Elasticity & it’s importance Revision Elasticity & it’s importance

What is Price elasticity? The responsiveness of one variable to changes in another When price rises what happens to demand? Demand falls BUT! How much does demand fall?

Investopedia Video https://www.youtube.com/watch?v=Pduf_fpshkU

Elasticity – the concept If price rises by 10%, what happens to demand? We know demand will fall By more than 10%? or By less than 10%? Elasticity measures the extent to which demand will change

react much to a change in price Consider a 10% increase in price PeD Mantra…. If answer is between 0 and -1 e.g. -0.4 or -0.8 The relationship is inelastic If the answer is between -1 and infinity e.g. -1.4 or 2 or 12.3 The relationship is elastic Consumers DO NOT react much to a change in price Consumers DO react To changes in prices 27/04/2019

Elastic or inelastic???? Use your whiteboards Would customers react lots (ELASTIC) or not much (INELASTIC)….. With the following PeD’s????

-3 Elastic or inelastic? Elastic – because a 10% increase in price would lead to a 30% fall in demand

-0.4 Elastic or inelastic? Inelastic – because a 10% increase in price would lead to a 4% fall in demand

-0.1 Elastic or inelastic? Inelastic – because a 10% increase in price would lead to a 1% fall in demand

-1.1 Elastic or inelastic? Elastic – because a 10% increase in price would lead to a 11% fall in demand

-14 Elastic or inelastic? Elastic – because a 10% increase in price would lead to a 140% fall in demand

What about the effect on revenue?

Using PeD to calculate changes in TR What if a company sells 10,000 units at £5. What is their current TR? TR = P x Quantity sold TR = £5 x 10,000 = £50,000 What if the company has a PeD of -0.5? If they reduced their price – would the customers react a bit or loads? is -0.5 inelastic or elastic? INELASTIC….

Using PeD to calculate changes in TR What if a company sells 10,000 units at £5. What is their current TR? TR = P x Quantity sold TR = £5 x 10,000 = £50,000 What if the company has a PeD of -0.5? …. and they reduce their price to £4.50 What would happen to their TR now? Will it increase or decrease? 1st you need to know what the % increase in price has been….?

Using PeD to calculate changes in TR What if a company sells 10,000 units at £5. And now their price is £4.50 What is the % change? Difference/original x 100 = % change 5 - 4.50 = 0.5 / 5 x 100 = -10% So if the company originally sold 10,000 units….. And PeD is 0.5 And price has dropped by 10 % What will happen to DEMAND? So what’s 5% 0f 10,000 units? 500 units But would that be a fall or an increase in sales????? 10% x 0.5 = 5%

And the last step of the calculation… The original Q is what would happen to the company TR if they changed their price from £5 to £4.50, with original sales of 10,000? Original TR £5 x 10,000 = £50,000

And the last step of the calculation… The original Q is what would happen to the company TR if they changed their price from £5 to £4.50, with original sales of 10,000? Original TR £5 x 10,000 = £50,000 New sales £4.50 x (10,000 + 500) = £4.50 x 10,500 = £47,250

Doesn’t guarantee higher profits! So a price cut …. Doesn’t guarantee higher profits!

What if they increased their price? Price was £5 but now £5.50? Price increase is 0.5/5 x 100 = +10% The company still has a PeD of -0.5 So sales will FALL by 5% 10,000 x 5% = 10,000 -500 So £5.50 x 9,500 TR = £52,250 So an inelastic product will earn MORE REVENUE with a price rise!

Who needs a recap?

Worksheet Questions… A company has a price cut from £10 to £8. What will be the impact on their revenue if they have a PeD of 0.8 and originally sold 30 units? A company has a price cut from £20 to £14. What will be the impact on their revenue if they have a PeD of 2 and originally sold 100 units? A company has a price rise from £15 to £16. What will be the impact on their revenue if they have a PeD of 2 and originally sold 100 units?

Worksheet Question 1 A company has a price cut from £10 to £8. What will be the impact on their revenue if they have a PeD of 0.8 and originally sold 30 units? 10-8 = 2/10 x100 = 20% fall in price 20% x 0.8 = 16% increase in sales 16% of 30 = 4.8 units… can’t sell .8 of a good so they must sell 5… Original TR = 10 x 30 = £300 New TR = (30 +5) x £8 = £280 A price cut with an inelastic good will reduce your revenue So a price rise with an inelastic good will increase your revenue

Worksheet Question 2 A company has a price cut from £20 to £14. What will be the impact on their revenue if they have a PeD of 2 and originally sold 100 units? 20-14 = 6/20 x100 = 30% fall in price 30% x 2 = 60% increase in sales 60% of 100 = 60 units Original TR = £20 x 100 = £2000 New TR = £14 x (100+60) = £2240 A price cut with an elastic good will increase revenue So a price rise with an elastic good will reduce revenue

Worksheet Question 3 A company has a price rise from £15 to £16. What will be the impact on their revenue if they have a PeD of 2 and originally sold 100 units? 15-16 = 1/15 x100 = 6.67% rise in price 6.67% x 2 = 13.34% fall in sales 13.34% of 100 = 13.34 units – but you can’t sell 0.34 of a product …so have to fall by 14 units Original TR = £15 x 100 = £1500 New TR = ( £16 x (100 – 14) = £1376 A price rise with an elastic good will reduce revenue So a price cut with an elastic good will increase revenue

How to make your product more inelastic …why??? …so customers don’t react to price increases! Make your product DIFFERENT to competitors – to keep them brand loyal. Take over the competition! So customers have to buy your products. Make price changes over a short period of time – so customers don’t notice!