Price Elasticity of Demand - Assignment Example

BUSINESS ECONOMICS Q.1 A. Price Elasticity of Demand: It is the measure of the degree of response of one variable to changes in another. Thus, the price elasticity of demand for a particular good is the relative degree of responsiveness of the quantity demanded to relative changes in its price. The elasticity of demand can be generally assessed from the steepness of the slope of the demand curve in a supply-demand graph. A very steeply sloping demand curve indicates that a given percentage increase in price will cause a small percentage decrease in the quantity of the commodity (inelastic demand), while a very gently sloping demand curve shows that a given percentage increase in price will produce a large percentage decrease in the quantity (elastic demand). Elasticity is numerically calculated by the percentage change in the dependent variable (quantity demanded) divided by the associated percentage change in the independent variable (price). Ignoring the plus or minus sign, an elasticity greater than 1 is referred to as relatively elastic and an elasticity less than 1 is referred to as relatively inelastic. Elasticity exactly equal to 1 is known as unit elasticity. Elasticity = (dY/dX) * X/Y where X is the independent variable (price, income, etc.) and Y is the dependent variable (quantity demanded, quantity supplied, etc). Calculating the Percentage Change in Quantity Demanded [700 - 1000] / 1000 = (-300/1000) = -0.3 Calculating the Percentage Change in Price [2.50 –2.20] /2.20 = (0.3/2.20) = 0.1363 Thus elasticity is e = (% Change in Quantity Demanded)/(% Change in Price) e = (-0.3)/(0.1363) = -2.200 For analyzing the price elasticity the negative value is ignored. The higher the price elasticity, the more sensitive consumers are to price changes. A very high price elasticity suggests that when the price of a good goes up, consumers will buy a great deal less of it and when the price of that good goes down, consumers will buy a great deal more. A very low price elasticity implies just the opposite, that changes in price have little influence on demand. In general, If e > 1 then Demand is Price Elastic (Demand is sensitive to price changes), If e = 1 then Demand is Unit Elastic, If e < 1 then Demand is Price Inelastic (Demand is not sensitive to price changes) Thus, the demand of gasoline is elastic in this case. This is because, gasoline is easily available at other gas stations and the consumer will buy from the place where it is cheaper. The stations are generally situated at places where demand is high. Since the prices of gasoline rarely goes down, drastically, the areas where demand is high are top priority for gas station owners. At the outskirts or highways, the demand is particularly high The demand for gasoline in US is elastic. It is very sensitive to price changes. Many people have studied these phenomena in US. One such study ( Molly, n.d.) examined 101 different studies and found that in the short-run (defined as 1 year or less), the average price-elasticity of demand for gasoline is -0.26. That is, a 10% hike in the price of gasoline lowers quantity demanded by 2.6%. In the long-run (defined as longer than 1 year), the price elasticity of demand is -0.58; a 10% hike in gasoline causes quantity demanded to decline by 5.8% in the long run. This is probably, because as the price increases, consumers start to look for substitutes to save costs. The use of public transport or pooling of cars etc. are viable options available to people. Q.1 B Let us calculate the Price elasticity: Change in demand is -0.4, Change in price = 1-.75/.75 = .25/.75 = 0.33 . Thus e = -0.4/0.33 = -1.21 Again, this is greater than 1, thus the price elasticity is elastic. Similarly, the frequency elasticity : Change in frequency = 0.1, Change in ridership = 0.4 Freq elasticity = 0.4/0.1 = 4.0 This is greater than 1, hence suggesting that the frequency elasticity is greater than 1, thus the change in frequency changes the ridership figures as well. Thus we see, that both ridership is elastic to both price as well as frequency. Thus though, the price has been hiked, the greater frequency of buses have brought in more consumers as more number can avail of the bus service rather than before, thereby increasing the ridership again. Q.3 Demand Curves: The demand curve can be defined as the graph depicting the relationship between the price of a certain commodity, and the quantity being purchased at that given price. They are used to estimate behaviors in a competitive markets, and is often combined with supply curves, to estimate the equilibrium price. This is the price at which all sellers are able to find a willing buyer, also known as market clearing price.(Paul & Robin, 2005). A demand curve is graphed, with the quantity on the x axis (often named in equations as "Q") and the price at on the y axis (often named in equations as "P"). Other determinants of demand such as income, taste and preference, prices of related or substitute goods are said to be constant. A change in one of these constants will cause a shift in the demand curve, and the expected behavior of that market.(Paul & Robin, 2005) The demand curve usually slopes downwards from left to right; that is, it has a negative association. This negative slope is known as the "law of demand," meaning that when other things are constant, if the price of the good increases, it will be purchased fewer consumers. Thus in this case, when residential construction was reduced, the price of plywood and timber reduced. Thus as the demand reduced, the quantity also falls, to maintain the equilibrium. The laws of supply and demand state that the equilibrium market price and quantity of a commodity is at the intersection of consumer demand and producer supply. Thus at equilibrium point quantity supplied equals quantity demanded. Equilibrium implies that price and quantity will remain there if it begins there. If the demand decreases, there is a leftward shift of the curve. The price and the quantity will also decrease. This is purely an effect of demand changing. . Thus when plywood demand decreased, the price also fell. As a result, in other sectors or industries, where there were substitutes to plywood, they started using plywood since its price had come down. In the same way, to stop, prices from falling further, the plywood industry started to explore other markets besides US to keep afloat. As a result, they started exporting this to Japan. Since the demand was less in US markets, the surplus was exported to Japan to keep the prices at a certain level. Japan started importing because, the prices of plywood from US were already down and it suited its ,markets. Q.4 Consent decree: A consent decree is a judicial decree expressing a voluntary agreement between parties to a suit, especially an agreement by a defendant to cease activities alleged by the government to be illegal in return for an end to the charges. a. A certain firm is said to enjoy monopoly if it is the only one that can produce a certain good and the other small companies have little or no impact on the dominant firm. Since there is no competition, monopoly firms make an economic profit. This results in other firms try to enter the market. But, if the firm has to remain a monopolistic one, there must be some barrier to entry for other firms. These could be legal barriers, in form of patent rights or natural barriers such as very high set up costs etc. If a company attempts to monopolize the market by charging prices that are too low (i.e., below its' costs of production), the company may be able to drive competitors out of the market temporarily. But in the long run, by continuously selling at prices below costs will eat up its financial capital and erode its profits. And if, to come out of this situation, the company raises its prices, the new or other competitors may/will enter the market again. Thus it is not possible for a company to monopolize the market by slashing its prices below cost price for too long. b. Safeways’ competitors might have complained against them. The case was argued between Safeway stores Inc., and Vance in1958. (Safeway vs Vance, 1958) c. No, the Safeways did not fight against the Department of Justice. Q.8 The Union efforts to organize the manufacturing sector have not met with the same degree of success as the public services sector. Infact, Union membership declined sharply in 2006, from 12.5 percent of all workers in both 2004 and 2005, to just 12.0 percent of all workers last year, according to the Bureau of Labor Statistics annual union membership report (Schmitt and Zipperer, 2007) The largest decrease in union membership rates has occurred in manufacturing sector. The union membership rates were lower in manufacturing (11.7 %) than in the rest of the economy (12.0%).( Schmitt and Zipperer, 2007) It is seen that the majority of unions do not campaign effectively. They do not put enough resources into the campaign. Moreover, they do not have the momentum and power necessary to take on the large multinationals. In addition, the job migration and plant closings has also led to the decline in union representation. Between 1997 and 2001, there was a drop in employment in the manufacturing sector of 9.2 percent. During the same time period, there was an increase in employment in the service sector of 10.9 percent (Bronfenbrenner, 2003) One of the main factor in decline in union density is the loss of union jobs. Union jobs are contracted out or moved out of the country. The labour laws are either weak or poorly enforced. There is no support from the government and it openly opposes unions in the private sector. The employers themselves are getting aggressive in their opposition to unions. They use tactics such as mandatory captive audience meetings, bribes, surveillance, threats, promises, and these are turning out to be extremely effective in thwarting union organizing efforts. Q.8B The main opposition of doctors to the optometrists bill is that the optometrists are not qualified enough to prescribe the drugs for eye diseases and this may put the patients ate considerable risk.(Wachdor, 2007) Thus patients will be vulnerable to misguidance by optometrists. But actually, when a systemic drug is indicated, optometrists must send their patients to a primary care physician to get a prescription. Most physicians want to see patients before prescribing — meaning an office visit, which increases costs and can delay care Basically, for doctors, this will mean less number of patients and hence their monopoly over medication will be challenged. People will have the option of going over to a doctor or an optometrist in case of small or non serious diseases. So, this will lead to economic loss to doctors. There demand will go down and they might have to reduce their fees/price in order to claim back their patients. Q.9 a Buyers are given a steep discount on 3M self stick notepads, if they bundle the purchase with other products. – This is the case of a tying arrangement. This is a sale or lease of a product on the condition that the buyer or lessee takes a second product as well. Tying arrangements can be illegal either as contracts in restraints of trade. Opposition to tying arrangements is because this creates a restriction on consumers on what they should purchase. A buyer would be forced to buy a product that they would not rather buy (Akers & Fernandez, 2004) b. United Airlines is giving discounts that hinge on not using other carriers. -- This is the case of Exclusive dealing arrangement. An exclusive dealing arrangement is an agreement between buyer and seller under which the buyer agrees to purchase all its needs of a particular product from the seller, i.e. the buyer agrees not to deal in the same product with a different supplier. (Akers & Fernandez, 2004) In this case, the united airlines is offering discounts to consumers such that they do not use any other carriers. c. PepsiCo’s frito division is using slotting fees to purchase space on store shelves. -- A slotting fee is a fee charged to companies by supermarket distributors in order to have their product placed on their shelves.(Sparkes, 2006) The fee varies depending on the product, manufacturer, and market conditions. This is a kind of tying arrangement wherein the producers pay to get their products on store shelves and thus the consumers are deprived of choice and competition. Slotting fees curb fair access to the market and erode consumer choice. Big companies are able to use their market power to keep competitors' products off the supermarket shelf. d. Anheuser- Busch offers discounts to limit distributor’s ability to bring rival brews to retailers. -- This is an exclusivity arrangement, wherein the company is barring the rivals entry to retailers and markets. Q.10 a Yes, the company is a protected company. The government is the only agency that has the power to physically force competitors out of business, i.e., it is the only agency that has the power to outlaw (i.e., regulate) competition. For example, the United States Post Office makes it illegal for anyone to charge less than 34¢ for first class mail. Q.10b. A coercive monopoly is a form of monopoly where a firm is able to make pricing and production decisions independent of competitive forces because all potential competition is barred from entering the market. It is a monopoly where there is no opportunity to compete through means such as price competition, technological or product innovation, or marketing; entry into the field is closed. A coercive monopoly has very few incentives to keep prices low and may deliberately price gouge consumers by curtailing production. (Lawrence, 2000). "A coercive monopolist will tend to perform his service badly and inefficiently."(Murray, 1982) Since the problem lies in the fact that the government protects such monopolies, the solution may be to reduce the size, scope or power of government. Government cannot misuse funds that it does not have and government cannot abuse powers it was never given in the first place. Thus the idea is to decentralize the political power. Reference: Akers, Jessica. and Fernandez, Dennis., “How Antitrust Laws Affect Intellectual Property”, La Vox , 2000 Bronfenbrenner , Kate., “Declining Unionization, Rising Inequality”, Multinational Monitor 24 : 5 , 2003 Espey, Molly., “Explaining the variation in elasticity estimates of gasoline demand in the United States: A meta-analysis”, Energy Journal. Krugman, Paul, and Robin, Wells. Microeconomics. Worth Publishers, New York., 2005 Lawrence, Kudlow., “The Judicial Hacker”, in Jewish World Review, 2000 Murray, Rothbard., “ The State Versus Liberty” in The Ethics of Liberty, 1982 SAFEWAY STORES, INC., v. VANCE, 355 U.S. 389 (1958) , Schmitt, John., Zipperer, Ben. “Union Rates Fall in 2006, Severe Drop in Manufacturing”, 2007 Sparks, Brian. “Slotting fee battle continues.” American Fruit Grower. 2001 Wachdor, Haley, “ Ophthalmologists raise brows over proposed optometry bill” New Mexico Business Weekly , 2007 Read More