F581 Economics

Demand & Supply Question  Impact depends upon the extent of the shift.  If demand shifts, the impact will depend on elasticity of supply.  If supply shifts, the impact will depend upon the elasticity of demand.  Impact of shift also depends upon other factors – if they stay the same (ceteris paribus) or change.

Elasticity Question  It is only an estimate, so may not be accurate and can’t be relied on for future decisions.  Depends upon other factors changing.  Depends upon the time period, e.g. PES more elastic in the long run.

Factors affecting Demand  Consumer Income  Price, availability of related products  Taste and Fashion

Factors affecting Supply  Costs of production  Size, structure, nature of industry  Government Policy  Other factors  Other factors (e.g. weather, health scare)

Determinants of PED  Availability and closeness of substitutes.  Availability and closeness of substitutes. (More substitutes = more elastic).  Proportion of income it takes up.  Proportion of income it takes up. (If product takes up small portion of income, then rise in price will cause little change in quantity demanded).  Time.  Time. (over time, as consumer find out about more substitutes, elasticity increases).

Determinants of PES  Availability of stocks of the product  Availability of stocks of the product. (Lots of stocks means more elastic, as firm can increase Supply quickly).  Availability of factors of production.  Availability of factors of production. (More capital can increase output and elasticity, but if new machinery has to be installed first, then it will be inelastic. More workers (labour) can also increase elasticity).  Time.  Time. (Where it takes a lot of time for supply to be adjusted, supply will be inelastic).

Subsidy Advantages of Subsidy + Encourages producers to supply goods with positive externalities. + Reduces producers costs. + Encourages consumption of a merit good. + Can correct the level of consumption to reflect Allocative efficiency. Disadvantages of Subsidy - Opportunity Cost to Government -Hard for government to set right amount of subsidy. -Effectiveness depends upon PED – limited effect if inelastic. -Time lag -May fail to pass on the subsidy. Alternatives: Increased info provision (esp. if merit good); Regulation. Evaluation: Depends on level of subsidy; if passed on; PED. Most effective method, although other measures may be useful.

Taxation Advantages of Taxation + Raises revenue for government, which can then be used to correct market failure. + Allows the market to function properly. + Polluter is forced to internalise the externality and make the polluter pay. Disadvantages of Taxation -Hard to determine size of tax, should equal externality, but calculating externality is hard. -Some of tax burden is passed on to consumer. -If demand is inelastic, consumption will not fall by as much as intended. -Inflationary. Alternatives: Increased info provision; Tradable Permits. Evaluation: Depends on if tax is at correct level; if product is inelastic will be less effective as producer could pass tax on to consumer; effectiveness depends on level of tax and if combined with alternatives.

Regulation Advantages of Regulation + Easy to understand. + Enforced by law. + Can modify behaviour to correct market failure. + Aim to result in optimum allocation of resources. + Especially important if there is a high risk of market failure. Disadvantages of Regulation -Must have a high level of public support. -Opportunity cost to enforce them. -May lead to a black market. -Do not compensate those that suffer from market failure. -Hard to set appropriate standards. Alternatives: Increased info provision; Tradable Permits; Taxation. Evaluation: Depends on how well enforced; may be combined with increased info to gain public support; depends on how much they cost.

Tradable Permits Advantages of Tradable Permits + Fairly easy to implement. + Allows the market to help solve the problem and gives firms the incentive to reduce negative externalities. + From government’s perspective, achieves desired environmental outcome. Disadvantages of Tradable Permits -Expensive to monitor, so opportunity cost. -Does not compensate victims of pollution. -Problems of calculating and distributing permits to polluters. Alternatives: Subsidies. Evaluation: Opportunity cost means money may be better spent on subsides; permits may be set at a too high level; so depends upon the level and how enforced.