China Price Elasticity 1

CHINA - PRICE ELASTICITY - THE UNITED KINGDOM

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Question 1: Explain the basic advantages and disadvantages of the 'free market' China is

moving forwards.

A free market economy is an economic system in which the operation of the market is not

planned or directed. This economic system allows individual producers and consumers to make

their own market decisions without any interference (Tomasi 2012). Producers of goods and

services are given the freedom to decide what, how and for whom to produce. In a free market

economy, producers of goods and services largely depend on the consumers spending decisions.

An important aspect of a free market economy is competition. A successful business in this

economic system is that which makes consistent profits in a market full of competitors.

Over the past few decades, China has initiated several economic reforms aimed at

implementing a free market economy. Before these economic reforms were initiated, China had

economic and trade policies that separated it from the global economy. The economy was

centrally controlled by the government which maintained the policies that were unfavorable for

the economy. Since the introduction of free market reforms in 1979, China has experienced a

tremendous economic growth to become one of the fastest growing economies. From 1979 to

2012, China has experienced constant annual growth in Gross Domestic Product (GDP)

estimated at an average of 10%. However, China was greatly affected by the global economic

crisis of 2008 which is one of the effects of a free market economy (Morrison 2013).

Advantages of a free market economy

a. Innovation and increase in efficiency and productivity

One of the basic advantages of a free market economy is innovation. The term innovation

refers to the development and use of new and better techniques and equipment to produce goods
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and services. A free market economy is based on the demand and supply and there are no

restrictions on the price and supply of commodities in the market. Since commodity prices are

not fixed, competing firms would want to keep the price of their products as low as possible in

order to attract more customers. Therefore, firms will try as much as possible to develop

innovative and efficient production methods. The firms will also develop innovative ways to

produce quality goods and services for their consumers.

b. Faster economic growth and increase in GDP

In a free market economy, competition between firms is the key driver in the market. A firm

will have a competitive advantage in the market if it will be able to produce quality goods at the

possible minimum cost. This will ensure that the firm will deliver quality goods at a lower cost to

the consumers. To minimize production costs, firms will have to device methods that will

efficiently utilize production resources. Competition will force out inefficient firms and in the

process release resources for better use. This will encourage faster economic growth (Pirazzoli

1996).

Disadvantages of a free market economy

a. Risk of emergence of monopolies

One of the risks associated with a free market economy is the emergence of monopolies. In a

monopolistic market, a single large firm controls the entire market which it serves. The firm will

have the power to control the price, quality, and other factors concerning the product it produces

or distributes in the market. Since a free market economy is not controlled, large firms with

excessive financial and market power may grow and dominate industries. In addition, smaller

firms may decide to merge together and form monopolies in the market. In other cases, free
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market conditions may force smaller firms to dissolve or become acquired by lager firms, and

thus, leading to monopolies. There are various disadvantages associated with monopolies. The

disadvantages include high prices, loss of efficiency and excessive power.

b. May lead to low production of essential goods and services

In a free market economy, the main business drivers are profit and return on investment. This

means that firms will specialize in maximizing profits rather than investing in production of

goods and services that will satisfy the social needs of a countrys population. Companies will

run away from producing certain essential commodities if they find out that they are not

sufficiently profitable. Thus, certain essential public goods such as roads, education, and health

may suffer from inadequate investment. In addition, firms will target production of goods for a

particular class of people. Low class people, such as the poor, may find it difficult to purchase

certain essential commodities due to their high prices.

Question 2: Explain the strength and weaknesses of a 'Mixed economy' as exemplified by

the United Kingdom

A mixed economy is a type of economic system in which production and trading activities

are carried out both through the market and through the state (Hall 2001). The economic

activities that are carried out by the independent individuals and companies in the market are

referred to as the private sectors. On the other hand, those economic activities that are carried out

by the state are referred to as the public sector. In the private sector, production and trading

activities are owned, controlled and funded by private individuals and companies. The ultimate

objective of the private sector is to make profit. In the public sector, production and trading

activities are owned, managed and funded by the state on behalf of the entire population. In a
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mixed economy, governments allow private individuals and companies to run most businesses.

However, the governments intervene to a varying degree in specific economic areas such as

regulation and spending on public services.

The United Kingdom is one of the countries which have a mixed economy. The UK

government spends about 40% of the countrys gross domestic product (GDP) on the public

sector. This constitutes spending of both the central and local governments. The government

spends on essential activities which affect everyone in the country. Some of these activities

include defense, health, transport, social security and others. These activities are carried out

under the main policy objectives of the central government. The government performs public

sector activities through various ministries which receive funding from the treasury. The main

purpose of the public sector is to enforce laws and regulations and protect the public as a whole.

Some of these services would be difficult for private individuals or companies to charge for.

The UK private sector accounts for about 60% of all the economic activity. Individuals and

companies operating in the private sector have a common objective of making profit. The private

sector economic activities are carried out at different levels (Kurrild-Klitgaard 2005). For

instance, the higher level private sector in the UK consists of large multi-national companies

such as Glaxo Smith Kline, Vodafone, Tesco and others while the lower level private sector

consists of smaller businesses such as pubs. Although private sector businesses vary in size, the

basic principles of operation are similar.

Strengths of a mixed economy

There are various strengths associated with the mixed economy. Intervention by the

government in mixed economies can help regulate economic activities that can lead to market
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failure. Government regulation can regulate monopolies to prevent abuse of monopolistic power.

The government can regulate activities such as mergers and excessive prices. There are other

economic activities that have negative impacts on the environment. The government regulates

such activities through taxation and other measures. There are those activities that are essential to

all people in the society and are not profitable to the private sector. The government can

encourage the private sector to invest in these economic activities by providing subsidies or state

support.

A mixed economy can help achieve a greater balance between the public sector and the

private sector. Most business and industry can be left to private firms. Economic growth greatly

relies on the efficiency of the economy. Since private firms are driven with the intention of

making profits, they tend to be more efficient as compared to the government controlled firms. A

mixed economy will ensure that the essential public services are availed while maintaining

economic growth and sustainability. The policies provided by the government in mixed

economies help in providing macro-economic stability.

Weaknesses of a mixed economy

One of the major weaknesses of a mixed economy is determination of how much

governments should intervene. For instance, discretionary fiscal policies can cause unintended

negative effects to the economy if they are not well controlled. Too much government

intervention can cause economic lapses as governments are known to be poor managers of the

economy due to political and short-term factors. Another weakness of a mixed economy is lack

of competitive neutrality between the private and public sectors. Some mixed economies have

differences regulation, pension treatment, and taxation in the public and private sectors. Some
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mixed markets such as the United Kingdom have put in place different approaches to achieve

competitive neutrality. However, there is limited consistency on how the competitive neutrality

approaches are applied in various parts of the United Kingdom government.

Question 3: Using demand and supply analysis explain the impact on the Chinese labour

market of the one child policy how the policy has affected the demographic make-up of the

population and what impact has this had on the labour market.

China introduced its birth control policy in the 1970s. This policy was aimed at

containing the sprawling Chinese population. The one child policy was officially implemented in

1980. This means that in the 1970s and the 1980s, there were more youths and children in the

Chinese labor market. The Chinese labour market over the years has had a substantial supply of

labour which far exceeded the demand. The growth in the labour force has been the center of the

Chinese economic growth and development over the past three decades. The labour market has

sustained the economic growth and the entire Chinese population provided the required market

for the manufactured goods. The labour market has produced economic growth and sustainability

to an extent that China is a major exporter of manufactured goods in the world market.

The one child policy that was implemented in the 1980 has implications on the Chinese

labour market. The continued economic growth demands that more labour will be demanded in

future to sustain economic activities. The problem is that the one child policy ensured that every

Chinese family was forced to have only one child. The working population of the 1980s and

2000s is ageing and they will no longer be working by the about 2015. Because of the policy, it

means that the remaining working population will be less than the actual amount of labour

demanded by the economy. The Chinese labour force and population are falling and it is

projected that by 2015, the labour force and population growth will turn negative. This is due to
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the fact that there will be more old people to be supported as compared to the working

population.

According to Credit Suisse (2011), China will experience a labour supply gap of

approximately 17.6 million people in 2017. Between 2017 and 2032, China is likely to face a

large increase in labour demand which will lead to a net shortage in the labour force supply. This

is illustrated in the supply and demand curve of the Chinese labour market as shown below.

Figure 1: Total labour supply and demand curve of the Chinese labour market
Due to one child policy implemented in 1980, china faces a risk of decrease in labour supply.

Due to the current demand for export and domestic consumption, labour demand is expected to

increase. From the above diagram, increase in labour demand will shift the demand curve from

LD1 to LD2. Assuming that the supply curve remains at LS1, the number or workers required

will increase from L3 to L4. The increase in demand will push the wage bill up from W3 to W4.

This is because industries will have to pay their workers more in order to retain them. The

equilibrium point will shift from C to D. Due to one child policy; the labour supply is expected

to drop as the working population age. This will shift the supply curve from LS1 to LS2. This
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means that there will be more competition for the limited labour and the wage will have to

increase further from W4 to W2 as shown in the diagram. Decrease in labour will reduce the

number of people employed from L4 to L2. The above diagram shows the general condition that

is likely to face the Chinese labour market.

Question 4: Explain the term price elasticity of demand and how the information can be

used of a business in a market economy to influence their decisions i.e. pricing strategies,

promotional strategies, and level of output.

In a market, the quantity of demand for a particular commodity may be affected by the

price of the commodity. Price elasticity of demand is a measure of the sensitivity of the quantity

demanded to variations in price of a particular commodity in the market. If the quantity

demanded does not respond much to variations in price, then the demand is inelastic. If the

demand varies a lot with variations in price, then the demand is elastic. Price elasticity of

demand provides an accurate measure of the effect of variations in price on the quantity

demanded. It is calculated as a ratio of the percentage change in quantity demanded to the

percentage change in price (Economics Online 2014). This is shown in the equation below:

The degree of sensitivity of the quantity demanded to variations in price can differ

significantly. The coefficient of the above equation can be greater of less than proportionate

depending on the response and provides the fundamental benchmark for measuring elasticity.

Price elasticity of demand is 1 when the quantity demanded changes proportionately with

changes in price. This response is called unit elasticity. When the price elasticity of demand is

less than 1, it means that the demand is inelastic. When the price elasticity of demand is greater
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than 1, it means that the demand is elastic. A price elasticity of demand of zero indicates that the

demand is perfectly inelastic while an infinite price elasticity of demand shows that the demand

is perfectly elastic.

The price elasticity of demand is very important to firms selling their products in the

market. Acquiring information about the response of consumers to changes in price can help

reduce risk and uncertainty. The price elasticity of demand can be used by a business in a market

economy to make various decisions. These decisions include the level of output, pricing policy,

and promotional strategies. Knowing the price elasticity of demand can help a business

determine the effect of change in price on its sales volume and total revenue. This sales

forecasting information can be used to determine the level of output of the business at specified

price in order to maximize the sales revenue.

The price elasticity of demand can also be used to determine the pricing strategies of a business

in a market economy. The price elasticity of demand can be used to determine whether to raise or

lower the price of a commodity. In cases where the demand is elastic, a business can gain more

revenue by reducing the price of a commodity. In cases where demand is inelastic, the business

can generate more revenue by increasing the price of the commodity. Different market segments

can have different elasticity of demand. In this case, the business can use the information to

decide whether to price discriminate.

The price elasticity of demand can also be used by a business to determine the

promotions strategies in a market economy. There are various reasons that may make consumer

demand to be elastic or inelastic. These include the number and closeness of substitutes, and

consumer loyalty to the brand. This information can be used by a business organization to win
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new customers and to retain the loyalty of the existing ones. Advertising will be used to shift the

demand and make it less elastic.

References

Credit Suisse. 2011. China: The turning point of the labour market. Credit Suisse, Available at:

https://doc.research-and-analytics.csfb.com/

Economics Online. 2014. Price elasticity of demand. [online] Available at:

http://www.economicsonline.co.uk/Competitive_markets/Price_elasticity_of_demand.html

[Accessed: 18 Jan 2014].

Hall, P. A. 2001. Organized market economies and unemployment in Europe: is it finally time to

accept liberal orthodoxy. Unemployment in the New Europe, Cambridge, pp. 52--86.

Kurrild-Klitgaard, P. 2005. The dynamics of intervention. Amsterdam: Elsevier JAI.

Morrison, W. M. 2013. Chinas Economic Rise: History, Trends, Challenges, and Implications

for the United State. Congressional research service, 7-5700 (RL33534), pp. 1-37. Available

at: http://www.fas.org/sgp/crs/row/RL33534.pdf [Accessed: 18 Jan 2014].

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Pirazzoli, M. 1996. The Free-Market Economy and Contemporary Chinese Literature. World

Literature Today, 70 (2), pp. 301--310.

Tomasi, J. 2012. Free market fairness. Princeton: Princeton University Press.