AS Micro The Importance of Elasticity of Demand

AS Micro The Importance ofElasticity of Demand

Price Elasticity of Demand

Elasticity Matters!What do I need to know?The definitions of each elasticityThe formula’s and be confident in using themHow to draw the diagramsThe determinants of PED and PESExamplesWhy they are important

Factors that Affect Price Elasticity Necessity or Availability of luxury? substitutes Consumer Brand loyalty income Frequency of Habits purchase

The price of a tablet computer falls from£800 to £600 and as a result, weekly salesof the tablet device expand from 100,000to 150,000. It can be inferred that theprice elasticity of demand for this pricechange is?% change in demand = 50%% change in price = -25%Price elasticity of demand = 50 / -25 = -2

A mobile phone company has 3 million customers for apackage of services. Each customer pays a monthly fee of£20. The company conducts market research and estimatesthat price elasticity of demand for this package is (-) 2. If thecompany reduces monthly fees by £5, the change in totalrevenue is likely to be:% change in price = 25%Elasticity = 2% change in demand = 50%New demand = 4.5 million customers @ £15 = £67.5 millionChange in total revenue = + £7.5 million

A manufacturer reduces the price of itswashing machines by 5% and, as a result,the volume of sales of washing machinesrises by 4%. The value of price elasticity ofdemand for the good following this pricechange is?Ped = 4% / 5% = 0.8 (demand is inelastic)

In September 2009, the London EveningStandard was charging 50p per copy and selling250,000 copies a day. In October 2009 a newowner decided to make it a free paper and byMarch 2010 the Standard was selling 600,000copies each day. Calculate the price elasticity ofdemand for this price change.% change in demand = 140%% change in price = 100%Price elasticity of demand = 1.4 (i.e. Elastic)

Peak and Off-Peak Demand

Peak and Off-Peak: Price & RevenuePrice S1 Price S1Poff-peak D1 Quantity Q1 Quantity Q1 Q1: Diagram assumes a fixed supply capacity in the market

Peak and Off-Peak: Price & RevenuePrice S1 Price S1 D2Poff-peak D1 Quantity Q1 Quantity Q1 Q1: Diagram assumes a fixed supply capacity in the market

Peak and Off-Peak: Price & RevenuePrice S1 Price S1 Ppeak D2Poff-peak D1 Quantity Q1 Quantity Q1 Q1: Diagram assumes a fixed supply capacity in the market

The case for price discounting Spare capacity Help low income Cash-flow groups New Market share customers

Dangers from discounting Price seen as indicator of quality PED could be lower than expected Consumers become anchored to lower price

Cross Price Elasticity of Demand

Cross price elasticityThe price of Good X rises by 20 %. As a result,the demand for a substitute Good Y rises by 10%. What is the cross-elasticity of demand forGood Y with respect to Good X?Xed = % change in DX / % change in PY= +10% / +20% = +0.5I.e. X and Y are weak substitutes

Using Cross Price ElasticityThe table below gives estimates of the priceelasticity’s and cross-elasticities of demand for busand rail travel. What would be the change in thevolume of rail travel resulting from a 25% increasein bus fares?

Using Cross Price ElasticityThe table below gives estimates of the priceelasticity’s and cross-elasticities of demand for busand rail travel. What would be the change in thevolume of rail travel resulting from a 25% increasein bus fares? Answer: = +4% (+0.16 x 25)

Income elasticity

Income elasticity of demand• Normal goods – positive income elasticity• Luxury goods – income elasticity > +1• Necessities – income elasticity >0 and <+1• Inferior products – negative income elasticity• Counter cyclical goods – products whose demand varies inversely to the macroeconomic cycle – demand rises in a downturn

Rising demand for cinema visits

And for pizza too!

Application of income elasticityThe table shows aconsumers expenditureon a range of goods atdifferent levels ofincome. For which gooddoes the consumerhave an incomeelasticity of demandgreater than zero, butless than one?

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AS Micro The Importance of Elasticity of Demand

by Geoff Riley

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