Post on 26-Dec-2015
Quick Quiz 27th Sept 2011
1. Define demand (1 mark)2. Illustrate the impact on demand
when there is a rise in price (4 marks)
3. Explain 2 factors that will increase demand (4 marks)
Objectives
• To understand and be able to calculate price, income and cross elasticity of demand
• Be able to evaluate the business relevance of these elasticity estimates
Price Elasticity of Demand (PED)
• Measures the responsiveness of demand for a product to a change in its price
• When demand is very responsive to changes in price it is said to be ‘price elastic’
• When demand is not very responsive to changes in price it is said to be ‘price inelastic’
Remember
• The %Δ QD is found by dividing the change in QD by the original QD
Δ QD X 100 Original QD
And Δ P is found by dividing the change in P by the original P
= %Δ QD
Example
• The price of a product rises from £20 to £24 and demand falls from 400 to 300
• The PED will be -25%/20% = -1.25
• Note PED is generally negative so for ease of comparing elasticities, economists tend to ignore the minus sign when interpreting figure
Value Description of Response
Perfectly Inelastic
PED= 0 A change in price will have no effect on QD
Inelastic 0<PED<1
The %Δ in QD is less than the %Δ in P (i.e. demand is not very responsive to changes in P)
Unitary PED=1 The %Δ in QD equals the %Δ in price
Elastic PED>1 The %Δ in QD is more than the %Δ in P (i.e. demand is very responsive to changes in P)
Perfectly Elastic
PED= ∞ A change in price will cause an infinite change in the QD
Diagrams• Perfectly Inelastic Demand- ‘for a given change in
price there will be no change in quantity demanded’
• Perfectly Elastic Demand- ‘for a given change in price there will be an infinite change in quantity demanded’
• Inelastic Demand- ‘for a given change in price there will be a proportionately smaller change in quantity demanded’
• Elastic Demand- ‘for a given change in price there will be a proportionately greater change in quantity demanded’
Different products are likely to have different elasticities of demand. The elasticity will depend on a number of factors (to follow)
Price
Quantity
QuantityInelastic
demandElastic demand
DD
Unit PED
• If price is raised by a certain percentage then the quantity demanded will fall by the same percentage
• Eg. A 10% increase in price will lead to a 10% fall in demand
• Revenue does not change as the price changes
PD
Q
A curve with unitary elasticity is a rectangular hyperbola with the formula PQ=k (k is a constant value)
The 10% Rule• Always use the 10% rule when
explaining elasticities• Eg. What does a PED of -1.9 indicate?• Demand is elastic. A change in the
price will lead to a proportionately larger change in quantity demanded. I.e. for a 10% rise in price, there will be a 19% fall in quantity demanded.
• Calculation: QD/10%= -1.9• So 10%x -1.9= QD= -19%
Activity• A firm producing decorative candles lowers
the price of one of its scented candles from £4 to £3.60 and finds that the weekly quantity demanded increases from 600 per week to 630
1. Calculate the PED for the scented candles, showing your working
2. Calculate the change in total revenue3. Illustrate the demand curve, showing the
change in revenue4. Should the firm have lowered the price of
their candles?
Activity• A pizzeria lowers the price of its most
popular takeaway pizza, the Margherita, from £5 to £4.50 and finds that the weekly quantity demanded increases from 60 to 72
1.Calculate the PED, showing your workings2.Calculate the change in total revenue3.Illustrate the demand curve, showing the
change in total revenue4.Should the firm have lowered its price?
Conclusions• If a firm has a product which is price
inelastic and it lowers it’s price it will receive a fall in total revenue, if it increases its price it will receive an increase in total revenue
• If a firm has a product which is price elastic and it lowers it’s price it will receive an increase in total revenue, if it increases it’s price it will receive a fall in total revenue.
Elasticity along a straight line
• Elasticity is not a measure of the slope of the demand curve
• For a straight line downward sloping demand curve, the value of PED falls as price falls
• Pencil, ruler and graph paper.....
Illustrate a demand curve using the following points
• Point A £20 Qty 60• Point B £18 Qty 80• Point C £10 Qty 160• Point D £8 Qty 180• Calculate the elasticity as we move from
point A to point B• Calculate the elasticity as we move from
point C to point D• What can we conclude from this?
Price Elasticity along a straight line demand curveP
D1
A
C
B
Q
At point A PED is ∞ (Q=0)
At point C PED is 0 (P=0)
At point B (exactly half way along the line) PED is 1
Factors Affecting PED
• In pairs• Think of a product which is likely to
have price inelastic demand• Why does is have price inelastic
demand?
Factors Affecting PED
• Availability of substitutes, less substitutes = more inelastic
• Time period- longer= more price elastic, habit, lack of info, durable goods purchased, l/t can change
• Necessities have a lower PED than luxuries- increase in P unlikely to reduce D
• Goods which form a relatively low proportion of total expenditure have lower elasticities than those which form a more significant proportion