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?*# 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?

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: = %ΔQ d %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

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

An inelastic demand Quantity Demanded Price

An inelastic demand Quantity Demanded Price P1P1 Q1Q1

An inelastic demand Quantity Demanded Price $ P 1 = $200 Q 1 = 400

An inelastic demand Quantity Demanded Price $ $400 P 1 = $200 Q 1 = 400 P 2 = $400 Q 2 = 350

An inelastic demand Quantity Demanded Price $ % change in demand = Q 2 – Q 1 x 100 Q 1 (Ignoring the sign) 350 $400

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

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

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

An inelastic demand Quantity Demanded Price $ PED is inelastic 350 $400

An elastic demand curve Quantity Demanded Price P 1 $200 Q 1 400

An elastic demand Price £ £ P 1 = $200 Q 1 = 400 P 2 = $100 Q 2 = 1200 Quantity Demanded

An elastic demand curve Price £ £ PED % change in demand = % change in price = *ignoring the sign Quantity Demanded

An elastic demand curve Price £ £ PED % change in demand = 200% % change in price = 50%

An elastic demand curve Price £ £ PED = 4 (elastic) % change in demand = 200% % change in price = 50% Quantity Demanded

Plot the following demand schedule for a liquid commodity. Price ($) Quantity demanded (litres)

Plot the following demand schedule Price ($) Quantity demanded (litres)

Calculate the PEDs at each point of the schedule Price ($) Quantity demanded (litres)

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

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

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.#

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

Look at the following graphs A & B: do they contradict?* Quantity Demanded Price Quantity Demanded Elastic PED > 1 Price Inelastic PED < 1 Unit Elasticity PED = 1 Relatively inelastic Curve Relatively elastic curve AB P1P1 P2P2

Look at the following graphs A & B: do they contradict?* Quantity Demanded Price Quantity Demanded Price Elastic PED > 1 Price Inelastic PED < 1 Unit Elasticity PED = 1 Relatively inelastic Curve Relatively elastic curve AB P1P1 P2P2

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

Perfectly inelastic demand curve Quantity Demanded Price £ £300 £400 PED is always 0

Perfectly elastic demand curve Price £200 Quantity Demanded PED is always ∞

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

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

Elastic or inelastic demand? A Sony portable PlayStation Household electricity

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

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

Short Term Demand for Oil Demand for Oil Price $ per barrel Oil Demand P1 P2 Q1Q2Q2 P3 Q3Q3 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 D short-run

Longer Term Demand for Oil – More Price Elastic Demand for Oil Price $ per barrel Oil Demand P1 P2 Q1Q2Q2 P3 Q3Q3 Longer run demand is relatively more elastic if non-oil substitutes develop D short-run D long-run