Question

How price elastic/inelastic might the demand curve for Starbucks coffee be? Give your reasoning

Answer 1

Price elasticity of demand (e_p) refers to the degree of responsiveness by change in quantity demanded due to change in price of the commodity. Formula wise, it is given as:

e_p = % change in Quantity Demanded / % change in price.

Elasticity varies from minus 0 to infinity and we say that demand is:

1. relatively elastic if |e_p| > 1
2. relatively inelastic if |e_p| < 1
3. unitary elastic if |e_p| = 1

Starbucks coffee is a hot favourite among the young and old alike. A steaming cuppa or a frothy chilled shake can surely make ones troubles temporarily vanish. But generally, Starbucks coffee is not a necessity when it comes to consumption. A necessity can be defined as something which is important for existence. If a large (or Venti as they call it) cup of Starbucks coffee were previously priced at an average of $4.50 and suddenly increases to $7.00 per cup, there will be tremendous fall in demand. This can be explained with the help of the following reason:

• Nature of the Commodity: Firstly, since Starbucks coffee isn’t important for one’s very existence (it’s not like somebody dies if denied a cup of Starbucks coffee), people who find it difficult to afford the expensive coffee will just opt out of the Starbucks demand market. This means that they stop demanding for Starbucks coffee and demand drops. Thus, price elasticity of demand for Starbucks coffee is relatively elastic.
• Availability of Substitutes: Secondly, Starbucks has a number of competitors offering close substitutes of the product. If coffee is very important for someone (relative to a person’s taste and preference) then he or she will simply walk out of Starbucks and head to one of its competitors to grab a cup of coffee at a lower price. Thus, price elasticity of demand for Starbucks coffee is relatively elastic. Had Starbucks been a monopoly in the coffee industry, there wouldn’t have been close substitutes than consumers wouldn’t leave Starbucks so easily.
• Income Level: Another very important determinant is the income level. People who are very rich do not really care whether the coffee prices increases to $7.00 or $70.00. If their preferences call for it, they’ll keep consuming Starbucks coffee anyway, But for low or middle income consumers, even a slight price change matters and those consumers search for satisfying the same utility at lower prices. Thus there will be a major drop in low to middle income consumers. Here the elasticities differ for the two income groups. For the rich, price elasticity of demand is relatively inelastic as there is not much change in quantity demanded due to change in price. But for low to middle income consumers, demand is relatively elastic as demand drops sharply with an increase in price.
• Number of Uses: Had Starbucks coffee had more number of uses than just one, then the demand would not have dropped as much. Even if the price increased, the commodity could be put to other uses and one would receive value for money. But since Starbucks coffee is just meant for consumption as a beverage, demand declines sharply as price increases.
• Habits of consumers: This is one factor that will try going against rational decisions of consumers. Rationally, when price increases, demand should fall. But if there are consumers who are too loyal to Starbucks and it’s a habit for them to consume Starbucks coffee, then demand will be relatively inelastic and wouldn’t drop much with increase in price.

Therefore in conclusion, GENERALLY the price elasticity of demand for Starbucks is relatively elastic with a flatter downward sloping demand curve. But, there can be a few exceptions (High Income, Habits) for which the price elasticity of demand for Starbucks can also be relatively inelastic, with a steeper downward sloping demand curve.