This document discusses price elasticity of demand, which measures how responsive demand is to changes in a good's own price. It provides the formula for calculating the price elasticity coefficient and explains what different coefficient values mean in terms of elastic vs inelastic demand. Factors that impact a good's price elasticity are also examined, such as availability of substitutes and degree of necessity. Examples are provided to demonstrate calculating price elasticity from changes in price and quantity demanded.

1. Price
Elas+city
of
Demand
EdExcel
Economics
1.2.3

2. What
is
Price
Elas+city
of
Demand?
• Price
elas4city
of
demand
(PED)
measures
the
responsiveness
of
demand
a=er
a
change
in
the
good’s
own
price
• The
basic
formula
for
calcula4ng
the
co-­‐efficient
of
price
elas+city
of
demand
is:
– Percentage
change
in
quan+ty
demanded
divided
by
the
percentage
change
in
price
• All
normal
goods
with
downward
sloping
demand
curves
will
have
a
nega4ve
coefficient
of
price
elas4city
of
demand
• Since
changes
in
price
and
quan4ty
usually
move
in
opposite
direc4ons,
usually
we
do
not
bother
to
put
in
the
minus
sign
• We
are
more
concerned
with
the
co-­‐efficient
of
elas+city
Elas4city
is
the
responsiveness
of
X
to
a
change
in
another
variable

3. Price
Elas+city
of
Demand
in
Ac+on
WH
Smith
have
recently
reduced
the
price
of
its
Kobo
Mini
E-­‐
reader
from
£60
to
£40.
They
predict
that
sales
of
the
E-­‐reader
will
increase
from
15,000
units
a
month
to
25,000
a
month
(na4onwide).
What
is
the
price
elas4city
of
demand
for
this
price
change
for
the
Kobo
Mini-­‐reader?
%
change
in
price
=
-­‐33%
%
change
in
demand
=
+66%
Coefficient
of
PED
=
2
I.e.
demand
is
price
elas4c
A
business
that
makes
suitcases
aimed
at
holidaying
tourists
has
increased
its
prices
by
5%.
As
a
consequence,
they
have
seen
a
drop
in
sales
between
January
and
March
by
15%
(compared
to
the
same
4me
last
year)
Calculate
the
price
elas4city
of
demand
and
comment
on
the
effect
on
total
revenue
%
change
in
price
=
+5%
%
change
in
demand
=
-­‐15%
Coefficient
of
PED
=
3
Total
revenue
will
fall

4. Numerical
Values
for
Coefficient
of
Price
Elas+city
1. If
Ped
=
0
demand
is
perfectly
inelas4c
-­‐
demand
does
not
change
when
the
price
changes
–
the
demand
curve
is
ver4cal
2. If
Ped
is
between
0
and
1
(%
change
in
demand
is
smaller
than
the
percentage
change
in
price),
then
demand
is
inelas4c
3. If
Ped
=
1
(%
change
in
demand
is
the
same
as
the
%
change
in
price),
then
demand
is
unit
elas4c.
A
15%
rise
in
price
would
lead
to
a
15%
contrac4on
in
demand
leaving
total
spending
the
same
at
each
price
level
4. If
Ped
>
1
then
demand
responds
more
than
propor4onately
to
a
change
in
price
i.e.
demand
is
elas4c.
For
example
if
a
10%
increase
in
price
leads
to
a
30%
drop
in
demand.
The
price
elas4city
of
demand
for
this
price
change
is
–3
Exam
Hint:
Be
careful
when
discussing
‘food’
or
‘electrical
goods’
–
different
classifica4ons
within
these
groups
will
have
different
values
of
elas4city
of
demand
and
/
or
supply

5. What
factors
determine
the
PED
of
a
product?
Number
of
close
subs+tutes
available
for
consumers
• The
more
close
subs4tutes
there
are,
the
more
price
elas4c
the
demand
e.g.
many
brands
of
breakfast
cereal
Price
of
the
product
in
rela+on
to
total
income
• When
the
%
of
budget
is
high,
demand
is
usually
more
price
sensi4ve
i.e.
price
elas4c
Cost
of
subs+tu+ng
between
different
products
• When
subs4tu4on/switching
costs
are
high,
demand
will
tend
to
be
price
inelas4c
Brand
loyalty
and
habitual
consump+on
• High
levels
of
brand
loyalty
makes
demand
less
price
elas4c
• Persuasive
adver4sing
can
make
demand
price
inelas4c
Degree
of
necessity
/
luxury
• Standard
assump4on
is
that
necessi4es
have
a
lower
price
elas4city
of
demand
whereas
luxuries
are
an
op4onal
spend

6. Inelas+c
Demand
(Ped
<
1)
• Following
a
change
in
price,
the
total
revenue
earned
by
the
producing
firm
will
depend
on
the
PED
for
its
product.
• If
the
coefficient
of
PED
is
<1,
a
rise
in
market
price
(e.g.
from
P1
to
P2)
will
lead
to
an
increase
in
total
revenue
for
the
seller
of
the
product.
If
the
co-­‐efficient
of
price
elas4city
of
demand
<1,
then
demand
is
said
to
be
price
inelas+c
i.e.
unresponsive
to
a
change
in
price
Price
Quan4ty
P1
P2
Q1
Q2
Demand
Increased
revenue
from
selling
at
a
higher
price
Lost
revenue
from
the
contrac4on
in
quan4ty
sold

7. Example
of
Inelas+c
Demand
–
Rare
Earths
• China
is
the
dominant
supplier
of
rare
earths
–
producing
over
90%
of
world
output
• The
lack
of
close
subs4tutes
makes
demand
price
inelas4c
• Low
PED
provides
China
with
a
source
of
monopoly
power
and
creates
condi4ons
in
which
China
can
restrict
exports
of
rare-­‐earth
metals
causing
price
to
rise
and
increase
their
total
revenue
Rare-­‐earth
metals
are
an
essen4al
raw
material
in
the
manufacture
of
solar
cells
and
bakeries
and
car
catalysts
Projected global demand for
products containing rare earths in
2014 (% change)
Magnets 42
Batteries 13
Displays (containing phosphor) 10
Polish 10
FCC (molecule splitting) 9
Others 5
Extractive metallurgy 5
Car catalysts 4
Vitrious additives 3

8. Elas+c
Demand
(Ped
>
1)
• If
demand
for
a
product
is
price
elas4c,
a
supplier
stands
to
gain
extra
revenue
if
they
reduce
their
prices.
• The
change
in
quan4ty
demanded
will
be
propor4onately
higher
than
the
reduc4on
in
price.
This
is
shown
in
the
diagram
opposite.
If
the
co-­‐efficient
of
price
elas4city
of
demand
>1,
then
demand
is
said
to
be
price
elas+c
i.e.
highly
responsive
to
a
change
in
price
Price
Qty
P2
P1
Q1
Q2
Demand
Increased
revenue
from
selling
more
at
a
lower
price
Lost
revenue
from
selling
at
a
lower
price

9. Perfectly
Inelas+c
Demand
(Ped
=
0)
• A
perfectly
inelas4c
demand
curve
is
an
extreme
case.
• It
implies
that
consumers
are
willing
and
able
to
pay
any
price
for
the
product.
• If
supply
falls,
equilibrium
market
price
can
rise
without
any
contrac4on
in
quan4ty
demanded.
If
the
co-­‐efficient
of
price
elas4city
of
demand
=
zero,
demand
is
perfectly
inelas+c
i.e.
demand
does
not
vary
with
a
change
in
price
Price
Qty
P2
P3
Demand
P1
Q1
S1
S2
S3

10. Perfectly
Elas+c
Demand
(Ped
=
infinity)
• If
demand
is
perfectly
elas+c,
a
change
in
market
supply
(shown
on
the
right
as
an
outward
shi=
of
supply)
will
not
lead
to
any
change
in
the
equilibrium
price.
• This
demand
curve
applies
to
highly
compe++ve
markets
where
no
supplier
has
any
“pricing
power”
If
the
co-­‐efficient
of
PED
=
infinity,
then
demand
is
perfectly
elas+c
–
there
is
one
price
at
which
consumers
are
prepared
to
pay
Price
Qty
P1
Demand
S1
S2
Q1
Q2

11. Unitary
Elas+c
Demand
(Ped
=
1)
• With
a
demand
curve
of
unitary
price
elas+city,
a
change
in
price
is
met
with
a
propor+onate
change
in
demand
• This
means
that
total
spending
by
consumers
on
the
product
will
remain
the
same
at
each
price
level
A
demand
curve
with
unitary
price
elas4city
has
a
coefficient
of
PED
equal
to
1
(unity)
throughout
Price
Qty
P1
Q1
Q2
P2
Demand

12. Co-­‐Efficient
of
PED
along
a
linear
demand
curve
• Price
elas4city
of
demand
along
a
straight
line
demand
curve
will
vary
• At
high
prices,
a
reduc4on
in
price
will
have
an
elas4c
price
response
–
i.e.
lower
prices
cause
total
revenue
to
rise
• Demand
is
price
inelas4c
towards
the
bokom
of
the
demand
curve
–
a
fall
in
price
causes
total
revenue
to
drop
For
a
straight-­‐lined
demand
curve,
the
PED
varies
along
the
curve
Price
Qty
P1
D
Q1
P2
Q2
A
fall
in
market
price
from
P1
to
P2
causes
total
spending
to
rise,
therefore
PED
>1
P3
P4
Q3
Q4
A
fall
in
price
from
P3
to
P4
causes
total
spending
to
fall,
therefore
PED
<1

13. Usefulness
of
Price
Elas+city
of
Demand
for
Producers
Firms
can
use
PED
es4mates
to
predict:
1. The
effect
of
a
change
in
price
on
total
revenue
of
sellers
2. The
price
vola+lity
in
a
market
following
changes
in
supply
–
this
is
important
for
commodity
producers
who
suffer
big
price
and
revenue
shi=s
from
one
4me
period
to
another.
3. The
effect
of
a
change
in
an
indirect
tax
on
price
and
quan4ty
demanded
and
also
whether
the
business
is
able
to
pass
on
some
or
all
of
the
tax
onto
the
consumer.
PED
can
be
used
by
a
business
for
price
discrimina+on.
• This
is
where
a
supplier
decides
to
charge
different
prices
for
the
same
product
to
different
segments
of
the
market
e.g.
peak
and
off
peak
rail
travel
or
prices
charged
by
many
airlines.
• Usually
a
business
will
charge
a
higher
price
to
consumers
whose
demand
is
price
inelas4c
• The
taxi
company
Uber
for
example
engages
in
surge
pricing

14. Price
Elas+city
in
Ac+on:
Uber
and
Surge
Pricing
Surge
Pricing
Peak
Demand
• Uber
is
a
fast-­‐growing
taxi
service
app
that
now
operates
in
more
than
50
countries
• In
May
2015,
Uber
was
valued
at
about
41
billion
U.S.
dollars
by
venture-­‐capital
firms
• Uber
engages
in
surge
pricing
–
also
known
as
dynamic
pricing
• When
market
demand
out-­‐strips
available
supply
e.g.
at
peak
4mes,
then
Uber
raises
the
average
fare
on
their
app
• The
aim
is
to
encourage
more
drivers
to
take
to
the
roads
to
expand
supply
• The
business
is
taking
advantage
of
low
price
elas4city
of
demand
at
busy
4mes
• Some
economists
have
cri4cised
this
policy
especially
during
emergencies

15. Cri+cal
Awareness:
Limita+ons
of
Elas+ci+es
Problems
with
inaccurate
or
incomplete
data
collec4on
Consumer
price
sensi4vity
changes
over
4me
Elas4city
of
demand
varies
by
region
/
4me
Not
all
businesses
are
profit
maximisers
Elas4city
will
vary
within
product
ranges
e.g.
economy
and
premium
products
Rival
producers
will
change
their
market
strategies
from
4me
to
4me

16. Price
Elas+city
of
Demand
EdExcel
Economics
1.2.3