ELASTICITY

Price Elasticity of Demand

Elasticity: a measure of the sensitivity of one variable to changes in another variable.

Elasticity = % change in dependent variable % change in independent variable

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Elasticity Quiz

Types of Elasticity• Price elasticity of demand• Income elasticity of demand• Cross elasticity of demand• Price elasticity of supply

Price Elasticity of Demand

Dependent variable = quantity demandedIndependent variable = price

Price elasticity of demand: measures the percentage change in demand for a product following a change in its price.

Ped = % change in quantity demanded % change in price PED = % Q % P

_________________

You have to Q up...

To P down…

C PED = ____0___Q_

C0 P

5 possible values for PED…

1. If % ∆ Q > % ∆ P ratio will be GREATER THAN 1 product is ELASTIC

E.g. a 20% rise in the price tomatoes (R1 - R1.20) leads to a larger fall in quantity demanded from 150 units to 100 (50%)

Calculate the PED…

2. If % ∆ Q < % ∆ P ratio will be LESS THAN 1 product is INELASTIC

E.g. a 50% rise in price from R10 to R15 leads to a smaller fall in sales (demand) form 100 units to 80 (20%).

Calculate the PED…

3. If % ∆ Q = % ∆ P ratio will be EQUAL TO 1 product is UNIT ELASTIC

E.g. price increases by 50%, demand decreases by 50%.

Calculate the PED…

4. If PED = 0 Change in price has no effect

Perfectly Inelastic

Demand curve will be ___________

5. If PED = ∞ Rise in price will cause demand to fall

to 0

Perfectly Elastic

Demand curve will be ___________

SUMMARY

• Perfectly inelastic = 0• Inelastic = from 0 - < 1 • Unitary elastic = 1• Elastic = >1• Perfectly elastic = ∞

What Determines Price Elasticity of Demand?

Number of close substitutes

2. Uniqueness of the product

My hockey shirt vs. my brother’s hockey shirt!

3. Degree of complementarity of a good/serviceComplementary goods tend to have a low PED

IPhones ITunesGames consoles GamesGolf clubs Golf ballsCars Car parts

4. The cost of switching between different products 24 month contracts

5. Luxury or necessity

6. The time period allowed following a price change

Petrol price increase very inelastic in ST

LT – people switch to fuel efficient/electric cars – demand becomes more elastic.

Impulse buys very inelastic

7. The % of a consumer’s income allocated to spending on the good

8. Habit forming goods

9. Peak and off-peak demand

• Cell phones call charges• Rail/airfares (school holidays)• Internet charges

10. Advertising and brand loyalty

Price elasticity of demand and total revenue for a producer

Change in the market What happens to total revenue?

Ped is inelastic and a firm raises its price. Total revenue ________

Ped is elastic and a firm lowers its price. Total revenue ________

Ped is elastic and a firm raises its price. Total revenue ________

Ped is 1.5 and the firm raises its price by 4% Total revenue ________

Ped is 0.4 and the firm raises its price by 30% Total revenue ________

Ped is 0.2 and the firm lowers its price by 20% Total revenue ________

Ped is 4.0 and the firm lowers its price by 15% Total revenue ________

Changing elasticities along a demand curve