Elasticity and temporary price rises

OK, I have a question for you. This was the example which popped to mind as I was reading your entry. (price elastic products)

Here in my Middle Eastern country, sheep are sold for meat. Each year, prior to the Festival of the Sacrifice (Muslim holiday where every family buys a sheep to butcher at home in the house), families go shopping for their sheep. In the weeks prior to the Festival, the price of sheep goes UP, UP, UP. Sometimes the prices seem to reach scandalous levels. Of course, after the Festival, the price falls back to normal.

It appears that according to your explanation, this would be a PRICE INELASTIC good. However, this is NOT a monopoly, as there are MANY, MANY sellers of sheep in the market-place. It looks more like a collusion of price-fixing among the many sellers, to me. What do you think about this?

Thanks for question, it is interesting. I feel that the increase in price is due to an exceptional increase in demand, but a relatively inelastic supply of sheep at this particular time.

What seems to happen at this particular point in time, is that demand for sheep may increase by, say 1000%. However, in this festival week, the supply cannot increase by 1000%? I assume that farmers will try and predict the increase in demand. However, it may be that they can only increase the supply of sheep on the market by say 500%. Therefore, despite an increase in the supply of sheep, the increase in demand for sheep is far greater and therefore prices rise.

Since buying a sheep, at this time, is seen as an essential purchase, demand is very inelastic for sheep during this week. Therefore, consumers are willing to pay the higher price (a price they wouldn’t pay at other times of the year when other types of meat would be seen as a substitute.)

Inelastic demand and monopoly

A good can still have an inelastic demand even if markets are competitive. Demand for sheep is inelastic because consumers don’t see any alternative to buying sheep. In the UK, demand for tobacco is inelastic because smokers don’t see any alternative to smoking

However, because there are many sellers, demand for individual farmers may be elastic. E.g. if one farmer sold cheaper sheep he would see an increase in demand. Similarly a particular brand of cigarettes may be elastic despite overall demand for cigarettes being inelastic.

Collusion and High Prices?

Perhaps the farmers could try harder to increase supply at this time, but, you can see the temptation to avoid doing this. This week offers a chance to make a very high profit. My feeling is that farmers are not actively colluding to set high prices. But, they don’t have much incentive to try and increase supply and avoid prices rising. In other words, it is easy for farmers to tacitly collude and allow prices to rise each year. Farmers have little to be gain from working out how to avoid the shortages which benefit them so much.

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Price Elastic Products – Are there any benefits?

Readers Question: When would you want to own a business that sells price-elastic products? Why?

Price elastic products mean that if there is an increase in price, there will be a bigger % fall in demand. Therefore, with elastic goods, there is little incentive to increase the price because there will be a bigger % fall in demand. Elastic products suggest the good is in a competitive market and therefore it is more difficult to make profits. If demand was price inelastic a firm could put up prices and make profits, for example, a firm with monopoly power is likely to have inelastic demand.

elastic-demand

When Price Elastic products are Beneficial

1. For a Sales Maximising Firm.

If a firm wishes to increase market share and increase its sales then price elastic means that cuts in price will beneficial in increasing sales.

  • However, it depends on how other firms react. If one firm cuts its price, demand may be elastic, but if all the other firms follow suit demand is likely to be inelastic and the price war only causes a small increase in sales (see Oligopoly Kinked demand curve)

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Banking Collapse and the Withdrawal of money

Readers Question: What do you think would happen if all depositors of a bank requested their deposits?

The Banking would probably collapse – unless it could secure unlimited funding from a Central Bank or other banks.

If a bank has deposits of £10billion. The bank will keep perhaps 1% in liquid assets (i.e. cash that can quickly be given to customers who demand it. Therefore, out of £10 billion, the bank will have cash reserves of say £100million. We say it has a liquidity ratio of 1%. Therefore, if customers asked for £100 million to be withdrawn the bank could do it. However, once customers require more cash, it faces a problem – The bank doesn’t have the deposits in a liquid form.

What banks do is they lend out deposits to other people. This is how they make a profit.  They pay you 2% a year to save money, then lend to someone else and charge 7%. They can do this because usually people don’t want to suddenly withdraw all their money and it is more profitable than simply keeping money behind the counter.

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How to avoid environmental damage in the economy

How do we avoid environmental damage in an expanding economy? It is not easy because a lot of environmental damage occurs as a result of negative externalities. In other words, the environmental damage from producing a good, driving a car primarily affects other people. Therefore, free markets are not efficient at dealing with environmental externalities. …

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The Price of Orange Juice – readers question

Readers Question: an orange juice sells at $3
when sugar price rise, orange juice sells at $3.2
but why when sugar price drop, orange juice still $3.20?

Why?

Sugar is an ingredient in the price of orange juice, therefore if the price rises, firms pass on the cost increases to consumers. Because all the firms pass on the cost increases, firms do not really lose any sales and market share should remain the same. Demand for orange juice is fairly inelastic, there are not many close alternatives. If the price of orange juice increased, would you stop buying it?

This is straight forward. However, if the price of sugar falls why does this not get passed on to consumers.

Well, a firm may think if I cut prices I will be more competitive and therefore, more people will buy it. However, if I cut prices then others will follow suit and we will all be worse off. Therefore, it is better to keep prices high and make more profits. Here, there is little incentive to cut prices, especially if you assume other firms will follow your example. Every firm wants to hope prices remain high so they don’t cut them.

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Supermarket Petrol and Competition

Readers Question: What are the consequences of competition between supermarket affiliated petrol stations and independent petrol retailers? Before the supermarkets entered the market for selling petrol, there was much less competition in the market for petrol. Therefore, independent retailers were able to set higher prices and gain higher profit margins. I believe prior to the …

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Budget 2008 Summary

A.Darling’s first budget is good news for those who don’t drink, smoke or buy SUVs.
No major changes, but these are some of the main features of the budget.

  • Cigarettes up 11p a packet of 20.
  • Beer up by 4p a pint, wine 14p a bottle, spirits 55p a bottle.
  • Duties on alcohol will go up by 2% above inflation for next four years.
  • related: Should tax on alcohol rise?

Cars and Petrol

• From 2009, major reform of the vehicle excise duty. For new cars from 2010, the lowest-polluting cars will pay no road tax in the first year. Higher-polluting cars will pay more.

• Funding set aside for road-pricing proposals. (road pricing in UK)

• 2p increase in fuel duty is postponed for 6 months due to high price of oil

• For environmental reasons, fuel duty will rise by 0.5p per litre in real terms in 2010. This is said to be for green reasons, but, is very small % of price.

Housing

• From April, key workers, such as teachers and nurses, will be able to borrow money from shared equity schemes.

• Stamp duty on shared ownership homes will not be required until people own 80% of their home.

• More people should have the chance to have a long-term fixed mortgage, which a report shows can reduce the risks for first-time buyers and can keep them on the housing ladder. (but, not clear whether people will actually take them out)

• Sites for 70,000 more houses have been identified. (But, when they will be built is another matter)

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What will be in the 2008 Budget?

On March 12th, Alistair Darling will deliver his first budget. With the economy slowing down, he is not left with much room for manoeuvre. Tax Revenues are less than the government hoped and the National debt is likely to soon exceed the government’s self imposed ceiling of 40% of GDP. In 2008-09 Mr Darling will …

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