Question

Instacart is a Web-based firm that offers home delivery of groceries. It buys the groceries in regular brick-and-mortar supermarkets, marks up the prices it pays, and then charges consumers the higher prices in exchange for making home deliveries. According to an article in the Wall Street Journal, Instacart marks up the price of potato chips by 26 percent, but it marks up the price of eggs by only 2.5 percent. Is it likely that Instacart believes that the demand for potato chips is more elastic or less elastic than the demand for eggs? Briefly explain.

Short answer

Instacart likely believes the demand for potato chips is more inelastic (less elastic) than the demand for eggs. This is reflected in their pricing strategy, marking up the price of potato chips higher than the price of eggs, because consumers are less responsive to price increases for potato chips than for eggs.

Step-by-step solution

Interpret the mark-up rates

Instacart marks up the price of potato chips by 26 percent and the price of eggs by only 2.5 percent. This means they charge a significantly higher price than what they pay for potato chips compared to eggs.

Understanding Price Elasticity of Demand

Price elasticity of demand is the percentage change in quantity demanded divided by the percentage change in price. It measures how responsive demand is to price changes. If demand is elastic, a small change in price will lead to a large change in quantity demanded. If it's inelastic, quantity demanded is not very responsive to price changes.

Applying Price Elasticity of Demand to the case

Instacart likely believes the demand for potato chips is more inelastic (less elastic) than the demand for eggs. When the demand is inelastic, consumers tend not to reduce their quantity demanded significantly even when the price increases, which is why Instacart can afford a higher mark-up on potato chips. On the other hand, marking up the price of eggs by only 2.5 percent suggests Instacart believes the demand for eggs is more elastic and consumers would reduce their quantity demanded significantly if prices increased substantially.

Key concepts

Elastic Demand

When discussing elastic demand, we're looking at how a product's quantity demanded changes in response to price changes. Elastic demand occurs when the percentage change in quantity demanded is greater than the percentage change in price. This means that consumers are very sensitive to price changes. If the price goes up, they'll significantly reduce their purchases; conversely, if the price drops, they'll likely buy much more.

Products with elastic demand tend to be those that aren't essential or have many substitutes available. For example, if a particular brand of cookies becomes more expensive, consumers can easily switch to another brand or simply forgo cookies altogether. This sensitivity forces businesses to be more cautious with pricing as large price increases could dramatically decrease sales.

Inelastic Demand

Inelastic demand refers to a situation where the quantity demanded doesn't respond significantly to price changes. In other words, the percentage change in quantity demanded is less than the percentage change in price. Consumers may consider these products as necessities or they might have fewer substitutes readily available.

For instance, gasoline for cars is often considered as having inelastic demand because people need to refuel their vehicles regardless of modest price fluctuations. Products with inelastic demand give sellers like Instacart more leeway to raise prices since consumers will still tend to make purchases despite price increases. This kind of demand is a central concept in determining pricing strategies for companies across various industries.

Quantity Demanded

The quantity demanded is the total amount of a good or service that consumers are willing and able to purchase at a given price, within a specific period. It is different from 'demand', which refers to the entire relationship between prices and the quantity consumers are willing to buy across a range of prices.

Changes in the quantity demanded are represented as movements along a demand curve due to a price change. If the price of a product drops, the quantity demanded typically increases and vice versa. However, it's critical to note that the quantity demanded can be influenced by other factors as well, such as changes in tastes, incomes, the prices of other goods, and expectations of future price changes.

Percentage Change in Price

The percentage change in price is a measure of how much the price of a product or service changes, expressed as a percentage. It's calculated by taking the difference between the new price and the original price, dividing that by the original price, and then multiplying by 100. In simpler terms, it's the proportion of price change relative to the original price.

In terms of economic analysis, this calculation is essential when examining the price elasticity of demand. By understanding this percentage, businesses can predict how changes in their pricing might affect demand for their products. For example, if a company realizes that their product has very elastic demand, even a small percentage increase in the price may lead to a large decline in quantity demanded, potentially hurting their overall revenue.