However, SIA needs to consider carefully before it launch a low price as it might trigger off a price war form its rivals, leading to a lose-lose situation. Moreover, air travel may be considered as a necessity service by some business travelers, thus their demand might be price inelastic. One possible option is to charge a higher fare for business class and a competitive pricing for economy class passengers.
Air travel is considered as a luxury good for most. As income increase demand for it will increase by more than proportion. SIA will benefit most as it is considered as one of the most preferred airline with excellent services. With increasing income as a result of economy recovery in 2011, SIA should increase its numbers of flights to cater for the increasing demand. SIA can also introduce longer non-stop flights to USA and Europe as consumers have higher purchasing power and will not mind paying more for more convenience.
During the recession in 2020 due to COVID-19, demand for SIA flights will drop sharply as consumers will opt for budget airlines instead. SIA has the option to lower its price or providing less “luxurious” services to lower cost. However, SIA might not want to pursue such option as it will tarnish its brand name. Alternatively, SIA started its own budget airline, Tiger Airways aka Scoot, to capture the lower end market.
(Update: Scoot and SQ each absorbs part of SilkAir, to merge and restructure)
The concept of XED will be useful to SIA in formulating strategies to counter pricing strategies of their rival airlines. As SIA and other major airlines are considered as closed substitutes, a reduction in fairs of rival airlines will cause demand for SIA to fall. Thus, in the short run, SIA has to react by reducing its fare as well. SIA should focus on differentiating their services in the long run in order to reduce the value of XED between its rivals. However, SIA might not be able to differentiate itself that successfully as other airlines will do likewise in the long run. SIA might need to explore other strategies such as forming alliances with other airlines to maximise its TR.
On top of the elasticity demand concepts, the elasticity of supply is equally crucial to SIA, as PES for SIA should be price inelastic. SIA is not able to increase its quantity supplied of flights in a short notice given the constraints of airplanes. Thus, even if demand increase as a result of good economic performance, SIA might not be able to increase the numbers of flights to meet the increasing demand.
In conclusion, the concepts of various elasticity concepts will be useful in helping SIA to formulate pricing and non-pricing strategies to maximize revenue. However, there are other considerations such as consumers’ taste and preferences, government’s policies towards foreign airlines etc.
Econs tuition teacher’s remarks:
What advanced judgement can you provide in this context? For eg, why may the strategies adopted by SQ not work?
More full length answers here: Econs Essay #21 | Econs Essay #23