BUS202 Demand And Supply: Economics Assignment Answer

Answer :

< align="justify" style="text-align:justify;">Part A

Answer 1

Examine 3 Factors that affect Price Elasticity of Demand with relative hospitality examples. How does a business owner maximise revenue knowing a product’s price elasticity of demand.

Price elasticity of demand indicates the ratio of change in quantity demanded of a product to the change in the prices. 

For some products, the demand is highly elastic which means that a small change in price can lead to large change in quantity demanded. For example, luxury goods, goods with close substitutes, narrowly defined goods will have a highly elastic demand.

For some products, the demand is highly inelastic which means that even a large change in price will lead to a small change in quantity demanded. For example, necessity goods or goods without close substitutes etc.

Hence, a business owner in hospitality industry can leverage this knowledge to maximise revenue as follows:

1. In cases where the hotel is one of its kind in the vicinity such that there are no close substitutes, the demand will be inelastic. Hence, the owner can charge higher prices and the demand will not reduce as much. Hence, if a business owner realises that no close substitutes are there, he must charge higher price.
2. Proportion of income spent on the offering also determines elasticity. If a large proportion of income is being spent, then demand will be elastic and vice versa. Hence, if the owner realises that the target consumers are those who will end up spending large proportion of their income on rooms, then he must be wary of charging higher prices as consumer may be unable to bear the increased spending leading to fall in demand. 
3. However, if the consumers are highly rich people who demand luxury and room tariff is small proportion of their income, demand will be inelastic such that an increase in price will not lead to change in demand. Then, the owner must increase prices to maximise revenue.

Answer 2

After recent floods in Brisbane, it was predicted that the prices of summer vegetables such as tomatoes would triple in price. Analyse the reason the prices were predicted to increase. Evaluate the effect of market equilibrium price.

As mentioned, the floods in Brisbane are an extraordinary weather situation such that it has an adverse impact of farming of summer vegetables such as, tomatoes. Hence, due to flooding, it is expected that the supply of tomatoes will be in shortage. This shortage will cause a leftward shift in supply curve such that quantity available of tomatoes will reduce drastically. The available supply will not be sufficient to meet the existing demand, leading to sharp increase in prices. This is explained through graph below:

In the above graph, downward sloping green line is the demand curve while upward sloping blue line is the supply curve. Initially, the market is in equilibrium where demand and supply curve intersect such that equilibrium quantity is Q₁ and equilibrium price is P₁. 

However, due to floods in Brisbane, the farming of tomatoes is impacted adversely so that there is a shortage of tomatoes. This causes the supply curve to shift to left. The demand curve is still the same. Hence, the new equilibrium is attained at much lower quantity of Q₂ and a much higher price of P₂.

Answer 3

Discuss with examples how “tax cut” and “government purchases” are used as part of expansionary fiscal policy to close a recessionary gap.

During recession, the government may use expansionary fiscal policy in order to close the recessionary gap by trying to shift the aggregate demand curve and influence the economy. For fiscal policy, moves can be made by altering the tax policy and government spending. When the government is trying to undertake expansionary fiscal policy, it will reduce the taxes and increase government spending so as to shift the aggregate demand curve upwards.

For example, if the government reduces income tax, this will leave more money in hands of the citizens such that their purchasing power will increase. In turn, this will allow them to spend more money such that the demand for goods and services will increase. Hence, aggregate demand curve shifts upwards. 

Similarly, if the government reduces corporate taxes, it will increase the profit of the business corporates such that they can create more business and more jobs that will lead to more purchasing power with the people such that the demand for goods and services will increase. Hence, aggregate demand curve shifts upwards.

Another example can be that the government increases its spending by increasing government purchases. This has a multiplier effect as the capital expenditure done by the government will be utilized by the people later that will lead to spending by the people as well. For example, creation of an airport will not only create jobs and increase purchasing power while it is being built, it will also have an impact later on when people will use the airport services.

Answer 4

Explain how a restaurant operator in a food court might be able to maximize revenue by having information about cross price elasticity of demand (where product A is your offering and product B is the offering of another seller in the food court).

Cross price elasticity of demand refers to the ratio of change in quantity demanded of a product to change in price of a related product. Hence, the quantity changes due to change in price of a related product.

So, if the two products, say A and B are complementary, increase (decrease) in price of A will lead to decrease (increase) in quantity demanded of B as people consume A and B together as a bundle and increase in price reduces purchasing power, leading to decrease in quantity demanded.

Intuitively, if the two products, say A and B are substitutes, increase (decrease) in price of A will lead to increase (decrease) in quantity demanded of B as more people will substitute expensive A (B) for relatively cheaper substitute B (A).

This knowledge can be of importance to understand impact on quantity demanded with respect to the related goods (substitute or complement). 

Hence, a restaurant in a food court can predict the impact on quantity demanded of his products. For example, let’s say the restaurant sells Chinese food for $10 and a competitor is selling Indian food for $10. The two are substitutes as a person will order either of the two. Let us say the competitor increases price of Indian food to $12, the restaurant can increase supply of Chinese food as more people will substitute expensive Indian food for Chinese food at $10. Let’s say the Indian food is now offered at $9 which will decrease quantity demanded for Chinese food. This can be countered by offering combos of complementary goods, such as adding a cold drink to the Chinese food will give more value at $10 and customers may still get attracted.

By calculating exact number of cross price elasticity, the restaurant can analyse the extent of impact on quantity demanded and plan its operations accordingly so as to maximise revenue.

Answer 5

List three points of product differentiation for a five-star hotel in Sydney CBD. Explain why it is important to offer product differentiation by using the concept of Monopolistic competition market structure.

A monopolistic competition is similar to perfect competition where the firm is the price taker not the price maker. There are a large number of firms selling similar products at similar prices. However, a firm can influence the price to an extent by providing differentiated product such that the consumer is ready to shell out more money. This can be done on various basis, such as utility of the product, or brand image etc.

A five-star hotel in Sydney CBD can offer product differentiation as follows:

1. It can make itself eco-friendly such that carbon footprint is minimal or negative. Today, many consumers are becoming aware about environment conservation and this feature will definitely differentiate the offering.
2. The hotel can create a strong brand such that the consumer perceives it not only as a service offering but an experience. This includes not only offering the tangible services but creating an emotional connect with its customers such that they take away good memories. In other words, the customer should feel that he or she has been well taken care of and pampered.
3. Finally, a hotel in CBD will have a large number of business travellers who are always on the go for business and may spend limited time in hotel. Apart from the required services such as wi-fi, traveling connectivity, shuttle services, etc., the hotel can offer extended hours of luxury services such as spa so that the business travellers can relax at their own convenience.

Part B

Answer 6

You are the manager of a recently built hotel near a freshly opened ski fields so you currently enjoy being a monopoly. Evaluate and illustrate your short run profit maximization position. Carefully explain why your current barriers to entry are weak and what implications this may have on your long term profit maximisation position.

As the manager of the only hotel that is freshly opened, the market structure in force is monopoly market structure. A monopoly enjoys the power of being the price maker such that it can dictate the price of its services to the consumer. A monopoly has no close substitute and has full control over supply. Hence, the manager can determine higher prices for the resort services and consumers will be forced to pay the price as it is the only resort in that location. Further, it can control the supply of services (or rooms) to create scarcity and charge even higher prices.

A monopoly maximises its profits at the point where its Marginal Revenue (MR) equal to Marginal Cost (MC). The quantity at this point is less than equilibrium and price is higher leading to supernormal profits as shown in the below graph:

It can be seen that a monopoly maximises profit at MR=MC while a perfect competition firm maximises at point where MC intersects demand curve as the demand curve is also the MR curve for a perfectly competitive firm. Hence, a monopoly firm has higher price of P_m and lower quantity of Q_m. 

A monopoly maximises its profits at the point where its Marginal Revenue (MR) equal to Marginal Cost (MC). At this point, the equilibrium quantity is lesser and equilibrium price is higher than that in perfect competition equilibrium. This indicates supernormal profits for the monopolist.

However, the barriers to entry are low and gradually, more hotels and resorts will come up in nearby location, leading to competition for the monopolist. This will force the monopolist to lower the prices and the process will continue till the market structure changes to perfect competition with no supernormal profits. 

The monopolist needs to come up with a long term plan so as to avoid the situation. The barriers to entry are low but product differentiation can help the monopolist. Creating a USP for the resort, such as an eco-friendly resort, can help the monopolist in long run. The differentiated product will attract consumers as they are getting conscious about their footprint on the environment. In long run, this can help the resort to charge a little higher than the competitors and still attract consumers.