BUSI 620 Week 2 DB Forum 2 Example

Discussion Board Forum 2: Quantitative Demand Analysis

BUSI 620 Global Economic Environment, Discussion Board Forum 2 (thread and 1 reply)

Thread by [Student Name]

The forum questions, the fuel retailer and the classmate's thread are composites standing in for the course's own; the research cited is real, and the requirements follow Liberty's public course guide for BUSI 620.

Thread

Baye and Prince (2017) measure own-price elasticity as the ratio of the percent response in quantity demanded to the percent move in price, and they tie it to the total revenue test: when demand is inelastic, a price increase raises revenue, and when it is elastic, revenue falls. Gasoline looks like a textbook case of inelastic demand, since most drivers cannot change how far they commute in a week.

The research supports that view for the market as a whole. Pooling gasoline elasticities published for many countries, Havranek et al. (2012) found that the literature suffered from publication bias, with insignificant or positive estimates rarely reported. After correcting for it, they put the mean short-run elasticity at about -0.09 and the long-run at about -0.31, roughly half the size of the typical published figures. A 10 percent rise in gasoline prices therefore cuts total consumption by about 1 percent in the short run.

That does not mean a single station can raise its price. Consider a composite regional fuel retailer with two stations across an intersection from a competitor. If it raises its price by 10 cents on a $3.50 gallon, about 3 percent, drivers who see both price signs simply turn into the other lot. If its volume falls by 15 percent, the station's own elasticity is about -5, highly elastic, and its revenue falls even though the market's demand is inelastic. Inelastic demand belongs to the product; elastic demand belongs to the seller who stands next to an identical one.

The practical answer to the forum question is that a retailer can earn more from inelastic market demand only when all sellers move together, as when crude oil costs rise for everyone, or when it differentiates through location, convenience or a loyalty program. The textbook's elasticity tools tell a manager which situation the firm is actually in, and a simple test, tracking volume for a week after a small price change, can measure the firm's own elasticity directly.

Reply to Simone

Simone, you described electric vehicles as substitutes for gasoline and argued that rising gas prices will push drivers toward them. I agree on the sign: by the textbook's definition, the cross-price elasticity between gasoline prices and electric vehicle demand should be positive, since a higher price of one raises demand for the other (Baye & Prince, 2017).

I would add a point about timing. Drivers do not substitute away from gasoline at the pump; they substitute when they replace a car, which happens every several years. That is one reason the long-run gasoline elasticity is several times the short-run figure. A manager at a dealership or a charging company should therefore expect a gas price spike to show up in sales over months and years, not weeks. There is a policy angle too. Federal tax credits and state rebates lower the effective price of an electric vehicle, so a cross-price effect from gasoline and an own-price effect from subsidies can arrive at the same time, which makes it hard to tell from sales data which one is doing the work. Do you think a short spike, like one caused by a refinery outage, changes car purchases at all, or does it take a lasting rise?

References

Baye, M. R., & Prince, J. T. (2017). Managerial economics and business strategy (9th ed.). McGraw-Hill Education.

Havranek, T., Irsova, Z., & Janda, K. (2012). Demand for gasoline is more price-inelastic than commonly thought. Energy Economics, 34(1), 201-207. https://doi.org/10.1016/j.eneco.2011.09.003