Question

The price elasticity of the demand for gasoline is \(-0.02\). The price elasticity of demand for gasoline at Joe's 66 station is \(-1.2\). Explain what might account for the different elasticities.

Short answer

Answer: The general price elasticity of demand for gasoline (-0.02) indicates that it is inelastic, meaning that changes in price have a small effect on the quantity demanded. On the other hand, the price elasticity of demand for gasoline at Joe's 66 station (-1.2) is elastic, indicating that changes in price significantly affect the quantity demanded. Factors that might account for the difference in elasticities include location (proximity to other competitive gas stations), substitutes (availability of alternative transportation), competition, and customer preferences (price sensitivity).

Step-by-step solution

Understanding Price Elasticity of Demand

Price elasticity of demand measures the responsiveness of quantity demanded to a change in the price of a good or service. It is calculated as the percentage change in quantity demanded divided by the percentage change in price. A good with a high price elasticity is considered to be elastic, meaning that its quantity demanded will change significantly with a change in price, while a good with a low price elasticity is considered inelastic, meaning that its quantity demanded will change only slightly with a price change.

Understanding the Price Elasticity of Demand for Gasoline in General (-0.02)

The price elasticity of demand for gasoline being -0.02 indicates that it is inelastic. This means that a change in the price of gasoline will not have a large effect on the overall quantity demanded for gasoline. It could be that gasoline is regarded as a necessity, and consumers are willing to pay almost any price to maintain their lifestyle and transportation needs.

Understanding the Price Elasticity of Demand for Gasoline at Joe's 66 Station (-1.2)

At Joe's 66 station, the price elasticity of demand for gasoline is -1.2, which indicates that it is elastic. This means that a change in price at Joe's 66 station has a significant impact on the quantity demanded of gasoline at that specific station. This could be due to various factors specific to Joe's 66 station, such as its location, the availability of substitute products (like alternative fuel or public transport), or competition.

Factors That Might Account for the Different Elasticities

Several factors could account for the difference in the price elasticities of demand for gasoline in general and at Joe's 66 station: 1. Location: Joe's 66 station might be situated among other gas stations with competitive pricing. As a result, consumers may have more options and might be more willing to change their buying habits based on price changes. 2. Substitutes: If Joe's 66 station is in an area with many alternative means of transportation (public transport, electric car charging stations, or bike lanes), consumers could be more sensitive to the price of gasoline and might be more likely to switch to these alternative modes when gasoline prices increase. 3. Competition: Joe's 66 station could face more competition from other gas stations, making consumers more responsive to changes in price. 4. Customer preferences: Consumers around Joe's 66 station may be more price-sensitive, meaning that a small price change can lead to more significant changes in customers’ buying behavior.

Key concepts

Inelastic Demand

Inelastic demand occurs when the quantity demanded of a good or service does not change significantly in response to price changes. This concept is crucial in understanding consumer behavior for products and services that are essential or have few substitutes. For example, in the case of gasoline, the general price elasticity is (-0.02), indicating that its demand is inelastic. Most consumers need gasoline for their daily activities, such as commuting to work or school, and will not drastically reduce consumption if prices rise.

When analyzing inelastic demand, it is important to consider the nature of the product: Is it a necessity or a luxury? How available are the substitutes? These questions help explain why, despite price increases, demand may remain relatively stable, with consumers continuing to buy close to the same amount as before.

Elastic Demand

Contrasting with inelastic demand, elastic demand is when the quantity demanded for a good or service is highly responsive to changes in its price. A perfect example can be observed at Joe's 66 gas station, where the price elasticity of demand is (-1.2), suggesting that consumers are very sensitive to price changes.

This elasticity implies that even a slight decrease in price could significantly increase the quantity of gasoline sold, whereas a slight increase in price could cause a substantial decline in sales. Demand elasticity can vary greatly from one location to another and can be influenced by a variety of factors, which are vital to consider when businesses are setting their prices or when economists are evaluating the potential impact of market changes.

Factors Affecting Elasticity

The degree of elasticity of demand for a product can be influenced by various factors. It's essential to know these factors to understand how sensitive consumers might be to changes in price.

• Availability of Substitutes: The more substitutes available, the more likely it is that demand will be elastic.
• Necessity vs Luxury: Typically, necessities have inelastic demand, while luxuries have more elastic demand.
• Proportion of Income: Goods that consume a larger portion of a consumer's income are usually more elastic in demand.
• Time: Over time, consumers may find alternatives or adjust their habits, usually leading to greater elasticity.
• Brand Loyalty: Strong brand loyalty can make demand for a product more inelastic, as consumers may be less responsive to price changes.

Knowing these factors helps explain why the demand for gasoline at Joe's 66 station is more elastic compared to the general demand for gasoline. Specific situations and competitive dynamics can greatly influence how responsive consumers are to price changes.

Substitute Goods

Substitute goods are products or services that can be used in place of one another. When substitutes are readily available, consumers can easily switch from one product to another in response to price changes, thereby increasing the price elasticity of demand. In the scenario of Joe's 66 station, alternative forms of transportation such as public buses, electric vehicle charging stations, or even bicycles serve as substitutes for gasoline-powered transportation.

As consumers become more aware of these alternatives, or if such alternatives become more convenient or cost-effective, the demand for gasoline at Joe's 66 station becomes more elastic. The presence of close substitutes is a critical factor that businesses must consider when evaluating the potential success of their pricing strategies and the vulnerability to competitor actions.