1. Price Elasticity of Demand

2. Elasticity – the concept
The responsiveness of one variable to changes in another
When price rises, what happens to demand?
Demand falls
BUT!
How much does demand fall?

3. Elasticity – the concept
If price rises by 10% - what happens to demand?
We know demand will fall
By more than 10%?
By less than 10%?
Elasticity measures the extent to which demand will change

4. Elasticity 4 basic types used: Price elasticity of demand
Price elasticity of supply
Income elasticity of demand
Cross elasticity

5. Elasticity Price Elasticity of Demand
The responsiveness of demand to changes in price
Where % change in demand is greater than % change in price – elastic
Where % change in demand is less than % change in price - inelastic

6. Elasticity Price ($) Quantity Demanded
The demand curve can be a range of shapes each of which is associated with a different relationship between price and the quantity demanded.
Quantity Demanded

7. Elasticity The Formula: % Change in Quantity Demanded
___________________________
Ped =
% Change in Price
If answer is between 0 and -1: the relationship is inelastic
If the answer is between -1 and infinity: the relationship is elastic
Note: PED has – sign in front of it; because as price rises
demand falls and vice-versa (inverse relationship between
price and demand)

8. Elasticity Total Revenue Price $5 D 100 Quantity Demanded (000s)
Total revenue is price x quantity sold. In this example, TR = £5 x 100,000 = £500,000.
This value is represented by the grey shaded rectangle.
The importance of elasticity is the information it provides on the effect on total revenue of changes in price. $5
Total Revenue D
100
Quantity Demanded (000s)

9. Elasticity Total Revenue D Price $5 $3 100 140
If the firm decides to decrease price to (say) £3, the degree of price elasticity of the demand curve would determine the extent of the increase in demand and the change therefore in total revenue. $5 $3
Total Revenue D
100
140
Quantity Demanded (000s)

10. Elasticity % Δ Price = -50% % Δ Quantity Demanded = +20%
Producer decides to lower price to attract sales 10
% Δ Price = -50%
% Δ Quantity Demanded = +20%
Ped = -0.4 (Inelastic)
Total Revenue would fall 5
Not a good move! D 5 6
Quantity Demanded

11. Elasticity Producer decides to reduce price to increase sales
% Δ in Price = - 30%
% Δ in Demand = + 300%
Ped = - 10 (Elastic)
Total Revenue rises 10
Good Move! 7 D 5 20
Quantity Demanded

12. The Meaning of Price Elasticity of demand
Elastic Demand: A strong response to a change in price
Unit Elastic demand: A proportional response to a price
change (total amount spent by consumers remains
unchanged)
Inelastic demand : A weak response to a price change

13. Elasticity If demand is price elastic:
Increasing price would reduce TR (%Δ Qd > % Δ P)
Reducing price would increase TR
(%Δ Qd > % Δ P)
If demand is price inelastic:
Increasing price would increase TR
(%Δ Qd < % Δ P)
Reducing price would reduce TR (%Δ Qd < % Δ P)

14. Total Outlay Method
Total Outlay is a way to calculate the price elasticity of demand method by looking at the effect of changes in price on the revenue earned by the producer.
If price and revenue move in the same direction, demand is inelastic.
If price and revenue move in the opposite direction, demand is elastic
If revenue remains unchanged in response to a price change, demand is unit elastic

15. Elasticity and Total Outlays

16. Total Outlay Method and slope of a demand curve
Look at Pg 85
Perfectly elastic Demand is where consumers are willing to pay any price in order to obtain a given quantity of a good or service. The situation can be represented by a horizontal demand curve.
An apple grower sells apples, along with many other apple growers , at a fruit and vegetable market. The grower can sell the entire load at the going market price. If the grower tries to sell the apples at a price above the going rate he will sell none.

17. Perfectly Inelastic demand is where consumers are willing to pay any price in order to obtain a give quantity of a good or service. This situation can be represented by a vertical demand curve. Example a person with a life threatening illness would be willing to pay almost anything.

19. Review Question
1 and 2 pg 86

20. Factors affecting elasticity of demand
Whether the good is a luxury or a necessity.
-necessities have relative inelastic demand-even if there is an increase in price, the quantity demanded will not fall to a great extent
-price elasticity of demand is higher for products that are regarded as luxuries

21. Factors affecting elasticity of demand
Whether the good has any close substitutes.
Goods with close substitutes tend to have highly elastic demand.
If the price increases the demand is is likely to contract more then proportionately.
Goods and Services with few or no close substitutes , such as water supply, would have inelastic demand- even if price increase, people cannot switch to another product

22. Factors affecting elasticity of demand
The expenditure on the product as a proportion of income
Items which take up a very small proportion of a person’s income would have a lower price elasticity of demand, whereas the demand for more expensive items would tend to be more elastic.

23. Factors affecting elasticity of demand
The length of time subsequent to a price change
If the price falls may take time to become aware and adjust to the price change
If it increases, consumers may take time to seek out alternatives and substitute products

24. Factors affecting elasticity of demand
Whether a good is habit forming (addictive) or not
Relative inelastic demand.
E.G Price rise in Alcho-pops and cigarettes did not lead to a large decrease in demand.
REVIEW QUESTION 1-3 pg 87
Chapter Review pg 89