Explain how the concepts of demand elasticity can shed light on the luxury goods market.

This paper explains concepts of demand elasticity, namely price elasticity of demand, income elasticity of demand, and cross elasticity of demand, as well as how these economic concepts can shed light on the luxury goods market, in particular, looking at fashion retail brands such as Prada and Gucci.

Firstly, price elasticity of demand can shed light on the luxury goods market; it measures the responsiveness of quantity demanded of a good to a change in its price, ceteris paribus. The demand for a good is said to be price elastic if a given percentage change in its prices causes a more than proportionate change in its quantity demanded, ceteris paribus. Conversely, the demand for a good is said to be price inelastic if a given percentage change in its price results in a less than proportionate change in its quantity demanded, ceteris paribus. A fall in price will result in a more than proportionate increase in quantity demanded for good that is price elastic. Conversely, given the same decrease, it will result in a less than proportionate increase in quantity demanded for a good that is price inelastic. While branded goods such as bags, shoes, or clothing from Prada and Gucci, can be considered demand elastic because they take up a large proportion of an individual's income, they can also arguably be considered demand inelastic because, to people who really desire these goods and have a strong taste and preference for these goods, there are no close substitutes for these goods. Therefore, it can be argued that changes in price would not affect the quantity demanded for these highly sought after goods that much.

Secondly, income elasticity of demand can shed light on the luxury goods market; it measures the responsiveness of the demand for a good to a change in income, ceteris paribus. Positive income elasticity of demand refers to the increase in demand for a good when income increases. Such goods are known as normal goods. Normal goods can be sub-divided to normal-necessity and normal-luxury goods. A normal-necessity good is income inelastic, which means that a rise in income will result in a less than proportionate change in demand whereas a normal-luxury good is income elastic, which means that a rise in income will result in a more than proportionate change in demand. Negative income elasticity of demand refers to the decrease in demand for good when income increases. Such goods are known as inferior goods. Inferior goods occur because rising income levels cause consumers to switch from lower quality product to a higher quality product as they are able to afford better alternatives. With these economic theories and concepts in mind, the luxury goods market is clearly in the realm of normal luxury, because as incomes rise in China, more Chinese have reportedly started buying branded goods, more than proportionately, especially Louis Vuitton. In fact, as incomes rise in Singapore, many have also started buying more branded goods as part of their lifestyles, and thus clearly we can utilise this concept both for the consumer – to understand their behaviour and the type of the goods that they are buying – as well as from the view of the retailer, who would do well to sell branded goods in a rising economic situation of high economic growth, and rising disposable incomes.

  

Third, cross elasticity of demand measures the responsiveness of demand for a good to a change in price of another good, ceteris paribus, and can be used to understand the luxury market. Positive cross elasticity of demand means the demand for a good and the price of another good change in the same direction. This suggests that the goods could be substitutes. Several substitutes to luxury goods are normal necessity goods, such as normal clothing brands or mass market brands, because no one has to only buy branded items. Negative cross elasticity of demand means that the demand of a good and the price of another good changes in the opposite direction. This suggests that the goods could be complements. For example, Prada and LV have complements for all their items, ranging from bags to wallets, to clothes and shoes. Thus, understanding cross elasticity is useful and relevant in the real world.

In conclusion, PED, YED, and XED can shed light on the luxury goods market, and demonstrate the usefulness and relevance of demand and supply analysis and the extent of the changes on differing types of goods. However, we should be alert to the fact that the ceteris paribus condition must hold for the analysis to be sound, and in real life often ceteris paribus does not hold, but, in general, elasticity of demand concepts are useful in understanding the luxury market and any other market. 

JC Economics Essays - Written under strict examination conditions, this H1/ H2 A levels economics essay on the luxury goods market was inspired by a few economics students and a field trip to Marina Bay Sands Singapore to see luxury brands, and eventually refined to be improved for sharing on this economics blog. The question is: what was good about this essay that made it receive a high grade by different economics examiners? Do think about it. Thanks for reading and cheers. 

Explain how the worldwide recession of 2008-2010 and the closure of some major airlines of the world after September 11th affected the market for air travel, and assess the relevance of various elasticity concepts in explaining the effects of these events on the airline industry as a whole. [25]

Note: This (theoretical) sample economics essay shows you how to systematically and methodically deal with Multi-Part, Complex Economics Essay Questions with Several Areas of Discussion to Address

Essay: 

To begin with, it is important to identify that the recession would have led to a drop in demand for air travel, while the closure of some of the major airlines would imply a fall in supply of air travel. Therefore, this essay will talk about the different permutations of a simultaneous fall in demand and supply, and their effects on the price and quantity output of air travel, with the aid of a diagram. Additionally, it will also be analysed in context why both the demand and supply of air travel had fallen.

Although both the demand and supply of air travel had fallen, it is important to note that relatively, if the demand had fell more than the supply and vice versa, the resulting price of air travel will differ.

[Insert diagram on fall in supply > fall in demand]

[Insert diagram on fall in supply < fall in demand]

From the first diagram, it could be seen that if the drop in supply was greater than the drop in demand, price rises, while quantity falls. However, in the second diagram, if the drop in demand was greater than the drop in supply, both price and quantity falls. These hence summarises the varying effects of a fall in both demand and supply on the market for air travel.

Moving on, it will be analysed in context why did the recession and the closure of major airlines lead to a fall in demand and supply of the air travel.

Firstly, it has to be taken into account that the demand for air travel is a derived demand, derived from the demand for vacations and business-related trips. In the case of a recession, the world’s income falls, thus significantly reducing the demand for vacations. Furthermore, with a recession, business activity slows down in tandem with the slowdown of the economy. This implies a fall in demand for business trips as well. Together, the fall in demand for both vacations and business trips means that the derived demand of air travel falls as well.

Additionally, the closure of some major airlines implies a reduction in the number of operating firms and hence the number of available flights. This ultimately leads to a fall in the supply of air travel.

In conclusion, for the first part of the question, the recession and closure of major airlines affected the air travel’s market via a fall in both demand and supply of air travel. However, there are varying effects depending on the relative extent of the fall of demand and supply.

The second part of the question requires the analysis of the extent of relevance of the various concepts of elasticities in explaining the effects of the worldwide recession, the increased fear of flying and the closure of some of the major airlines on the airline industry. Therefore, this part of my essay will explain the various concepts of elasticities in context, before concluding with some limitations of the use of elasticities.

Price elasticity of demand measures the responsiveness of quantity demanded of a good to a change in its prices, ceteris paribus. It is calculated by taking the percentage change in the quantity demanded of the good over the percentage change in its price. Therefore, it affects the gradient of the demand curve. The steeper the slope of the demand curve, the more price inelastic is the good. In context, the fall in supply of air travel arising from the closure of some major airlines will result in a rise of price of air travel. However, since there are no close substitutes for air transport (as the speed of other forms of transport are not comparable), especially for long distance travel, the demand for air travel is likely to be relatively price inelastic. Hence, the rise in price of air travel will lead to a less than proportionate fall in quantity demanded for air travel.

Income elasticity of demand measures the responsiveness of the demand for a good to a change in income, ceteris paribus. It is calculated by taking the percentage change in demand for a good for a given percentage change in income. For normal goods, income elasticity of demand is positive as when income increases, demand for the good increases and vice versa. Normal goods could be further divided into necessities and luxury goods, where the former’s demand rises less than proportionately with a rise in income, while the latter’s demand rises more than proportionately. There are also inferior goods, where demand of the goods drops with a rise in income.

[Insert diagram on falling demand curves]

In context, vacations are largely a luxury good for most households, thus they are income elastic. Thus, with the recession and thus fall in income, the demand of vacations is likely to have a more than proportionate fall. On the other hand, business trips are more likely to be unable to be put off in the short run, thus they are more income inelastic and hence demand is likely to fall to a smaller extent when income falls. However, in the long run as business activity slows down, business trips will not be required, thus they may become income elastic. Therefore, in the long run, the demand for air travel is likely to be income elastic, implying a more than proportionate fall in demand, with a fall in income arising from the recession.

Price elasticity of supply measures the responsiveness of quantity supplied of a good to a change in its price, ceteris paribus. It is calculated by taking the percentage change in the quantity supplied of the good over the percentage change in its price. Therefore, it affects the gradient of the supply curve, the steeper the slope, the more price inelastic is the supply. In context, the fall in demand for air travel results in a fall in price of air travel. However, since most flights have been scheduled months in advance so planes will fly even if demand falls, thus in the short run supply of air travel is rather price inelastic. This means that there will be a less than proportionate fall in quantity supplied of air travel with a fall in price. However, the same does not hold in the long run. In the long run, airlines close down if subnormal profits are incurred; hence rendering the supply of air travel price elastic. This leads to a more than proportionate fall in quantity supplied with a fall in price of air travel.

           

Lastly, cross elasticity of demand measures the responsiveness of demand for a good to change in price of another good, ceteris paribus. It is calculated by taking the percentage change in demand for the good for a given change in price of another good. Substitutes have positive cross elasticity of demand while complements have negative cross elasticity of demand. Unrelated goods have zero cross elasticity of demand. Also, the magnitude of the cross elasticity of demand suggests how strong the goods are as substitutes or complements to each other. However, cross elasticity of demand is not relevant in this context as the preamble did not mention a change in price of related goods.

In conclusion, with the exception of cross elasticity of demand, the various elasticity concepts are largely relevant in explaining the effects of the events on the airline industry. Despite this, there are certain limitations. Firstly, elasticity concepts will not be suitable to measure the fall in demand caused by the fear of flying, since such change in preferences against air travel is intangible and unquantifiable. Hence the relevance of such concepts to explain the effects are largely limited since the fear of flying most likely accounts for the large part of the fall in demand. Furthermore, since elasticity figures can only be estimated based on past data, it may be inaccurate to use such to foresee the effects of current events since economic conditions would have changed.

JC Economics Essays - H1 and H2 standard 'A' Levels Economics Essays - tutor's comments on this essay - Basically, there are times in an examination when the examiners ask multiple parts in one single question. This essay simulates combining two essay parts (usually a part (a) and a part (b) essay) into one essay, and the best way to address it is to imagine that it is indeed two parts - and answer each part accordingly. There are several other essays on this site that are similar to this one, but  are in the part (a) and part (b) version, and the style would be different for each. Think about how you could improve on the method suggested above. Special thanks to A.G. for her contribution, as well as the econs students behind this very impressive work.  

Assess the relevance of price elasticity of demand, income elasticity of demand, cross elasticity of demand and price elasticity of supply in explaining the effects of a worldwide recession and an increased fear of flying on the airline industry. [15]

Apart from considering how changes in price is affected by the changes in demand and supply, it is also important to take into account the responsiveness to the change in price, income and other goods. Thus, this essay aims to discuss the relevance of the various elasticities of the changes in demand and supply and the limitations of the concept. 

Price elasticity of demand measures the responsiveness of quantity demanded of a good to a change in its price, ceteris paribus. The demand for a good is said to be price elastic if a given percentage change in its prices causes a more than proportionate change in its quantity demanded, ceteris paribus. Conversely, the demand for a good is said to be price inelastic if a given percentage change in its price results in a less than proportionate change in its quantity demanded, ceteris paribus.

[Insert a diagram with both elastic and inelastic demand curves]

As shown, the steeper the demand curve, the more price inelastic. A fall in price will result in a more than proportionate increase in quantity demanded for good that is price elastic. Conversely, given the same decrease, it will result in a less than proportionate increase in quantity demanded for a good that is price inelastic.

Secondly, income elasticity of demand measures the responsiveness of the demand for a good to a change in income, ceteris paribus. Positive income elasticity of demand refers to the increase in demand for good when income increases. Such goods are known as normal goods. Normal goods can be sub-divided to normal-necessity and normal-luxury good. A normal-necessity good is income inelastic, which means that a rise in income will result in a less than proportionate change in demand whereas a normal-luxury good is income elastic, which means that a rise in income will result in a more than proportionate change in demand.

Negative income elasticity of demand refers to the decrease in demand for good when income increases. Such goods are known as inferior goods. Inferior goods occur because rising income levels cause consumers to switch from lower quality product to a higher quality product as they are able to afford better alternatives.

 

Cross elasticity of demand measures the responsiveness of demand for a good to a change in price of another good, ceteris paribus. Positive cross elasticity of demand means the demand for a good and the price of another good change in the same direction. This suggests that the goods could be substitutes. Negative cross elasticity of demand means that the demand of a good and the price of another good changes in the opposite direction. This suggests that the goods could be complements.

Price elasticity of supply measures the responsiveness of quantity supplied of a good to a change in its price, ceteris paribus. The supply of a good is price elastic if a given percentage change in its price causes a more than proportionate change in its quantity supplied. Conversely, the supply of a good is said to be inelastic if a give percentage change results in a less than proportionate change in its quantity supplied.

[Insert a diagram with both supply elastic and inelastic curves]

As shown, the steeper the supply curve, the more price inelastic. A fall in price will result in a more than proportionate decrease in quantity supplied for a good that is price elastic. Conversely, given the same decrease, a price inelastic good will show a less than proportionate decrease in quantity supplied. 

In the context of price elasticity of demand, the elasticity of air travel can be analysed using the factors that affect price elasticity of demand, such as availability of substitutes, degree of necessity and proportion of income.

Firstly, the greater the availability of substitutes and the more homogenous the good is, the higher the price elasticity of demand. In terms of air travel, there is no close substitute that is as efficient and as fast as the plane when travelling long distances. In order to travel across the latitudes, there is almost no close substitute for air travel. Hence, air travel can be considered price inelastic of demand. However, some may argue that in the case of short distance travelling, there are substitutes such as trains, cars and public transports that may be as efficient on a well-developed transport network system. Hence, the degree of substitution may differ and is subjective. 

Secondly, the higher the degree of necessity, the lower the price elasticity of demand. Since air travel is usually for leisure and relaxation, the degree of necessity may be low for most households that go on a vacation for leisure. Hence air travel can be considered as price elastic of demand. However, the degree of necessity is debatable especially in the case of businessmen as air travel may be a necessity in order to improve sales or make profits. Thus, in this case, air travel is price inelastic of demand. 

Thirdly, the larger the proportion of income spent, the more price elastic. Air travel is usually costly, especially when it is long distance or for longer period of time. Hence, it is price elastic. 

In the context of income elasticity of demand, air travel is considered normal luxury good for most households hence it is considered income inelastic. However, some may consider air travel as a normal necessity especially when business travelling is concerned. Thus, whether a normal good is a necessity (income inelastic) or is it a luxury (income elastic) depends on individual. 

In the context of price elasticity of supply, it can be explained via a long run and short run concept. In the short run, air tickets are booked in advance and cannot be cancelled immediately, supply is fixed, and hence supply is less elastic. However, in the long run, people’s fear of flying may cause a decrease in supply since demand is extremely low. Hence, supply becomes more elastic.

However, there are limitations of applying the demand elasticity concept. In this situation, the fear of flying cannot be measured by elasticity as the changes in tastes and preferences are un-quantifiable. Thus, the impact is not taken into consideration causing the fall in demand to be less than expected, especially in the long run. In addition the cross elasticity is inapplicable as there is no close substitute. The various elasticities are also derived from past data that may be outdated and hence inapplicable for current economic situation.

In conclusion, responsiveness towards changes in price increase is not constant due to the changing economic situation and in reality, several other factors are also able to influence the elasticity instead of being ceteris paribus. Thus, the effect on the airline industry can be only explained to a certain extent.

JC Economics Essays – H2 A levels – Economics tutor’s comments: This economics paper seeks to address the adapted examination question on elasticities and their relevance, to a specific context. This paper develops the arguments and ideas around the economics question, which is good - always answer the question posed. As it is a part (b) question adapted from an A level Economics question, there was an earlier part (a) to it which dealt with explaining the various elasticity concepts on offer. As an assignment or a training exercise, perhaps think to yourself or check out the various definitions - definitions (as well as mathematical equations) for the various types of elasticities: PED, YED, XED (or CED), and PES. What good points are there to praise about this economics paper? A thesis, anti thesis, and synthesis approach to the essay is clearly and obviously used, which should please practically all Economics tutors and examiners when they are marking. It might be a very good idea to make examiners happy when grading papers. However, there are a few simple problems with this economics essay. First, the conclusion is a bit too concise and does not push the envelope, and certainly could be improved upon. How could you help this candidate improve on her conclusion, by writing it better? Also, what other aspects of this essay could be improved upon - what have you noticed is missing from this essay that could have been written in? Think about it. Special thanks to the kind, valuable, and beautiful contributions of AG and other students for this economics blog. 

(b) How far would the knowledge of demand elasticities be useful to a govt in devising policies that discourage the use of private cars? [15]

(b) How far would the knowledge of demand elasticities (PED, YED, XED) be useful to a government in devising policies that discourage the use of private cars? [15]

To discourage the use of private cars, there are a few policies that the government can implement. The government can implement policies to curb car ownership, curb car usage, or encourage the use of public transport. This paper argues that the knowledge of demand elasticities is useful to help governments in terms of car ownership, car usage, and public transport strategies, and to a large extent this knowledge is quite useful for helping the government make good decisions to tackle road congestion.

Firstly, car ownership can be reduced through a variety of measures. Car ownership can be discouraged by taxing the purchases of new cars, thus making them more expensive, thereby reducing the quantity demanded. Taxes shift the supply curve of cars to the left, thus reducing the equilibrium quantity demanded. Alternatively, an equivalent policy is to set a quota below the free market equilibrium quantity. A quota is a mandatory number of cars that limits the car population. By controlling car ownership, the population growth of cars is curbed and with a smaller car population, there will indirectly be fewer cars on the road.

Alternatively, car usage can be controlled directly using road pricing whereby motorists are charged for using congested roads. For example, in Singapore we have ERP. Electronic Road Pricing is a road toll system that reduces the usage of cars. This reduces the number of cars on that road, hence lowering the extent of traffic congestion.

Finally, lowering the fares or improving the quality and accessibility of public transport, for instance, lowering the fares of SMRT trains or raising the quality of SBS buses, encourages people to switch away from driving private cars to using public transport, hence reducing the usage of cars and traffic congestion in the process.

The knowledge of PED, YED, and XED are quite useful in helping governments devise policies to discourage the use of private cars. PED can be applied here. If demand is price elastic, a low tax rate is able to significantly reduce the quantity demanded. Hence an indirect tax is a suitable policy to curb car usage or ownership. However, if the demand is price inelastic, a very high tax rate is required to significantly reduce the quantity demanded. Hence indirect taxes are likely to be politically unpopular because the imposition of a very high tax rate can result in the government being perceived as being more interested in raising revenue rather than in curbing car usage. Hence a quota is probably politically more acceptable because the government is perceived to be controlling the quantity directly rather than trying to raise revenue. However if the government were to auction off the quota permits, they might again be accused of trying to raise revenue rather than fight traffic congestion.

YED can also be applied here. Knowing the income elasticity of demand enables the government to estimate the extent of the change in demand in response to a change in income. So as income rises with economic growth, the government is then be able to better determine how much car taxes should be raised so as to prevent car population and usage from rising. If the demand for cars is income elastic (i.e. normal luxury), car ownership and usage taxes have to be raised frequently and/or substantially as the country experiences economic growth. Again, the government might be seen as being more interested in raising revenue than in curbing traffic congestion so indirect taxes are likely to be politically unpopular while a quota is likely to be politically more acceptable.

Cross elasticity of demand (XED) measures responsiveness of the demand for a good to a change in the price of another good. It is calculated by taking the percentage change in the demand for the good over the percentage change in the price of the other good. XED can be applied here as well. Since public transport are substitutes to private cars, knowing the cross elasticity of demand for cars with respect to the price of a public transport enables the government to know whether cutting public transport fares is an effective way of curbing car usage. Alternatively, by improving the quality and accessibility of public transport, this makes it a closer substitute to private cars, hence raising the cross elasticity of demand between the two goods. Hence, for a given reduction in the price of public transport, there is a greater impact in curbing the demand for car usage.

In conclusion, knowing the various demand elasticities is to a certain extent quite useful in helping a government decide on which policy to choose. However, it is probably less useful in helping the government decide how much to tax or what fares to charge for public transport. This is because elasticity figures are estimated based on pass data, so they are not fully applicable to the current context as economic conditions tend to change over time. Hence, all elasticity figures should be considered carefully.

JC Economics Essays - Tutor's Commentary: This essay paper was written under exam conditions, and is still well structured, much like the companion complementary part (a). However, as usual, the usual questions apply: how can I make this essay better? How can I use an economics diagram to make this paper better? It has a good structure and is well crafted, yes. May I use this approach in my other Economics essays, or is this only applicable to this type of questions or only to elasticities? A quick word of advice here: please do not swot/ mug/ memorise Economics essays - try to understand the underlying structure, pattern, and system of writing, and always think to yourself - how can I make this essay better and more structured? Why do I prioritise the points this way? Why do I write like this? And how can I be better than I am already? Think hard and you will succeed.