Principles of Economics: Demand, Price, and Government Policies

This economics assignment explores the concept of demand elasticity, specifically in the context of olive oil, and its impact on revenue. It analyzes how changes in price affect the quantity demanded, differentiating between elastic and inelastic demand. The assignment then examines the implications of a worldwide olive oil shortage and suggests government policies to address rising prices in Australia. The solution discusses the implementation and consequences of a price ceiling, including potential benefits for consumers and the risk of creating black markets and production inefficiencies. Furthermore, it considers the alternative policy of government subsidies for olive producers, evaluating its impact on consumer prices and the potential for increased tax burdens. The assignment draws on economic principles and theories, referencing works by Mankiw, Varian, Parkin and Bade, and Friedman to support its analysis.

Running head: PRINCIPLES OF ECONOMICS
Principles of Economics
Name of the Student
Name of the University
Author note

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Table of Contents
Answer 3..........................................................................................................................................2
Answer 4..........................................................................................................................................2
References........................................................................................................................................5

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Answer 3
a) Demand elasticity actually captures the consumers’ ability to adjust demand at different
pricing point. There is direct impact of price change on quantity demand as suggested
from the law of demand. It is generally computed as a percentage change in demand with
to a percentage change in price (Mankiw 2014). The extent to which demand changes in
line with price is not same in every situation and for every commodity. When change in
demand outpace that of the change is price, then elasticity measure is greater than one. In
case of inelastic demand elasticity measure is less than one as here responsiveness of
demand is less. For luxury items, a small change in demand induces consumers to change
their demand largely. Hence, luxury items constitute elastic demand. Olive oil is
considered as a luxury product as it is mostly used in restaurant or rich household in the
nation. Therefore, the demand for olive oil is price elastic.
b) In case of elastic demand, a small change in price leads to a much greater change in
quantity demand. Revenue is the product of price and quantity. An increase in price is
likely to increase revenue to the producers. Whereas decrease in demand in response to
rise in price, pushes revenue down. The revenue will move to the direction of dominating
force (Varian 2014). With an elastic demand of olive oil, decrease in demand more than
offset the price rise. Hence, producers in olive oil industry suffer from a loss of total
revenue.
Answer 4
With a worldwide shortage of supply in olive production, the price of olive oil is sky
reaching. However, Australian people are likely to remain unaffected and they are continuing

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consumption of olive oil. In this situation, government in Australia should take appropriate
policy to support the consumption of olive oil lovers.
To control the price government can set a price ceiling in the olive oil market. Price
ceiling is a policy of fixing upper limit of the price by regulation (Parkin and Bade 2015).
Producers are not allowed to their prices above that limit. This benefits the consumer as they are
provided with their desired good at a low price than without regulation. Following diagram
explains a market with price ceiling.
Figure 1: Market with price ceiling
(Source: as created by author)
In the above figure equilibrium price and quantity with free market condition is indicated
as p* and Q*. Pc is the price when government put a ceiling price in the market.
However, the policy of price ceiling has some shortcomings. With a lower price, an
excess demand is created in the market. From supply shortage, a black market can be developed

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to fulfill the excess demand. There can be inefficiency in production results in deadweight loss to
the society.
Another policy that government can adapt is to give a subsidy to olive producers. The
subsidy will reduce the effective cost to the producers and then they will be able to maintain their
profit margin though offering the good at a low price (Friedman 2017).
However, since the subsidy amount is paid out of government tax revenue consumers
though have to pay a lower price for the final product but it can indirectly harm them by
increasing tax burden.

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References
Mankiw, N.G., 2014. Principles of macroeconomics. Cengage Learning.
Varian, H.R., 2014. Intermediate Microeconomics: A Modern Approach: Ninth International
Student Edition. WW Norton & Company.
Parkin, M. and Bade, R., 2015. Introduction to Microeconomics.
Friedman, L.S., 2017. The microeconomics of public policy analysis. Princeton University Press.