ECON20039- Economics for Managers

Term 3, 2020

Assessment 2
Table of Contents
Questions (a)..............................................................................................................................3

Question (b)................................................................................................................................7

References................................................................................................................................13
Questions (a)
Concept of income elasticity of demand

The demand elasticity helps in measuring the different factors, which influence the demand
for a commodity or a product such as income and price. Income elasticity of demand refers to
the modification in quantity demanded of a commodity due to a change in income. The
income elasticity measures the degree of responsiveness of demand for a commodity when
there is a change in the income of a person (Dhingra 2020). It can be computed by dividing
the percentage change in demand by the percentage change in income. The formula that is
used for checking the income elasticity of demand is

Income elasticity of demand (YED) = percentage change in the demanded quantity of

commodity/percentage change in income.

The customers tend to be more responsive to a certain commodity of the income elasticity of
the commodity is higher. To measure the income elasticity of certain products the products
are categorised into two types such as normal goods and inferior goods. The different types of
goods can show different income elasticities such as positive, negative, and unresponsive.

Importance of income elasticity of demand

It is important to measure the income elasticity as it helps the business organisation in the
process of forecasting the demands for their goods and services, which are likely to be
changed due to the change in income patterns. The income elasticity helps in forecasting the
level of production that is required for different commodities at a particular time in the future
by the customers (Woodward & Veal, 2019).

The use of income elasticity also helps in the classification of inferior and normal goods. It
helps business organisation in changing and modifying the business strategies according to
the demands and level of income of the customers. Another importance of income elasticity
is that it helps in predicting the cycles related to sales of the goods and services by the
business organisation.

Actual income elasticity of demand estimates for two products

Normal goods
Income elasticity helps in determining the elasticity of a product such as elastic or inelastic
based on its nature or category to which it belongs i.e., normal or inferior goods. From the
above discussion, we know that the coefficient used for measuring elasticity of income is
YED.

The product is generally elastic when the elasticity of income (YED) is not less than zero.
YED is positive for goods such as normal goods. Hence, it can be seen when there is a rise in
the level of income of the customers then the demand for normal goods also upsurge
(Bakhshoodeh 2017).

Normal good can be further categorised into normal luxuries and normal necessities. The
income elasticity is positive for both normal luxuries and normal necessities goods, but the
elasticity of income is low for normal necessities in comparison to normal luxurious goods.
YED also is known as the coefficient of income elasticity is between the range of 0 – 1 for
normal necessities. Some of the examples of normal necessities are fuel, milk, and medicine.

The demand of the customers for necessary goods does not get affected due to the change in
the customers’ income or price level. The demand change in terms of percentage is less than
the level of change in the income for these goods.

On the other hand, luxury goods are high on the elasticity of income. Some of the examples
of luxury goods are jewellery, electronic products, etc. it is generally seen the customers tend
to invest in luxury goods with the increase in their level of income. The demand change in
terms of percentage is more than the level of change in the income for these goods.
Inferior goods

The elasticity of income for an inferior good is negative when means the value of YED is less
than zero. The increase or rise in the income of the customer reduces the demand for inferior
goods. The goods are termed as inferior as they typically have superior substitutes. An
example of an inferior good is that when the income of the customer rise then the customer
tends to opt for cab services instead of public transport for traveling. In this case, public
transportation can be termed as an inferior good. The demand curve shift in an inward
direction due to the reduction in demand for inferior goods when the income of the customers
rises due to economic growth. The demand curve shift in an outward direction due to the rise
in demand for inferior goods when the income of the customers reduces due to economic
recession (Ghoddusi & Roy, 2018).
 When the good is normal, then the relationship between the demand of the good and income
is positive i.e. an increase in income leads to an increased quantity demanded. 

Eg: Given wheat is a normal good. An increase in income by 10% leads to an increase in
demand for wheat by 5%. 

So Ed= 5%/10%=0.5

The sign of elasticity would be positive, as there is a positive relationship between them. 

In the case of inferior goods, there is a negative relationship between the income and goods,
which means an increase in income, would lead to a reduction in demand for the good. E.g.:
given public transport. An increase in income by 10% reduces the demand for public
transport by 2%. So 

Ed= (-)2%/10%

     =(-)0.2

The sign is negative because there is a negative relationship between them. 

COVID-19 affecting the income elasticity of demand for goods and services

The outbreak of the pandemic has changed the supply and demand pattern of the economies
of the world. The starting of 2020 was very much dreadful as half of the economies were in a
knockdown situation to control the outbreak of the coronavirus. The lockdown of the
economies put a standstill situation for some people working at the factories, or
manufacturing units. Some people lost their jobs and become unemployed. This caused a fall
in the level of income of the people or the customers (Danieli & Olmstead-Rumsey, 2020).
The demand for necessary or normal goods such as food and health care goods was high for
people to survive this pandemic situation. People were not able to leave their houses or the
government restricted travel to other places. People were demanding the necessary products
such as grocery items, and Covid essential items such as masks, sanitizer, PPE kit, etc. as
necessary goods. The recession in the economies of the world leads to falling in the income
of the people and hence resulted in a fall in demand for goods and services. Normal goods
such as grocery items, with an income elasticity of demand between 0 and 1 is a necessity. As
income increases, the demand for a necessity increases less than proportionately.

 If the income elasticity of demand for a commodity is greater than 1, then the
commodity is said to be income elastic.
 If the income elasticity is equal to one, then the commodity has unitary income
elasticity.
 If income elasticity is zero, quantity demanded is constant regardless of income.
 If the income elasticity of demand is negative, less is bought at higher incomes and
more are bought at a lower income.
Question (b)
The key features of monopoly

The key features of monopoly are:

1. Single seller: one of the key features of a monopoly is that there is a single seller for a
product or goods. There is no difference between industry and firm.
2. Restriction of entry: restriction of entry is another feature of monopoly. The
restriction can be followed in form of institutional, economic, legal and artificial, etc.
3. No close substitutes: the products that are sell by the monopolist have no close
substitute and the so the cross elasticity related to the demand for the products is very
small. The price elasticity related to the demand for the products of the monopolist is
not more than one. In the monopolist market, the demand curve is downward sloping.
A monopolist can recognise the gaps, eliminates the competition, and controls the
supply of a specific commodity. To maximum revenue, the monopolist uses his power
of single selling in the market (Quintos).  
4. Price Maker: The monopolist acts as the price maker in the whole industry as they
have the authority of selling the specific product in the market. The customers have to
buy according to the price set by the monopolist, as there is no option for substitute
products in the market.

The main reasons why monopolies arise

There are several reasons for monopolies to arise. One of the reasons is that one firm finds it
better to operate alone in a particular industry. The reason to operate in a particular industry
alone is to increase the level of production largely so that it can set economies of scale. It also
allows the firm to regulate the prices of its products and services so that it can act as a barrier
to the entry of new ones.

The second reason for the rise of monopolies by firms is to reduce the level of competition in
the target market. It can be seen that the big firm in industries collaborate with smaller firms,
which help them to act as a monopoly. The firm to regulate the prices of its products and
services such as reduce the prices so that it can act as a barrier for entry of new ones.
The third reason is for the monopoly to arise is that government intervention. To keep the
market efficient the government keeps certain industries in the market. Likewise, when
governments provide copyrights to firms, which provide the firms with the authority to act as
monopolies, at least for some time.

Monopolies can be seen in many industries of Australia such as Australia Postal Service,
Translink (Transport Industry), and Water industry. In this assignment, I will be taking the
example of Australia’s Postal service industry.

Australia Post is a government-owned business enterprise and the sole shareholder is

Australia’s Commonwealth Government (Abbott 2018). The Australia Postal service is a
monopoly as the government of Australia supports and operates it. Australia Post is the only
seller in the market and has control of the pricing system of the product. The characteristics
that are similar between postal service in Australia and the Monopoly market are discussed
below:

Monopoly Australia Post

Single seller Australia Post is a government-owned business
enterprise. Australia Post is the only seller in the
market
multiple buyers The number of customers’ visits to Australia post is
more than 1000 million online and in-store (Abbott
2018).
Price maker Being a single seller in the market, the postal
service can regulate the pricing system of its
products.
Barriers to entry The Government of Australia has full control over
the entry of new firms in this domain and on the
level of investment.
No substitute The individual postal service present in Australia is
Australia Post. No other substitutes are available.
Market share The Australian Postal service gains a huge market
share.
Abnormal profits In the year 2019-20 the Australia Post earned a
profit of $7.5billion after tax. (Abbott 2018).

The important role played by the Australia Post in the spread out of bushfires and uncertainty
of Covid-19 was like never before. The local post office worked as the community hub
during the spread out of the summer bushfire as the banking system was not functional. A
full-year profit before the payment of tax was recorded about $53.6 million, up 30 percent,
with group revenue,– increased by the prosperous in eCommerce - up 7 per cent to a record
$7.5 billion, a more than $500 million than recorded in the last year. The postal service
witnessed profit before tax by $13 million this year even after the increased cost of network
and losses in the letter business (Australia Post Annual report 2020).

Dividends of $21.0 million were paid by the postal services to the government of Australia
their only shareholder in this financial year. According to the result, the dividend payment is
estimated to be $27.9 million. The closing cash balance of the balance sheet of the Australian
post is of $775.3 million. It is anticipated that this year the organisation will either exceeded
or met all of the agreed performance standards that support the community service
responsibilities, comprising retaining 4,330 Post Offices and delivering 97.1 per cent of
letters on time or early (Australia Post Annual report 2020). The five-year trends of the
Australia post are listed below:

Source: Australia Post Annual report (2020)

Profit earned before and after tax

The total amount of revenue earned in the last 5 years is represented in the below graph:
Source: Australia Post Annual report (2020)

Some of the reason governments engage in policy intervention with respect to monopoly
firms:

Prevent higher prices: government of Australia regulates the monopolies to stop increasing
the price of the product beyond the competitive equilibrium. This will cause a failure in the
welfare of consumers and inefficiency of allocation.

Quality of service: one of the reasons for intervention or regulation by the government is that
a firm having the power of monopoly can provide an inferior quality of products, but under
the regulation of government, it cannot be so.

Monopsony power: A firm having the power of monopoly (selling) can exploit the power
buying in case of monopsony. For example, stores can use their central position in the
market to reduce the margins of profit of farmers.

Promote competition: to promote competition in the market government regulate the market
for encouraging the firm.

Natural Monopolies: natural monopolies arise due to higher economies of scale, and the
level of efficiency of firms. Therefore, the level of competition cannot be boosted, and it is
important to control the firm the prevention the exploitation of monopoly power (Pettinger
2020).

Australian government policies towards regulating monopolies

Increasing competition with antitrust laws: to decrease the negative impact related to
monopoly, the Government of Australia tries to prevent the firms from holding power within
their hands. The Government has put out some laws, which are known as anti-trust policy,
anti-trust law, and competition law/policy. The laws help in the prevention of mergers among
the companies having huge power in the market as mergers reduce the high competition in
the industry.

Regulation: the government uses the process of regulating the market price for intervening
directly. This type of intervention is done for natural monopolies by decreasing ATC.
Monopoly in the market always does not mean gaining positive profit. The economic profit is
subject to the average cost per unit, price and quantity produced. The diagram provided
below shows that when price = ARC then profit is Zero and price= mc means the monopolist
incurs a loss. For a controller setting prices, this can be a problem as marginal cost pricing
causes losses and average cost pricing leads to deadweight loss. A monopolist will leave the
industry if the controller prefers MC pricing. The controllers can reply to the monopolist by
subsidisation method (Simshauser 2017). This can be done by raising funds by using taxation
and triggering inefficiencies in the alternative market. The regulation of price lessens
incentives for firms to decrease costs to maximize profits. In the real market, most controllers
resolve this problem by permitting firms to take a higher price than MC.
References
Abbott, M. (2018). The long-term performance of a utility: The case of the Australian Post
Office. Competition and Regulation in Network Industries, 19(3-4), 137-158.

Australia Post Annual report (2020). Retrieved 28 November 2020, from

https://auspost.com.au/content/dam/auspost_corp/media/documents/2020-australia-post-
annual-report.pdf

Bakhshoodeh, M. (2017). Is positive income elasticity of demand really associated with

normal goods?: revisiting the Slutsky equation and net benefit ratio. International Journal of
Business and Development Studies, 9(2), 71-84.

Danieli, A., & Olmstead-Rumsey, J. (2020). Sector-specific shocks and the expenditure
elasticity channel during the covid-19 crisis. Available at SSRN 3593514.

Dhingra, I. C. (2020). Unit-2 Demand and Elasticity of Demand. IGNOU.

Ghoddusi, H., & Roy, M. (2018). Income Elasticity of Demand Versus Income Elasticity of
Consumption. Available at SSRN 3122844.

Pettinger, T. (2020). Regulation of monopoly - Economics Help. Retrieved 28 November

2020, from https://www.economicshelp.org/microessays/markets/regulation-monopoly/

Quintos, P. Notes on Monopoly Capital in the 21st Century. IMPERIALISM, 19.0

Simshauser, P. (2017). Monopoly regulation, discontinuity & stranded assets. Energy

Economics, 66, 384-398.

Why Does a Monopoly Business Arise?. (2020). Retrieved 28 November 2020, from
https://www.economicsdiscussion.net/monopoly/why-does-a-monopoly-business-arise/17059

Woodward, R., & Veal, T. (2019). KEEPING IT ALL TOGETHER. Teaching Business &
Economics, 23(2), 27-29.