Economics Cases

Eslsca MBA : Summer 2015 - Intake 48

Presents to: Prof./ Ahmed Mabrouk
By
Mohamed Abdel Rahman Moussa
&
Mohamed Saad Metwaly Eltahan
Water Case:

(a) How do you expect the price-elasticity of the demand for water to vary
with the total annual consumption of the household?

The estimated range of price elasticity of demand for water is -0.20 to -0.40.
This means that the elasticity of demand is inelastic. Thus percentage change in
The quantity demanded is less than the percentage change in the price.
To know how it will vary we have to consider the factors that influence the
elasticity of Demand.
 Type of the product, in the water case it is a necessity.
 The closeness of substitutes; the water doesn’t have any substitutes.
 Proportion of income spent on the Good; here a variance can appear between
poor and rich families.
 The time elapsed since the price has changed.
Therefore any change in the price will cause a change in the demand with a lower
rate. It will have very insignificant in the total consumption of the household.

(b) Who benefit relatively more from a flat fee? Poor or rich
households?

I think this depends on how the flat fee is calculated. In most of cases it is
according to the size of the home and its place. It also depends on the
consumption. Also considering the report conducted by environment Canada,
that consumption was 70% higher among users subject to flat fees as compared
to those subject to volume based rates. Considering these three factors together,
I think the poor will benefit more from the flat fee structure than the rich. For the
following reasons:

 Poor families will not be charged a high rate of flat fee as their houses are
 Small and not in expensive areas.
 The average and necessary consumption for water among different
 Families with the same number of family members are almost equal;
  Whether among poor or rich.
According to the research conducted, it is about the excess consumption,
not in the necessary usages, and in the case of the poor families, they will
use it or benefit from it without paying any extra money. As for values
versus money from the poor families’ point of view they are getting value
more than the money they are paying. And actually more than what they
can afford to pay. While for the rich, they can afford to pay be metering
and its will not be a big portion of their income.

(c) Considering that a large proportion of residential users face a flat

fee or even decreasing unit prices, do you think that the price
elasticity of residential demand is under or over estimated?

The price elasticity of water is definitely inelastic, for the reasons discussed
above; however it can be overestimated, as the price has insignificant weight in
changing the demand; specially when facing a flat fee, and the change in the
price will lead to insignificant change in the consumption.

(d) What are the implications of your answer in (c) for raising the
prices as conservation policy?

Based on the answer of question C, raising the price will lead to a decrease in
the consumption with a lower rate. However it will increase the total revenues
for the water company. Here are some suggestions for conservation the water:

 Replacing the flat fee with metering based on the real consumption.
 As the water company is a monopoly; it can practice price
 discrimination between household and the business usages.
 Awareness marketing campaigns; to tell the people, whether poor or
 rich, the importance of regulating the consumption.
Star Hub Case:

A. Identify changes in demand and costs (fixed and marginal costs

relative to the number of subscribers) arising from StarHub’s
acquisition of the EPL rights.

The demand for Star Hub cable TV raised as the subscriber base has shown an
increase by 4% and reached to 504,000 customers at the end of December 2007.
Hence, it leads to rise in the revenue of the Star Hub by 9% due to rise in
the number of its subscribers.
The fixed cost relative to the number of subscribers would be US$160 Million
which was paid by Star Hub initially to win the bid to broadcast EPL for
Singapore. Since the number of subscribers in the end of 2007 reached to
504,000, therefore fixed cost per subscriber would be around $3.17.
The marginal cost would be the additional cost incurred due to the payment of
Royalty to the content providers such as ESPN, Discovery Travel .. based on the
number of subscribers to the content. It is expected to have a decrease in the
number of ESPN subscribers due to Star Hub’s acquisition of the EPL rights. It
is also possible to have an increase in the number of other channels’ subscribers
due to the total increase in Star Hub customers.

B. Which of the changes in (a) would be relevant to Star Hub’s pricing

of cable TV services?

The increase in fixed costs and the increase in demand (which may lead to
increase in marginal cost for the royalty paid to channels other than ESPN) are
the most important factors in determining the pricing decision of StarHub’s
cable TV. The cable operator may have to raise its prices in order to maximize
the profits as it is the only cable operator in Singapore. That is why, after
acquiring the English Premier Rights, it raised the price of basic packages by $4
to $24 a month with effect from July 11 and the price of the sports package by
$10 to $25 a month, with effect from October.
C. Do you think that, prior to the 2007 price increases, Star Hub’s
prices had maximized profits?

Prior to the 2007 price increases, Star Hub reduced the prices of basic packages
to $20 a month in 2001. Also, the operator unbundled the TV package into
thematic basic packages and new channels were being added in the thematic
basic package. But still Star Hub did not increase its basic package prices even if
its marginal cost increased due to additional royalty payment to the additional
channels like CCTV-9, Discovery Travel & Living and STAR Chinese Channel.
But sometime, it also increased prices for sports package in 2004, where there is
increase in marginal cost due to royalty paid to ESPN per subscriber.
Hence, Star Hub profit maximization will depend on the effects of decrease in
basic package prices and increase in sports package prices with relation to number
of subscribers to each package, and if these effects caused marginal revenue to
equal marginal cost or not.
D. From the view point of a content provider like ESPN which
receives a per- customer royalty from a cable TV operator, explain
the moral hazard to which the cable TV operator is subject.

Moral Hazard problem occurs in situations where one party is ready to take
more risk as the burden of that risk falls on the other party. In the above case,
the moral hazard problem would be faced by the cable TV operator because
ESPN is sponsored by the cable TV operator by paying the channel per
customer royalty. Therefore, in case if there is any problem faced by the viewers
of ESPN channel, then it would be the responsibility of the cable TV operator
to resolve that issue as customers would complain to the cable TV operators
only and not to the ESPN channel provider.

E. From the viewpoint of EPL, explain how a lump-sum bid would

resolve asymmetry of information between EPL and cable TV
operators.

Usually asymmetry of information arises when one party has better or more
timely information than the other party in a transaction.
In the above case, asymmetry of information between EPL and cable TV
operators arises because cable TV operators were under impression of higher
profits to be earned once they win the bid but sametime the exact number of
current and expected cable TV operators subscribers is unknown for EPL
during the transaction, which makes the monthly or annualy royalty fee risky for
EPL.
Also, Star Hub is able to create an EPL monopoly in Singapore after the bid as
the only cable operator, and EPL has a lack of information during transaction
about the way Star Hub will control the issue and the possible changes in cable
TV operators in Singapore in the near future.
So from the viewpoint of EPL, the agreed on huge lump-sum bid helped EPL to
solve that asymmetry and have a good profit ahead.
At the same time, Star Hub made a very smart move by unbundling the entire
cable package into sports and basic package so that higher prices would be paid
by only the sports lovers. Therefore, rise in the prices of sports channel will not
lead to fall in the total revenue as the price elasticity of demand of sports
channel will be very low. Winning the bid allowed Star hub to create market
power so that it would be able to earn higher profits at the same marginal cost.

Electricity Case:

1. Explain how the impact of a price increase on electricity consumption

depends on the price elasticity of demand?

Electricity Consumption & Elastic Demand

In the case of elastic demand, an increase in the price of electricity would cause
quantity demanded to fall by a greater percentage than the percent increase in
price.
The implication here is that a price increase of electricity would reduce shortage
issues.

Electricity Consumption & Inelastic Demand

Since the electricity market actually has inelastic demand, an increase in the price
of electricity would result in a proportionately smaller decrease in the quantity
demanded
The implication here is that a price increase for electricity would result in higher
total expenditures on electricity. Quantity demanded would not decrease
enough to reduce shortage issues.
The degree to which quantity demanded changes with changes in price,
depends on
the price elasticity of demand .

2. The price elasticity of the Indian demand for electricity has been
estimated to be -0.65 among residential users and -0.45 among
industrial users. If these elasticity apply to China as well, how will
the impact of a price increase be spread between residential as
compared with industrial users?

Industrial users are less likely to change their electricity usage than residential
users.
Industrial users would bear more of the burden of a price increase due to their
lower price elasticity (their total expenditure would increase more than that of
residential users)

3. Many Chinese organizations ignore the market system. For

instance, they borrow money from banks and refuse to repay, thus
creating “bad debts” for lenders. Likewise, they might consume
electricity without bothering topay the power supplier. Do such
organizations cause the demand for electricity to be more or less
price elastic?

When organizations refuse to pay loans or their power bills, this will cause theprice
elasticity of demand for electricity to be less elastic.

4. a-How does the contract price of thermal coal affect an electric

power plant's marginal cost?

When contract prices are set for thermal coal, then the variable costs for the
electric power plants will decrease. This is because thermal coal is an input in
producing electricity then, the marginal cost will decrease with contract pricing
because decreased input costs will result in lower TC.

b-If the contract price were raised to 99% of the spot market price,
how would that affect the electric power plant’s?

If the contract price for thermal coal increases to 99% of the market price, then
the marginal cost of electricity production would increase. This would shift the
power plant's supply curve to the left.
Using marginal cost pricing, the government would need to increase the price to
equal the new marginal cost and avoid a power shortage.
Marginal cost pricing: the policy in which the price is set equal to the marginal
cost and the provider must supply the quantity demanded.