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Price Elasticity of Demand

Price Elasticity of Demand. DP Economics. The concept of elasticity. Elasticity is the measure of responsiveness in one variable to a change in another Elasticity was coined from the properties of rubber i.e. stretchiness. Cut-throat competition?*#.

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Price Elasticity of Demand

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  1. Price Elasticity of Demand DP Economics

  2. The concept of elasticity • Elasticity is the measure of responsiveness in one variable to a change in another • Elasticity was coined from the properties of rubber i.e. stretchiness

  3. Cut-throat competition?*# Gillette – the manufacturers of the Mach 3 razor - controls over 70 per cent of the world's wet shave razor market and takes 90 per cent of the $1.5 billion annual global profits If the price of Mach3 razors went up by 20% - would you still buy them?

  4. Definition of Price Elasticity • Price elasticity of demand (PED) measures responsiveness of demand to change in the price of the good.# • The basic formula for calculating PED is: PED = percentage change* in quantity demanded percentage change in price OR: = %ΔQd %ΔP • (i) Price falls; expansion of demand • (ii) Price rises contraction of demand • Hence an inverse relationship between price and demand (giving a negative value for PED) • As results are always negative or zero we ignore the sign

  5. Values for elasticity of demand* • If PED = 0; demand is perfectly inelastic - demand does not change when the price changes • If PED is between 0 and 1; demand is inelastic • If PED = 1 then demand is said to be unitary elastic • If PED > 1, then demand responds more than proportionately to a change in price – i.e. demand is elastic

  6. An inelastic demand Price Quantity Demanded

  7. An inelastic demand Price P1 Q1 Quantity Demanded

  8. An inelastic demand Price P1 = $200 Q1 = 400 $200 400 Quantity Demanded

  9. An inelastic demand Price P1 = $200 Q1 = 400 $400 P2 = $400 Q2 = 350 $200 350 400 Quantity Demanded

  10. An inelastic demand Price % change in demand = Q2 – Q1 x 100 Q1 (Ignoring the sign) $400 $200 350 400 Quantity Demanded

  11. An inelastic demand Price % change in demand = 12.5% % change in price = $400 $200 350 400 Quantity Demanded

  12. An inelastic demand Price % change in demand = 12.5% % change in price = 100% $400 $200 350 400 Quantity Demanded

  13. An inelastic demand Price % change in demand = 12.5% % change in price = 100% Price elasticity of demand = 12.5 / 100.0 = 0.125 (< 1) $400 $200 350 400 Quantity Demanded

  14. An inelastic demand Price $400 PED is inelastic $200 350 400 Quantity Demanded

  15. An elastic demand curve Price P1 $200 Quantity Demanded Q1 400

  16. An elastic demand P1 = $200 Q1 = 400 Price P2 = $100 Q2 = 1200 £200 £100 1200 400 Quantity Demanded

  17. An elastic demand curve Price PED % change in demand = % change in price = *ignoring the sign £200 £100 1200 400 Quantity Demanded

  18. An elastic demand curve Price PED % change in demand = 200% % change in price = 50% £200 £100 1200 400

  19. An elastic demand curve Price PED = 4 (elastic) % change in demand = 200% % change in price = 50% £200 £100 1200 400 Quantity Demanded

  20. Plot the following demand schedule for a liquid commodity.

  21. Plot the following demand schedule

  22. Calculate the PEDs at each point of the schedule

  23. PEDS for the demand schedule Point 1 (0,15) (ignoring the sign)

  24. PEDS for the demand schedule* Point 4 (30,6) Point 5 (40,3) Point 6 (50,0) Point 1 (0,15) Point 2 (10,12) Point 3 (20,9)

  25. Notes • PED will go from infinity to zero for all straight line curves as you move down from left to right with a PED of 1 in the middle of the demand curve. • Do not be taken in by the slope steepness as this depends on the scales chosen and points chosen • Moving from A to B along a demand curve will have a different PED then B to A (Try it) • The above is solved by mid-point PED calculation (p139) • Pure maths students will notice that a more sophisticated method of calculating PED for curves will involve calculus namely differentiation.#

  26. Look at the following graphs A & B: do they contradict?* A B Price Price Elastic PED > 1 Relatively inelastic Curve Unit Elasticity PED = 1 Relatively elastic curve Price Inelastic PED < 1 Quantity Demanded Quantity Demanded

  27. Look at the following graphs A & B: do they contradict?* A B Price Price Elastic PED > 1 Relatively inelastic Curve Unit Elasticity PED = 1 P1 Relatively elastic curve Price Inelastic PED < 1 P2 Quantity Demanded Quantity Demanded

  28. Look at the following graphs A & B: do they contradict?* A B Price Price Price Elastic PED > 1 Relatively inelastic Curve Unit Elasticity PED = 1 P1 Relatively elastic curve Price Inelastic PED < 1 P2 Quantity Demanded Quantity Demanded

  29. The extremes of elasticity • Perfectly Inelastic • Perfectly Elastic • Unitary Elastic • These rarely exist but behave as good benchmarks for comparison

  30. Perfectly inelastic demand curve Price £400 PED is always 0 £300 £200 600 Quantity Demanded

  31. Perfectly elastic demand curve Price PED is always ∞ £200 1200 400 Quantity Demanded

  32. Unitary elastic demand curve Price PED is always 1 at every point Hyperbolic curve Quantity Demanded

  33. Factors that Determine PED Read p 142/145 • (1) Number of close substitutes for a good and the uniqueness of the product in the market • (2) Degree of necessity of consumption (e.g. absolute luxury to addiction) • (3) The % of a consumer’s income allocated to consumers’ spending on the good • (4) The time period allowed following a price change

  34. Elastic or inelastic demand? A Sony portable PlayStation Household electricity

  35. Elastic or inelastic demand? A tall latte from Costa Coffee from a railway station vendor A pound of pork sausages from a local market

  36. Time Frame and Price Elasticity: Oil Price Shocks* 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

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

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

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