JC Economics Essay Series #49 – Income Elasticity of Demand & Market Structures

JC Economics Essay Income Elasticity of Demand & Market Structures Model Answers 

Sometimes, examiners set much harder questions by mixing concepts across topics. An eg is here: Income Elasticity of Demand  and  Market Structures! Income Elasticity of Demand (YED) relates to effects of income changes, whereas Market Structures highlights the degree of competition in a market. The following essay question illustrates the combined analysis of both concepts.


Question (Modified from past year Cambridge – UCLES – SEAB exam question)
(a) Explain why might a firm aim to become big. (10)
(b) Discuss the relative significance of the concepts of income elasticity of demand and market structures in determining how this fall in demand for hotel accommodation might affect both a luxury hotel and other types of hotel. (15)


JC Economics Essay – Large Firms & Advantages


Revenue Advantages
Charge higher prices ,and earn more revenue

Cost Advantages
Internal economies of scale (EOS). Offer 2-3 examples.
(Sketch relevant diagram(s) to show the above.)


JC Economics Essay – YED & Market Structures


Fall in mkt DD for hotel accommodation maybe due to falling income / recession. Impact on 5 star hotel and other types of hotel differs due to differences in market structures that they operate in, the size of AVC and the nature of the hotel accommodation (luxury, necessity or inferior good)

Luxury hotel
Income elasticity of demand (YED) > 1 (high proportion of traveller’s income) More than proportionate fall in DD : large. fall in room charges (P) and occupancy rate (Q) → significant drop in rev earned & hence profit (sketch diagram of change of TR)

Non – luxury hotel
Budget hotel

YED < 0 (basic amenities, no meals – inferior) Recession rise in dd for budget hotels → rise in P & → higher revenue


Market Structures
Ability to withstand the adverse dd shocks also depends on mkt structure the hotels are operating in.

Higher BTE due to higher level of setup costs –> less competitive oligopoly –> greater ability to accumulate reserves from supernormal profits earned –> more reserves to undertake counter strategies to tide over fall in mkt dd

Lower degree of BTE –> more competitive mkt structure –> lower pool of accumulated reserves + intensified competition during downturn to maintain mkt share in falling dd –> may be more badly hurt.

1. Depends on source of fall in demand. If COVID-19, all types of hotels will suffer!

2. Depends on magnitude and expectation of duration of fall in DD.

3. May also depends on proportion of fixed costs (FC) vs variable cost (VC)

For luxury hotels (eg 5-6 star rated ones), AVC likely be high due to more exclusive scale of production – e.g. labour costs (chambermaid, bellboys, personal butler)

If fall in mkt demand is persistent, -> drop in P may not be able to cover the high AVC->subnormal profit –> exit the industry

For budget hotels:
AVC likely be relatively lower due to smaller and less exclusive scale of production which allows multi-tasking: Rise in TR + low AVC = large rise in profits

The concept of market structures is definitely more significant in determining impact if fall in DD on each hotel type.


Remarks by JC Econs tutor specialist:
1. Though not necessary, non-luxury lower rating hotel eg: 3-4 star hotel

YED < 1 (lower proportion of traveller’s income) Less than proportionate fall in DD less sig. fall in room charges (P) and occupancy rate (Q)→ less sig. fall in rev earned–>

2. For 3-4 star ones, fall in mkt dd but lower AVC: lowered P may still be able rise in profits to cover AVC over a longer period of time

3. In general, budget hotels most to gain / least to lose from fall in mkt dd. Impact on 5 star luxury hotel and 3-4 star less conclusive as it depends on the firm’s nimbleness in implementing counter strategies to address the falling profitability.

4. This is a tough question. You can skip the essay in J2 but NOT in J1!

Econs Essay #48 | #50