2008 Essay Question 1

Question

Developments in modern technology, such as faster broadband internet connections, portable DVD players, iPods and MP3 players, have had major impacts on the demand for and the supply of recorded music and associated products.

Assess how the markets involved might be affected by these developments. [25]

Answer

Faster broadband internet connections will increase the downloading speed and hence reduce the downloading time. Therefore, they will lead to a change in tastes and preferences towards digital music. When this happens, the demand will rise which will lead to an increase in the price and the quantity. When the demand for digital music rises, whether the price or the quantity will rise by a larger proportion will depend on the price elasticity of supply. The supply of digital music is likely to be price elastic as the production time is likely to be short. Therefore, the quantity is likely to rise by a larger proportion than the price.

Technological advancements will lead to a rise in labour productivity. Labour productivity refers to output per hour of labour. When labour productivity rises, firms will need a smaller amount of labour to produce any given amount of output. Therefore, the cost of production will fall which will lead to an increase in the supply. When the supply of digital music rises, the price will fall and the quantity will rise. When this happens, whether the price or the quantity will change by a larger proportion will depend on the price elasticity of demand. Digital music does not have close close substitutes as CD music cannot be played on the devices for digital music. Furthermore, digital music is generally cheap and hence the small proportion of income spent on the good is small. Therefore, the demand for digital music is likely to be price inelastic. It follows that the price is likely to fall by a larger proportion than the rise in the quantity.

The increase in the demand and the increase in the supply of digital music will both lead to an increase in the quantity. Although the increase in the demand will lead to a rise in the price, the increase in the supply will lead to a fall in the price. In reality, apart from faster broadband internet connections, the demand for digital music is also rising due to the bigger and increasing storage space of the devices which are used to play digital music. Therefore, the increase in the demand is likely to be large. It follows that the increase in the demand is likely to be greater than the increase in the supply and hence the price is likely to rise. Students need to draw a diagram showing a simultaneous shift in the demand and the supply curves.

Digital music and MP3 players are complements and hence the increase in the demand for digital music will lead to an increase in the demand for MP3 players . Since the cross elasticity of demand between digital music and MP3 players is negative, the fall in the price of digital music due to the increase in the supply will lead to an increase in the demand for MP3 players. Therefore, the demand for MP3 players will rise which will lead to an increase in the price and the quantity. The supply of MP3 players is likely price elastic as the production time is likely to be short given that they are mass produced on assembly lines which are highly automated and they can be stocked in large quantities given that they are small in size and non-perishable. Therefore, the quantity is likely to rise by a larger proportion than the price.

Technological advancements will lead to a fall in the cost of production of MP3 players which will lead to an increase in the supply. When this happens, the price will fall and the quantity will rise. The demand for MP3 players is likely to be price elastic due to the availability of close substitutes such as smartphones and iPods. Therefore, the quantity is likely to rise by a larger proportion than the fall in the price.

The increase in the demand and the increase in the supply of MP3 players will both lead to an increase in the quantity. Although the increase in the demand will lead to a rise in the price, the increase in the supply will lead to a fall in the price. As the increase in the demand for digital music is likely to be large, the increase in the demand for MP3 players is likely to be large. Therefore, the increase in the demand for MP3 players is likely to be greater than the increase in the supply and hence the price is likely to rise. Students need to draw a diagram showing a simultaneous shift in the demand and the supply curves.

Digital music and CD music are substitutes and hence the increase in the demand for digital music will lead to a decrease in the demand for CD music. Since the cross elasticity of demand between digital music and CD music is positive, the fall in the price of digital music due to the increase in the supply will lead to a decrease in the demand for CD music. Therefore, the demand for CD music will fall which will lead to a fall in the price and the quantity. The supply of CD music is likely to be price elastic as the production time is likely to be short and it can be stocked in large quantities given that it is small in size and non-perishable. Therefore, the quantity is likely to fall by a larger proportion than the price.

Technological advancements will lead to a fall in the cost of production of CD music which will lead to an increase in the supply. When this happens, the price will fall and the quantity will rise. The demand for CD music is likely to be price elastic due to the availability of a close substitute which is digital music that can be played on smartphones. Therefore, the quantity is likely to rise by a larger proportion than the fall in the price.

The decrease in the demand and the increase in the supply of CD music will both lead to a fall in the price. Although the decrease in the demand will lead to a decrease in the quantity, the increase in the supply will lead to an increase in the quantity. Students need to consider the relative price elasticities of demand and supply and the relative changes in the demand and the supply to determine the effect on the quantity.

The relative price elasticities of demand and supply
Due to the elastic supply, the decrease in the demand is likely to lead to a large decrease in the quantity, and due to the elastic demand, the increase in the supply is likely to lead to a large increase in the quantity. Therefore, the effect on the quantity will depend to a large extent on the relative changes in the demand and the supply.

The relative changes in the demand and the supply
As the increase in the demand for digital music is likely to be large, the decrease in the demand for CD music is likely to be large. Therefore, the decrease in the demand for CD music is likely to be greater than the increase in the supply and hence the quantity is likely to fall. Students need to draw a diagram showing a simultaneous shift in the demand and the supply curves.

Conclusion

To be discussed in class.

A more elaborate answer to 2008 Essay Question 1 will be provided in the economics tuition class.

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