Price Elasticity of Demand

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?
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
Elasticity
4 basic types used:
Price elasticity of demand
Price elasticity of supply
Income elasticity of demand
Cross elasticity
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
Elasticity
Price ($)
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
 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)
 Elasticity
Price
Total revenue is price x
The importance of elasticity
quantity sold. In this
is the information it
example, TR = £5 x 100,000
provides on the effect on
= £500,000.
total revenue of changes in
price.
This value is represented by
the grey shaded rectangle.
$5

Total Revenue

100 Quantity Demanded (000s)

 Elasticity
Price 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
$5 revenue.

$3

Total Revenue
D
100 140 Quantity Demanded (000s)
 Elasticity
Price ($)
Producer decides to lower price to attract sales

10 % Δ Price = -50%
% Δ Quantity Demanded = +20%
Ped = -0.4 (Inelastic)
5 Total Revenue would fall
Not a good move!

D
5 6
Quantity Demanded
 Elasticity
Price ($)
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 Quantity Demanded 20
 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
Elasticity
If demand is price If demand is price
elastic: inelastic:
Increasing price would Increasing price would
reduce TR (%Δ Qd > % increase TR
Δ P) (%Δ Qd < % Δ P)
Reducing price would Reducing price would
increase TR reduce TR (%Δ Qd < %
(%Δ Qd > % Δ P) Δ P)
Total Outlay Method
Total Outlay is a way to If price and revenue move
calculate the price in the same direction,
elasticity of demand demand is inelastic.
method by looking at If price and revenue move
the effect of changes in in the opposite direction,
price on the revenue demand is elastic
earned by the producer. If revenue remains
unchanged in response
to a price change, demand
is unit elastic
Elasticity and Total Outlays
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.
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.
Review Question
1 and 2 pg 86
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
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
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.
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
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