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# 1aa kno how on price elasticity of demand

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### 1aa kno how on price elasticity of demand

1. 1. Kno-how! on price elasticity of demand Students should be able: Define, measure and interpret price elasticity of demand
2. 2. Elasticity Background Reading: Phillip Allan Nutter p.? p.?
3. 3. Elasticity – The concept The responsiveness of one variable to changes in another
4. 4. Price Elasticity of Demand If price rises by 10% - what happens to quantity demand? We know quantity demanded will contract By more than 10%? By less than 10%? Or exactly 10%? Elasticity measures the extent to which demand will change.
5. 5. Price Elasticity of Demand The responsiveness of demand to a small change 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. 6. Price Elasticity of Demand The formula: PED = % Change in Quantity Demanded ___________________________ % Change in Price Note: PED has – sign in front of it; because as price rises demand falls and vice-versa (inverse relationship between price and demand)
7. 7. Price Elasticity of Demand Alternative formula: PED = D QD DP * P1 Q1
8. 8. Different demand curves Price (£) Quantity Demanded
9. 9. Inelastic demand Price (£) Producer decides to lower price to attract sales % Δ Price = -50% 10 % Δ Quantity Demanded = +20% PED = -0.4 (Inelastic) Total Revenue would fall 5 Not a good move! D 56 Quantity Demanded
10. 10. Elastic demand 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
11. 11. Price elasticity If demand is price elastic PED will be between -1 and infinity Increasing price would reduce Total Revenue (%Δ Qd > % Δ P) Reducing price would increase TR (%Δ Qd > % Δ P) If demand is price inelastic: PED will be between 0 and -1 Increasing price would increase Total Revenue (%Δ Qd < % Δ P) Reducing price would reduce TR (%Δ Qd < % Δ P)
12. 12. Price Elasticity of Demand and Consumer Expenditure Special cases
13. 13. P Perfectly inelastic demand (PD = –0) D P2 b P1 a O Q1 Q
14. 14. P Perfectly elastic demand (PD = –) a b D P1 O Q1 Q2 Q
15. 15. P 20 Unit elastic demand (PD = –1) a b 8 D O 40 100 Q
16. 16. Price Elasticity of Demand and Consumer Expenditure Special cases = PED = 0 (perfectly inelastic) PED =  (perfectly elastic) PED = –1 (unitary)
17. 17. Elasticity Value Perfectly Elastic Diagram Meaning Increased Price will lead to... Possible Examples ∞ Demand infinite at a given price. Demand 0 at any other price Total Revenue falls to zero. Theoretical special cases Elastic 1<∞ % change in qty demanded is greater than % change in price A fall in total revenue. SUV’s, 5 star hotels, flat screen TV’s Unitary 1 % change in demand equal to % change in price Total revenue remains unchanged. Special cases, potenital any good? Inelastic 0<1 % change in qty demanded is less than % change in price. A rise in total revenue. Petrol, cigarettes, rice. Perfectly Inelastic 0 No change in demand when price changes A rise in total revenue. Highly addictive goods.
18. 18. Determinants of price elasticity of demand Number and closeness of substitutes – the greater the number of substitutes the more elastic NOT anything else. Goods which might appear to be inelastic for other reasons such as small proportion of income but even these would not be if they had substitutes. Only determinant of PED is SUBSTITUTABILITY
19. 19. Importance of price elasticity of demand Relationship between changes in price and total revenue Importance in determining what goods to tax (tax revenue) Importance in analysing time lags in production Influences the behaviour of a firm