Transcript Price elasticity of demand

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)
Elasticity of Demand
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’
Calculating PED
PED =
% ∆ QD
%∆P
Remember
• The %Δ QD is found by dividing the
change in QD by the original QD
Δ QD X 100
Original QD
=
%Δ QD
And Δ P is found by dividing the change in P
by the original P
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
Perfectly
Inelastic
Inelastic
Unitary
Elastic
Perfectly
Elastic
Description of Response
A change in price will have no effect
on QD
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)
PED=1 The %Δ in QD equals the %Δ in price
PED= 0
The %Δ in QD is more than the %Δ in
P (i.e. demand is very responsive to
changes in P)
PED= ∞ A change in price will cause an infinite
change in the QD
PED>1
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’
•
D
P
P
D
Q
Perfectly Inelastic
Perfectly Elastic
Q
Different products are likely to have
different elasticities of demand. The
elasticity will depend on a number of factors
(to follow)
Price
D
Inelastic demand
D
Quantity
Quantity
Elastic demand
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
P
D
A curve with unitary
elasticity is a rectangular
hyperbola with the formula
PQ=k (k is a constant value)
Q
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%
•
•
•
•
•
What about these ones?
PED= -0.7
PED= -1.3
PED=-2
PED=-1
Short Activity on PED
PED and Revenue
Total Revenue
• TR= Price x no. of units sold
• Complete the next activity- PED and
Revenue
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 revenue
3. Illustrate the demand curve, showing the
change in revenue
4. 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 workings
2.Calculate the change in total revenue
3.Illustrate the demand curve, showing the
change in total revenue
4.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?
•
•
•
•
•
P
Price Elasticity along a straight line
demand curve
A
B
D1
C
Q
P
Price Elasticity along a straight line
demand curve
At point A PED is ∞ (Q=0)
A
At point C PED is 0 (P=0)
B
At point B (exactly half way
along the line) PED is 1
D1
C
Q
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
Questions
• Answer questions on sheet
• PED WORKSHEET