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Price Elasticity What is it all about ?

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Situation 1 You have $15 to spend You must spend all your money In my “Econ goodies” shop the prices for my goods are as follows $3.00

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Situation 2. “A new Day” Peanut Catastrophe!!!!!!!

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Situation 2 Due to a peanut catastrophe the price of snickers bars has increased to $4.00 and all other products prices remain the same. Econ Goodies $3.00 $4.00 $3.00

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Situation 3 “Another Day” The peanut catastrophe is resolved

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Situation 3 The peanut catastrophe is resolved and the price of snickers decreases to original market price of $3 Further a university donor has offered scholarship support to students leading to an increased income for all. Income = $24 $3.00

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Situation 4 “Another new Day” The peanut production catastrophe has returned – the price of snickers increases to $4.00 But income remains at $24 as the university donor keeps offering scholarships

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In two groups of 5 Determine the market quantities for situation1 and situation 2 Construct a market demand curve for snickers

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How can I calculate a percentage change in price??? Well the first thing that we need to do is work out the basic change in the price of the product

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Percentage Change Calculation We started off with a price of $3 per snickers bar and our new price was $4.00 This is a $1.00 rise in price. We divide the change in price by the original price and multiply the answer by 100 to turn it into a percentage 1.00 x 100= +33.33% 3.00

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Bob the Blob’s Question Time

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Help! I got stuck on the last question when the price went down. Okay well it’s nothing to worry about. You just keep using exactly the same formulae as we did when the price was going up! Let’s take a look at the answer you should have got.

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We know that in 2006 the price of a Mars Bar was $4.80 and that by 2008 the price had fallen to just $4.00. So using what we have already learnt, we take away $4.00 from $4.80 and that leaves us with.80c (Hint. You always take away the smaller number from the larger number). We now divide.80c by the cost of the Mars Bar in 2006, which was $4.80 and multiply this answer by 100. e.g..8 x 100 = -16.67% EASY!!! 4.80 Notice that this time we have a NEGATIVE percentage change as the price has FALLEN!

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Bob the Blob’s Question Time Here have some more practice!

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Okay I get that now thanks. How does demand change if I put my prices up or down? Well we are basically going to do exactly the same thing as we did for price. We just need to change the information into a percentage. Let’s see if you can do this on your own!

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Look very carefully at your own market demand tables and see if you can work out the answers to this question Take your time and think about what we have just covered Calculate the percentage change in demand if the price for Snickers changes from 3.00 to 4.00. Show all of your working!_______________________________ ______________________________________ ______________________________________ ______________________________________ ___________________________

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If the price of a Snickers changed from $4.00 to $3.00 then what happened to demand? So now we know that, all we have to do is to work out the percentage change in demand.. Let’s have a look if you got the answers right!

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Ok, but how can I calculate the responsiveness of demand to a given change in price to any type of product sold? This is just, Price Elasticity!!! It simply uses all of the calculations that we have used to help us to work out whether demand for a product will rise or fall if we put change the price and more importantly by how much demand will rise or fall!

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PRICE ELASTICITY OF DEMAND e.g. % change in quantity demanded = PeD % change in price The calculation is really easy to use. You just need to remember that Quantity is always the top value and Price is the bottom. Let’s have a look at how we can use this equation. to help us decide whether to raise or lower our prices. TIP. Can’t remember the formula? Try remembering that you need to Q before you can have a P!

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Example Economics Tee-shirts Let’s imagine that we want to raise our prices from $20 to $40 per Economics Tee- shirt. The first thing that we need to do is to calculate both the percentage change in price and also the percentage change in demand. So......

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% Change in Price 40p – 20p = $20 20 x 100 = +100% rise in price 20 % Change in Demand 15 Tee Shirts– 5 Tee Shirts = 10 Tee Shirts 10 x 100 = -66.67% fall in demand 15 for Tee Shirts So we now use the Price Elasticity formulae. e.g. - 66.67% (% change in quantity demanded)= - 0.67 + 100% (% change in price)

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Okay well I got -1.67 for the cards and -0.60 for the toothpaste. What does this mean?

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Great well these are the correct answers so let’s take a look at their meanings in more detail. The actual value of any elasticity calculation is very important and can tell us a lot about the type of product and whether it is sensible to raise or lower the price. Take a look at this diagram below: 0 -1 InelasticElastic -0.60-1.67

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Correct! Any item with an elasticity value of less than -1 is called inelastic and items with values greater than -1 are price elastic. So that means that the toothpaste was price inelastic and the Christmas cards were price elastic.

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PRICE ELASTIC If an item is found to be price elastic then this means that any percentage change in price will result in a GREATER percentage change in quantity demanded Okay so I should not put my prices up then because I can expect a greater percentage fall in demand! EXACTLY! Although you might want to think about lowering your prices as this will mean a larger percentage increase in demand!

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Well the main reason is that there are plenty of alternatives (SUBSTITUTES) that a consumer can turn to if your prices become too high for them. If we look at Coony’s Christmas Cards, he was planning on raising the price to $1.20 each. Well the customer can simply go and buy their cards at another shop where the prices are cheaper! We now know Coony should NOT put up his Christmas Card prices. If he does, then he can expect a larger fall in demand and therefore a big drop in revenue as well! On the other hand, he could put his prices of cards down. This should mean a lot more customers and higher revenue as well. The problem is, can he cope with all of the extra demand for cards? He would certainly need to order more stock! But what makes a good price elastic?

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PRICE INELASTIC If an item is found to be price inelastic then this means that any percentage change in price will result in a SMALLER percentage change in quantity demanded. Okay so if I put my prices up demand will fall but only by a little bit....EXCELLENT! But what makes a good price inelastic? EXACTLY! If you have an INELASTIC product, then it is generally not a good idea to think about lowering your prices as it is unlikely to result in many more customers buying your product!

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Well the main reason is that there are VERY FEW alternatives that a consumer can turn to if your prices become too high for them. A good example is petrol. We still buy it even if prices are high as we need it to run our cars. But what makes a good price inelastic?

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If we look at Coony’s toothpaste, he was planning on raising the price to $1.75 each tube. Well the customer needs toothpaste and whilst they might be able to find some cheaper brands the basic product has no alternative! We now know Coony CAN put up his toothpaste prices. If he does, then he can expect the percentage increase in price to be greater than any fall in demand. This means that he can make more money! He must be careful though, as he cannot keep putting up prices to very high levels. If he did this, then eventually the customer will find some alternative product and demand will fall.

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Okay well I think that you are ready to try answering the final questions!

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© 2007 Thomson South-Western. Elasticity... … allows us to analyze supply and demand with greater precision. … is a measure of how much buyers and sellers.

© 2007 Thomson South-Western. Elasticity... … allows us to analyze supply and demand with greater precision. … is a measure of how much buyers and sellers.

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