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Price Elasticity of Demand DP Economics
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:
= %ΔQd
%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
P1
Q1
An inelastic demand
Quantity Demanded
Price
$200
400
P1 = $200
Q1 = 400
An inelastic demand
Quantity Demanded
Price
$200
400350
$400P1 = $200
Q1 = 400
P2 = $400
Q2 = 350
An inelastic demand
Quantity Demanded
Price
$200
400
% change in demand
= Q2 – Q1 x 100
Q1
(Ignoring the sign)
350
$400
An inelastic demand
Quantity Demanded
Price
$200
400
% change in demand
= 12.5%
% change in price
=
350
$400
An inelastic demand
Quantity Demanded
Price
$200
400
% change in demand
= 12.5%
% change in price
= 100%
350
$400
An inelastic demand
Quantity Demanded
Price
$200
400
% change in demand
= 12.5%
% change in price
= 100%
Price elasticity of demand
= 12.5 / 100.0
= 0.125 (< 1)
350
$400
An inelastic demand
Quantity Demanded
Price
$200
400
PED is inelastic
350
$400
An elastic demand curve
Quantity Demanded
Price
P1 $200
Q1 400
An elastic demand
Price
£200
400
£100
1200
P1 = $200
Q1 = 400
P2 = $100
Q2 = 1200
Quantity Demanded
An elastic demand curve
Price
£200
400
£100
1200
PED
% change in demand =
% change in price =
*ignoring the sign
Quantity Demanded
An elastic demand curve
Price
£200
400
£100
1200
PED
% change in demand = 200%
% change in price = 50%
An elastic demand curve
Price
£200
400
£100
1200
PED = 4 (elastic)
% change in demand = 200%
% change in price = 50%
Quantity Demanded
Plot the following demand schedule for a liquid commodity.
Price ($)
Quantity demanded
(litres)
0 15
10 12
20 9
30 6
40 3
50 0
Plot the following demand schedule
Price ($)
Quantity demanded
(litres)
0 15
10 12
20 9
30 6
40 3
50 0
0
10
20
30
40
50
60
0 5 10 15 20
Quantity DemandedPr
ice
($)
Calculate the PEDs at each point of the schedule
Price ($)
Quantity demanded
(litres)
0 15
10 12
20 9
30 6
40 3
50 0
0
10
20
30
40
50
60
0 5 10 15 20
Quantity DemandedPr
ice
($)
PEDS for the demand schedule
Point 1 (0,15)
010
0
15
31
1
P
P
Q
Q(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)
5.110
30
6
31
1
P
P
Q
Q0
10
0
15
3
P
P
Q
Q
25.010
10
12
31
1
P
P
Q
Q4
10
40
3
31
1
P
P
Q
Q
undefinedP
P
Q
Q
0
50
0
01
1
67.010
20
9
31
1
P
P
Q
Q
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 Price
Quantity Demanded
Elastic
PED > 1
Price Inelastic PED < 1
Unit Elasticity PED = 1
Relatively inelastic Curve
Relatively elastic curve
A B
Look at the following graphs A & B: do they contradict?*
Quantity Demanded
Price Price
Quantity Demanded
Elastic
PED > 1
Price Inelastic PED < 1
Unit Elasticity PED = 1
Relatively inelastic Curve
Relatively elastic curve
A B
P1
P2
Look at the following graphs A & B: do they contradict?*
Quantity Demanded
Price Price
Quantity Demanded
Price Elastic
PED > 1
Price Inelastic PED < 1
Unit Elasticity PED = 1
Relatively inelastic Curve
Relatively elastic curve
A B
P1
P2
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
£200
600
£300
£400PED is always 0
Perfectly elastic demand curve
Price
400 1200
£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
Q1 Q2
P3
Q3
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
Q1 Q2
P3
Q3
Longer run demand is relatively more elastic if non-oil substitutes develop
D short-run
D long-run
