Transcript Price-Elasticity-of

Imagine the price of all the items below
has doubled? What will happen to demand?
Theme 1: Introduction to markets
and market failure
In this theme, students will consider how markets work, looking at how supply and demand interact to allocate
resources in local, national and international markets. They will learn how to apply supply and demand analysis to realworld situations and be able to offer explanations of consumer behaviour. This will involve looking at both how
consumers act in a rational way to maximise utility and how
firms maximise profit, but also why consumers may not behave rationally.
1.2 How markets work
Subject content
1.2.3 Price, income and cross elasticities of demand
What students
need to learn:
a) Understanding of price, income and cross elasticities of
demand
b) Use formulae to calculate price, income and cross
elasticities of demand
c) Interpret numerical values of:
o price elasticity of demand: unitary elastic, perfectly and relatively elastic, and perfectly
and relatively inelastic o income elasticity of demand: inferior, normal and luxury goods;
relatively elastic and relatively inelastic o cross elasticity of demand: substitutes,
complementary and unrelated goods
d) The factors influencing elasticities of demand
e) The significance of elasticities of demand to firms and government in terms of:
o the imposition of indirect taxes and subsidies
o changes in real income
o changes in the prices of substitute and
complementary goods
f) The relationship between price elasticity of demand and
total revenue (including calculation)
Price elasticity of demand
The responsiveness of demand
to a change in price.
Calculated by:
% change in quantity demanded
% change in price
Key terms:
• Price inelastic demand: The demand
for a product changes relatively less
than the change in price
• Price elastic demand: The demand for
a product changes relatively more than
the change in price
Calculate PED up to 2 decimal places
a)
A fall in price from £10 to £6 causes demand to extend from 100 to 150
b)
A rise in price from 90p to £1.20 results in a contraction in demand from 300 to 200
c)
The price of a product increases from £8 to £9, which causes demand to contract from 800
to 200
d)
A cut in price from 48 Euros to 36 Euros causes demand to rise from 200 to 210
e)
Demand extended from 2580 to 3120 whenp rice falls from £12 to £9.
f)
Demand contracts from 19,000 to 10,000 when price rises from 65p to 75p
Price Inelastic Demand
P
Relatively Inelastic Demand
P1
-a large price change results
in only a small change in Qd
P0
D
Q1
Q0
Q
Price Elastic Demand
P
Relatively Elastic Demand
- a small price change results
in a large change in Qd
P1
P0
D
Q1
Q0
Q
Elastic
£45
-2 = %∆Q/ -10%
-2 x -10 = 20%
600
600 x £45 = £27,000
Previously
£50 x 500 =
£25,000
R = PxQ
Now
£45 x 600 = £27,000
-2 = %∆Q/ +5%
-2 x 5% = -10%
Change in Quantity = -10%
New Quantity = 450
Revenue = 450 x 52.50 =
£23,625
Perfectly Price Inelastic Demand
P
Perfectly Inelastic Demand
P1
-any price change does not
change quantity demanded
- PED = 0
P0
D
Q1
Q0
Q
Perfectly Price Elastic Demand
P
Perfectly Elastic Demand
- infinite demand at one market
price
P1
P0
D
P2
- any price change results in no
demand at all
- PED = ∞
Q
Q
Q
EXERCISE
1a) When prices for Blue Jeans increase by 5%, the quantity of Blue Jeans that are
demanded decrease by 2.5%. What is the price elasticity of demand for Blue Jeans?
1b) Are Blue Jeans relatively elastic or relatively inelastic in relation to price?
2a) When prices for Sailboats increase by 6%, the quantity of sailboats demanded
decreases by 12%. What is the price elasticity of demand for Sailboats?
2b) Are Sailboats relatively elastic or relatively inelastic in relation to price?
3a) When prices for fresh water increase by 5%, the demand does not change. In this
situation, what would be the price elasticity of demand for water?
3b) Does this make Water perfectly inelastic or perfectly elastic?
4a)When Petrol Prices rise from £0.75/litre to £0.80/litre, demand for petrol does not
appear to decrease. In this situation, is Petrol perfectly elastic or perfectly inelastic?
PED changes along demand
At small Qd, PED will be higher
P
At large Qd, PED will be lower
Elastic
Somewhere in the middle, PED = 1
Unitary Elasticity
(PED = 1)
Inelastic
D
Q
Assess the factors that influences PED?
Necessity
Habit
Availability of
substitutes
Brand loyalty
Proportion of
income spent
on a product
Income of
consumer
Inelastic or elastic?
• Toothpaste
• Champagne
• Cut flowers
• Bandages
• One brand of ground pepper
A little case study…
• A UK travel agent specialises in holidays to
Spain, Greece and China. It estimates that it
faces the following price elasticities of demand
for these holidays:
Spain: -2.0
Greece: -1.1
China: -0.6
• Discuss the possible reasons why the PED may
vary between the countries.
PED and Revenue
• Total revenue = P x Q
• A firm’s revenue will change with changes
in either P or Q
• Depending on elasticity, changes in price
will either increase or decrease total
revenue
PED and Revenue
P
Inelastic Demand
P1
P0
D
Q1
Q0
Q
Lost revenue from Qd < gain in revenue from P
-  P → Revenue
PED and Revenue
P
Elastic Demand
P1
P0
D
Q1
Q0
Q
Lost revenue from Qd > gain in revenue from P
-  P → Revenue
PED and Revenue
So:
Firms facing inelastic demand curves can
increase revenue by increasing price
Firms facing elastic demand curves can
increase revenue by decreasing price
Page 49
Debate
Write the costs and
benefits on post-its
and prioritise which
are the most
important factors?
Do the costs
outweigh the
benefits?