1. IB Business and Management
Elasticity of Demand
IB Business and Management

2. What is Elasticity?
Elasticity measures how responsive demand is to a change in a particular variable
The IB syllabus includes:
Price Elasticity of Demand
Income Elasticity of Demand
Cross-price Elasticity of Demand
Advertising Elasticity of Demand

3. Price Elasticity of Demand

4. Elasticity

5. The relationship between price and demand

6. Elastic Demand?

7. Price Elasticity of Demand
Price Elasticity of demand is concerned with how responsive the demand for a product is to a change in price
How much will the demand change as a result of a change in the price?

8. Price Inelastic Goods
Goods where demand is relatively unresponsive to a change in price
Demand will reduce but by a relatively small amount
Firms would like their products to be price inelastic.... Why?
Can you think of any examples?

9. Price Elastic Goods
Demand for the product is relatively responsive to a change in price
Firms will have very little freedom to increase prices as this will result in a large decrease in demand
Can you think of any examples?

10. Calculating Price Elasticity
PED = % Change in quantity demanded
% change in price
Example: The price for a wardrobe is reduced from £50 to £47 and as a result sales rise from 2,000 to 2,240 units.
% change in demand = 240/2000 X 100 = 12%
% change in price = -£3/£50 X 100 = -6%
PED = +12%/-6% = -2

11. Classifying Price Elasticity
Price Elasticity will always have a negative value – Why?
PED Value (ignoring minus sign)
Negative value less than 1
Price Inelastic
Exactly -1
Unit Elasticity
Negative Value more than 1
Price Elastic

12. PED and Revenue for Price Elastic Products
Increase in SP
Large Decrease in QD
Revenue Falls
Revenue = Selling Price x Quantity Demanded
Decrease in SP
Large Increase in QD
Revenue Increases
Therefore firms who assess their products to be Price Elastic should consider carefully before increasing prices and can be in a difficult position if their costs increase

13. PED and Revenue for Price Inelastic Products
Increase in SP
Small Decrease in QD
Revenue Increases
Revenue = Selling Price x Quantity Demanded
Decrease in SP
Small Increase in QD
Revenue Decreases
Therefore firms who assess their products to be Price Inelastic have great freedom with their selling price.

14. Using PED to calculate changes in revenues
PED = % Change in quantity demanded
% change in price
How could we rearrange this formula to make % change in quantity demanded the subject?
% change in quantity demanded = PED X % change in price

15. E.g. A product costs £100. At this level demand for the product is 60 units
What would revenue be at this price level?
Total Revenue = £100 X 60 = £6,000
The company are considering increasing the price to £110
% change in quantity demanded = PED X % change in price
The product is Price Inelastic – PED -0.5
What will the % change in demand be?
If PED is -0.5 a 10% increase in price will result only in a 5% decrease in demand
So the new level of demand will be?
60 ÷ 100 x 95 = 57
So what will the new revenue be?
New Total Revenue = £110 X 57 = £6,270

16. Answer: The product is Price Elastic – PED -2
What will the % change in demand be?
If PED is -2 a 10% increase in price will result in a 20% decrease in demand
So the new level of demand will be?
60 ÷ 100 x 80 = 48
So what will the new revenue be?
New Total Revenue = £110 X 48 = £5,280

17. Exam Question (b) (i)

18. Exam Question (b) (ii)

19. Factors influencing Price Elasticity
Necessity or luxury
Availability of substitutes
Income of customers
Brand Loyalty

20. Questions
Why do firms prefer to sell products that are price inelastic?
How can firms reduce the price elasticity of their products?

21. Implications of Price Elasticity of Demand
Helps firms decide on their pricing policy
Helps predict the effect of exchange rate fluctuations on exported goods
Helps governments to work out optimum levels of taxation on goods to maximise tax revenues

22. What do the following graphs show?

23. Exam Question (b) (i)

24. Exam Question (b) (ii)

25. Income Elasticity of Demand

26. Income Elasticity of Demand
Income elasticity of demand is concerned with how responsive the demand for a product is to a change in income
How much does the demand for a product increase or decrease with a change in consumer’s incomes?

27. Calculating Income Elasticity
IED = % change in demand
% change in income
Whereas an increase in price will always lead to a fall in demand (negative correlation) an increase in demand can lead to either a fall or a rise in demand depending on the type of product.
Therefore IED can be negative or positive

28. Interpreting Income Elasticity of Demand
An IED with a value < 1 is income inelastic and a value of > 1 are income elastic (regardless of whether they are negative or positive)
Products can be split into one of three categories: Normal Goods, Luxury goods or Inferior goods

29. Inferior Products
Inferior products are those where an increase in income leads to a decrease in demand
Inferior products have a negative IED
Inferior products can be income elastic or inelastic
Demand falls as incomes rise and people tend to buy more luxury products
E.g. A 10% increase in income leads to a 5% decrease in demand for Tesco Value white bread. IED = -5%/10% = -0.5

30. Luxury Goods
Luxury goods are products where an increase in income will lead to a large increase in demand and vice versa.
Luxury goods are therefor income elastic
Luxury goods have a positive IED >1
E.g. An increase in income of 10% leads to a 20% increase in demand for cruise holidays. IED = 20%/10% = +2

31. Normal goods
Normal goods are products where an increase in income leads to a small increase in demand and vice versa
These products have a positive income elasticity < 1
Normal goods are therefore income inelastic
These products are normally ‘everyday’ items
E.g. A 10% increase in income leads to a 6% increase in the demand for jammy dodgers. IED = 6%/10% = +0.6

32. Normal, Inferior or Luxury

33. Issues with income elasticity
Can help a firm to predict sales if they know the economic forecast
Goods can fall into different categories to different groups of people. What is considered a necessity is subjective
Goods can move between categories over time

34. Question
Product A
Product B
Price Elasticity
-3.5
-0.5
Income Elasticity
+0.4
+2.5
What products can be drawn about the nature of the two products A and B?

35. Cross-price Elasticity of demand

36. Cross-price elasticity
Measures how responsive the demand for a product is to a change of price of another product
These other products can be:
Substitutes
Complements
Not-related

37. Calculating Cross-price elasticity
CED = % change in demand for Good A
% change price of Good B

38. Substitutes
Substitute products compete for demand as they can be used in place of each other
These products can be competitor products or other products that fulfill the same needs

39. Suggest some substitutes for these products…..
Train travel

40. Elasticity of demand and substitute products
What is likely to happen to the demand for a product if the price of it’s substitute increases?
There is a positive relationship between the demand for a product and the price of it’s substitutes
The cross-price elasticity will be a positive number
The higher the value the greater the elasticity

41. Complements
Complements are products that are joint in demand as they are related products

42. Suggest some complements for these products…..

43. Elasticity of demand and complement products
What is likely to happen to the demand for a product if the price of it’s complement increases?
There is an inverse relationship between the demand for a product and the price of it’s complements
The cross-price elasticity will be a negative number
The more negative the value the greater the elasticity

44. Other considerations with cross-price elasticity
What would it mean if the calculation returned a result of zero?
Knowledge of cross-price elasticity can help businesses forecast the impact on revenues if competitors implement a price change

45. Advertising Elasticity of demand

46. Advertising elasticity of demand
Advertising elasticity of demand (AED) measures the degree of responsiveness of demand for a product following a change in the advertising expenditure for the product

47. Calculating Advertising Elasticity of demand
AED = % change in demand
% change in advertising expenditure
Can the results be positive or negative?
What would a large figure suggest?
How might a firm use this information in planning it’s marketing strategy?

48. Considerations with AED
Is very difficult to determine in reality as it is difficult to determine whether advertising expenditure or another factor lead to a change in demand
Also, AED is dependent on the effectiveness of the advertising rather than just the amount of expenditure