Extended Essay Economics



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Extended Essay

Economics

Has a rise in prices affected demand for vegetables in HAL market, Bangalore?

Examination Session: May 2008

School Name: Indus International School Bangalore

School Code: 2272

Word count: 3126

Abstract

My research question is “Has a rise in prices affected demand for vegetables in HAL market, Bangalore?” I chose this topic because I felt compelled to investigate the extent to which demand had been affected by rising prices, since I have heard many people complaining of the increase prices for a good that is so essential to every socio-economic group.

My investigation was based purely on primary data. I went to HAL Market in person, along with my driver to help me translate, to ask local vendors the prices of certain vegetables, and the quantity they sold per day, over the period of one year. I questioned three shopkeepers about Carrots, Onions and Tomatoes, orally. I compiled the data and analysed it using economics theory and tools learnt in the classroom, and from various economic textbooks.

My research proved that a rise in price did not affect demand for Onions and Tomatoes, but did affect demand for Carrots. I was able to conclude that different vegetables have vastly different price elasticity of demand and that there are many other non-price factors that determine demand for vegetables. I found that demand for onions and tomatoes was highly price inelastic. Prices had changed, but people demand the same level of goods nonetheless. This showed me that demand was not determined by price alone. I now understand that tomatoes and onions are essential vegetables especially in South India, and will therefore be demanded by nearly every single household in Bangalore. Carrots however, showed a fall in quantity demanded, as a result of the increased price.

Word Count - 262

Acknowledgements:

I would like to thank the three shop keepers in HAL Market, for cooperating with me in my research investigation by giving me the appropriate data. I would also like to thank my driver, for helping me translate my questions from English into Kannada, the local dialect.

Contents Page

Title Page...............................................................................1

Abstract.........................................................................2

Acknowledgement.........................................................3

Table of Contents..........................................................4

Introduction...................................................................5

Determinants of Demand..............................................6

Price Elasticity of Demand.............................................8

Scope of Investigation...................................................9

Primary Data Collection...............................................10

Analysis........................................................................11

Conclusion...................................................................13

Bibliography.................................................................14

Introduction

Over the course of the past one year or so, as a student of economics, the sharp rise in price level of many goods in India has interested me greatly. I have been curious for some time, as to the causes and effects of this rise in price. The extended essay gave me the means to investigate and analyse the specifics regarding this price rise, in a chosen area for a chosen good. I have decided to investigate the reasons and outcomes of the price rise in locally produced vegetables, being sold at Bangalore’s HAL fresh-market. I chose this good because it is something that the vast majority or residents in India consume. This topic is one where I felt I could successfully apply economics theories learnt in class, to the real world to see if they hold true.

The main purpose of this exercise is to investigate the extent of the relationship between the price of the vegetables and the quantity demanded. In theory at least, the relationship is said to be inverse, in that if the price of the vegetable rises, the quantity demanded will fall and vice versa. When suppliers have to set a higher price for their goods, for whatever reason, consumers will be discouraged to buy that good. This is because, a consumer, can buy the same good, for a lesser price, elsewhere.

Determinants of Demand

Broadly speaking, there are numerous determinants of demand.

The price of a good is probably one of the biggest determinants. The demand curve on a basic demand and supply diagram is usually downward sloping, meaning that price and demand are inversely related. If prices fall, consumers will be able to buy a higher quantity of the good, for the same price, thus extending demand. The opposite would happen if prices rise, showing that demand and price and inversely related – the very theory I am trying to investigate. This is depicted in the graph below:


Price



P2

Contraction

P1

Demand


Q1

Q2

O

Quantity

Shown above, is a downward sloping demand curve showing contraction in demand. This is when price rises (from P1 to P2) and the quantity demanded subsequently falls (from Q1 to Q2). The opposite is the case when price falls, known as contraction of demand.

Demand for a good also depends on the level of incomes in the country. If incomes are on the rise, people will have more disposable income with which to purchase goods. Disposable income is the amount of income an earner would be able to spend on good services, after taxes are deducted. If a person has greater disposable income, he would enjoy higher spending power and would therefore we able to demand more of a good. Thus, income levels and demand are directly related. For example, a person who receives a higher salary he would be able to buy a luxury good that he may earlier have not have had the disposable income to afford, such as a new car for example. Income itself can be measured in different ways. Money or nominal income is income without deductions (also known as gross income), disposable income is the money left after all tax deductions and real income is the purchasing power of money an individual has. Real income is always related to price level and varies inversely with inflation. When money incomes remain constant and price level rises, real incomes fall and when inflation rate falls and money income remain constant, purchasing power rises. This is known as the income effect and is one of the primary causes for the downward sloping demand curve. Because vegetables are normal goods, demand for them decreases as income levels increase, because consumers will use their increased incomes to purchase newer, more expensive alternatives for the sake of better quality or more variety. These costlier alternatives are known as normal goods. An example of an inferior good and a normal good is a bicycle and a car. As an individual’s income level rises and inflation remains constant, his purchasing power rises and he switches from the lower quality transport (bicycle), to the more expensive, higher quality transport (car). In our case, if real incomes rise, consumers may switch to vegetables from large vendors such as ‘Reliance Fresh’, ‘Namdhari’s Fresh’ or ‘Food World’ which are more expensive, but are of a higher quality due to the fancy shops and packaging they are sold in. Thus, demand for vegetables in HAL Market could fall due to an increase in Real Incomes.

Personal tastes also play a more in determining demand for a good. A person may enjoy a specific good and will therefore choose that good over a substitute to fulfil his tastes. This is often the case with branded goods, where a consumer remains loyal to a brand will therefore demand it over a competitor, increasing demand for his preferred good. Population changes have a strong effect on demand for essential goods such as rice. When a country’s population rises, there will be a greater number of people in need to certain goods, each year. This would in turn cause an increase in demand for those goods. Demand for luxury goods may not necessarily be affected as much as demand for essential goods such as vegetables.

Government policies have a massive effect on demand for certain goods. If a government wants to decrease demand for certain goods it can increase tax on those goods, increasing price and lowering demand. This was the case in India, where the government imposed a 125% tax on imported, new cars in India, lowering demand for them drastically and giving a better chance to local producers. The government can also use policies to increase demand for products, by giving producers subsidies which would lower their costs, decreasing prices and increasing demand. For example, the government of a country could introduce subsidies on fabrics if it wished to raise demand for fabrics in the country. The government also gives subsidies to farmers after supply side shocks. These include drought, flood and political upheaval that causes supply of vegetables to fall, through no fault of the farmers’. The government provides these farmers with additional money so that they can survive, even after a crop has been ruined or depleted.

Prices of substitutes can affect demand for a good. A substitute good is a good which can be used by a consumer in place of another. They are usually priced very similar to each other since their functions are almost identical and consumers would usually choose the cheapest option. This is known as a substitution effect; where consumers switch their demand to lower priced substitutes if there is a rise in price of a good. The substitution effect is prevalent in the vegetable market and is another cause for the downward sloping nature of the demand curve. These goods are usually price elastic (a percentage change in price would result a greater then proportionate change in demand), for example toothpaste and washing-powder. Price elasticity of demand is in turn determined by Therefore, the demand for a good is directly related to the price of its substitutes. Prices for complementary goods (goods which are consumed with another good. eg. Shoes and socks) is inversely related to demand for a good. For example, if the prices of mobile phone batteries rise, demand for mobile phones will fall. Thus, demand for a good is inversely related to the price of its complementary goods.

Changes in bank loan interest rates can also affect demand for certain goods. For example, if interest rates on loans rise, people will be discouraged from borrowing sums of money and will be less likely to make large investments such as cars or houses, causing a decrease in demand on these goods. However, as people do not need to take bank loans to purchase vegetables, I do not this think is a relevant

Price Elasticity

Price elasticity is also a determinant of demand. Elasticity measures the responsive of one variable, to a change in another. In this case, we observe the price elasticity of demand; i.e. the degree to which demand changes due to a change in price. Demand for a good is said to be inelastic, when a large change in price brings about only a small change in demand. This is shown by a demand curve that has a steep slope, as shown below:


P2

Price

P1



Demand

Q2



Q1

Quantity

A relatively large change in price (P1 ­­­- P2) is followed by less than proportional change in quantity demanded (Q1 – Q2) showing a highly inelastic demand curve. Essential goods are highly price inelastic. Perfectly inelastic demand is where the demand curve is vertical. This is merely a theoretical demand curve, since in real life, a situation where consumers will demand a good regardless of its price is highly unrealistic. Some goods are however, highly price inelastic. They include water, bread and oil. Everyone complains about rising fuel prices, yet everyone still has to pay an increased amount for the same amount of fuel for their cars!

E
Price
lastic demand is where a change in price brings about a proportionately greater change in quantity demanded. This is characterised by a gentle sloping demand curve. Basically, a small change in price will result in a much greater change in quantity demanded, as shown below.


P1



Demand

P2

Quantity

Q1



Q2

O

A small change in price (P1 – P2) brings about a much larger change in demand (Q1 – Q2). Perfectly elastic demand, again, is highly unrealistic in the real world. Luxury goods are often highly price elastic; if prices of non-essential goods go up, people will not mind not demanding them.

Scope of Investigation

I chose the HAL fresh-market because it is frequented by many socio-economic groups and sells a variety of produce. HAL market came into existence as a result of Hindustan Aeronautics Limited being set up in Bangalore. HAL itself is a company running under the Ministry of Defence that manufactures equipment for aircraft, navigation, aerospace and communication. HAL is headquartered in Bangalore though it has many facilities in other locations in India. Bangalore’s only major commercial airport was also built and used by HAL. HAL employs close to 9,500 workers and so, along with the building of its facility in Bangalore, a school, hospital and market were also built. Thus, HAL market was initially built to serve those working at HAL in 1940. In those days, HAL was considered to be on the Bangalore’s outskirts. Now, however, with Bangalore’s rapid growth over the last 10 years, the area has become very central and is therefore being used by a much greater number of people. Therefore, the size of market has also grown to meet the needs of those living around it.

I collected my data by orally questioning three shopkeepers. As I am not fluent in the local language, Kannada, I asked my driver to help translate. The language barrier proved a little troublesome when trying to explain the purpose of my investigation; Shopkeeper number 2 thought I was a rival vegetable vendor who wanted to know how to price his goods! This could be one of the sources of discrepancy in my primary data.

Primary Data Collection

I used HAL market to collect primary data by asking a series of questions to three different vegetable vendors. The questions were designed to give me first hand data, on which to base my investigation. To each of the three vendors I asked the following for Onions, Carrots and Tomatoes:


  1. Current Price (October 20th 2007)

  2. Current daily quantity sold (October 20th 2007)

  3. Price of vegetable 6 months previously (April 2007)

  4. Daily quantity sold 6 months previously (April 2007)

  5. Price of vegetable one year previously (October 2006)

  6. Daily Quantity sold one year previously (October 2006)

These are the results I obtained:

Shop

Vegetable

Oct 2007 Price (Rs)

Oct 2007 Quantity (kg/day)

Apr 2007 Price (Rs)

Apr 2007

Quantity (kg/day)



Oct 2006 Price (Rs)

Oct 2006 Quantity (kg/day)

1

Carrot

40

30

20

50

20

45




Onion

10

500

16

500

17

500




Tomato

20

500-1000

20

500-1000

20

500-1000

2

Carrot

42

30

24

40

24

40




Onion

9

400

13

400

15

400




Tomato

23

600

24

600

23

600

3

Carrot

42

25

23

30

20

30




Onion

10

500

16

400

16

400




Tomato

21

600-700

20

600-700

20

600-700

Analysis

We can use this table to find the Price Elasticity of Demand for the vegetables, over a period of time. Price elasticity of demand as mentioned earlier, measures the degree of responsiveness of demand, to a change in price of a good. It is given by the formula:

% Change in Quantity Demanded

% Change in Price

For the time period of October 2006 – April 2007, we can the following figures of Price elasticity of demand for


  1. Shop 1:

Carrot – 11% / 0% = ∞

Onion – 0% / 6% = 0

Tomato – 0%/ 0% = Undefined


  1. Shop 2:

Carrot – 0% / 0% = Undefined

Onion – 0% / 13% = 0

Tomato – 0%/ 4% = 0


  1. Shop 3:

Carrot – 0% / 15% = 0

Onion – 0% / 0% = Undefined

Tomato – 0%/ 0% = Undefined

It can be observed that not once, do both variables change. This is the reason for all the price elasticity figures to be shown as zero, infinity or undefined. When price elasticity of demand of zero, it means that demand for the good is perfectly inelastic. This can be shown in the graph below:


Price

PED = 0


P

Quantity demanded



O

Basically, the graph shows that consumers will demand the good at any price. This is highly unrealistic. In real life, no matter how essential a good is, consumers will stop demanding a product after a time, if it is priced too high, by sellers.

When price elasticity of demand is infinity, it means that demand is perfectly elastic. At this price, consumers will demand an infinite amount, but will demand nothing if price changes. Again, this is highly unrealistic.

Many values for Price elasticity are also showing an undefined value. This is because neither price, nor quantity demanded has changed.

The figures seem to be a result of unreliable data; the time period is only 6 months and shop keepers were giving rough estimates of quantity sold.

Over a one year period (from October 2006 – October 2007):



  1. Shop 1:

Carrot – 33.3% / 100% = 0.33

Onion – 0% / 41% = 0

Tomato – 0%/ 0% =Undefined


  1. Shop 2:

Carrot – 25% / 75% = 0.33

Onion – 0% / 40% = 0

Tomato – 0%/ 0% = Undefined


  1. Shop 3:

Carrot – 16% / 110% = 0.15

Onion – 25% / 37.5% = 0.66

Tomato – 0%/ 5% = 0

Carrots seem to be the only vegetable where Price Elasticity of Demand is consistently NOT zero. The price elasticity of demand for carrots is between 0.15-0.33. It is less than 1 and so, demand for carrots is seemingly price inelastic. This means that consumers demand carrots even though their price is rising. However, demand for carrots is not perfectly inelastic. For onions and tomatoes however, demand is highly inelastic, except for a seemingly inexplicable change in onion prices in October 2007.

One possible reason for these figures is the fact that onion and tomato are an integral part of south Indian cooking. They will be bought in great quantities by households every month. Carrots have a high price because they a ‘luxury’ as far as vegetables go. And yet their demand is price inelastic, because it is a nutritious vegetable and people can afford to buy carrots due to higher real incomes. With their basic needs, they are also able to consumer better quality vegetables due to their higher purchasing power.

Conclusion

I feel that the vegetables I chose did not reflect the ‘rise in price’ that is said to be affecting the vegetable market. The only vegetable where a significant rise in price is apparent is carrots. This is because tomatoes and onions are used in almost every meal, in south Indian households, whereas as carrots are a more expensive alternative which adds variety. Because onions and tomatoes are used so frequently, their demand will be almost perfectly inelastic; people will be willing to pay near any price for those goods because they are essential. Carrots are not essential and are usually bought by higher socio-economic classes as compared to the masses and are therefore affected by a rise in price. That being said, the rise in price of carrots shows us a number of things. Firstly, in Shop 1, we can see very clearly that as price rises from Rs 20 to Rs 40, quantity demanded falls from 40kg per day to 30kg per day, from the time period October 2007 to October 2008. However if we look at the 6 month period, we can see how when price remains the same (Rs 20), quantity sold actually rose from 45kg to 50kg per day. Similar patterns are visible in shops 2 and 3. Basically, demand has only changed significantly for Carrots, being the only non-essential vegetable I researched about. Prices for Onions and Tomatoes did not even fluctuate to any great degree. I think that to be able to conduct a more accurate investigation, I would have to choose the vegetables whose prices I am documenting, more carefully.

Though my investigation says many PED values are zero this does not give a true picture. From this I can conclude that though economic theory assumes price to be one of the prime determinants of demand, my investigation has proved it may not be true. According to me, the demand for vegetables may be influenced to a large extent by changing lifestyles, health consciousness and non-vegetarians cutting down on meat and substituting more of vegetables. This has given rise to new questions. I would need to examine the change the price of non-essential vegetables, to get a better sense of the nature of demand for those vegetables.



Bibliography:

  1. Economics from a Global Perspective (Second edition) – Alan Glanville, Pages 56-63

Published May 2005.

  1. Economics- In terms of the Good, the Bad and the Economist – Matt McGee, Pages 134-142

Second imprint – 2005



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