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Emerging economies which are experiencing rising affluence are adopting a trend

towards Western consumerism. At the same time, rapid technological advancement


has emerged in the clothes industry.

(a) Using economics analysis, explain why prices of clothes could fall. [10]

(b) Discuss the usefulness of price elasticity of demand, income elasticity of demand
and price elasticity of supply in explaining the impact of each of the above events
on the markets for branded and non-branded clothes. [15]

Marking Scheme
(a)
Level Knowledge, Application, Understanding, and Analysis Marks
L3 Well-developed explanation of the demand and supply determinants that 7 – 10
explain why prices of clothes could fall.

Max 7m if students do not justify the relative shifts of the demand and
supply curve but provide a well-developed explanation of the demand and
supply determinants with a diagram.
L2 Undeveloped explanation of the demand and supply determinants that 4–6
explain why prices of clothes could fall.
OR
One-sided developed explanation of the demand or supply determinants
that can lead to falling prices of clothes (max 5m).
L1 For an answer that shows descriptive knowledge of why prices of clothes 1–3
could fall.
Max 3m if students bring in only government intervention in the form of
price ceilings

(b)
Level Knowledge, Application, Understanding, and Analysis Marks
L3 Well-developed explanation of the effects of rising affluence and 9 – 11
technological advancement on the market for branded and non-branded
clothes using the three elasticity concepts, with appropriate examples
related to the clothes market.
L2 Undeveloped explanation of the effects of rising affluence and 6–8
technological advancement on the market for branded and non-branded
clothes using the three elasticity concepts.
OR
Developed explanation of the effects of rising affluence and technological
advancement on the market for branded and non-branded clothes using
two elasticity concepts (max 8m).
L1 For an answer that shows descriptive knowledge of the relevance of the 1–5
elasticity concepts in explaining the effects on the clothes market.
Allow up to 4 additional marks for evaluation
E2 For an evaluative assessment based on economic analysis i.e. one that 3–4
considers the usefulness of elasticity concepts – other factors that impact
the market, profit-maximising objective of firms, limitations in data
collection for elasticity concepts, etc. in explaining the effects on the
clothes industry.
E1 For an unexplained evaluative assessment, or one that is not supported 1–2
by economic analysis on the usefulness of elasticity concepts in
explaining the effects on the clothes industry.

1
(a)
Introduction: Define key terms
Demand refers to the quantities of goods and services that consumers are willing and able to
buy at various price levels over a period of time, ceteris paribus. Supply refers to the
quantities of goods and services that producers are willing and able to sell at various price
levels over a period of time, ceteris paribus. When demand intersects supply, equilibrium is
attained as quantity demanded is equal to quantity supplied and there is no tendency for
either consumers or producers to change their decisions.

Set the approach to the question


In the market for clothes, there is rising demand due to rising affluence but prices are falling
as a result of rising supply that is greater than rising demand.

Body:
Step 1: Explain the determinants of demand
Determinant of demand #1: Level of Income
Rising affluence in emerging economies such as the BRIC – Brazil, Russia, India and China
implies that income levels are rising in such nations. This leads to an increase in purchasing
power. Since clothes in general are necessities, a subset of normal goods, there will be an
increase in demand for clothes.

Determinant of demand #2: Taste or preferences


There is also a change in taste or preferences in emerging economies whereby they are
moving towards Western consumerism culture. They are more likely to change their
wardrobe more often, hence buying new clothes more often leads to an increase in demand
for clothes.

Determinant of demand #3: Size of Population


The world population is expected to hit 9 billion by 2050 and this increase in size of
population means that there will be an increase in demand for clothes which are necessities.

Overall, there is rising demand for clothes.

Step 2: Explain the determinants of supply


Determinant of supply #1: Technological advancement
The clothing industry has also experienced some technological advancement in recent years.
New ways of preparing fabric, use of automated garment manufacturing machines or even
virtual garment prototyping will improve the efficiency of producing clothes. This means that
less factor inputs are required to produce the same amount of output, hence reducing costs
of production. The fall in costs of production will increase profit margins, thereafter leading to
an increase in supply of clothes.
OR
With the advent of technology such as online payment systems and blogs, there has been a
sprout of online blogshops to sell clothes. This allows clothes sellers to do away with a brick-
and-mortar shop that incurs rental costs. Less labour is also required. Consequently, this
leads to a fall in costs of production and rising profit margins. Supply of clothes thus
increases.

Determinant of supply #2: Costs of production


Nylon and cotton prices has fallen much in 2012 from its peak in 2011 and since nylon and
cotton are factor inputs in the production of clothes, this will lead to a fall in costs of
production. Profit margins then increase and producers have the incentives to increase the
supply of clothes.

Overall, supply of clothes increases.

2
[Note: Students are allowed to explain rising costs of production in the clothes market but
they must synthesise the conflicting shifts in supply curve and reach the conclusion that
supply increases overall OR Students can explain falling demand coupled with rising supply
however, there are not that many factors that students can explain for a fall in demand.]

Step 3/4: Justify the relative shifts in demand and supply and draw a well-labeled and well-
explained diagram

The impact of an increase in demand and supply on equilibrium prices depends on the
relative magnitude of shifts in demand and supply. However, the fact that prices of clothes
are falling despite rising demand suggests that the increase in supply dominates the increase
in demand. This is because clothes are necessities and changes in demand due to the
above mentioned factors are unlikely to result in large shifts in demand. When people are
already buying a certain amount of clothes to fulfill their daily needs, they are unlikely to
significantly increase their demand for clothes.

S0
Price of clothes
S1

P0
P1

D0 D1

0
Q0 Q1 Quantity of clothes
The increase in demand leads to a rightward shift of the demand curve from D 0 to D1 and the
increase in supply leads to a rightward shift of the supply curve from S 0 to S1. Since an
increase in supply dominates the increase in demand, equilibrium price is falling from P0 to
P1. Equilibrium quantity is increasing from Q0 to Q1.

Conclusion:
The prices of clothes can be falling despite rising demand due to the fact that supply is
increasing at a much faster pace. However, there needs to be a continual breakthrough in
technology to sustain this large increase in supply to sustain the fall in clothes prices.

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(b)
Introduction: Define PED, PES, YED and XED
The price elasticity of demand for a good measures the responsiveness of the quantity
demanded of a good to a given change in the price of the good itself, ceteris paribus. Income
elasticity of demand for a good measures the responsiveness of the demand to a given
change in the level of income, ceteris paribus. Price elasticity of supply for a good measures
the responsiveness of the quantity supplied of a good to a given change in the price of the
good itself, ceteris paribus.

Body: Thesis – Elasticity concepts are useful

Explain change in supply with PED


The PED for branded clothes is likely to be greater than 1 i.e. demand is price elastic since
they are considered to be luxury goods and take up a large proportion of an average
consumer’s income. The PED value for non-branded clothes is likely to be lesser than 1 i.e.
demand is price inelastic since they are necessities and take up a small proportion of an
average consumer’s income.

Since the clothes market is experiencing technological advancement leading to an increase


in supply as explained in part (a), the prices of clothes will fall and quantity of clothes will
increase and PED is relevant in examining the magnitude of change in price, quantity and
total revenue as seen in Figure 1.
Price
S1 S2

E1
P1 E2
P2 E3
P3
Dbranded
Dnon-branded
O Q1 Q3 Q2
Quantity

Figure 1 Market for branded and non-branded clothes

Assuming that the supply for branded and non-branded clothes is the same at S1, an
increase in supply shifts the supply curve to the right from S1 to S2. The prices of non-
branded clothes will experience a larger fall in price from P 1 to P3 compared to the prices of
branded clothes which fall from P1 to P2. The quantity of non-branded clothes will experience
a smaller increase in quantity from Q1 to Q3 compared to the quantity of branded clothes
which increases from Q1 to Q2.

In terms of total revenue, a fall in price of non-branded clothes leads to a less than
proportionate increase in quantity demanded. The gain in revenue due to the rise in quantity
demanded is smaller than the loss in revenue due to the fall in price, hence total revenue
falls from OP1E1Q1 to OP3E3Q3. On the other hand, a fall in price of branded clothes leads to
a more than proportionate increase in quantity demanded. The gain in revenue due to the
rise in quantity is larger than the loss in revenue due to the fall in price, hence total revenue
increases from OP1E1Q1 to OP2E2Q2.

4
Explain change in demand using YED and with PES
Branded clothes are considered luxury goods and have a YED value that is greater than 1
and demand is income elastic. Non-branded clothes are more of necessities i.e. 0<YED<1
and demand is income inelastic. Rising affluence leads to an increase in income and
consequently, an increase in demand as explained in part (a). In this case, the demand for
branded clothes will increase more than proportionately whereas the demand for non-
branded clothes will increase less than proportionately. This is illustrated in figure 3 whereby
the demand curve for branded clothes shifts to the right by a larger extent from D to D branded
whereas the demand curve for non-branded clothes shifts to the right by a smaller extent
from D to Dnon-branded.
Price
P2 P3

E3
P3
P2 E2
E1
P1

Dbranded
D Dnon-branded
O Q1 Q3 Q2
Quantity

Figure 2 Market for branded and non-branded clothes

Branded clothes will experience a larger increase in both price and quantity from P 1 to P2 and
Q1 to Q2 compared to non-branded clothes. The increase in revenue for the branded clothes
market is also larger, from OP1E1Q1 to OP3E3Q3, compared to the non-branded clothes
market which is from OP1E1Q1 to OP2E2Q2.

The nature of the product i.e. branded or non-branded clothes influence the price elasticity of
supply. Branded clothes tend to be produced in limited quantities or may be hand-sewn.
Thus, it tends to have a price inelastic supply i.e. PES<1 because the producer cannot
increase the quantity supplied readily. On the other hand, non-branded clothes tend to be
manufactured in bulk in factories and quantity supplied can be changed readily to respond to
changes in prices i.e. PES>1.

Since an increase in income leads to an increase in demand, the prices of clothes will rise
and quantity of clothes will increase as well and PES is relevant in examining the magnitude
of change in prices, quantity and total revenue as seen in Figure 3.
Price
Sbranded

E3 Snon-branded
P3
E2
P2
E1
P1

D2
D1
O Q1 Q3 Q2
Quantity

Figure 3 Market for branded and non-branded clothes

Assuming that the demand for branded and non-branded clothes is the same at D 1, an
increase in demand shifts the demand curve to the right from D 1 to D2. The prices of branded
clothes will experience a larger rise in price from P 1 to P3 compared to the prices of branded
clothes which rises from only P 1 to P2. The quantity of branded clothes will experience a
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smaller increase in quantity from Q1 to Q3 compared to the quantity of non-branded clothes
which increases from Q1 to Q2.

In terms of total revenue, a rise in price of branded clothes leads to a less than proportionate
increase in quantity supplied. On the other hand, a rise in price of non-branded clothes leads
to a more than proportionate increase in quantity supplied. However, total revenue will
increase for both markets.

Anti-thesis: Elasticity concepts are not useful

#1: Limitations of elasticity concepts – ceteris paribus assumption


There are limitations in the use of elasticity concepts in explaining the effects of rising
affluence and technological advancement in the clothes industry on the market for branded
and non-branded clothes. The analysis of the effects on the market is done based on the
assumption of ceteris paribus. In reality, various factors are likely to change simultaneously.
As emerging economies become more affluent, taste or preferences of their consumers
towards branded and non-branded clothes might also change. Non-branded clothes could
become inferior goods to some consumers, hence demand will fall instead of rise and the
above analysis may differ.

#2: Size/ type of market matters


The impact of the above events on the two markets also depends on the size of the firm of a
clothes retailer or type of market structure that they are in. The branded clothes market tends
to be dominated by a few large retailers who serve the high-end clothes market and tends to
be global conglomerates. As such, the market tends to be oligopolistic. This means that
despite the increase in supply which will cause prices to fall, the retailers will be able to
influence the price change and continue to maintain high prices. In contrast, the non-branded
clothes market tends to have more small firms which are local start-ups and operate in
shopping centres or neighbourhoods. They tend to be monopolistically competitive. In this
instance, the retailers are likely to have lesser market power to influence prices.

Evaluation/ Conclusion:
In conclusion, elasticity concepts are useful in explaining the effects of the above events on
the market for branded and non-branded clothes. However, its usefulness depends on the
reliability of the elasticity data collected. Emerging economies tend to have poorer data
collection processes compared to developed countries, either due to low literacy rates or
poor technology. Thus, caution needs to be exercised when using the elasticity concepts.

Elasticity concepts are only helpful in explaining changes on prices, quantity and revenue.
They may not be helpful in explaining changes in profits earned. An increase in revenue may
not imply an increase in profit. Both markets need to find ways to reduce their costs too.