Questions:
1.Explain why only the demand side of the ‘Market’ covered in this case study could be seen as Perfectly Competitive and why the case study suggests that the demand curve is downward sloping.
2.The Case study Identifies some non-price determinants of demand. Explain how changes in these determinants Impact upon Market outcomes.
3.Use your understanding of price elasticity of demand to speculate on the impact on bridge revenues of a near 50% reduction for a one way crossing.
1.In the given case study, it is seen that it is about a bridge that crosses Oresund Strait. The bridge is owned by the state and thus it is highly competitive goods. Moreover, it is not that easy to increase the supply of the bridge anytime they want. This makes the supply of the bridge fixed in that area. Thus due to the change in price that the travelers needs to pay while crossing the bridge affects only the demand side of the market. However, the price of crossing the bridge is same for the state and thus it has to be taken as given. The demand for the usage of the bridge cannot alter the price that the authorities have set for crossing the bridge. Thus, the demand for the bridge is elastic at the given price as it is n the case of perfectly competitive market. Thus, this proves that the case show only the demand side of the market as perfectly competitive.
The case also suggests that due to perfect competition the demand curve is downward sloping. This is because in such a market with an increase in price the demand of the people crossing the bridge decreases. Thus, the inverse relationship between the price and the demand for the bridge makes the demand curve downward sloping (Foster, Haltiwanger, & Syverson, 2016). As the market forces set the cost of crossing the bridge it has to be applied otherwise, the travelers might take other routes. Thus, the market has to reach the equilibrium price in any case affecting the demand in inverse direction. It is seen in the case that due to high cost the car movement got reduced in the bridge, whereas, drop in the cost attracts much more traffic in a year.
The case has violated two assumptions to the law of supply such as no speculation about future prices and unchanged cost of production. It is seen that due to a fall in traffic crossing the bridge, the state decided to change the price that the travelers pay while crossing the bridge. It decided to cut 50 percent off on one way travelling. Such as decision was taken with a speculation of increasing the flow of traffic on the bridge. This violated the assumption of supply that stated no speculation of future prices. Moreover, in order to attract more traffic on the bridge the staffs managing the bridge started taking up new advertising campaign, which will result in an increase in their production and management cost. Such an effort by the bridge maintenance staff led to the violation of another assumption of supply. According to the assumption of supply, the cost of production should not change. This assumption was made on the ground that if the cost of production increases along with the price then it would not be profitable for the state to own the bridge. However, this assumption was violated in the case study by investing more on advertisement (Rios, McConnell, & Brue, 2013).
2.The non-price determinant of demand that has been pointed out in the case study is the taste and preference of the consumers. According to this determinant, a consumer chances its demand for a product depending on his/her tastes and preference of a good (Mankiw, 2014). This change in demand is irrespective of the price the company is charging for the good. Similarly, in the case study it is seen that the demand for the bridge from the ministers of Sweden is affected due to their preferences. They do not prefer to travel from the bridge due to its teething problem irrespective of the fees charged on the bridge while travelling. In such as case the demand changes due to change in non-price factor and price remaining constant. Thus, a change in this factor will affect the demand either positively or negatively. It also has an impact on the equilibrium price as there is a shift in the demand curve upward or downward.
Figure 1: Shift in demand due to change in preference of the travelers
Source: Author’s creation
From the above diagram, it can be seen that the supply curve of the bridge is relatively inelastic because the authority of the bridge cannot increase the supply of the bridge even if there is an increase in the cost charged for crossing it. This is because there is a lot of capital and time required to built the bridge or extend it. This makes the supply curve relatively elastic (Pinson, & Madsen, 2014). Demand curve is directly affected by the changes in the preferences of the travelers to cross the bridge. Firstly, it can be seen that with the increase in preferences of the travelers to use the bridge to go from one place to another will lead to an increase in demand curve. In the figure, it resulted in an upward shift in demand curve from D to D1. Thus, the demand for the bridge increases from Q to Q1. Whereas, the opposite reaction happens when the preference of the customer moves away from the bridge and take a different route instead will cause a decrease in the demand for the bridge. This will result in a downward shift of the curve from D to D2. This result in a fall n quantity demanded from Q to Q2. Moreover, it is seen that even though the change in demand was not due to the change in the price yet the price is affected. It is seen that the equilibrium price before the chances took pace was at E. with a rise in demand the price shifted to E1 and with a fall in demand, the price fell to E2. This happens because with a rise in demand for the product there is excess demand in the market compared to supply. This pushes the price up (Wetzstein, 2013). Similar affect happen with a fall in price that causes excess supply. Thus with a change in non-price factors the equilibrium price is also affected.
3.Due to the reducing demand for using, the bridge by the travelers for travelling purpose the authority decided to reduce the price by 50 percent for the one way crossing. This was decided to be done for the last three months of the year. However, such a reduction in price of crossing the bridge will lead to an increase in the demand of the customer. The demand for the bridge is highly elastic because of the availability of other substitutes such as ferry and alternative routes. Such elasticity of demand causes a huge change in demand for the product with a slight change in price of crossing the bridge. This is because according to elasticity of demand it shows the percentage of change in quantity demanded by the customer with a slight change in price of the bridge (Lin & Prince, 2013).
Figure 2: Elasticity of demand
Source: Author’s creation
From the above figure it can be seen that a highly elastic demand curve is slanting and downward sloping. A slight change in price in such as curve causes a huge change in quantity demanded. As it can be seen that as price fell from P1 to P2 the quantity demanded for the product increases from Q1 to Q2. Similar effect happened when the authority decided to reduce the price by fifty percent for one-way crossing. The increase in the demand for bridge usage will cause an increase in the revenue (Mankiw, 2014). It can be seen that under highly elastic demand, percentage increase in quantity demanded is relatively more than the percentage decrease in price. This proves that the revenue from the bridge will also increase more than fifty percent of the decrease in the cost charged for crossing the bridge. This is demand for the bridge is highly elastic due to availability of large number of substitutes such as alternative routes, ferry and others. The gap between the increase in price and the number of travelers in the route is wide enough. Thus, it can be seen that the management team of the bridge that runs across Oresund Strait will gain a lot after a decrease in price by fifty percent for the travelers. Travelers will at least choose this route more than the alternative routes for one way if not two way. Price elasticity of demand thus offers a great help to the bridge authority to decide whether they should implement any cut off on the price of crossing the bridge. This is because it directly helps them to know the revenue of the state. It is a good technique to decide the price of every product in order to estimate the revenues.
References
Foster, L., Haltiwanger, J., & Syverson, C. (2016). The slow growth of new plants: Learning about demand?. Economica, 83(329), 91-129.
Kirzner, I. M. (2015). Competition and entrepreneurship. University of Chicago press.
Lin, C. Y. C., & Prince, L. (2013). Gasoline price volatility and the elasticity of demand for gasoline. Energy Economics, 38, 111-117.
Mankiw, N. G. (2014). Principles of macroeconomics. Cengage Learning.
Pinson, P., & Madsen, H. (2014). Benefits and challenges of electrical demand response: A critical review. Renewable and Sustainable Energy Reviews, 39, 686-699.
Rios, M. C., McConnell, C. R., & Brue, S. L. (2013). Economics: Principles, problems, and policies. McGraw-Hill.
Wetzstein, M. E. (2013). Microeconomic theory: concepts and connections. Routledge.
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