In economic theory, a monopolist would determine the price and output that would maximise his profits. Discuss whether firms in the real world would always set prices at profit-maximising levels. [25]

This essay argues that, while according to economic theory, a rational monopolist would set MC = MR to maximise his profits, in the real world, firms sometimes do not want to maximise their profits because they sometimes have alternative aims like revenue maximisation, or are often unable to because of imperfect information and bounded rationality and depend on "rules of thumb" like cost-plus pricing.

On the one hand, a monopolist would rationally seek to maximise profits, using the MC = MR rule, or the profit maximisation rule (also known as the marginalist way or principle). A monopoly is defined as one dominant firm that produces a unique good with no close substitutes, for instance, De Beers in terms of diamonds or Microsoft in terms of the software that it produces. The market structure that a monopolist faces generally has very high barriers to entry, either in terms of natural barriers to entry like large economies of scale, or man-made barriers to entry like powerful legislation and patent rights, price setting power due to the large market share commanded by the monopolist, and often imperfect information exists in the market, just like it does in software and high capital-intensive technologies.

On the other hand, in the real world, firms often do not want to maximise profits. They may want to maximise their growth or revenue instead of profits. 

To maximise their growth and expansion, they could produce where AR = 0, which would maximise output, so as to extend their lead in the market and would thus promote the growth of their firm. 

To maximise revenue, firms could easily produce where MR = 0. This economic theory is particularly interesting. According to the famous economist William Baumol, if the aim of a firm is to maximise its sales instead of profits, one possibility is that it would produce where MR = 0. This is due to the issue of the division between ownership and control of a firm. With the separation of ownership and control in modern corporations, the issue is that managers of a firm, like the Chief Executive Officer or Managing Director, may seek prestige and higher salaries by trying to expand sales even if it were at the expense of profits, which would be shareholders’ interests. According to Baumol and Williamson, managers may seek to maximise their own utility rather than profit-maximise, which would benefit the firm. And according to Bearle and Means, the ownership of companies is spread out over a large number of shareholders with little individual power, while control and decision-making is in the hands of a few managers. 

However, some firms would aim to maximise their revenues but this would still be subject to "satisficing" – which means to reach at least a minimum level of profit, but a level which is lower than pure profit maximisation.

Another reason why firms may not maximise profits is that they are unable to do so, even if they are willing. According to Herbert Simon, decision makers face the situation of imperfect information and have to make decisions under uncertainty in the real world. Even though they may be rational or try to be, they eventually use what is known as “bounded rationality”, and therefore make decisions using the information that is available to them. Using Simon’s theory of bounded rationality necessitating satisficing, Cyert and March argued that real world firms aim for satisficing behaviour and even found empirical data to support their view. 

One alternative way of making pricing and output decisions is to use cost-plus pricing, which is basically to take P = AC + a mark up, which is why this method is called cost-plus pricing. Hall and Hitch would agree, as they argued that company executives often make decisions using “rules of thumb” rather than the marginalist way of MC = MR.

In conclusion, to a large extent firms in the real world do not aim at profit maximisation in the sense that they set MC = MR, and often are unwilling or unable to set MC = MR. They often operate under conditions of imperfect information and make bounded rational decisions, and may often use cost-plus pricing. However, to a large extent, firms that do not care at all about profits would not survive in the long run, and it is not a far stretch of the imagination to say that either by luck or by skill, in the long run, all firms would approximately reach a level of pricing and output that is profit maximising because firms that did not make profits would not have survived in the long run against their more rational and efficient competitors.

Economics Tutor's Comment - This is an excellent effort for the A levels that answers the economics question comprehensively. Also, the use of economic theory is very strong in this economics essay. Do think of which economics diagrams are needed to be drawn and explained in this essay to make it an even stronger paper that supports your case that you are making. Thank you for reading, and cheers.

JC Economics Essays - This useful and relevant economics essays site can help students studying economics do well at the A-Levels (Cambridge, A1/S, A2, H1/H2/H3 levels), and the international AS level economics examinations. IB students can also benefit from the top-quality economics content here. This economics website contributes useful economics content, lesson materials, examination tips and techniques, and model economics essays that students in both Singapore and the UK, as well as also all around the world, can use to excel in economics.

This excellent economics essay was jointly written and contributed by both SS and WT, the first, our editor of JC Economics Essays, and the second, our resident Economics expert who helps students understand the beauty of Economics and its applications in real life. (Some of the economics content for alternative theories of the firm was also learnt from economics modules/lessons at the University of Manchester - Business Economics in 2008.) Thank you for reading and cheers! 

Consumers and producers are generally assumed to be motivated by self-interest. Explain how the pursuit of self-interest can help to address the central economic problem of limited resources and unlimited wants. [10]

Adapted from an actual economics essay examination

This economics paper explains that the pursuit of self-interest results in an efficient allocation of resources through the price mechanism, which addresses the problem of scarcity. 

Human wants are unlimited, while earth's resources of land, labour, capital, and entrepreneurship are limited. This results in scarcity. What is scarcity? It refers to the situation where resources that are limited are not able to meet the requirement of unlimited wants. However, there is a solution to meeting these two different imperatives - and that is the free market, with its price mechanism, which as Adam Smith said, acts like "an invisible hand". 

The price mechanism means that it is the intersection of demand and supply that determines the price and the quantity eventually produced. It is the rational choice of millions of suppliers, producers, and firms meeting the requirements of millions of consumers, individuals, and households. Demand is defined as the willingness and ability to purchase a good or service, ceteris paribus, while supply is defined as the willingness and ability to produce a good or service, also ceteris paribus. 

The price mechanism addresses the central problem of economics, coordinating resources to their best uses, and solving the problem of what to produce, how to produce, and for whom to produce, because it serves the important four functions of signaling, rationing, allocating, and incentivising. The signaling function is one where the price of a good allows for a re-calibration of the quantity demanded and quantity supplied. As the price of a good increases, indicating a more pronounced situation of scarcity, the quantity demanded of a good falls, while the quantity supplied rises, ceteris paribus. The converse is also true, where the fall in the price of a good, which indicates an amelioration of scarcity, results in an increase in the quantity demanded and a fall in the quantity supplied.

Given the prevailing market prices, buyers who seek to maximise their utility will demand the good. Under this demand function, those are willing and able to pay for the good are able to obtain it, while those who are not willing or able to pay will go without the good. Meanwhile, producers who are willing and able to produce the good at a cost below or equivalent to the prevailing market price will produce it, as they are incentivised to maximise profits, while those who produce at a cost above the market price will not. This also determines the allocation of resources that go into producing this good.

In conclusion, the pursuit of self-interest utilises the price mechanism to address the problem of scarcity, achieving an efficient allocation of resources.

Economics Tutor's Comment - This is a very strong effort for the A levels and covers quite a few important points and arguments. The candidate's use of economic theory is quite strong in this economics essay. However, one should not and cannot rest on one's laurels. What would make this economics essay even better? Thank you for reading. Cheers!  

JC Economics Essays - This economics essays site helps students with the A-Levels (Cambridge, A1/S, A2, H1/H2 levels), and the international AS level economics examinations. This blog provides a range of useful economics content, materials, tips and techniques, and model economics essays that students in the United Kingdom, and all around the world, can use to excel in their studies and examinations.

This model essay with sample comments was contributed by WT, our resident Economics expert who helps students understand the beauty of Economics and its applications in real life. WT has a strong interest in Econometrics, Economic History, International Trade, and Game Theory, especially applications to real life. This economics post was edited by S. S., the editor of JC Economics Essays.

View: Are The Water Price Hikes in Singapore Announced in 2017 Justified?

This economics view post is contributed by the editor of JC Economics Essays

The Budget and Committee of Supply Debates 2017 in Singapore had many economic policies announced. However, one major announcement stood out and generated a lot of debate, including many negative views – yes, the water price hikes, especially the figure of 30%.

In summary, the issue here is that the price of water in Singapore is set to increase by 30 per cent in two phases, from 1 July 2017 onwards.

This economics view post argues that while some may say the hikes are not justified, the reality is that the water price hikes are based on sound economics and are needed, necessary, and important for Singapore’s survival.

Before we delve into economic terms like "LRMC" and "pricing" and "infrastructure", there are of course, non-economic arguments based upon reasoning about Singapore’s strategic imperatives and our fundamental vulnerabilities.

Singapore’s Deputy Prime Minister Teo Chee Hean said, rather clearly, that water is critical to Singapore's survival, and Singapore has adopted a strategic approach in planning for its water supply. It may not be a very well-known fact that water is tied rather closely to Singapore’s sovereignty, a significant reflection that water is critical to Singapore’s survival. According to the National Library Board, the Separation Agreement signed between the governments of Singapore and Malaysia on 9 August 1965 guaranteed the 1961 and 1962 water agreements.

As DPM Teo went on to say, "Our struggle to make sure our people have water, is the struggle for Singapore's survival and independence… To make sure that we could survive, preserve our independence and thrive, we have taken a strategic approach to planning for water supply.” 

This strategic argument reflecting the importance of water has actually led to concrete steps taken to reduce Singapore's dependence on imported water and raise Singapore's water security. 

To reduce Singapore's dependence on imported water from Malaysia, the government has increased the size of the local water catchment area (in other words, reservoir water) and to build up water supply from non-conventional sources, namely NEWater (in other words, reclaimed water or less glamorously, “sai chui” in Singapore local parlance) and desalinated water (in other words, treated seawater), by setting up water treatment plants in various parts of Singapore. In total, these form the four national taps of Singapore.

The real success of the four national taps came in 2011. When the 1961 water agreement with Malaysia expired, Singaporeans did not face a disruption in water supply, and the event passed almost unnoticed.

DPM Teo went on to argue that, in the same vein, Singapore must prepare now for 2061 when the second water agreement with Malaysia, which currently meets half of Singapore’s water needs, expires. Besides preparing for the future, DPM Teo also warned of a more immediate worry (at least in the near term). Johor's Linggiu Reservoir is only one-third full and there is a danger of it failing in prolonged dry weather – and the water is needed by both Malaysia and Singapore. 

Other than the fact that the water source is under stress, while bilateral ties are sound today, where in recent years Singapore and Malaysia have shared a good relationship, what would happen if climate change and increasing water scarcity makes it challenging and difficult politically for Malaysia to export water to Singapore?

However, let us turn to the economics and look at the issue from an economics perspective. 

While housing, healthcare, and education are subsidised in Singapore, because they are essentially merit goods, it was argued in Parliament that water has to be priced fully because consumers must feel the price of water to realise its value. It is a sound economic principle that the ones using the water should be the ones to pay for it. In other words, the Minister of the Ministry of Environment and Water Resources, Masagos, is essentially right in terms of economic reasoning – water is not a merit good and should not be subsidised, whereas there are foregone positive externalities to society or there would be under-consumption of goods such as housing, healthcare, and education if they were not to be subsidised by the government. 

Now for the pricing itself, beyond the economic principles. 

Minister Masagos said in Parliament that even with the impending 30 per cent hike in water prices, the price of water here will fall short of the Long Run Marginal Cost (LRMC) — which is the increase in cost of producing an additional unit of water, over the long run, arising from increasing production. 

In other words, he argued that the increased price of water will bring up the pricing to nearer the true LRMC of water. 

With the 30 per cent increase, the price will be close to, though slightly lower than, the price of the next drop of water or LRMC. This is the best way to emphasise the scarcity value of water, because the price will fundamentally reflect the long run cost of the next drop of water – and this is based on economic reasoning. If the price is equal to the LRMC, production would be allocative efficient - a concept familiar to economics students, where the price reflects the additional (i.e., marginal) cost of production. 

In Parliament, it was revealed that the LRMC of water comes from the costs of NEWater and desalination. And between the two, Singapore will have to depend more on desalination – which is more expensive than NEWater – to meet increasing water demands, as there is a limit to recycling used water in the NEWater plants. For example, three more desalination plants will be built by 2020. 

And why are the relatively cheaper NEWater plants not being used instead? The answer is that as the proportion of water being reclaimed for NEWater increases, waste water becomes more concentrated, thus becoming difficult and even more costly to treat. 

In addition, it also costs the government more to build new and replacement pipes to deliver water - thus adding to the LRMC.

In the final analysis, while there are actually solid strategic reasons for raising the price of water to build critical infrastructure to ensure Singapore’s future, the price hikes are based on sound economics.

JC Economics Essays – This is an economics blog with views, opinions, and perspectives on a wide range of socio-economic issues. It also has a wide range of A level economics essays answers. 

Since 2007, this useful and popular economics blog has assisted students with economics essays, in particular the A level Economics examinations at H1, H2, and H3 levels, and the International Baccalaureate (IB) Economics too.

And there are many economics essays on this site that economics students can access, read, and reflect on for improving their essays and learn how to answer examination questions. Thank you for reading and cheers! 

Explain, with relevant economic theories and with the use of diagrams, the factors affecting the price and output decisions of an oligopoly firm. [10]

An oligopolistic market refers to a market that is dominated by a few firms, each possessing a significant market share. What are the assumptions for an oligopoly? There are four assumptions for an oligopoly firm. There are few sellers and many buyers, high barriers to entry, imperfect information and either homogeneous or differentiated product. There is mutual interdependence or rivalry between firms in an oligopolistic market, which leads to strategic, game theoretic behaviour of firms. Mutual interdependence or rivalry refers to a situation where a firm has to consider the reactions of its competitors when making its decisions, in which it might make strategic, game theoretic pricing and output decisions. This economics essay thus attempts to explain how mutual interdependence or rivalry affects a firm’s price and output decisions, and how collusion and advertising affect a firm’s decisions.

Oligopolies tend to have sticky prices that are rigid and are often unchanged. In an oligopoly, when a firm lowers its price, it will draw a significant number of customers away from its rivals. These rival firms are unlikely to sit back and do nothing but will instead lower their prices in response to avoid losing a big portion of their sales.

However, should a firm raise its price, it will instead lose much of its customers to its rivals. Since its rivals benefit by not reacting they will probably not raise their price in response. Based on such observations, oligopoly pricing behavior based on the kinked demand curve was derived, showing price rigidity.

[Insert a diagram on oligopoly’s kinked demand curve model]

The oligopolistic firm will set the price at MC = MR. The firm will not produce at any output where MC > MR as they generate losses. Hence, the profit maximizing or the loss minimizing point is when MC = MR. This kinked demand curve model shows that there tends to be price rigidity in an oligopoly due to mutual interdependence. Firms tend to stick to the prevailing price and are reluctant to change to alter prices.

An oligopoly firm will only alter its price if its marginal costs change substantially, and if the marginal costs fall significantly there could be a price war - an oligopoly will decide rationally that it could lower prices, increase output, and thus put some rivals out of business.

[Insert a diagram on oligopoly’s kinked demand curve model - showing a price war]

There are other factors affecting the decision of price and output by oligopolistic firm. For instance, collusion may affect the oligopolistic market and help make it become a monopoly market.

Collusion refers to the act of firms jointly determining the price or output. There are two types of collusion, namely explicit collusion and tacit collusion. Collusion can be explicit where firms formally gather to fix prices or output. A formal collusion oligopoly is called a cartel. Tacit collusion could still occur as firms cooperate informally by following a price leader. Both explicit and tacit collusion can work like a monopoly market which can control output and set the price.

[Insert diagram on collusive oligopoly - monopoly diagram]

           

A collusion oligopoly can be a price setter as a monopoly at maximum profit point i.e. MC = MR and set the price without the limit of price rigidity of an oligopolistic firm.

When there is a price war, the oligopolistic firms retaliate by cutting prices, triggering successive rounds of price cuts. Such an occurrence is known as a price war, which is generally detrimental to all firms as heavy losses are incurred throughout the market. A firm might want to punish its rival for taking unilateral actions. In addition, the reasons for price wars are less strategic and more short-term in nature. For example, due to an unexpected recession, managers might desperately slash prices in order to make sales targets or to raise revenue to overcome cash flow problems.

In conclusion, the factors affect the price and output of a firm in an oligopolistic market is mainly price rigidity which depends on the market itself. Collusion oligopoly will give the firm more market power to set its price beyond the limitation of price rigidity. A price war may result in decreasing prices of the firm. Therefore, the price and output of a firm in an oligopolistic market are affected by many factors in different conditions.

JC Economics Essays - H2, H3 Economics essays - tutor's comments: This economics essay deals with oligopolies, strategic behaviour, and pricing and output decisions of firms, with a simple hint of game theory, assuming that firms are rational and thus make rational decisions. Game theory is an important mathematical tool that can help in general economics analysis, but specifically, especially for H3 examinations, undergraduate economics courses, and economics in general. However, there was very little depth of game theory in this economics paper. There are many important elements of this economics essay which make it worth many marks and a rather good examination grade. However, the usual questions for improvement still apply: how could you make this essay answer better? Could examples have been used? Always try to answer the question, and think of how you could make your answers better when dealing with economics questions. 

Explain how a monopolistic firm and a perfectly competitive firm make their pricing and output decisions in relation to the differences in the barriers to entry to their respective industry. [10]

This essay topic is on market structures, and in particular barriers to entry with respect to monopolies and perfectly competitive firms. What are barriers to entry? Barriers to entry refers to reasons that deter and prevents new firms from entering a market. They could be further categorized specifically into artificial barriers to entry and natural barriers to entry. What are monopolies and perfectly competitive firms? Monopolies refer to firms in markets with only one seller selling a uniquely differentiated product that have no close substitutes while perfectly competitive firms are those in markets that consist of large number of buyers and sellers selling homogeneous products. 

In order to explain the difference in pricing and output decisions between a monopoly and a perfectly competitive firm, a comparison between the characteristics of both firms need to be made. This Economics essay therefore talks about the various assumptions a monopoly and a perfectly competitive firm, before moving on to explain diagrammatically the difference in their pricing and output decisions.

        

Monopolies assumes the characteristics of high barriers to entry, uniquely differentiated product with no close substitutes, one seller or a dominant firm in a market and generally imperfect information. On the other hand, perfectly competitive firms assume characteristics of low or almost no barriers to entry, homogeneous products, large number of buyers and sellers, and perfect information.

           

The following diagrams will move on to explain the pricing decisions of a monopolistic firm and a perfectly competitive firm respectively.

[Insert diagram of a monopolistic firm]

           

Due to the high barriers to entry, a monopolistic firm is a price setter and thus is able to secure the profit maximization (or loss minimization) point at MC = MR, to earn supernormal profits.

[Insert diagram of a perfectly competitive firm]

           

On the other hand, the low barriers to entry means that a competitive firm is a price taker as it accepts the price pre-determined by the intersection of the market demand and supply curves.

Therefore, because it accepts the market price, it produces at an output level at MC = MR, and controls only its output level to vary its profits.

           

The high barriers to entry allows monopolistic firms to set their prices as it is unlikely that there will be an entry of new firms to reduce the market power and hence pricing influence of that monopolists. However, perfectly competitive firms are unable to do that since the low barriers to entry means that new firms could easily enter the market, diluting each firms’ market power, thus all firms have small market power, resulting in them being price takers.

In conclusion, barriers to entry are a significant assumption that affects the pricing decisions of monopolistic and perfectly competitive firms, although the other assumptions also play an important role.

JC Economics Essays - H2 A level Economics style, model, sample economics materials - tutor's comments: This economics essay is written in a simple, lucid, clear, short, and direct manner which addresses the economics question posed at the start. This makes this essay answer easy to follow and clear, direct, and easy to mark for the examiner, which are all plus points for this model paper. There is very good use of diagrams to illustrate ideas and points. While a bit short, the conclusion is simple, easy, and direct. The conclusion in this case can be short because this is not a 13, 15 or 25 mark essay question, which would require a longer, more evaluative, and higher value added response as a conclusion. The question is: how can you improve on this economics essay, to make it more of a model economics answer? At the same time, there are other essay styles to write this economics essay, some of which use more words and approach this question from a slightly different angle to answer the question equally well. What do you think? Thanks for reading and cheers. 

Examine, with relevant examples, how American car producers might use the price (PED) and income elasticity of demand (YED) concepts to help determine their pricing and output decisions. [15]

This economics essay applies concepts of elasticity to the car market, using real world examples from the USA. Price elasticity of demand measures the responsiveness of quantity demanded of a good to a change in its price, ceteris paribus. It is calculated by taking the percentage change in quantity demanded of a good over the percentage change in price. Income elasticity of demand measures the responsiveness the demand for a good to a change in income, ceteris paribus. It is calculated by taking the percentage change in the demand of a good over a percentage change in income. 

After having defined the two main economic concepts, this essay seeks to explain how they can be used to determine pricing and output decisions with the aid of diagrams before linking them to various car producers and finally evaluating the usefulness of these concepts.

[Insert diagram on price elastic demand showing the loss and gain in revenue when price falls]

With the aim of maximizing total revenue in mind, with a fall in price in a price elastic demand, the firm would gain an area bigger than the area loss. This shows that the quantity demanded will increase more than proportionately, resulting in an increase in total revenue earned by the firm.

[Insert diagram on price inelastic demand showing the loss and gain in revenue when price rise]

Likewise, with the same goal in mind, a rise in the price of a good with an inelastic demand would result in the firm gaining an area bigger than the area loss. This indicates that the quantity demanded will fall less than proportionately, also leading to an increase in total revenue. Hence, by knowing the price elasticity of demand for their goods, the firm would know when to raise or cut prices for its benefit in earning maximum total revenue.

For income elasticity of demand, with regard to positive income elasticity, with an increase in income, the demand rises for the normal good and firms should produce more of them when the country faces strong economic growth. As for negative income elasticity, with an decrease in income the demand rises for the inferior good and firms should produce more when the country is having a recession. With a higher magnitude, the extent of the change in demand increases and the firm should be more responsive in terms of the quantity supplied.

When linking these concepts to various car producers, for price elasticity of demand, the bigger firms such as Ford and Chrysler, experience greater price inelasticity for their cars as they are more luxurious and expensive. For the smaller vehicle firms in the USA whose goods are price elastic, they can reduce this extent through extensive advertising and product differentiation.

For income elasticity of demand, cars might be considered to be as normal goods as they offer more convenience and comfort as compared to taking public transport where it is likely to be more crowded and people have less personal space. In addition, some car companies produce cars of better quality and have established brand loyalty amongst consumers. For these car producers, the income elasticity of their cars is more elastic.

In particular, Ford cars can generally be considered normal goods, and more of these should be produced in a good economic climate. However, if Ford really wants to earn much more, it should produce more of its luxury series, the Lincoln (Lincoln Motor Co. produces what can be considered a luxury American car). However, if Ford produces cheaper, simpler cars, this would only be an effective strategy in an economic downturn because the cheaper, simpler models could arguably be considered inferior goods (relative to the normal and normal luxury goods that Ford produces). 

In conclusion, while evaluating the usefulness of these concepts, price elasticity of demand may not be that effective as the cost involved in production has to be factored in for the car companies to truly earn profits and not merely rely on the demand for them. As for income elasticity of demand, it may not be that useful either as data was taken from past statistics and thus may not be very accurate for today as the economy would have changed.

JC Economics Essays - economics tutor's comments: This part (b) economics essay did make an attempt to answer the economics question posed and in fact used a few American car examples, which is good. It is always a good idea to answer the question directly in Economics examinations. However, this economics paper could have done much better had it given more analysis both in theory and also using more real world examples of American car companies. Overall, it did a good job. Special thanks to A G and T students; the essay was written under examination conditions but has been edited for blog posting. 

(b) Examine how the car producers might use the price and income elasticity of demand concepts to help determine pricing and output decisions. [15]

Singapore’s car population grew by almost 40% from 370 000 in 1997 to 515 000 today. - Adapted from Singapore’s Ministry of Transport

(b) Examine how the car producers might use the price and income elasticity of demand concepts to help determine pricing and output decisions. [15]

Car producers can use the price and income elasticity of demand concepts to help determine pricing and output decisions. This essay discusses how car producers can use the concepts. First, PED measures the responsiveness of the quantity demanded of a good for a given change of its price, ceteris paribus. On the other hand, YED is defined as the responsiveness of the demand of a good to a change in income, ceteris paribus.

First, PED can be used to help firms. Let us assume that firms aim to maximise total revenue. If demand is price elastic, as prices fall, this will lead to a more than proportionate increase in quantity demanded, which leads to a rise in total revenue. On the other hand, if demand is price inelastic, as prices rise, there will be a less than proportionate fall in quantity demanded, hence raising total revenue also. The implication here for car producers is that they can make use of this knowledge to determine their pricing strategies.

For example, the many major car producers have competitors producing similar products e.g. Toyota, Volkswagen and Hyundai. Therefore, such cars are relatively elastic in demand because they have many substitutes. Therefore such producers should lower the price to increase total revenue.

On the other hand, some exotic or luxurious car producers such as Ferrari or Rolls Royce have fewer competitors and very a differentiated product, so the demand for their cars is relatively price inelastic. Hence, such car producers should lower raise the price to increase total revenue.

YED is also useful to car producers. Normal goods have positive YED, where a normal necessity has a YED between 0 and 1, whereas a normal luxury good has a YED of more than 1. A normal good is defined as any good whose demand increases as income increases, where a necessity has a demand curve that increases less than proportionately to an increase in income, whereas a luxury has a demand curve that increases more than proportionately to an increase in income. Hence firms should produce more normal goods in general if the general level of income rises in an economy.

On the other hand, inferior goods have negative YED. An inferior good is defined as any good whose demand increases as income decreases. Hence, firms should produce more inferior goods when there weak economic growth and income decreases.

Also, the higher the magnitude of YED, the greater the extent of the change in demand and hence the more the firm should respond in producing output. For example, Geely and Cherry QQ are inferior goods and more should be produced in a downturn, whereas Nissan and Toyota are normal (can be considered normal necessity) goods and more should be produced in an upturn, and Ferrari and Porsche are normal luxuries, and even more should produced in an economic upturn. Therefore, even the extent of the change matters when it comes to producing output.

In conclusion, PED and YED are very useful concepts for car producers. On the other hand, it is more likely that producers may aim to maximise profits than revenue, hence, knowing elasticity is insufficient because we also need to consider costs. Total profit is equal to total revenue minus total cost. Furthermore, elasticities are estimated based on past data, and therefore may not be very useful if current economic conditions have changed drastically. Hence, in my opinion, elasticity concepts – while important – need to be understood in their nuances.

Junior College Economics Essays - Tutor's Commentary: This is the second part (part (b)) of the question addressed earlier, written by the same hardworking, clever student of mine, and was written under timed, stressful, examination-like conditions. (Of course, he did write the paper after consultation with me, and then I did work through the paper again to clean it up and improve upon our joint project... but that's another story.) The real question is: is it possible to write this under examination conditions? The ANSWER: It is definitely possible to craft a paper of this standard or EVEN better whilst under examination conditions during the A levels. However, do remember to add in diagrams (what diagrams would be really useful here?) and explain those diagrams to convince your Economics examiner to give you a really good grade.