CIE AS SAMPLE ESSAYS
2.2 Price elasticity, income elasticity and cross elasticity of demand
9708/21/M/J/24
Assess the extent to which price elasticity of supply or cross elasticity of demand is most useful to businesses. [12]
PES measures how responsive the quantity supplied of a good is to changes in its price. This metric is crucial for businesses as it provides insight into how quickly they can adjust production in response to market demand fluctuations. For instance, a high PES indicates that a firm can rapidly increase output when prices rise, helping capitalize on potential profits. Conversely, low PES suggests that supply cannot be quickly adjusted, which may lead to lost sales during high-demand periods.
However, while PES can help businesses estimate their responsiveness to market changes, it is not always precise. External factors, such as supply chain disruptions or production capacity limits, can affect a firm’s ability to respond swiftly. Moreover, businesses may hold varying levels of stock, which can influence the time required to adapt supply.
XED measures the responsiveness of demand for one good when the price of another good changes. This is particularly useful for businesses in understanding competitive dynamics. A positive XED indicates that two products are substitutes, while a negative XED suggests they are complements. For example, if the price of coffee increases, a café may observe increased demand for tea (a substitute), which can guide pricing and marketing strategies.
XED also helps businesses gauge how sensitive their products are to competitors’ pricing strategies. However, the relationship captured by XED can change rapidly due to market trends or consumer preferences, meaning the data may become outdated quickly. As such, while XED is insightful, businesses must regularly reassess these relationships to remain competitive.
When comparing PES and XED, both metrics provide unique insights but serve different purposes. PES is more beneficial for businesses focused on production and supply chain management, allowing them to plan for immediate market changes. In contrast, XED is crucial for strategic positioning in relation to competitors, particularly in markets with many substitute and complementary goods.
In conclusion, the extent to which each measure is useful varies based on industry characteristics. PES is indispensable for businesses in sectors like agriculture and manufacturing, where supply-side dynamics dominate. It helps in optimizing production and inventory management. XED is more beneficial for businesses in retail and technology, where understanding product interdependencies and competitor strategies is crucial. Therefore, Neither PES nor XED can be deemed universally superior; their usefulness is context-dependent. Businesses should employ both metrics in tandem, leveraging PES for supply-side decisions and XED for demand-side strategies, to navigate complex market environments effectively.
9708/21/M/J/23
With the help of a formula, explain the meaning of cross elasticity of demand and consider which determinants are most important in establishing the size and sign of its coefficient (8)
Cross elasticity of demand (XED) measures the responsiveness of the quantity demanded for one good to a change in the price of another good. This concept is essential in determining whether two goods are substitutes or complements. The formula for XED is: % change in quantity demanded for good X / % change in price of good Y.
The magnitude of XED depends heavily on two primary determinants: the strength of the relationship between goods and consumer loyalty.
The difference in XED values between stronger and weaker substitutes arises because of how closely related the goods are in fulfilling consumer needs and preferences. The difference in XED values between stronger and weaker substitutes arises because of how closely related the goods are in fulfilling consumer needs and preferences. On the other hand, Coca-Cola and tea are weaker substitutes because they serve different purposes and appeal to different preferences. Coca-Cola is a cold, sugary carbonated beverage, while tea can be hot or cold and is often consumed for its calming or health-related properties. While some consumers may switch to tea if Coca-Cola’s price rises, the overlap in their target market is limited. As a result, the proportionate increase in tea’s demand is smaller compared to Pepsi’s demand, leading to a lower positive XED, such as +0.5. Therefore The more interchangeable the goods are in satisfying consumer needs, the greater the sensitivity to price changes, resulting in a higher XED. For weaker substitutes, the limited interchangeability results in a smaller demand response, leading to a lower XED value.
Consumer loyalty is another determinant influencing XED. Loyal consumers tend to exhibit less sensitivity to price changes, leading to a lower XED. For example, iPhone users may continue to purchase iPhones despite a price increase, rather than switching to a close substitute like Samsung. This demonstrates how strong brand loyalty can dampen the substitutive relationship’s impact on XED. In contrast, for goods with weak consumer attachment, such as straws and soda, XED might be higher because consumers are more likely to alter their purchasing behavior in response to price changes.
In evaluating the significance of the determinants influencing XED, the strength of the relationship between goods clearly stands out as the most critical factor. While consumer loyalty also influences XED, its impact is secondary to the inherent relationship between goods. Loyalty can temper the responsiveness of demand to price changes, but it cannot override the fundamental substitutive or complementary nature of goods. For instance, even if some Coca-Cola consumers are brand-loyal and unwilling to switch, the strong substitutive relationship between Coca-Cola and Pepsi ensures that a price change in Pepsi will still significantly affect Coca-Cola’s demand. This is because the close similarity and interchangeability between the two products compel many consumers to respond, driving the demand shift regardless of brand preferences.