Principles of Economics

This document provides an overview of the principles of economics, including the concept of price elasticity of demand and its determining factors. It also evaluates the elasticity of three different products - soft drinks, gasoline, and tobacco. Additionally, it discusses the Australian post as a monopoly company and the inefficiency of monopoly and the need for government intervention.

Running head: PRINCIPLES OF ECONOMICS
Principles of Economics
Name of the Student
Name of the University
Author Note

1PRINCIPLES OF ECONOMICS
Table of Contents
Response to Question 1..............................................................................................................2
Evaluation of elasticity of three different products................................................................3
Soft Drinks.............................................................................................................................3
Gasoline..................................................................................................................................4
Tobacco..................................................................................................................................5
Response to question 2...............................................................................................................7
Australian post: A Monopoly Company................................................................................7
Inefficiency of monopoly and government intervention........................................................9
References................................................................................................................................11

2PRINCIPLES OF ECONOMICS
Response to Question 1
The magnitude of change in demand of a particular good due change in price of that good or
any other good shows the price elasticity of demand for the former good. Therefore, the price
elasticity of demand is written as the proportion between percentage change in demand and
percentage change in price (Thimmapuram and Kim 2013). Thus, this ratio gives the value of
price elasticity of demand. The price elasticity of demand is considered as relatively elastic
when its value is greater than one and relatively inelastic when the value is less than one
(Galperin and Ruzzier 2013). Relatively elastic price elasticity of demand means demand
changes more than the change in price and the case is opposite when price elasticity of
demand is relatively inelastic. The price elasticity of demand (PED) can be formulated as
PED=% change∈demand
% change∈price
¿ , PED= ∆ Q
∆ P × P
Q
Determining Factors of price elasticity of demand
Various factors determine how demand will respond due to their change. The key factors are
stated below:
 Available complementary goods and degree of complementarity between them
 Time
 Number of existing and accessible substitute goods
 Type of good
 The number of ways the good can be used
 Durability of the commodity

3PRINCIPLES OF ECONOMICS
 Amount of expenditure spent on the commodity
Evaluation of elasticity of three different products
Soft Drinks
Consumption of soft drink elevates the issue of obesity. To address this problem tax
imposition is an effective policy to reduce soft drink consumption because it increase the
price and discourages consumers. Hence, change in price does change the demand of soft
drink. A study that was conducted in Chile found that cross price of elasticity of soft drink
with respect to water to be 0.63. The cross price elasticity is positive in this case making the
goods substitutes. However, in the study value of own price elasticity found to be 1. The
value indicates that 1 unit change in soft drink price changes its demand by -1.37 units
(Guerrero-Lopez, Unar-Munguía & Colcher, 2017). Here, the value of PED is greater than 1,
hence demand is relatively elastic.
Product Cross price elasticity Own price elasticity
Soft drink 0.63 -1.37
Figure 1: Demand curve (elastic) for soft drinks
P2
P1
D
Price
QuantityO Q1Q2

4PRINCIPLES OF ECONOMICS
Source: (Created by the Author)
In Figure 1, the demand curve is relatively flatter because the own price elasticity of
demand is relatively elastic for soft drinks.
There are various substitutes of soft drinks such as tea, fruit juice, coffee, water and
other beverages and all of them shares positive cross price elasticity with soft drinks. Hence,
the relative elastic behaviour of soft drinks is justified because of availability of many
substitutes. Therefore, consumers will shift to available substitutes if price of soft drinks
increases.
Gasoline
Price elasticity of demand for gasoline changes with time, that is, the PED of gasoline
shows different values in case of short run and long run. Therefore, it is important to discuss
the PED of gasoline. Assuming a condition where price of gasoline increase significantly,
thus, to reduce consumption of gasoline one can use shared car service to reach office, can
use bicycle to reach nearby markets. However, in most of the studies it is found that PED of
gasoline is shown as relatively inelastic. Considering, a theoretical situation to find out the
degree of change in demand of gasoline due to increase in its price. In the long run the
average PED of gasoline is -0.58. This indicates, if price of increases by 1 unit then its
demand decreases by 0.58 units. However, the average PED of gasoline in the short run
found to be -0.26, which is different from the long run value (Moffatt, 2018). This short run
value indicates that 1 unit increase in price decreases the demand for gasoline by 0.26 units in
the short run.
Product Long run Price Elasticity Short run Price Elasticity
Gasoline -0.58 -0.26

5PRINCIPLES OF ECONOMICS
Even if the PED of gasoline is different in long run and short run, the value is below 1
in both the instances, that means, the demand is relatively inelastic. It indicates that amount
of decrease in demand is less than the amount of increase in price of gasoline. In Figure 2, the
inelastic demand curve is shown.
Figure 2: Inelastic demand curve for
gasoline
Source: (Created by the Author)
In the short run, demand of gasoline is less sensitive than that of long run. Hence,
elasticity of gasoline changes with time. In short run, demand is less sensitive due to buying
habits and low availability of substitutes. However in the long run people have new
substitutes and can reduce their consumption by availing different alternatives like shared car
service. Hence, in long run demand is more sensitive.
Tobacco
Tobacco is an addictive product and its demand decreases lower than the proportion
of increase in price. Thus, its demand is relatively inelastic. This is supported by most of the
studies related to PED of tobacco products. In designing of policy to reduce tobacco

6PRINCIPLES OF ECONOMICS
consumption, the PED of tobacco plays an important role. According to the estimations by
the World Bank it is found that average elasticity of tobacco products varies with economic
status of countries (different for developed and developing countries). In developed countries,
the average price elasticity of tobacco is found to be -0.4. This indicates that with 1 unit
increase in price of tobacco its demand falls by 0.4 units. On the other hand, in developing
countries the average price elasticity of demand of tobacco found to be -0.8
(tobaccoinaustralia.org.au. 2019). This indicates that with 1-unit increase in price of tobacco
its demand decreases by 0.8 units.
Product Price Elasticity
(for Developing countries)
Price Elasticity (for
Developed countries)
Tobacco -0.8 -0.4
However, the magnitude of the elasticity of tobacco in both developed and developing
countries suggests that the demand of tobacco is relatively inelastic. In Figure 3, inelastic
demand curve of tobacco is shown.
Figure 3: Inelastic demand curve for tobacco

7PRINCIPLES OF ECONOMICS
Source: (Created by the Author)
The major reason behind the inelastic nature of demand of tobacco is that it is
addictive. Hence, people do not want to reduce its consumption much due to increase in its
price. It is also found that in teenagers and adults belonging to youth group elasticity are
higher in comparison to aged adults. Hence, age is another factor that affects elasticity of
tobacco.
Response to question 2
Australian post: A Monopoly Company
The number of buyers and sellers in the market is considered to categorize the type of
market structure in the field of economics. The power of buyers and sellers depends on the
type of market it is operating or participating. Among all the competition models in
economics monopoly gives the maximum power to the seller because in monopoly there is
numerous buyers with only one seller to serve them (Askar 2013). Hence, it justifies the high
market power of the seller. Numerous buyers, one exclusive product, maximum entry
barriers, maximum market power characterizes the monopoly market and the single firm
represents the entire industry.
One of the biggest monopoly player in Australia is the Australia postal service. It
received its monopoly power is purely constitutional and is legalized by the government with
complete entry barriers (The Sydney Morning Herald 2014). It has monopoly over letter
delivery, parcels, stamps and other important delivery services. For example, Australian Post
charges $2.40 as delivery cost for letters weighing less than 250 grams.
In monopoly market, firms have control over important raw materials, high fixed cost,
presence of externalities in network and there is regulation by government that restrict entry
of new firms (Bucella and Fanti 2016). These are the main reasons that create monopoly

8PRINCIPLES OF ECONOMICS
power for a single firm. Exclusive control over raw material enables a firm to produce unique
product for the market that no other firms will be able to replicate due to unavailability of
raw material enabling the firm to enjoy monopoly power for that particular product. In a
market where fixed cost is very high discourages new firms from entering because the
existing firm has the unmatchable economies of scale by which it can over throw any new
firm. With presence of network externality, the products have large number of loyal users and
increases it value (Haghpanah et al. 2013). This works as natural barrier to entry. The most
important among all is the government regulation that enables monopoly power of a firm
because it cannot be questioned. Australian Post draws its monopoly power from the
regulatory barriers created by the government. Thus, the government provides the Australian
post the special right of delivering letters, parcels and other deliverables to different parts of
Australia at reasonable price. The company needs to abide by all the mandates of the
government like serving 90 percent of addresses in Australia for 5 times every week and the
number of branches it should have in urban and rural areas.
Australia post operates in a monopoly market that restricts entry of new firms. Hence,
there is no scope of competition. The entry barrier in this case is due to government
regulation, thus entry is completely restricted, and no firm can even try to think of entering
the market. Both the firms willing to enter and the people of Australia suffer due to this. The
monopoly power of a firm enables it to charge the price it wants in exchange of its goods and
services and in the most cases it is above the efficient market price. Perfect competition is the
only market structure where price is determined efficiently and consumers are least exploited
(Vrousalis 2016). Thus, due to monopoly power of the Australia post consumers and other
potential firms loses economic surplus.
In the postal industry, being the only firm Australian post has the power of deciding
the price for the entire market. This complete power of price taking decision is the prime

9PRINCIPLES OF ECONOMICS
concern for the Australian people because they have no option other than depending on
Australian post for postal services. Australian post also using its monopoly power revises
postal rates in regular intervals. The prices charged by the company exceeds the fair market
price and thereby exploits the consumers, this has created dissatisfaction among the
consumers.
However, with the advent of the online mail delivery system people shifted from
physical mode of mail delivery to the online mode. This shift has posed severe threat to the
Australian post. Its physical mail delivery volume has declined by manifolds. A new proposal
suggests increasing the postal rate charged by the Australian post to cope with the adverse
situation and recover from the losses it made. Moreover, keeping the growth of the online
mail delivery system in mind it can be said that in long run Australian post should stop its
operation to avoid further losses.
Inefficiency of monopoly and government intervention
The monopoly firm is not at all accepted in a society, as it can never generate efficient
market outcome. A monopoly firms fails to provide efficient allocation because it charges
price that equals the marginal cost, which is inefficient in nature. On the other hand, it also
fails to provide efficient production because it produces way over the minimum point of
average total cost. In both the cases, there is significant amount of consumer exploitation that
leads to loss of social welfare in the form of deadweight loss of quantity. This happens due to
allocative and productive inefficiency. Thus, monopoly market structure is not at all desirable
in a society in any case.

10PRINCIPLES OF ECONOMICS
Figure 4:
Welfare loss and inefficiency under monopoly
Source: (Created by the Author)
A market outcome, which is socially inefficient, can never be attained under
monopoly. Hence, government intervention is required to achieve a socially efficient
outcome. The government can regulate the monopoly price and quantity by imposition of
regulatory policy such that socially efficient outcome. Many countries in the world
introduced antitrust laws to control the existing monopoly firms in the market. However, in
the case of Australia, the Australia Competition and Consumer Commission (ACCC)
monitors and controls the monopoly firms activities and guarantees socially efficient
outcome. ACCC controls and regulates the monopoly activities of Australia post with three
key responsibilities. It examines any proposal for increasing price of services, investigates
any disputes in delivery of bulk mail occurred in relation to the terms and conditions of the

11PRINCIPLES OF ECONOMICS
Australian post and ensures that Australian post operates as per designed rule by keeping
record of the activities of the company.
References
Askar, S.S., 2013. On complex dynamics of monopoly market. Economic Modelling, 31,
pp.586-589.
Buccella, D. and Fanti, L., 2016. Entry in a Network Industry with a'Capacity-then-
Production'Choice. Seoul Journal of Economics, 29, pp.411-429.
Galperin, H. and Ruzzier, C.A., 2013. Price elasticity of demand for broadband: Evidence
from Latin America and the Caribbean. Telecommunications Policy, 37(6-7), pp.429-438.
Guerrero-Lopez, C. M., Unar-Munguía, M., & Colchero, M. A. (2017). Price elasticity of the
demand for soft drinks, other sugar-sweetened beverages and energy dense food in
Chile. BMC public health, 17(1), 180.
Haghpanah, N., Immorlica, N., Mirrokni, V. and Munagala, K., 2013. Optimal auctions with
positive network externalities. ACM Transactions on Economics and Computation, 1(2),
p.13.
Moffatt, M. (2018). What's the Price Elasticity of Demand for Gasoline?. Retrieved from
https://www.thoughtco.com/price-elasticity-of-demand-for-gasoline-1147841
The Sydney Morning Herald (2014). Australia Post: Let's free it up. [online] The Sydney
Morning Herald. Available at: https://www.smh.com.au/opinion/australia-post-lets-free-it-up-
20140624-zsjy0.html [Accessed 11 May 2019].

12PRINCIPLES OF ECONOMICS
Thimmapuram, P.R. and Kim, J., 2013. Consumers' price elasticity of demand modeling with
economic effects on electricity markets using an agent-based model. IEEE Transactions on
Smart Grid, 4(1), pp.390-397.
tobaccoinaustralia.org.au., 2019. 13.1 Price elasticity of demand for tobacco products -
Tobacco In Australia. Available at: https://www.tobaccoinaustralia.org.au/chapter-13-
taxation/13-1-price-elasticity-of-demand-for-tobacco-produc
Vrousalis, N., 2016. Exploitation as domination: A response to arneson. The Southern
Journal of Philosophy, 54(4), pp.527-538.