What determines whether the price elasticity of demand for a good is high (say, -5) or low (say, -0,5)? Ultimately, the answer must be sought in consumer tastes. If it is considered socially essential to own a television, higher television prices may have little effect on quantity demanded. If televisions are considered a frivolous luxury, the demand elasticity will be much higher. Psychologists and sociologists may be able to explain more fully than economists why tastes are as they are. Nevertheless, as economists, we can identify some considerations likely to affect consumer responses to changes in the price of a good. The most important consideration is the ease with which consumers can substitute another good that fulfils approximately the same function.
Consider two extreme cases. Suppose first that the price of all cigarettes is raised 1 per cent, perhaps because the cigarette tax has been raised. Do you expect the quantity of cigarettes demanded to fall by 5 per cent or by 0,5 per cent? Probably the latter. People who can easily quit smoking have already done so. A few smokers may try to cut down but this effect is unlikely to be large. In contrast, suppose the price of one particular brand of cigarettes is increased by 1 per cent, all other brand prices remaining unchanged. We should now expect a much larger quantity response from buyers. With so many other brands available at unchanged prices, consumers will switch away from the more expensive brand to other brands that basically fulfil the same function of nicotine provision. For a particular cigarette brand the demand elasticity could be quite high.
Ease of substitution implies a high demand elasticity for a particular good. In fact this example suggests a general rule. The more narrowly we define a commodity (a particular brand of cigarette rather than cigarettes in general or oil rather than energy as a whole), the larger will be the price elasticity of demand.
Measuring Price Elasticities.
To illustrate these general principles we report estimates of price elasticities of demand in Tabl. 5.
bl 5. Estimates of Price Elasticities of Demand in the UK
| Good (general category) | Demand elasticity | Good (narrower category) | Demand elasticity |
| Fuel & light Food Alcohol Durables Services | -0,47 -0,52 -0,83 -0,89 -1,02 | Dairy produce Bread & cereals Entertainment Expenditure abroad Catering | -0,05 -0,22 -1,40 -1,63 -2,61 |
The table confirms that the demand for general categories of basic commodities, such as fuel, food or even household durable goods, is inelastic. As a category, only services such as haircuts, the theatre, and sauna baths, have an elastic demand. Households simply do not have much scope to alter the broad pattern of their purchases.
In contrast, there is a much wider variation in the demand elasticities for narrower definitions of commodities. Even then, the demand for some commodities, such as dairy produce, is very inelastic. However, particular kinds of services such as entertainment and catering have a much more elastic demand. Small changes in the relative price of restaurant meals and theatre tickets may lead households to switch in large numbers between eating out and going to the theatre, whereas the demand for getting out of the house on a Saturday evening may be relatively insensitive to the price of all Saturday night activities taken as a whole.
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VOCABULARY NOTES
typically falls
a dividing line
unit-elastic (unitary-elastic) demand ,
to raise/to lower revenue /
the key piece of information
to set the price (syn. to quote) ,
foreign holidays
to refer to
parts of the curve corresponding to prices ,
adjusted for inflation
prices typically charged ,
be observed historically
determinants , ,
the answer must be sought in
socially essential ,
a frivolous luxury
why tastes are as they are
nevertheless (syn. however)
to identify some considerations , ,
the ease ,
to substitute smth for smth
a substitute
substitution
to fulfil approximately the same function
extreme cases
the latter (ant. the former) ()
to quit (syn. to give up) smoking
one particular brand of cigarettes
to fulfil basically
nicotine provision
the more narrowly we define
to illustrate general principles
to report estimates in a table
durables
dairy produce
cereals
entertainment ,
catering
the table confirms
as a category
haircuts , .
sauna baths
to alter the broad pattern
a much wider variation
whereas (syn. while, whilst)
to be relatively insensitive
taken as a whole
Assignments
I. Suggest the Russian equivalents
goods with high or low demand elasticities; prices adjusted for inflation
II. Replace the parts in italics by synonyms
to set the prices; ease of substitution suggests a high demand elasticity; may cause households to...; to turn from...to; relatively inelastic
III. Fill in the gaps with the words and expressions from the text Demand is __ if the price elasticity is more negative than -1.
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2. Demand is __ if the price elasticity lies between -1 and 0.
3. If the demand elasticity is exactly -1, we say that demand is __.
4. Whether or not demand is elastic is __ required in setting the price.
5. Economists will say that the demand for oil is __, but the demand for foreign holidays is __.
6. Such statements refer to parts of the demand curve __ prices (__ inflation) that are typically charged for these goods and services.
7. The answer must __ in consumer tastes.
8. If televisions arc considered __, the demand elasticity will be much higher.
9. As economists, we can __ some considerations likely to affect consumer __ in the price of a good.
10. The most important consideration is the ease with which consumers can __ another good that __ approximately the same function.
11. Consider two __ cases.
12. With so many other brands __ at unchanged prices, consumers will switch away from the more expensive brand to other __ that basically fulfil the same __.
13. __ implies a high demand elasticity for a particular good.
14. The table __ that the demand for general categories of basic commodities is inelastic.
15. Households simply do not have much scope __ the broad pattern of their purchases.
16. There is a much wider __ in the demand elasticities for narrower definitions of __.
17. Small changes in the __ price of restaurant meals and theatre tickets may lead households to switch in large numbers between eating out and going to the theatre, __ the demand for getting out of the house on a Saturday evening may be relatively __ to the price of all Saturday night activities taken as a whole.
IV. Check your prepositions. Insert a suitable preposition in each of the blanks in these sentences
1. He is interested __ economics.
2. He is not concerned __ non-essential commodities.
3. The demand __ bananas will probably increase.
4. The supply __ cigarettes does not usually fluctuate.
5. The consumers' need __ such a commodity is well-known.
6. There was a change __ the quantity of material supplies.
7. He paid quite a lot of money __ that car.
8. He paid the money __ that man.
9. Non-essential commodities like chocolates cannot be compared basic commodities like fuel.
V. Find in the text English equivalents/or the following
/ ...; ; , ; , ; ; ; ...%; ( ); ; ;
VI. Answer the questions
1. Explain when demand is elastic, inelastic or unit-elastic.
2. How do consumer tastes determine the demand elasticity?
3. What considerations are likely to effect consumer responses to changes in the price of a good?
4. Illustrate the consideration of the demand elasticity according to the case of substitution on the part of buyers by the example of cigarettes.
5. State the interdependence between the scale of definition a commodity and the price elasticity of demand.
6. Think why the demand for going out Saturday nights may be relatively inelastic to the price of the activities.
7. Give your own examples of an elastic and inelastic demand.
VII. Translate using all the active possible
1. . (2 ) .
2. , 1- - ...%, , , , , . .
3. . , , . .
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A MODEL OF THE ECONOMY ( )
Economists spend a lot of time trying to develop models of the working of the economy. The London Business School, like many universities and also the Treasury, has a model of the economy which it has entered into a computer. The reason for this is that much of its work is concerned with forecasting future economic trends so as to aid decision-making by business and government. The London Business School's model can be fed with economic information, such as changes in tax rates, and it will then predict how the economy will behave. Such predictions are an invaluable aid to business decision-making because, for example, businesses can find out whether people's
incomes are Likely to rise or not.
The complete economy comprises many millions of economic units. There are households, as one kind of unit. There are also firms, and the departments of both central and local government. These units together decide the economy's total spending. They also decide its total income and its total level of production of goods and services. But in order to develop a simple model of the economy we need to ignore the government sector and the possibility of transactions between households and foreigners. Suppose we are dealing with an isolated economy, one which has no government. Let's assume that there are two main sectors in the economy: households and firms. Households supply firms with the factors of production that firms need to carry on their concerns.
Thus, households provide labour services, both skilled and unskilled, in return for the payment of wages. They may also supply land for which they are paid rent. Finally, they might supply the finance, which is essential to the business. If the finance is in the form of a loan they receive interest payments, but if they have purchased shares in the business they may be entitled to a share of the profits. Most households provide some factor services or services of productive/actors, to a public or private business. Anyone at work is providing labour, and if you or someone in your family has bought shares in the privatization programme (in, for example, British Gas, British Telecom or the water authorities) then they have supplied share capital. Households receive payments for these factor services, that is to say, they earn factor incomes, such
as wages, rents and profits.
The other part of our simple model portrays firms supplying households with all the goods and services that they require. In return for these the households pay the firms. These two sets of actions create the model of the circular flow of money, which is shown in Fig. 3.
In fact, there are two flows. One which is monetary and one comprising goods and' services. A flow of factor services from households to firms for which there is an opposite stream of factor payments and a flow of goods and services, which households pay firms. It is this monetary flow in which we are most interested.
What does the figure suggest? It suggests that there are three ways of measuring the amount of economic activity in the economy. First, we can measure the value of goods and services produced, second, we can measure the level of factor earnings. These factor earnings represent the value of factor services supplied. Third, we can measure the value of spending on goods and services. Then, economists refer to the size of the monetary circular flow as the level of national income.
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If we assume that all the goods and services, which are produced are in fact sold and that households spend all their income, then we have arrived at what economists call a neutral equilibrium. The level of income, which is spent and received by the two groups will not alter since as one group receives it, they spend it with the other.
Figure 3. The Circular Flow of Income
The fact that the economy is in a neutral equilibrium means simply that the level of national income, and hence the level of economic activity, are stable and unchanging. (An equilibrium is a point of balance in which there is no inherent tendency to change). If the economy was in equilibrium it does not mean that everyone who wants a job has one or that the country is importing exactly the same value of goods and services as it is exporting.
VOCABULARY NOTES
to aid decision-making ,
the model can be fed with economic information
total income ,
total level of production of goods and services
to deal with an isolated economy , to carry on their concerns
to provide labour services ()
to receive interest payments
shares
to be entitled to a share of the profits
factor services or services of productive factors
the water authorities
to supply share capital
factor incomes
to portray
a monetary flow
an opposite stream (. )
factor payments ()
to measure the amount of economic activity
the value of goods and services produced
the level of factor earnings
the value of factor services supplied
the value of spending on goods and services
a neutral equilibrium
the circular flow of income ()
an inherent tendency to change
Assignments
I. Suggest the Russian equivalents
forecasting future economic trends; to feed with economic information;
factors that firms need to carry on their concerns; to provide labour services;
circular flow of money; a flow of factor services; factor payments; neutral equilibrium; set of action
II. Replace the parts in italics by synonyms
the model can be filled with economic information; they have bought shares;
they have the right to get a share of the profits; the flow includes goods and services; the level of income will not change; the level of income and consequently the level of economic activity
III. Fill in the gaps -with the words and expressions/ran the text
1. The model of the economy is concerned with forecasting __ so as to aid __ by business and government.
2. Such predictions are __ aid to business decision-making because businesses can find out whether people's incomes __ to rise or not.
3. These units together decide the economy's __, __ and __.
4. In order to develop a simple model of the economy we need to __ the government sector and __ between __ and __.
5. Suppose we are dealing with __, one which has no government.
6. In order to develop __ of the economy we need to __ that there are two main sectors in the economy: __ and __.
7. Households provide __, both __, in return for __.
8. If the finance is in the form of __, households receive __, but if they have purchased __ in the business they may be entitled to __.
9. Households receive payments for __, that is to say, they earn __, such as __, __ and __.
10. There are two flows: one which is __ and one ___ goods and services.
11. The model suggests that there are three ways of__ in the economy.
12.We can measure __, __ and __.
13. Economists refer to __ of the monetary circular flow as __.
14. If we assume that all the goods and services, which __ are in fact __ and that households spend __, then we have arrived at what economists call
15. The fact that the economy is in a neutral equilibrium means simply that the level of __, and hence the level of __, are.__ and __.
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16. An equilibrium is a point of balance in which there is no __.
IV. Find in the text English equivalents/or the following
; ; ; ; , ...; ; ; ; () ; ; ; ; ; ( -) ; ;
V. Give explanations in English
to pay rent; a loan; interest payments; share capital; factor services; factor payments; factor incomes; factors of production; a neutral equilibrium in the economy
VI. Read the description of drawing a circular/low
Start with the two blocks. The one on the left should be labelled "households", and the one on the right "firms". On the top of the inner loop, circle, put "goods and services", with an arrow running from the firms block to the households block. At the bottom of the inner loop put "services of productive factors", with an arrow running from households to firms. On the outer loop, at the top, put "spending on goods and services", with an arrow running from households to firms. And finally, at the bottom of the outer loop, put "factor incomes", with an arrow running from firms to households.
Find in the text English equivalents for the following
; (); (); ... ...; ; ; ;
Draw the circular flow (it will be different from the one in the unit!) and describe it using all the active possible
VII. Answer the questions
1. What units does the economy comprise? What do they decide?
2. What are the two main sectors in the economy?
3. What sets of actions create the model of the circular flow of income?
4. Dwell on the monetary flow. How is the level of national income connected with it?
5. Dwell on the flow of goods and services.
6. What does the figure suggest?
7. How can the amount of economic activity be measured?
8. What's an equilibrium? a neutral equilibrium? VIII. Translate using all the active possible
1. ( ) , () (), , .
2. , , , , .
3. , , , , , .
4. , , , , .
INJECTIONS ( )
An injection is simply an addition to the circular flow of income, which does not arise from the spending of households. It was unrealistic to assume earlier that there would be no such additions. These additions or injections will, of course, increase the size of the circular flow and thus the level of activity in the economy. There are three recognized ways in which funds can flow into an economy. They can be generated through:
Investment
Government spending
Export sales
Figure 4. Additions to the Circular Flow of Income
Investments.
Investment is expenditure on productive capital goods. That is, goods which can be used to produce other goods and services. Thus, investment is usually held to be expenditure on factories, machinery and other physical assets. It is important to realize that economists use the word investment in a different context to the layman. An economist referring to investment does not mean the purchase of paper financial assets such as stocks or shares. Clearly, if the ownership of a company's shares is transferred from one UK citizen to another there is no overall impact on the economy.
Investment can be categorized into net investment and gross investment. Net investment is investment, which actually increases the nation's stock of capital goods. It is such investment that enables the economy to grow. However, some investment is necessary to replace capital stock that is worn out or obsolete. This loss of value of assets is called depreciation. When this replacement is added to the net investment the total achieved is termed gross investment.
You should note that investment increases the circular flow since it comprises extra spending that has not originated in. the circular flow. The main influences on the amount of investment that takes place are:
* the rate of interest since firms often have to borrow to undertake the investment
* the firm's expectation about the future behaviour of the economy. If they believe the economy will boom and the level of economic activity will increase, then they are more likely to enjoy increased sales. They may well decide to invest in new machinery or in a new factory. On the other hand, if the level of investment declines then there will be less injections than previously into the economy and the rate of growth of economic activity (or the national income) will fall. Economic statistics show us that over the last few decades the level of gross investment in the UK economy has fluctuated. This will have been one of the factors affecting the level of national income and the environment in which businesses operate.
