Microeconomics

1. How is elasticity a useful concept for firms and government?

Elasticity, which according to A.Neale and C.Haslam “Economics in a business context” is a term “used in economics to describe the relationship between a proportionate change in one variable and a proportionate change in a related variable”. Plain-speaking it is the measure of how one aspect of a products make-up, be it the price, or supply of available substitutes, will affect another. Elasticity demonstrates the relationship one factor such as price has on another such as demand.

It is a useful concept for firms because the main goal of any organisation is to maximise profits. A firm will not just increase the price of a product without investigating the possible effects on demand. Elasticity can be used by a firm to clear a surplus. It is a useful concept for Government because it is important that they know what to collect indirect taxes from. Petrol, cigarettes and alcohol are often targets for taxation, whereby the government can receive an income to spend on public services. These items have a low price elasticity of demand, that is the consumer will be less likely to buy another product should the price be changed.

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The main determinants of elasticity include: Availability of substitutes, the period of time, the product price in relation to the income of the consumer, the price of production and the state of technology.

For firms to maximise profits and for government to tax people effectively and maximise their income the causes of a change in demand need to be identified. The main reasons for a change in demand are: Changes in tastes or fashions, changes to peoples disposable income, changes in population and changes or predicted changes in the future availability of goods. Two main assumptions are made, firstly that the main aim is to maximise profits and revenue, and that a change in price reflects a change in revenue.

The government is also concerned with fair competition, and by taxing certain goods it can control a market to a certain extent and prevent monopolies building up and preventing competition. So overall, firms will always try and maximise profits and by having knowledge of consumer reactions to changes they can do this more effectively. Governments need to be able to maximise their own income through taxes, whilst regulating the markets to some extent. Elasticity helps both to achieve these goals.

2. Consider a local bus company. How (if at all) does the marginal cost of providing transport for each passenger vary according to the time of day?

The marginal cost, which in definition is the change in total cost resulting from a change in output will possibly be affected at each time of day because of how many passengers one bus can take. At peak times when demand for buses is at its highest point the bus company may well want to lay on another bus. Therefore the marginal cost will affect the total cost because the firm will have to employ another driver and have the petrol costs of another bus.

The marginal cost of running a bus from A to B will change extremely slightly due to the load exerted on the bus. But the difference between a bus carrying one person and fifty is not significantly high. Another way in which the marginal cost may vary is in the length of the journey. Assuming that during rush hour the bus will take twenty minutes instead of ten to reach its destination then the amount of petrol used will be higher. Many transport firms such as trains tend to adjust their prices to be higher during times of increased demand. This is known as peak pricing. What this question is asking is whether the actual cost of getting someone from place to place will really change with the peak periods.

All costs for the local bus firm are not fixed, the bus will no doubt experience wear and tear on seats should it be used more often, but there is little difference to the company costs if they are carrying one customer or fifty. The real issue is over whether the buses will be used.

3. Why is privatisation no guarantee of improved economic performance?

Nothing is a guarantee of improved economic performance because although the market can be predicted it cannot be totally controlled and people cannot be forced to use goods and services. Privatisation, as the opposite of nationalisation sells a company to a buyer who will run the firm instead of the government. Its advantages are that the government doesn’t have to spend money running the firm and receives a payment which can be instantly invested. Its use is to create healthy competition in a market and benefit the consumer. The main government objectives are to protect producers income, create a minimum wage (through law or the so called ‘invisible hand’) and create a surplus.

The classic case of where privatisation hasn’t brought success is in the health sector. Waiting lists were supposedly going to fall, the level of service was set to rise and staff should receive company benefits as a result. However, the companies taking over from the government in running these firms found that they had many overheads to deal with and many investments in equipment required. It is easy for the government to set targets but if the company only has a certain amount of staff available (not just through attracting the staff but through the lack of qualified staff available) then they can only serve the public at a certain rate and to a certain standard. If the number of beds needed exceeds those in the hospital not everybody can be accommodated. The government thought that by privatising the industry it could wipe out the problems, but the problems were quite deep rooted and complex. The government needed firms who could invest money whilst the hospitals made a loss, which is unrealistic.