Foundation economics: assessment questions and explanations

Economics

There are several factors that could contribute to increased demand for owner-occupied housing in the United Kingdom. Given that this demand is presently suppressed by a poor economy, most of the conditions under which demand would increase involve finding ways to boost overall economic performance. One normal policy prescription, lowering interest rates, is effectively off the table with the current rate at 0.5% and the Bank of England expected to maintain this rock bottom rate for the foreseeable future (Oxlade, 2013). Banks could lower lending rates to buyers, but these rates are usually based on spreads relative to the rate at which banks borrow, so there might not be much flexibility for banks to lower rates profitably.

One way would be to boost the economy through fiscal stimulus, government putting money into the economy instead of taking it out. This would create better demand conditions, and would also give a confidence boost to a British public now skeptical about the long-run prospects for economic recovery given the heroic state of economic bungling in the past few years. Richer and more confident people are more likely to demand owner-occupied housing. Another way to stimulate demand in the economy comes from the classic move of lowering prices. If prices in the housing market decline, the shift down the aggregate demand curve implies that the quantity demanded will increase. There might be an offsetting decline in the supply, but right now there is a surplus in the market, so such a decline in supply would merely bring the market to an equilibrium condition.

A third means by which demand in the housing market can be stimulated is if the economy begins to improve. A stagnant economy, absent of fiscal stimulus, can still improve if there are technological innovations, particularly those that create new products or improve productivity in existing production. New products come with their own demand that can transcend intense economic malaise -- smartphones have done just fine and they were introduced right when the economy was collapsing. New innovation and productivity improvement can increase GDP, wages, and create new jobs, all of which will have a positive effect on the housing market. Lastly, an external source of capital can be found. While this could come from finding new export markets (trade policy) it could just as easily come from transfers of wealth by any means, such as remittances from overseas, as booming economies elsewhere could generate either transfers or increased demand for British products, thereby increasing exports.

Supply can be shifted by any number of different factors. With housing, the big issue is that the supply of existing stock is relatively fixed. Old supply can crumble its way out of the market, bringing about change in the supply dynamic if there is no cause for new supply to be added. If the surplus persists over time, the housing stock will decrease through attrition to restore equilibrium. This will take a longer time. The supply of housing can also be reduced through more efficient means, like becoming involved in a war with Germany. Last time that happened, the housing stock in Britain was reduced rather quickly and unceremoniously. It was reduced too much, in fact, and to restore equilibrium a massive post-war building spree ensued. A supply boom could also involve building new housing today. The driver of this, however, is going to be demand. The high fixed investment to build homes and perishability of empty ones means that even with minimal transaction costs to do so (minimal interest, red tape), builders are not going to build without the potential for a sale shortly after completion at worst. As a result, they are more likely to respond to demand conditions rather than to other forms of stimulus, which are significantly less powerful.

2. a)

p per mile

Demand

Total Revenue

Old Total Cost

New Total Cost

8

6

10

4

12

3

Midpoint

% formula

8-10 pair

-1.8

-2.5

10-12 pair

-1.57

-1.25

b) The profits under the old cost structure are as follows: 120 million for the 8p fare, 60 million for the 10p fare and 30 million for the 12p fare. Thus, 8p was the optimal price under the old cost system.

c) The case states "demand willMillion miles." That number is rather integral to the completion of this question. The bus company should decide on this option by calculating the profits expected from adopting the option. Whichever option yields the highest profit is what should be adopted.

Question 3.

a) If the price of DVDs rises, demand for DVDs will fall.

b) If the price of DVDs falls, demand for DVDs will rise.

c) If the supply of DVDs rises, this probably increases demand. The reason is simple -- an increase in the amount of DVDs means that there is more choice of content available. The more content that is available, the more consumers will be interested in the product. Price might decline, in theory, if each different movie was its own company competing for market share. That is not the case, however. There are actually few media companies that control the vast majority of content. Moreover, any given DVD only lasts a few hours, and consumers have many hours with which to watch DVDs. Therefore no price competition is necessary; it is only necessary to have attractive content for the next purchase decision. Only bad content will see a decrease in price (i.e. The bargain bin). DVDs are probably not a good illustrative example for the basic supply-demand relationship.

d) If consumer income decreases, the demand for DVDs will probably decrease, as DVDs are a discretionary purchase. Discretionary purchases are usually the first to be cut when income declines. However, if DVDs are a low-cost substitute for more expensive forms of entertainment, they should see demand increase. More likely, however, consumers will turn to fixed-cost entertainment (like their television package or Internet) and the aggregate demand for DVDs will decrease.