1. Elasticity of Demand

2. Price Elasticity of Demand
Defining price elasticity of demand (PeD)
measures the strength of response of consumer demand to a change in price.
Measures our reaction to a change in price

3. Price Elasticity of Demand and Consumer Expenditure
Defining Total consumer Expenditure
TE = P × Q
Illustrating TE graphically

4. Total expenditure Consumers’ total expenditure = firms’ total revenue
£2 x 3m = £6m D
Q (millions of units per period of time)

5. Price Elasticity of Demand and Consumer Expenditure
Effects of a price change: elastic demand
Price rises Total Expenditure falls
See graph

6. Elastic demand between two points
Expenditure falls
as price rises
P(£) b 5 10 a 4 D 20
Q (millions of units per period of time)

7. Elastic demand between two points5 10
revenue gain a 4 D
revenue loss 20
Q (millions of units per period of time)

8. Price Elasticity of Demand and Consumer Expenditure
Effects of a price change: inelastic demand
Price rises: Total Expenditure rises

9. Q (millions of units per period of time)
Inelastic demand
Expenditure rises
as price rises c 8 15
P(£)
revenue gain a 4
revenue loss D 20
Q (millions of units per period of time)

10. Price Elasticity of Demand
Applications to pricing decisions
Applications to tax decisions
Income Elasticity (at end)
Revenue predictions
Government revenue changes from taxes on products

11. Price Elasticity of Demand
Measuring price elasticity of demand
use of percentage changes
the sign: positive or negative?
the value: greater or less than 1?
% change in QD
% change in P

12. Price Elasticity of Demand
Measuring price elasticity of demand
greater than -1 then price elastic
less than -1 then price inelastic
% change in QD
% change in P

13. Price Elasticity of Demand
Determinants of price elasticity of demand
availability of substitute goods
proportion of income spent on the good
habit
fashion
frequency of purchase

14. Elastic or Inelastic?

15. Elastic or Inelastic

16. Elastic or Inelastic

17. Elastic or Inelastic?

18. Elastic or Inelastic

19. Elastic or Inelastic?

20. Measuring Elasticity ÷ % change in QD % change in P Change in QD
Original QD
Change in P
Original P

21. Measuring Elasticity m n
P (£)
Demand
Q (000s)

22. Price elasticity of demand
% change in QD
% change in P ÷ 10 2 8
= 4

23. Price Elasticity of Demand and Consumer Expenditure
Special cases
PeD = 0

24. Totally inelastic demand (PÎD = 0)b P1 a O Q1 Q

25. Price Elasticity of Demand and Consumer Expenditure
Special cases
PeD = 0
PeD = 

26. Infinitely elastic demand (PÎD = ¥)b P1 D Q2 O Q1 Q

27. Price Elasticity of Demand and Consumer Expenditure
Special cases
PeD = 0
PeD = 
PeD = –1

28. Unit elastic demand (PÎD = –1)20 b
100 8 D O 40 Q

29. Price Elasticity of Demand and Consumer Expenditure
Special cases
PeD = 0 – perfectly inelastic
PeD =  - perfectly elastic
PeD = –1 – unitary elasticity

30. Demand Changes with Income
Consumers increase the demand for most good when income rises – NORMAL GOODS
Demand for a good may fall when income rises and vice versa – INFERIOR GOODS

31. The London Restaurant market
Watch the video clips and comment on the types of goods and their elasticities:
Restaurant Food
Prepacked sandwiches
Sandwich boxes

32. Goods can be both! Bread NORMAL if you are on a low income
INFERIOR for higher income earners

33. Other Elasticities Income elasticity of demand measurement
determinants
degree of necessity
rate at which people are satisfied
level of income
Applications – we can work out the effect of a price change/tax change

34. Income Elasticity
If sellers know the income elasticity of their product they can predict what will happen to their revenue when incomes change
The Government would also be able to predict changes in revenue from taxes on products
% Change in demand
% Change in Income

35. If income rises?
Some products are still out of our reach. How much is an Aston Martin? £183,000
Some products we will buy no more of. Eg a newspaper
Some we will buy a little more of eg food. (Food is income inelastic in a high-income economy such as ours).
Some we will buy more of eg entertainment, meals out. Income elasticity tends to be greater than 1
Some we will buy less of eg no more Tesco Value for me or white bread!

36. Income Elasticity
A normal good will always have a positive income elasticity because quantity demanded and income either both increase (+/+) or both decrease (-/-)
An inferior good will always have a negative elasticity - opposite signs each way

37. Giffen Goods Theory by Sir Robert Giffen!
A giffen good is a special sort of inferior good
Giffen observed that the consumption of bread increased as the price rose
Bread was the staple food of those on low incomes – bread would ‘fill’ empty stomachs! And as its price had risen they could afford less luxuries like meat and so bought more bread

38. Income Effect
If the price of a good rises, the real income of a consumer falls
Cannot buy the same basket of goods and services as before.

39. Substitution Price rises Buy more pears
If the price of a good rises, consumers will buy less of that good and more of others because it is relatively more expensive.
Price rises
Buy more pears

40. Cross Elasticity
The quantity demanded of a good varies according to the price of other goods
Eg a rise in the price of beef would increase demand for pork (substitute)
A rise in the price of cheese would lead to a fall in demand for macaroni (complement)

41. % ∆ Price of another good Y
Cross Elasticity
% ∆ Q demanded good X
% ∆ Price of another good Y
Two goods which are substitutes will have a positive cross elasticity
Two goods which are complements will have a negative cross elasticity
The cross elasticity of goods which have little relationship to each other would be zero (independents)

42. Example – positive cross elasticity
A rise in the price of fish may cause demand for chicken to increase (substitutes)
What will have happened to the demand curve for chicken?
Price of Fish
Quantity of Chicken Demanded

43. Example – negative cross elasticity
A rise in the price of air travel causes a fall in the demand for foreign holidays (complementary goods)
What will have happened to the demand curve for foreign holidays?
Price of air travel
Quantity of foreign holidays demanded

44. Example – zero cross elasticity
A rise in the price of apples leaves the demand for gloves unaffected!
However we must remember that a change in the price of a product affects our purchasing power and may affect the demand for an unrelated product.
Price of apples
Quantity of gloves demanded

45. The significance of cross elasticity
Firms may realise that if a product has a high positive cross-elasticity, then a decrease in price will attract more customers.
A low positive cross –elasticity gives a firm more power to raise the price.
A high negative cross elasticity means lowering the price of the cheaper complement can increase sales of the other product.