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Price Elasticity of Demand P INELASTIC DEMAND: a change in the price will lead to a relatively small decrease in quantity demanded Demand Q Price Elasticity of Demand P ELASTIC DEMAND: a change in the price will lead to a relatively large decrease in quantity demanded Demand Q Price Elasticity of Demand • The elasticity of demand refers to the extent to which demand changes as prices change. • The precise definition for PED is: • The responsiveness of demand to a change in price • The formula for Price Elasticity of Demand is: Ped = % change in quantity demanded % change in price % change in quantity demanded = % change in price = difference original difference original Price Elasticity of Demand • The formula for Price Elasticity of Demand: Ped = % change in quantity demanded % change in price PED = 0 = Perfectly Inelastic PED < 1 = Inelastic PED = 1 = Unitary PED > 1 = Elastic PED = infinity = Perfectly Elastic PED: Example Mexico: Mexicans are the world’s largest per capita consumer of coca cola. The company have decided to increase the price of a litre bottle from $1.25 to $1.50. The demand for coca cola that month in Monterrey dropped from 160,000 litres to 145,000 litres. Calculate the Price Elasticity of Demand. Answer: 0.094/0.2 = 0.47 PED = INELASTIC PED: Example 2 • United States: • The United States economy is currently in a deep recession. This has forced manufacturers of Smith and Wesson luxury guns to reduce their price for a handheld magnum .357 from $1750 to $1289. They have experienced an increase in sales in Texas from 3200 units per month to 5000 units. Calculate the Elasticity of Demand. 1800/3200 % 461/1750 (.563) % (.263) = 2.14 PRICE ELASTIC PED: Example 3 • Malaysia: • Due to a poor harvest the price of Maggi’s noodles in Johor Bahru has increased from 1.5 MYR to 2.0 MYR. The quantity demanded has fallen from 50,000 packets per week to 47,000 packets. What is the price elasticity of demand? 3000 / 50000= 0.06 .5/1.5 = 0.333 0.18 Price Inelastic PED Example 4 • Singapore: • Luxury watch brand Rolex have increased prices in Singapore after intense marketing at the Grand Prix.The average price for a men’s watch has increased from $2000 to $2200. This has been accompanied by a fall in sales of 23% this month. Calculate the price elasticity of demand. 0.23 200/2000 = 0.1 PED Example 5 • Great Britain: • British airways have decided to reduce the price of their flights from London to Dubai to from $770 to $720. This has increased daily passenger numbers from 600 to 680 per day as flyers move from other airlines. Calculate the PED. 80/600 = 0.133 50/750 = 0.065 Price elastic 2.05 PED Example 6 • Greece: • Sales of soap in Greece have fallen by 8% this year in the financial crisis. This has been accompanied by a 15% increase in the price. Calculate the PED. QD = .08 P = .15 Price inelastic 0.53 Elasticity and Total Revenue • Calculate the new and old total revenues for each example. • What is the relationship between elasticity and total revenue? When the PED is elastic: An increase in price reduces TR When PED is inelastic: An increase in price increases TR.