Economics for Business: Elasticity of Demand and Australian Monopoly

This report delves into key economic concepts, examining the price elasticity of demand for various products like gasoline, tobacco, and soft drinks, using data from recent publications. It analyzes the determinants of elasticity and provides elasticity estimates, comparing short-run and long-run scenarios. Furthermore, the report presents a case study on the Australian Post, identifying its monopoly power, the reasons behind it (government regulation), and the resulting market inefficiencies, including how consumers are affected. The report then discusses the role of government intervention in curbing this monopoly power to ensure market efficiency and consumer welfare.

Running head: ECONOMICS FOR BUSINESS
Economics for Business
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1ECONOMICS FOR BUSINESS
Table of Contents
Answer 1....................................................................................................................................2
Price elasticity of demand......................................................................................................2
Determinants of elasticity of demand....................................................................................2
Evaluation of elasticity of three different products................................................................2
Answer 2....................................................................................................................................6
Monopoly in Australia: a case of Australian post..................................................................6
Inefficiency arising from monopoly and role of government intervention............................7
List of References......................................................................................................................9
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Answer 1
Price elasticity of demand
The measure of price elasticity of demand gives an estimation for responsiveness of
demand of a good for a proposed change in price. It is expressed as a ratio of percentage
change in quantity demanded to percentage change in price. If the estimated measure of price
elasticity exceeds 1, then demand is considered as relatively elastic. Demand here changes
more than price (Jain & Ohri, 2015). If the estimated measure of elasticity is below 1, then
this indicates demand changes less than price. This is called relatively inelastic demand. The
formula for price elasticity of demand is given as follows
Price elasticity of demand= Percentage change∈quanity demanded
Percentage change∈ price
¿ dQ
dP × P
Q
Determinants of elasticity of demand
The responsiveness of demand depends on a number of different factors. The major
factors determining price elasticity of demand are as follows.
 Number of available substitutes
 Proportion of income spent on the good
 Number of uses of the commodity (Nguyen & Wait, 2015)
 Complementarity between goods
 Time
Evaluation of elasticity of three different products
Gasoline
The study of Gasoline elasticity is one of the vital topic to understand the effect of a
proposed increase in price on demand of gasoline. There are several ways following which
one can reduce the fuel consumption because of a higher price. For example, people can take
carpool for reaching office or schools, can go to post office or supermarket in one trop
instead of making two trips or more. The price elasticity of demand for gasoline indicates a
hypothetical situation where that identifies the extent of change in demand for gas following
an increase in price. Most studies support the claim that price elasticity of demand for
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gasoline is relatively inelastic in nature. In the short run (considered a period less than 1 year)
the average price elasticity of demand for gasoline is -0.26. That is 10 percent increase in
gasoline price lowers demand by 2.6 percent. The elasticity measure however is different in
the long run. The estimated average elasticity of demand for gasoline in the long run is -0.58
(Moffatt, 2018). That means, in the long run given a 10 percent increase in gasoline price,
quantity demanded lowers by 5.8 percent.
Product Price Elasticity (short run) Price Elasticity (long run)
Gasoline -0.26 -0.58
The elasticity measure for gasoline though differs between short run and long run, in
both the cases estimated elasticity is less than 1 meaning a relatively inelastic demand. That
mean wen price of gasoline changes, the corresponding changes in quantity demanded is
always less than price. The inelastic demand curve for gasoline is shown in the figure below.
Figure 1: Demand (inelastic) curve for gasoline
(as created by author)
In case of gasoline elasticity varies with time. Demand is less sensitive in the short
run because of buying habits of people and less availability of substitutes. In the long run
people however adjust to high price by cutting back their fuel consumption by reducing
number of trips to supermarket or post office or using car pool (Lin & Prince, 2013). Also,
new substitutes can be developed making demand more sensitive in the long run.
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Tobacco
The price elasticity of demand for tobacco products has useful implication in
designing policy to reduce tobacco consumption. Studies mostly found that demand for
tobacco products are likely to be inelastic in nature. That is consumption of tobacco products
decrease by a lower proportion than any proposed price increase. As stated in the article
tobacco products have a relatively smaller elasticity than other consumer goods. The world
bank estimates suggest that average elasticity for tobacco products in developed countries is -
0.4. The measure implies that tobacco consumption lowers by 4 percent if price increases by
10 percent. In developing countries however measured elasticity is -0.8
(tobaccoinaustralia.org.au., 2019). That is to say demand decreases by 8 percent when price
increases by 10 percent.
Product Price Elasticity
(Developed countries)
Price Elasticity
(Developing countries)
Tobacco -0.4 -0.8
The estimated measure of elasticity suggests that demand is relatively inelastic both
for developed and developing countries. The inelastic demand curve for tobacco products is
shown in figure 2.
Figure 2: Demand (inelastic) curve for tobacco
(as created by author)
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In case of tobacco products, the addictive nature of the good results in a relatively
inelastic demand. The nicotine contents of these products are addictive to people and
therefore people are not willing to reduce demand much for a given increase in price. Another
factor influencing elasticity of tobacco consumption is age (Cobiac et al., 2015). Elasticity is
relatively higher for among teenagers and younger adults than older adults.
Soft drinks
Imposition of tax on soft drinks and associated increase in price is seen as an effective
tool to lower consumption of soft drinks and to address the associated problem of obesity.
Study based on household spending in Chile has found an estimated own price elasticity of -
1.37. This means for a 10 percent increase in price of soft drinks, consumption of soft drinks
reduces by 13.7 percent. As demand changes more than price, demand of soft drinks is
relatively elastic in nature. The paper not only estimates own price elasticity of demand for
soft drinks but it also shows estimates of cross price elasticity. The cross price elasticity of
soft drinks with respect to price of plain water is 0.63 (Guerrero-Lopez, Unar-Munguía &
Colcher0, 2017). The positive cross price elasticity suggests that soft drinks and plain water
are substitutes.
Product Own price elasticity Cross price elasticity
Soft drink -1.37 0.63
As own price elasticity of demand for soft drink is relatively elastic, the demand curve
of soft drinks is relatively flatter as shown in the following figure.
Figure 3: Demand (elastic) curve for soft drinks
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(as created by author)
In case of soft drinks, it is availability of various substitutes that explains relatively
elastic behavior of the products. The different substitutes of soft drinks include coffee, tea,
plain water, other flavored beverages, sweet snacks, sugar and honey and desserts, each
having a positive cross price elasticity of demand with soft drinks. In response to an increase
in price of soft drinks people shift their consumption to any of the available substitutes.
Answer 2
Monopoly in Australia: a case of Australian post
The economic theory classifies market in terms of degree of competition as
determined from the number of buyers and number of sellers. The degree of competition in
the market determines market power of buyers and sellers in the market. Monopoly is an
extreme form of market characterized by the presence of only one seller and a large number
of buyers. The single seller in the monopoly market meets the demand of large number of
buyers and therefore has high degree of market power (Case, Fair & Oster, 2014). Several
distinctive features of monopoly market include single seller with large number of buyers,
unique product, high market power, high entry barriers and the industry under monopoly is
same as the firm.
In Australia, one industry having characteristics of a monopoly market is the postal
service of Australia. In delivering parcels, letters and other deliverables the Australian post
has a statutory monopoly power. The monopoly power of Australian post is defined for
letters that weight less 250 grams with a delivery cost of $2.40 (accc.gov.au, 2016).
Australian post is a legalized monopoly where entry of competitors is restricted by
government regulation.
There are several reasons that create monopoly power of a single firm. The four
primary reasons for monopoly power of a firm include high fixed cost, ownership over a
strategic raw material, presence of network externality and government regulation restricting
entry in the market. In a market with high fixed cost new firms generally do not enter as they
are not able to bear the high cost. It is cost effective for the single firm to serve the industry
because of economies of scale (the case of natural monopoly). Secondly, when a firm has an
exclusive ownership over a raw material then it is not possible for others to produce the same
good. The uniqueness of the product gives the single seller a monopoly power (Maurice &
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Thomas, 2015). For product or service having a network externality, value of the product or
service increases as more and more people use it. This acts as a natural entry barrier to the
new entrants. The fourth important source of monopoly power is the regulatory barriers
imposed by the government in an industry. The monopoly power of Australian post is
maintained by the government’s regulatory barriers. Australian government permits the
exclusive right of Australian post to deliver parcels, letter and others to various parts of
Australia at a reasonable cost. It is mandatory for the company to serve nearly 90 percent of
the addresses for 5 times in each week. Government also mandates the minimum outlets
requirement for Australian post in the rural and urban areas.
The monopoly market having completely restricted entry limits competition
(Belleflamme & Peitz, 2015) Similarly, monopoly power of the postal company in Australia
limits competition in the industry. Given the regulatory barriers small firms cannot enter the
market. Not only competing firms but also people in Australia has to suffer due to monopoly
power of Australian post. As monopoly firm is the price maker in the market, it can always
charge a price higher than efficient or fair market price (anao.gov.au, 2019). The socially
efficient price can only be determined by high degree of competition in the market place.
With monopoly power of Australia post and subsidiaries operating in Australia, small
business and consumers hurt by losing potential economic surplus.
The price making power of Australian post is a cause of concern for consumers and
the society as a whole. As people have no other option but to depend on the monopoly postal
company, a higher postal rate creates discontent among consumers. Australian post however
proposes time to time upward revision of postal rate. Recently, proposal has been given to
revise the off-peak rates in postal service. The monopoly of Australian post distorts efficient
market outcome by exploitation of excessive market power.
The exclusive position of Australian post in postal delivery service has however been
threatened by spread of online delivery. With a notable decline in volume of physical mail
delivery it become difficult for Australian Post to recover cost and maintain profitability
(Leigh & Triggs, 2016) To recover the loss from reduction in volume of mail delivery
Australian Post has made a proposal to increase postal rate. However, if the situation persists
it will be not feasible for Australian post to continue operation in the long run.
Inefficiency arising from monopoly and role of government intervention
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The monopoly power of single firm in the market results an inefficient market
outcome. Neither productive nor allocative efficiency are attained under condition of
monopoly. The monopoly market is allocative inefficient as price charged in the market is
above the efficient price that equals marginal cost. Monopoly market is productively
inefficient because the monopoly firm in the long does not produce at the minimum point of
average total cost (Waldman & Jensen, 2016). Because of allocative inefficiency monopoly
price is greater than competitive price. Because of productive inefficiency monopoly output
is smaller than socially efficient quantity. Equilibrium under monopoly and the resulted loss
in social welfare is shown in the following figure.
Figure 4: Inefficiency and welfare loss under monopoly
(as created by Author)
Attainment of socially efficient outcome under condition of monopoly calls for
government intervention (Carlton & Perloff, 2015) Government by imposing regulation on
price and quantity can control monopoly power of the single firm and ensure market outcome
to be socially efficient. In many countries antitrust laws are designed to control monopoly
power of any existing firm. In case of Australia however, Australian Competition and
Consumer Commission observes activities of monopoly firm and takes necessary action to
protect consumers from exploitation in the monopoly market. ACCC has been assigned with
three primary responsibilities to regulate Australian Post. First, the commission assesses any
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proposal of price increase by Australian post. Second, it enquires inti the any recorded
disputes related to terms and condition of Australian post in delivery of bulk mail
(accc.gov.au, 2019). Third, the commission administer records activities of Australian post in
line with designed rule.
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List of References
accc.gov.au. (2016). Assessing cross-subsidy in Australia Post. Retrieved from
https://www.accc.gov.au/system/files/1076_Assessing%20cross-subsidy%20in
%20Australia%20Post%202015_FA.pdf
accc.gov.au. (2019). ACCC role in postal services. Retrieved from
https://www.accc.gov.au/regulated-infrastructure/postal-services/accc-role-in-postal-
services
anao.gov.au. (2019). Australia Post's Efficiency of Delivering Reserved Letter Services |
Australian National Audit Office. Retrieved from
https://www.anao.gov.au/work/performance-audit/australia-posts-efficiency-
delivering-reserved-letter-services
Belleflamme, P., & Peitz, M. (2015). Industrial organization: markets and strategies.
Cambridge University Press.
Carlton, D. W., & Perloff, J. M. (2015). Modern industrial organization. Pearson Higher Ed.
Case, K. E., Fair, R. C., & Oster, S. M. (2014). Principles of microeconomics. Pearson.
Cobiac, L. J., Ikeda, T., Nghiem, N., Blakely, T., & Wilson, N. (2015). Modelling the
implications of regular increases in tobacco taxation in the tobacco
endgame. Tobacco control, 24(e2), e154-e160.
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.
Jain, T. R., & Ohri, V. K. (2015). Principal of Microeconomics. FK Publications.
Leigh, A., & Triggs, A. (2016). Markets, Monopolies and Moguls: The Relationship between
Inequality and Competition. Australian Economic Review, 49(4), 389-412.
Lin, C. Y. C., & Prince, L. (2013). Gasoline price volatility and the elasticity of demand for
gasoline. Energy Economics, 38, 111-117.
Maurice, S. C., & Thomas, C. (2015). Managerial Economics. McGraw-Hill Higher
Education.
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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
Nguyen, B., & Wait, A. (2015). Essentials of Microeconomics. Routledge.
tobaccoinaustralia.org.au. (2019). 13.1 Price elasticity of demand for tobacco products -
Tobacco In Australia. Retrieved from https://www.tobaccoinaustralia.org.au/chapter-
13-taxation/13-1-price-elasticity-of-demand-for-tobacco-produc
Waldman, D., & Jensen, E. (2016). Industrial organization: theory and practice. Routledge.
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