Rational Decisions in Tourism and Tourist Expenditure on Entertainment and Accommodation

Answer

Part (a) — Determinants of the tourist’s and the firm’s decisions [10]

Both decisions are made by rational economic agents applying the marginalist principle — weighing marginal benefit against marginal cost — but the benefits, costs and decision rule differ.

The tourist (a consumer maximising net utility). A rational tourist goes on holiday if the marginal benefit exceeds the marginal cost. The marginal benefit is the satisfaction from the trip — visiting attractions such as Universal Studios, the experience of nature parks. The marginal cost is the money spent on airfare and accommodation, plus the opportunity cost of that income and time. The tourist consumes up to the point where marginal benefit equals marginal cost, maximising net utility; income, the price of the holiday and of substitutes/complements, and tastes all shift this calculus.

The firm (a producer maximising profit). A rational firm opens a new hotel if it expects to earn at least normal profit — the minimum return needed to keep its capital in this use rather than the next-best alternative. The marginal benefit is the expected revenue from guests; the marginal cost is utility bills, supplies and wages, plus the opportunity cost of the funds invested. The firm proceeds only if expected total revenue covers total cost (including normal profit); expected demand, costs, and the returns available elsewhere are the determinants.

Part (b) — Reasons for higher entertainment spending and lower accommodation spending [15]

Consumer expenditure is price times quantity, so the changes are read off shifts in demand and supply and the relevant elasticities.

Entertainment — expenditure rises via higher demand. Demand for entertainment rose with the record visitor arrivals and rising tourist incomes, and possibly with successful Singapore Tourism Board campaigns shifting tastes. A rightward demand shift raises both price and quantity, so expenditure on entertainment rises. The income factor is likely the stronger driver: entertainment is a luxury for tourists ($YED > 1$), so rising income raises demand more than proportionately, whereas tastes adjust slowly and rival destinations compete for the same visitors.

Accommodation — expenditure falls as supply rises faster than demand. Demand for accommodation also rose — it is a complement to holidays, and higher incomes raise the ability to pay. But supply rose more, with many boutique hotels opening.

Because accommodation is a near-necessity for tourists ($0 < YED < 1$), the demand rise was modest, while the supply expansion was large; the net effect is a fall in price. With demand price-inelastic (tourists must stay somewhere, few substitutes), the rise in quantity is less than proportionate to the price fall, so the loss of expenditure from the lower price outweighs the gain from higher quantity — overall expenditure on accommodation falls.

Evaluation. The rise in entertainment expenditure is most plausibly driven by rising tourist incomes (luxury, $YED > 1$), amplified by rising arrivals from fast-growing Asian economies; tastes play a secondary role. The fall in accommodation expenditure is most plausibly driven by supply outpacing demand, given the boutique-hotel boom against inelastic, necessity-type demand. Two qualifications matter. First, the result is not uniform across the accommodation market: demand for five-star hotels (more luxury, higher $YED$) may have risen more, so high-end expenditure could fall less or even rise, while budget accommodation drives the aggregate decline. Second, the conclusions rest on the assumed elasticities — inelastic, necessity demand for accommodation and luxury demand for entertainment — which hold in the short run but could shift if, say, alternative lodging (short-term rentals) makes accommodation demand more elastic. On balance, rising incomes explain the entertainment rise, and a supply-led price fall against inelastic demand explains the accommodation decline.