Economics Principles - Problems - and Policies

Question: Discuss about the Economics for Principles, Problems, and Policies. Answer: Introduction: The Bagels and Cream cheese are complementary goods. As demand for bagels rises, the demand for cream cheese will also increase and when demand for bagels falls the demand for cream cheese also declines. As the equilibrium price of cream cheese has risen the equilibrium quantity of bagels has fallen. This is because, as the price rises, the demand for cream cheese has fallen. Since, cheese cream and bagels are complementary goods, the demand for bagels will decline as well. The equilibrium quantity of bagels declined not because of the rise in price of flour but due to the rise in price of milk. Due to rise in price of milk, the cost of production of cream cheese has risen. The rise in cost of production will induce the producer to cut down the production of cream cheese. Therefore, there will be fall in supply as represented by the shift of S1 curve to S2 in panel (a). The fall in supply will lead to rise in price of cream cheese from P1 to P2. There will be a fall in demand for cheese due to price rise, as shown by the shift from Q1 to Q2. As demand for cream cheese declines, bagels demand will also fall from D1 to D2, as shown in panel (b). Fall in demand will lead to fall in equilibrium quantity of bagel, and quantity will from Q1 to Q2. Figure 1: Impact of price change on Complementary Goods Source: Created by Author When the government imposes price floor, it implies that price cannot be set below that level. If the price floor is imposed below the market clearing price, then through demand and supply mechanism price will reach at market clearing price. If the imposed flooring is set above the market clearing price, then market cannot attain equilibrium as price cannot fall below the level of price flooring. In such situation, demand for bagels will be less but there will be huge supply of it. Due to excess supply, the market will become inefficient. Due to high price of bagels, people will purchase less bagels so quantity demanded will decline. Therefore, there will a loss in the consumer surplus. On the other hand, as producer are getting high price, they will sell more and will earn high producer surplus by capturing a part of consumer surplus. However, some part of previous surplus of producers will be lost, because sellers have to forego some of its customers, who are not willing to buy bagels at high price. Social welfare is maximized when total surplus is maximised. However, due to price flooring, an amount of welfare is lost. This can be represented in the following diagram. Figure 2: Inefficiency of Price Flooring Source: Created by Author The triangle highlighted in red, is the portion that neither goes to consumers not to the producers. This is the deadweight loss to the society. Therefore, the total surplus is less in case of price flooring and it is inefficient outcome of the market. Boom- energy produces Horse-Energy Bars and Choco Bars. In order to understand, whether these products are complement of each other or substitutes, cross price elasticity of these goods has to be verified. Cross price elasticity implies how demand of one product changes due to change in price of another product. If the value of CPE is positive, then the products are substitute of each other. This implies that if price of Choco bar increases then demand for Horse-energy bar will increase. Moreover, if the magnitude is greater than one, then these products are close substitute of each other. If the value of CPE is negative, then the products are complements to each other. This implies that if the price of Choco bar increases, the demand for Horse-energy bar will decrease. If the magnitude is more than one, then these products are strongly complements to each other. If the CPE is zero, then it implies that there is no interdependence between these two products. In such case, there will be no change in the demand for Horse-energy bars due to change in price of Choco bars. References Rios, M.C, C.R. McConnell, and S.L. Brue, Economics: Principles, Problems, And Policies, 2013. Frank, R., Microeconomics And Behavior, 2014. Nicholson, W. and C. Snyder, Intermediate Microeconomics And Its Application, 2014.