Transcript Elasticity of Demand - burgate

Elasticity of Demand
A2 Business Studies
Unit 4 - Marketing
Objectives
Introduction
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The demand for goods and services is
determined by a wide variety of factors
The demand for the new Fiat Punto will be
influenced by:
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The price
The price of similar cars
The amount spent on advertising
Seasonality
And many other factors
Introduction (2)
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Elasticity measures how the demand for a product
changes in response to a variable such as price or
income.
Each variable that affects demand has its own relative
elasticity
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A price rise is likely to reduce demand
An increase in advertising is likely to increase demand
The elasticties most commonly used business are
Price & Income
Price Elasticity of Demand
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In the short term, the most important factor affecting
demand is PRICE
If Coca-Cola increased the price of Coke, sales would
almost certainly fall
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Some consumers would switch to a different brand
Some would buy Coke less frequently
If Coca-cola increased their price by 10%, and demand
only fell 1%, they would benefit hugely from the price
hike
Price Elasticity of Demand (2)
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How much will demand fall when price
increases?
This can be answered by calculating the price
elasticity of demand for Coca-cola
PEoD is not about whether the demand
changes with price, but the degree to which it
changes
Price Elasticity of Demand (3)
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Price elasticity can be calculated using the
following formula:
% Change in quantity demanded
Price elasticity
=
% Change in price
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If a 10% price increase led to a 20% fall in
demand, the price elasticity would be:
-20% = -2
10%
Price Elasticity of Demand (4)
-20%
10%
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= -2
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This demonstrates that for
every 1% price increase,
demand will fall by 2%
Some product are more price sensitive than
others
Example 1
Example 2
Using price elasticity information
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There are two main purposes for price
elasticity:
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Sales forecasting
Pricing strategy
Forecasting sales
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A firm considering a price rise will want to know
the effect the price change is likely to have on
demand
The Sun newspaper cut its price by 20% (from
25p to 20p, and sale rose by 16% (which was
up to 4million copies per day
–
What was it’s price elasticity?
16%
-20%
= -0.8
Can the
higher
demand levels
be met?
Pricing strategy
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There are many factors that determine the
demand and profitability of a product that are
beyond control
However, the price a firm charges is within its
control
Price elasticity information can be used in
conjunction with the firm’s own information
about costs, to forecast the effect of price
change on profit
Pricing Strategy Example
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A second hand car dealer sells 60 cars each
year.
Each car costs around £2,000 to buy
Annual overheads are £18,000
He charges customers £2,500 per car
How much profit does he make per year?
Pricing Strategy Example 2
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Total revenue = £2,500 x 60 = £150,000
Total Cost
= £18,000 + (2,000 x 60)
= £138,000
Total Profit
= £150,000 - £138,000
= £12,000
Pricing Strategy Example (3)
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From past experience, the salesman believes
the price elasticity of his cars is approximately
–0.75
He is thinking about increasing his prices to
£3,000 per car, and increase of 20%
How would this impact profit?
% Change in demand
= 20% x –0.75
= -15%
Pricing Strategy Example (4)
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A 15% fall in demand on current sales equates
to a fall of 9 cars per year:
60
x 15 = 9 cars per year
100
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On the basis of these new figures, the new
annual profit would be:
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Total revenue
Total cost
New Profit
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= £3,000 x 51 = £153,000
= £18,000 + (51x£2,000) = £138,000
= £153,000 – £138,000 = £15,000
Pricing Strategy Example (5)
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This equates to an increase in profit of 175%
£33,000 - £12,000
£12,000
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x 100 = 175%
These calculations are all based on two
assumptions:
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The price elasticity of –0.75 was correct
Other factors that could affect demand remain
unchanged