This document discusses demand, supply, and elasticity. It specifically discusses: - The law of demand and factors that influence demand elasticity like substitutes and proportion of income spent. - Starbucks as an example company, discussing their global presence and a past price increase decision. - Formal analysis of why increasing prices for inelastic goods can increase profits. - Application to fertilizer markets - demand is increasing due to population and biofuel growth, while supply is inelastic, causing price increases that ultimately raise food prices too.

2.  Demand: Desire for good or a service
backed by ability and willingness to pay.
 The Law of Demand-
Quantity demanded ∞ 1
Price of good
 Ed= %Change in quantity demanded
%Change in price of good

3.  Number of uses of commodity
 Number and closeness of substitutes for
the commodity
 Time-period of price change
 Proportion of income spent on the
commodity

4.  An American coffee company based
in Seattle, Washington.
 Founded in 1971, Starbucks is now the
largest coffeehouse company in the world.
 22766 stores in 65 countries and
territories:12802 in the USA, 1930 in
China, 1409 in Canada, 1121 in Japan and
825 in the UK.
Source: www.wikipedia.org

5. Drink prices increased by nearly 8%.
Did this just when customers were cutting
back on their Starbucks trips and switched
to cheaper alternatives.
Businesses can’t make decisions based on
hunch, gut feel, latest management fad, or
so called conventional wisdom.
Decisions need to be based on data and
analysis.
Source: www.iterativepath.wordpress.com

6. Despite some customers being price
sensitive, there were some loyal
customers who were price insensitive.
Thus there were customers who were
inelastic to the price change and thus more
revenue could be generated from these
customers.
A formal proof on why increasing prices
yields better profits.

7. 44% gross margin on their premium drinks.
Retailed for $3.75 → New price=$4.05
Profit per cup =$1.78
If sales fall by ΔN cups, then
lost profit =1.78ΔN
If N units sold initially.
Increase in profit from 30 cent price
increase is 0.3N.
Source : GAAP statements

8. Net loss only if 1.78ΔN>0.3N
Sales has to fall by 17% from its current
levels.
For the price increase to be unprofitable,
price elasticity of demand must be just
over 2.
Price sensitivity is most likely to be lower
than 17% as premium drinks moved to
inelastic part of the demand curve.

9. Supply - providing various goods and
services by firms and companies.
Quantity supplied ∞ Price of good
Elasticity of supply:
%Change in quantity produced
%Change in price of good

10.  Demand for food and biofuels constantly
increasing.
 Results in the increase in demand for
fertilisers for crop growth.
 Reasons:
-Population growth
-Shrinking world grain stocks
-Appetite for corn
-Palm oil to make biofuel
-Growing demand for food especially meat

11. The fertilizer mines and factories are
having trouble keeping up.
The supply of fertilizer is inelastic.
The more inelastic supply, the faster prices
rise when demand increases.

12.  Not enough substitutes
 Environmental issues
-Causes depletion of fossil fuel
resources
-Water pollution due to nitrogen release
-Dangerous to marine life

13. Fertilizer is an input into food production.
As fertilizer prices rise
→ the supply of food decreases
→ less food availability
→ higher food prices.
→Lead to a search for substitutes to
fertilizer.