Question

Please address the question below and prepare a 2000 word response in traditional essay format. A good practice is one to include one reference every 100 words. Please remember that references are not included in word count and that a wide range of resources should be used for your assessment. A general rule of thumb for a 2000 word piece would be a minimum of six resources.

‘Prompted by the recession in Europe to search for promising wealthy new markets, the German Luxury Goods Exhibition in Dubai attracted top German designer names supplying perfumes, silverware, crystal and jewellery. The response to the exhibition was extremely positive.’ (Gulf News, 3 November 2016)

1) Explain the Terms (i) Income elasticity of demand (ii) cross-elasticity of demand.

2) How can these terms be applied to the market for German luxury goods, and (given that Dubai is a rich Middle Eastern Estate) How might they be used to explain the success of the exhibition?

3) What are economies of scale and why are such economies available only in the long run?

4) Since economies of scale exist, why do long-run marginal costs increase, ultimately, as output increases?

Answer 1

Ans 1 Income elasticity of Demand : Income elasticity of demand measures the responsiveness of demand for a particular good to changes in consumer income. It can be calculated as,

Ed = [(#Q / #P) / (P / Q)] * 100, where # refers to "change in "

Lets say if the price of a car is 5000 and quantity demanded is 10000. If price changes to 10000 and quantity demanded is 8000. Change in price is 5000 and change in quantity demanded is 2000.

Ed = [( 2000 / 5000 ) / (5000 / 10000)] = 0.8

There are five types of elasticity of demand:

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Cross elasticity of Demand is the responsiveness of the quantity demanded of one good changes when price of another good changes.

• P1A is the price of good A at time 1
• PA2 is the price of good A at time 2
• Q1B is the quantity demanded of good B at time 1
• Q2B is the quantity demanded of good B at time 2
• #QB is the change in the quantity demanded for good B
• #PA is the change in the price of good A

Cross price elasticity of demand is always positive for substitute goods because the demand for one good increases when the price for the substitute good increases while the cross elasticity of demand for complementary goods is negative. As the price for one item increases, an item complemented with that item and necessary for its consumption decreases because the demand for the main good has also dropped.

Ans 2 Luxury German goods selling well in Dubai market could have cross price elasticity of demand because the prices of the German goods must be low compared to Dubai goods that was the reason these goods were selling good in Dubai market.

Ans 3 Economies of scale are achieved when increasing the cost of production in long run of a firm decreases the cost of that firm in long run. Simply the cost per unit declines as production rises. The economies of scale curve is a long-run average cost curve, because it allows all factors of production to change. Short-run average cost curves assume the existence of fixed costs, and only variable costs were allowed to change. In sum, economies of scale refers to a situation where long run average cost decreases as the firm’s output increases.

While in the short run firms are operating on a single average cost curve, in the long run when all costs are variable, they can choose to operate on any average cost curve. Thus, the long-run average cost (LRAC) curve is actually based on a group of short run average cost (SRAC) curves

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The shape of the long-run cost curve is common for many industries. The left-hand portion of the long-run average cost curve, where it is downward sloping from shows the case of economies of scale. In this portion of the long-run average cost curve, larger scale leads to lower average costs.

In the middle portion of the long-run average cost curve, economies of scale have been filled. In this situation, allowing all inputs to expand does not much change the average cost of production. We call this constant returns to scale. In this LRAC curve range, the average cost of production does not change much as scale rises or falls.

the right-hand portion of the long-run average cost curve, shows a situation where, as the level of output and the scale rises, average costs rise as well. This situation is called diseconomies of scale. A firm or a factory can grow so large that it becomes very difficult to manage, resulting in very high costs.

Thus the economies of scale can only be shown in long run where two three short run average cost curve makes a economies of scale.

Ans 4 Since economies of scale exist, but there comes a situation when the firm become so large that it becomes very expensive to manage it and the variable cost becomes so large because of old building of firm, depreciation or machinery, rising wages etc. We already discussed the case of diseconomies of scale in above example which tells about this issue.