AS Micro The Importance of Elasticity of Demand

AS MicroThe Importance of

Elasticity of Demand

Price Elasticity of Demand

Elasticity Matters!

What do I need to know?The definitions of each elasticityThe formula’s and be confident in using themHow to draw the diagramsThe determinants of PED and PESExamplesWhy they are important

Factors that Affect Price Elasticity

Necessity or luxury?

Availability of substitutes

Consumer income Brand loyalty

Habits Frequency of purchase

The price of a tablet computer falls from £800 to £600 and as a result, weekly sales of the tablet device expand from 100,000 to 150,000. It can be inferred that the price elasticity of demand for this price change is?

% change in demand = 50%% change in price = -25%Price elasticity of demand = 50 / -25 = -2

A mobile phone company has 3 million customers for a package of services. Each customer pays a monthly fee of £20. The company conducts market research and estimates that price elasticity of demand for this package is (-) 2. If the company reduces monthly fees by £5, the change in total revenue is likely to be:

% change in price = 25%Elasticity = 2% change in demand = 50%New demand = 4.5 million customers @ £15 = £67.5 millionChange in total revenue = + £7.5 million

A manufacturer reduces the price of its washing machines by 5% and, as a result, the volume of sales of washing machines rises by 4%. The value of price elasticity of demand for the good following this price change is?

Ped = 4% / 5% = 0.8 (demand is inelastic)

In September 2009, the London Evening Standard was charging 50p per copy and selling 250,000 copies a day. In October 2009 a new owner decided to make it a free paper and by March 2010 the Standard was selling 600,000 copies each day. Calculate the price elasticity of demand for this price change.

% change in demand = 140%% change in price = 100%Price elasticity of demand = 1.4 (i.e. Elastic)

Peak and Off-Peak Demand

Peak and Off-Peak: Price & Revenue

Price

Quantity

Price

Quantity

S1

Q1

Q1: Diagram assumes a fixed supply capacity in the market

Q1

S1

P off-peak D1


Price

Quantity

Price

Quantity

S1

Q1


Q1

S1

P off-peak D1

D2


Price

Quantity

Price

Quantity

S1

Q1


Q1

S1

P off-peak D1

D2

P peak

The case for price discounting

Dangers from discounting

Cross Price Elasticity of Demand

The price of Good X rises by 20 %. As a result, the demand for a substitute Good Y rises by 10 %. What is the cross-elasticity of demand for Good Y with respect to Good X?

Xed = % change in DX / % change in PY= +10% / +20% = +0.5I.e. X and Y are weak substitutes

Cross price elasticity

Using Cross Price Elasticity

The table below gives estimates of the price elasticity’s and cross-elasticities of demand for bus and rail travel. What would be the change in the volume of rail travel resulting from a 25% increase in bus fares?

Using Cross Price Elasticity

The table below gives estimates of the price elasticity’s and cross-elasticities of demand for bus and rail travel. What would be the change in the volume of rail travel resulting from a 25% increase in bus fares? Answer: = +4% (+0.16 x 25)

Income elasticity

Income elasticity of demand

• Normal goods – positive income elasticity• Luxury goods – income elasticity > +1• Necessities – income elasticity >0 and <+1• Inferior products – negative income elasticity• Counter cyclical goods – products whose

demand varies inversely to the macroeconomic cycle – demand rises in a downturn

Rising demand for cinema visits

And for pizza too!

Application of income elasticity

The table shows a consumer's expenditure on a range of goods at different levels of income. For which good does the consumer have an income elasticity of demand greater than zero, but less than one?

AS Micro The Importance of Elasticity of Demand

Business

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