1. Price Elasticity of Demand
A basic introduction to the important concept of price elasticity of demand and its relevance both to businesses and consumers.

2. Applications of the idea of elasticity of demand
The introduction of the congestion charge for motorists in London
Consumer response to recent cuts in the prices of broadband access to the net
How will demand for air travel respond if a new tax on aviation fuel is introduced?

3. Definition of Price Elasticity
Price elasticity (Ped) measures responsiveness of demand to change in price of good itself
Formula for calculating Ped is
Ped = % change in Qdx / % change in Px
When price falls we expect to see an expansion of demand
When price rises we expect to see a contraction of demand
Therefore an inverse relationship between price and demand (negative value for Ped)
We ignore the sign but focus instead on the coefficient of elasticity

4. Values for price elasticity of demand
If Ped = 0 then demand is said to be perfectly inelastic. This means that demand does not change at all when the price changes
If Ped is between 0 and 1 (i.e. the percentage change in demand from A to B is smaller than the percentage change in price), then demand is price inelastic
If Ped = 1 (i.e. the percentage change in demand is exactly the same as the percentage change in price), then demand is said to be unit elastic
If Ped > 1, then demand responds more than proportionately to a change in price. Demand is said to be price elastic

5. Demand curves with different price elasticity
Perfectly Elastic Demand
Perfectly Inelastic Demand
Demand
Quantity Q1 Q2 Q3 P1 P2 P3

6. Inelastic and elastic demand curves
Relatively Inelastic Demand
Relatively Elastic Demand
Price
Price P2 P2 P1 P1 P3 P3
Demand
Demand Q2 Q1 Q3 Q2 Q1 Q3

7. Elasticity of demand and total revenue
Market A
Market B
Price
Price
Demand in segment B of the market is relatively inelastic. A higher unit price is charged and total revenue also increases
Higher revenue from reducing the price from Pa to Pb (the gain in quantity sold more than offsets the lower price per unit) Pb Pa Pa Pb
Demand
Demand Qa Qb
Quantity Qb Qa
Quantity

8. Importance of price elasticity of demand for a business
Firms can use price elasticity of demand (PED) estimates to predict:
The effect of a change in price on quantity demanded
The effect of a change in price on total revenue & expenditure
The likely price volatility in a market following unexpected changes in supply – important for commodity producers
The effect of a change in indirect tax on price and quantity demanded and also whether the business is able to pass on some or all of the tax onto the consumer
Information on the price elasticity of demand can be utilized as part of a policy of price discrimination (or yield management). This is where a monopoly supplier decides to charge different prices for the same product to different segments of the market e.g. peak and off peak rail travel

9. Price Elasticity of Demand – A Relative Elastic Demand
Price falls from £350 to £250
% change in price = 60%
% change in demand = 100%
Price elasticity = 1.67
i.e. demand is price elastic A B
Demand

10. Price Elasticity of Demand – A Relatively Inelastic DemandB
Price rises from £3.00 per packet to £6.00 following an series of increases in government taxes
% change in price = 100%
% change in demand = 20%
Price elasticity = 0.2
i.e. demand is price inelastic
Demand A

11. Price Elasticity of Demand along a Demand Curve
Tutor2u Economics Revision
Price Elasticity of Demand along a Demand Curve
Elastic demand
For a price fall
Ped>1
Inelastic demand
For a price fall
Ped < 1
Demand (D)
At mid-point of demand curve, price elasticity of demand = 1
Geoff Riley

12. Price Elasticity of Demand along a Demand Curve
Tutor2u Economics Revision
Price Elasticity of Demand along a Demand Curve
When price falls from £90 to £80
Total revenue increases
Demand (D)
At mid-point of demand curve, price elasticity of demand = 1
Geoff Riley

13. Price Elasticity of Demand along a Demand Curve
Tutor2u Economics Revision
Price Elasticity of Demand along a Demand Curve
When price falls from £30 to £20, total revenue decreases
Demand (D)
At mid-point of demand curve, price elasticity of demand = 1
Geoff Riley

14. Demand Curves With Different Price Elasticity
Relative Inelastic Demand

15. Demand Curves With Different Price Elasticity
Relative Elastic Demand
Relative Inelastic Demand

16. Extreme Values for Price Elasticity of Demand
Tutor2u Economics Revision
Extreme Values for Price Elasticity of Demand
Perfectly Elastic Demand
Perfectly inelastic demand – consumers totally insensitive to price changes
Perfectly elastic demand – when each firm in the market produces perfect substitutes
Geoff Riley

17. Extreme Values for Price Elasticity of Demand
Tutor2u Economics Revision
Extreme Values for Price Elasticity of Demand
Perfectly Inelastic Demand
Perfectly inelastic demand – consumers totally insensitive to price changes
Perfectly elastic demand – when each firm in the market produces perfect substitutes
Geoff Riley

18. Elasticity of Demand for a non-linear Demand Curve
Tutor2u Economics Revision
Elasticity of Demand for a non-linear Demand Curve
Demand
Perfectly inelastic demand – consumers totally insensitive to price changes
Perfectly elastic demand – when each firm in the market produces perfect substitutes
Geoff Riley

19. Factors that Determine Ped
Tutor2u Economics Revision
Factors that Determine Ped
(1) The number of close substitutes for a good / uniqueness of the product
(2) The degree of necessity of consumption or whether the good is a luxury
(3) The % of a consumer’s income allocated to spending on the good
(4) The time period allowed following a price change
(5) Whether the good is subject to habitual consumption –
(6) The breadth of definition of a good or service. ( brand PED is often elastic, whereas the product’s PED may be inelastic)
Key factor is the number of close substitutes in the market and the ease of switching
Geoff Riley

20. Elastic or Inelastic demand?
Gateway cuts the price of their desktop PCs by 10%
A fall in the price of Euro-star tickets
An increase in the price of the Financial Times
A taxi home from a night-club on a Friday night
A rise in average car insurance premiums
Motorway petrol prices rise by 5% after the budget
Vodafone cuts their mobile phone charges
The price of central heating oil rises by 20% due to a rise in world oil prices
A local leisure club decreases monthly charges by 15% in a bid to increase the number of members

21. Case Study: Demand for Oil after Shocks

22. Time Frame and Elasticity: Oil Price Shocks
Tutor2u Economics Revision
Time Frame and Elasticity: Oil Price Shocks
The longer the time frame => the more elastic is demand
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
Higher prices made it more attractive to exploit higher cost reserves of oil – which increased supply and brought prices down again
Long run demand will be more elastic than short run demand
Geoff Riley

23. 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
Price
$ per barrel
Oil Demand P3 P1 P2
D short-run Q3 Q1 Q2
Demand for Oil

24. Longer Term Demand for Oil – More Price Elastic
Longer run demand is relatively more elastic if non-oil substitutes develop
Price
$ per barrel
Oil Demand P3 P1 P2
D long-run
D short-run Q3 Q1 Q2
Demand for Oil

25. Using Price Elasticity of Demand
Tutor2u Economics Revision
Using Price Elasticity of Demand
How much tax revenue will higher “sin taxes” on cigarettes and alcohol provide?
Why do airlines often give discounts for advance bookings?
What happens to our demand for foreign holidays when the exchange rate appreciates?
Why do hotels lower room-rates at weekends and why do car rental firms charge lower prices at weekend?
Will a business always pass on higher costs to consumers (and this also applies to indirect taxes) ?
Will the introduction of road tolls in London and other cities actually cut road congestion?
Price elasticity of demand has many applications in the A Level syllabus
Geoff Riley