Transcript Price-Elasticity-of

Imagine the price of all the items below
has doubled? What will happen to demand?
Price Elasticity of Demand
PED measures the responsiveness of quantity demanded to
a change in price
-it is the mathematical relationship between ∆P and ∆Qd
PED = %ΔQd
%ΔP
PED is always negative (because P&Q move in opposite
directions) so we often drop the ‘–’ sign.
If a change in price significantly alters the quantity
demanded, then PED is said to be “relatively elastic.”
If a change in price does not have much affect on quantity
demanded, then PED is said to be “relatively inelastic.”
Price Inelastic Demand
P
Relatively Inelastic Demand
P1
-a large price change results
in only a small change in Qd
- 0<PED <1
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
- 1 < PED
D
Q1
Q0
Q
What determines PED?
• Substitutes – the demand for a good is more
elastic when there are more close substitutes –
we can easily change demand
• Necessity v. Luxury – necessity goods tend to be
more inelastic as we must buy them and in fixed
quantities – luxury purchases are more flexible &
responsive to price
• % of income spent on the good – goods which
take up a higher proportion of our income tend to
be more elastic as we ‘feel’ the price change &
respond to it more
What determines PED?
• Time period allowed after a price change –
demand tends to be more inelastic in the short run
as we cannot make changes quickly, but in the
long run we can assess and change accordingly
so be more elastic
• Habitual consumption – goods which are bought
out of habit tend to be more inelastic as it is more
difficult for the consumer to change
• Advertising / fashion / fads – goods which are
‘must have’s’ tend to be more inelastic as we are
willing to pay any price (advertisers aim to make
our demand more inelastic)
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
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
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