Transcript Price Elasticity of Demand

Price Elasticity of Demand
DP Economics
The concept of elasticity
 Elasticity is the measure of
responsiveness in one variable to a
change in another
 Elasticity was coined from the
properties of rubber i.e. stretchiness
Cut-throat competition?*#
Gillette – the manufacturers of the
Mach 3 razor - controls over 70 per
cent of the world's wet shave razor
market and takes 90 per cent of the
$1.5 billion annual global profits
If the price of Mach3 razors went
up by 20% - would you still buy
them?
Definition of Price Elasticity


Price elasticity of demand (PED) measures responsiveness of
demand to change in the price of the good.#
The basic formula for calculating PED is:
PED = percentage change* in quantity demanded
percentage change in price
OR:
= %ΔQd
%ΔP




(i) Price falls; expansion of demand
(ii) Price rises contraction of demand
Hence an inverse relationship between price and demand
(giving a negative value for PED)
As results are always negative or zero we ignore the sign
Values for elasticity of demand*
 If PED = 0; demand is perfectly
inelastic - demand does not change
when the price changes
 If PED is between 0 and 1; demand is
inelastic
 If PED = 1 then demand is said to be
unitary elastic
 If PED > 1, then demand responds
more than proportionately to a change
in price – i.e. demand is elastic
An inelastic demand
Price
Quantity Demanded
An inelastic demand
Price
P1
Q1
Quantity Demanded
An inelastic demand
Price
P1 = $200
Q1 = 400
$200
400
Quantity Demanded
An inelastic demand
Price
P1 = $200
$400
Q1 = 400
P2 = $400
$200
Q2 = 350
350 400
Quantity Demanded
An inelastic demand
Price
% change in demand
$400
= Q2 – Q1 x 100
Q1
$200
(Ignoring the sign)
350 400
Quantity Demanded
An inelastic demand
Price
% change in demand
$400
= 12.5%
% change in price
=
$200
350 400
Quantity Demanded
An inelastic demand
Price
% change in demand
$400
= 12.5%
% change in price
= 100%
$200
350 400
Quantity Demanded
An inelastic demand
Price
% change in demand
$400
= 12.5%
% change in price
= 100%
$200
Price elasticity of demand
= 12.5 / 100.0
= 0.125 (< 1)
350 400
Quantity Demanded
An inelastic demand
Price
$400
PED is inelastic
$200
350 400
Quantity Demanded
An elastic demand curve
Price
P1 $200
Q1 400
Quantity Demanded
An elastic demand
P1 = $200
Price
Q1 = 400
P2 = $100
Q2 = 1200
£200
£100
400
1200
Quantity Demanded
An elastic demand curve
Price
PED
% change in demand =
% change in price =
*ignoring the sign
£200
£100
400
1200
Quantity Demanded
An elastic demand curve
Price
PED
% change in demand = 200%
% change in price = 50%
£200
£100
400
1200
An elastic demand curve
Price
PED = 4 (elastic)
% change in demand = 200%
% change in price = 50%
£200
£100
400
1200
Quantity Demanded
Plot the following demand schedule for a liquid
commodity.
Price
($)
Quantity
demanded
(litres)
0
15
10
12
20
9
30
6
40
3
50
0
Plot the following demand schedule
0
Quantity
demanded
(litres)
15
10
12
20
9
30
6
40
3
50
0
60
50
Price ($)
Price
($)
40
30
20
10
0
0
5
10
Quantity Demanded
15
20
Calculate the PEDs at each point of the schedule
Quantity
demanded
(litres)
0
15
10
12
20
9
30
6
40
3
50
0
60
50
Price ($)
Price
($)
40
30
20
10
0
0
5
10
Quantity Demanded
15
20
PEDS for the demand schedule
Point 1 (0,15)
Q P1
3 0

  0
Q1 P 15 10
(ignoring the sign)
PEDS for the demand schedule*
Point 1 (0,15)
Point 4 (30,6)
Q P
3
0



0
Q
P 15 10
Q P1
3 30

 
 1.5
Q1 P 6 10
Point 2 (10,12)
Point 5 (40,3)
Q P1
3 10



 0.25
Q1 P 12 10
Q P1
3 40

 
4
Q1 P 3 10
Point 3 (20,9)
Point 6 (50,0)
Q P1
3 20

 
 0.67
Q1 P 9 10
Q P1
0 50

 
 undefined
Q1 P 0 0
Notes
 PED will go from infinity to zero for all straight line
curves as you move down from left to right with a PED of
1 in the middle of the demand curve.
 Do not be taken in by the slope steepness as this
depends on the scales chosen and points chosen
 Moving from A to B along a demand curve will have a
different PED then B to A
(Try it)
 The above is solved by mid-point PED calculation (p139)
 Pure maths students will notice that a more
sophisticated method of calculating PED for curves will
involve calculus namely differentiation.#
Look at the following graphs A & B:
do they contradict?*
A
Price
B
Price
Elastic
Relatively inelastic Curve
PED > 1
Unit
Elasticity
PED = 1
Relatively elastic curve
Price Inelastic
PED < 1
Quantity Demanded
Quantity Demanded
Look at the following graphs A & B:
do they contradict?*
A
Price
B
Price
Elastic
Relatively inelastic Curve
P1
PED > 1
Unit
Elasticity
PED = 1
Relatively elastic curve
Price Inelastic
PED < 1
P2
Quantity Demanded
Quantity Demanded
Look at the following graphs A & B:
do they contradict?*
A
Price
B
Price
Price Elastic
Relatively inelastic Curve
P1
PED > 1
Unit
Elasticity
PED = 1
Relatively elastic curve
Price Inelastic
PED < 1
P2
Quantity Demanded
Quantity Demanded
The extremes of elasticity
 Perfectly Inelastic
 Perfectly Elastic
 Unitary Elastic
 These rarely exist but behave as good
benchmarks for comparison
Perfectly inelastic demand curve
Price
£400
PED is always 0
£300
£200
600
Quantity Demanded
Perfectly elastic demand curve
Price
PED is always ∞
£200
400
1200
Quantity Demanded
Unitary elastic demand curve
Price
PED is always 1 at
every point
Hyperbolic curve
Quantity Demanded
Factors that Determine PED
Read p 142/145
 (1) Number of close substitutes for a good and
the uniqueness of the product in the market
 (2) Degree of necessity of consumption
(e.g. absolute luxury to addiction)
 (3) The % of a consumer’s income allocated to
consumers’ spending on the good
 (4) The time period allowed following a price
change
Elastic or inelastic demand?
A Sony portable PlayStation
Household electricity
Elastic or inelastic demand?
A tall latte from Costa Coffee
from a railway station vendor
A pound of pork sausages from
a local market
Time Frame and Price Elasticity:
Oil Price Shocks*
 Two World oil price shocks of the 1970s
 Response to higher prices was modest in the
immediate period
 As time passed, people found ways to consume less
petroleum and other oil products
 Better mileage from their cars (switch to smaller
vehicles)
 Higher spending on insulation in homes and
factories
 Car pooling for commuters
 Car manufacturers invested enormous sums in more
fuel efficient vehicles seeing a long term market
opportunity
 Development of oil substitutes in the long run
 natural gas, solar heating, nuclear energy
Short Term Demand for Oil
The demand for oil is
inelastic in response to price
changes in the short run
This is mainly because it is
an essential input into many
production processes
Oil Demand
Price
$ per barrel
P3
P1
P2
D short-run
Q3
Q1
Q2
Demand for Oil
Longer Term Demand for Oil – More Price Elastic
Longer run demand is
relatively more elastic if
non-oil substitutes develop
Oil Demand
Price
$ per barrel
P3
P1
P2
D long-run
D short-run
Q3
Q1
Q2
Demand for Oil