Demand And Supply Costs And Macroeconomic Analysis Essay

Question:

Discuss about the Demand And Supply Costs And Macroeconomic Analysis.

Answer:

From the graph above, it can be noted that the market is not at equilibrium at the maximum water supply level of 22.50 million liters in a day. The corresponding price level to this supply level is $0.6 per 1000 liters. The corresponding demand is 23.25 Million liters per day. This clearly shows that this market is not at equilibrium. If the residential demand rises while the supply level remains constant, the demand curve will shift rightwards causing an increase in both price and equilibrium quantity.

The nature of water is such that it’s a necessity and this explain why it is inelastic at high prices. As water prices increase, the demand keeps falling. At high prices the consumers have already reduced their demand to the minimum level they can, thus, any other increase in price will have no impact on demand. Income is another key influence, since water is a commodity mostly in high use, the income level determines its elasticity, people with higher income tends to spend more water regardless of the price level. Thus, their demand for residential water is inelastic. For those with low income, their demand is inelastic only when the price charged are too low, when price rise to some greater extent, their demand becomes relatively elastic. Water is subject to habitual consumption and thus inelastic at most price levels.

The initial equilibrium price is $0.67 and the quantity is 23.00. However, the market is not operating at equilibrium; its operation is below the equilibrium where demand is greater than supply at the market price of $ 0.60. This shortage is equal to 23.25 – 22.50 = 0.75 million liters. Due to the inelastic nature of water demand, it’s expected that the whole tax burden will be shifted to the consumers. Therefore, we assume that price rises from $0.60 to $0.65 at the current supply level. Since supply is inelastic also, it’s expected that it will shift leftwards to accommodate the price rise. The shortage will reduce because the demand level will fall from 23.25 to a value in between 23.00 and 23.25 as represented by the arrow. Thus, the tax will help reduce the shortage. The new equilibrium level in the water market will be at a higher price level but at a lower quantity level.

Pizzas (Q)

Fixed costs (FC)

Variable costs (VC)

Total costs (TC) = FC + VC

Marginal costs (MC) =?TC/?Q

Average total costs = TC/Q

Average variable costs =VC/Q

0

$1,000

$0

$1,000

0

0

0

200

$1,000

$360

$1,360

$1.80

$6.80

$1.80

400

$1,000

$840

$1,840

$2.40

$4.60

$2.10

600

$1,000

$1,440

$2,440

$3.00

$4.07

$2.40

800

$1,000

$2,160

$3,160

$3.60

$3.95

$2.70

1000

$1,000

$3,000

$4,000

$4.20

$4.00

$3.00

1200

$1,000

$3,960

$4,960

$4.80

$4.13

$3.30

1400

$1,000

$5,040

$6,040

$5.40

$4.31

$3.60

1600

$1,000

$6,240

$7,240

$6.00

$4.53

$3.90

1800

$1,000

$7,560

$8,560

$6.60

$4.76

$4.20

2000

$1,000

$9,000

$10,000

$7.20

$5.00

$4.50


Over the years, diabetes and obesity have led to acceleration of the health care costs. This problem has been argued to have been contributed greatly by the excessive usage of sugary drinks. Thus, it can be said that consumption of sugary drinks e.g. sodas is creating a negative externality. There are external costs that are associated with its consumption (McAfee and Lewis, 2018). The government has a role of lowering the impact of negative externalities while promoting positive externalities. Health costs on the part of the government has gone up steadily over the years and thus a need for immediate action. Most governments in many nations have voted for imposition of tax on sugary drinks. While many have already implemented the strategy, other are planning to do so in the future. Other nations like the US have voted against its effectiveness.

Private Marginal Cost (PMC) is the cost incurred by private producers when allowed to produce freely without government intervention. They produce Q* quantity and sell at price P* at the initial equilibrium. The government imposes a tax on sugar to ensure that producers incur the Social Marginal Cost which is greater than PMC as it covers all the external costs (The Economist, 2017). MD is the marginal damage, the marginal damage is lower when fewer quantities are produced (consider MD1), but higher when the quantity produced rises (consider MD2). The tax imposition raises the cost of production and thus forcing the producers to sell at a higher price Pt, the quantity demanded falls from Q* to Qt. This fall in quantity demanded represents the policy’s success in discouraging consumption of sugary drinks.

Soft drink’s demand is elastic. This is because the quantity consumed change much whenever there is an increase in price. The change is only by a greater proportion. According to a study carried out by Guerrero-L?pez, Unar-Mungu?a and Colchero (2017) on the consumption of soft drinks in Chile, the elasticity of demand was found to be -1.3. This means that a 10% price rise resulted in demand cut by 13.7%. Another study by Colchero ET. Al. (2015) on the Mexicans’ consumption of soft drinks found the elasticity of demand to be -1.06 meaning that a 10% price rise would cause demand for soft drinks to fall by 10.6%. However, there are many factors that determines the elasticity of soft drinks. For instance, in the rural areas where people have lower income, demand tends to be more elastic than in the urban areas where consumers’ income is higher. Health awareness programs also tend to increase the demand elasticity for soft drinks.

Using the argument of Schwartz (2014), tax can be considered to be less effective compared to other awareness programs. He argued that even if taxes are raised, most of the consumers do not get awareness of the tax they are paying. Most people are ignorant of the tax payable, their interest is always on the price level. His argument was that the tax imposition is significantly smaller to create some impact on the desirable effects. A study carried out gave the following results; for the middle income quantiles, only one household was noted to respond to the sugar tax. Lower income earners were argued to continue consuming the same level at the opportunity cost of other spending.

Based on this argument, and the fact that the tax imposition cannot be very high enough to induce the desirable effect, one would vote against the sugary tax and for the awareness programs. Consumers will know of the harmful effects of consuming sugary drinks and make their own decision to lower their consumption. On the other side, Roache and Gostin (2017) argued for the tax on the basis that it leads to generation of more revenue for the government, it discourages consumption and that the increase in cost of production creates an incentive for the producers to reformulate their products to reduce the sugar component. This again sounds better to achieve the best results for improving health. Taxation is therefore the most effective choice.

The study by Basu and Madsen (2017) confirmed of the effectiveness of sugar tax. The study was done in Berkeley, California, United States. There was an imposition of a penny-per-ounce tax which led to a greater impact on the price level. It’s noted that the tax was substantially transferred from the producers to the consumers. This led to a decline in the quantity demanded and also the supply. The other impact was on untaxed beverages (teas, water, and milk). The demand for this untaxed beverages rose during this period. This clearly demonstrates the effectiveness of this policy. Consumers after suffering from price increments decided to shift their consumption from sugary drinks to healthy untaxed beverages. On the other hand, MacGuill (2017), argued that even if the tax was effective in consumption of soft drinks, it’s not evident of lowering overweight, obesity and other related diseases.

He argued that the effect of the decrease in consumption fades very quickly and thus desirable impacts are not achieved. He also noted that sugar taxes have not yet proven to cut body mass index (BMI), diabetes, obesity or even heart diseases. Bascu??n and Cuadrado (2017) also noted that the sugar taxes imposed are insufficient to have impact on obesity. From this argument, it can be confirmed that the decrease in consumption of soft drinks does not have major influence on improving health. Thus, sugar tax cannot be concluded to be that effective. Since the tax is cripplingly employed by many nations, subsequent research might yield better results that will lead to increased efficiency.

Bibliography

Bascu??n, J. and Cuadrado, C. (2017). Effectiveness of sugar-sweetened beverages taxes to reduce obesity: evidence brief for policy. Medwave, [online] 17(08), pp.e7054-e7054. Available at: [Accessed 5 May 2018].

Basu, S. and Madsen, K. (2017) Effectiveness and equity of sugar-sweetened beverage taxation. PLoS Med 14(6): e1002327.

Colchero, M., Salgado, J., Unar-Mungu?a, M., Hern?ndez-?vila, M. and Rivera-Dommarco, J. (2015). Price elasticity of the demand for sugar sweetened beverages and soft drinks in Mexico. Sciencedirect, [online] 17(1). Available at:

Guerrero-L?pez, C., Unar-Mungu?a, M. and Colchero, M. (2017). Price elasticity of the demand for soft drinks, other sugar-sweetened beverages and energy dense food in Chile. BMC Public Health, [online] 17(1). Available at: [Accessed 4 May 2018].

MacGuill, S. (2017). FactCheck: Do taxes on sugary drinks actually work? [Online] TheJournal.ie. Available at: [Accessed 5 May 2018].

McAfee, R. and Lewis, T. (2018). Try our new reader! Click here Introduction to Economic Analysis, v. 1.0. [Online] FlatWorld. Available at: [Accessed 4 May 2018].

Mnmecon (2011). The Pigouvian tax. [Online] mnmeconomics. Available at: [Accessed 4 May 2018].

Roache, S. and Gostin, L. (2017). The Untapped Power of Soda Taxes: Incentivizing Consumers, Generating Revenue, and Altering Corporate Behavior. International Journal of Health Policy and Management, 6(9), pp.489-493.

Schwartz, E. (2014). The Impact of Inelastic Demand on a Sugary Drink Tax. [Online] Econlife. Available at: [Accessed 4 May 2018].

The Economist. (2017). Pigouvian taxes. [Online] Available at: [Accessed 4 May 2018].

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