Transcript Price elasticity of demand

ELASTICITY
It measures the degree of
responsiveness of quantity demanded
due to a change in a specific factor that
affects demand.
http://www.youtube.com/watch?v=dY046bTDD1U&feature=related Inelastic
http://www.youtube.com/watch?v=jADzbRKIa_U Elastic (Just at the end of the episode)
Price elasticity of demand
• It measures the extent to which demand for a
product changes due to a change in its price.
Price inelastic
Customers are not responsive to changes in price
Essential
Price elastic
Customers are highly responsive to changes in
price.
Price elastic or inelastic?
Price elastic or inelastic?
Inelastic
Elastic/Inelastic
Elastic
Inelastic
> 1 (ignoring the
minus sign)
<1 (ignoring the
minus sign)
<1 (ignoring the
minus sign)
Unitary price elasticity
Change in price leads to a proportional change in
the quantity demanded
= 1 (ignoring the
minus sign)
Example:
we increase the price of ice cream from USD1 to
USD1.05. Because of increased price we used
to sell 200 ice creams a day, now we sell 190
ice-creams a day....
Implications and uses of price elasticity of
demand
• Decide on pricing policy. Ex: Price inelastic
demand = It’s likely to raise price
• Luxury products= High PED. They tend to
suffer the most during recession (Elastic)
• Helps government to determine the optimum
level of taxes (Price inelastic products). Ex:
Petrol and cigarettes.
• Exporters will generally benefit from lower
exchange rate. Assuming PED for exports is
Price elastic
Factors affecting price elasticity of
demand
• Substitution: number and availability of
substitutes, PED (Elastic), people can buy to
another place because there are a lot of
competitors.
• Income: incomes, less sensitive to changes in
price (Inelastic)
• Durability: More durable a product is, Price
elasticity of demand (Elastic). Customers may try
their possessions last a little longer if price of
durable products is on the rise.
• Time: Ex: Parents with children in private
education are unlikely to withdraw their
offspring from school. This could be disruptive
to their learning. (Inelastic)
• Fashion, addictions, habits and tastes:
• Necessity
Income elasticity of demand
• It measures the degree of responsiveness of
demand for a product following a change in
the income level.
Nappies
Water
Giffen goods – A special case of Inferior goods.
Advertising elasticity of demand
• It measures the degree of responsiveness of
demand for a product following a change in
the advertising expenditure for that product.
Billboards
Cross-price elasticity of demand
Complements
A fall in the price of computers, perhaps due to
advances in production technologies, has led an
expansion in their demand. This then leads to an
increase in the demand for computer software
products
Examples of complement products
1)
2)
3)
4)
5)
Hamburger and catsup
DVD players and DVDs
Boots and laces
Torch and battery
Toothbrushes and toothpaste
Substitutes
A fall in the supply of strawberries, perhaps due to a poor harvest,
has caused an increase in its price and reduced the quantity
demanded. The higher price in strawberries has subsequently
caused an increase in the demand for bananas
Examples of substitutes
1) Eyeglasses and contact lens= Imperfect
substitute
2) Pepsi and Coca Cola= Perfect substitute
3) Gasoline for cars and prefer taking a bus to
save money
4) Paper bags and plastic
5) Coffee and tea
• Higher value of CED, more customers see the
products as being close substitutes.
Business case No. 1
Toshiba is one of the world´s manufacturers of flash
memory chips used in mobile phones, digital cameras
and digital players. In April 2007, the Japanese
electronics giant announced that its profits increased
by almost 76% despite a fall in the price of memory
chips by some 60%. Prices of memory chips are
expected to fall even further as competition intensifies.
a) Comment on the price elasticity of demand for
Toshiba memory chips
a) To what extent does knowledge of price elasticity of
demand prove useful for firms, such as Toshiba, that
face intense competition?
Business case No. 2
Cross-price elasticity of demand
Explain how the demand for supermarket ownlabel cola would change in each of the following
situations:
a) The price of Coca-Cola falls dramatically due
to a special promotion.
b) The price of supermarket own-label cola is
affected by an increase in its production
costs.
c) A government advertising campaign warns of
tooth decay caused by drinking fizzy drinks.
Answer
Business Case No. 3
It is common knowledge that the Price of a concert
ticket keeps going up. Madonna fans in the UK paid
between $160 and $320. The public opinion was split;
some thought the prices were outrage whilst others
thought it represented good entertainment value.
Changes in market forces have meant that rock and pop
stars can make huge amounts of money from each
concert they do. Madonna´s 2004 Re-invention tour
grossed $125 million worldwide, more than any other
artist that year. Some analysts argue that music artists
have been forced into doing concerts to combat the
decline in their potential earnings caused by people
illegally downloading music from the internet.
Questions
a) Define market forces
b) Outline two reasons why music fans might
be prepared to pay such high prices for concert
tickets
c) Justify whether you feel that concert tickets
are relatively price elastic or price inelastic
Answers
Checking
• http://en.wikipedia.org/wiki/Giffen_good
• https://athene.umb.no/emner/pub/ECN111/
Ovingsoppgaver/ECN111_P_4_F.htm
• http://highered.mcgrawhill.com/sites/0070901651/student_view0/ch
apter6/practice_exercise.html
• http://en.wikipedia.org/wiki/Engel's_law