Question

QUESTION ONE

Alfred Banda, is a producer of commodity X who has experienced an increase in the cost of producing the commodity. As a result, he responds by increasing the price of commodity X from ZMW5 to ZMW10 and continues to produce 250 units of commodity X. Consumers of commodity X respond by reducing the quantity demanded. As such, Alfred’s sales reduce from 250 units to 200 units of commodity X.

REQUIRED:

1. Define a necessity good in terms of elasticity.                                                           [1 Mark]
2. Find the price elasticity of supply.                                                                                [3 Marks]
3. Is supply elastic, inelastic or unit elastic? Justify.                                                     [2 Marks]
4. Find the price elasticity of demand.                                                                             [3 Marks]
5. Is demand elastic, inelastic or unit elastic? Justify.                                                  [2 Marks]
6. Calculate the loss in consumer surplus to the buyers of commodity X.               [4 Marks]
7. Calculate the dead-weight loss to the society.                                                          [2 Marks]
8. Draw a well labelled diagram showing (v) and (vi).                                                  [4 Marks]
9. State four ways in which you can display the law of demand.                               [4 Marks]

Answer 1

i) Necessity goods are those goods that consumers purchase irrespective of their income levels. That means their income elasticity is close to zero. In other words necessity goods have almost an inelastic demand. These are generally goods that do not have any close substitutes. Example: food, water etc..

ii) Price elasticity of supply is given by the formula :

Price elasticity of supply = % change in quantity supplied / % change in price

(250 - 250)/250 ÷ (10 - 5)/5

= 0÷1 = 0

iii) Therefore, the supply is inelastic. Even after, increasing the price from 5 to 10, Banda has not considered reducing supply.

iv) price elasticity of demand = % change in quantity demanded/ % change in price

= (200 - 250)/250 ÷ (10 - 5)/5

= -1/5÷1 = -0.2

v) price elasticity of demand is negative. Therefore, for a unit change in price there will be 20% decline in quantity demanded.

vi) consumer surplus = price willing to pay  - price actually paying = 5 - 10 = -5.

Therefore the loss in consumer surplus for buyers of commodity X is 5 units.