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Price Elasticity of Demand

- Price elasticity of of demand is a measure of how much the quantity demanded of a product changes when there is a change in the price of the product.
- PED = Percentage of change quantity demanded of the product
-----------------------------------------------------------------

Percentage change in price of the product

- Example – A publishing firm discovers that when they lower the price of one of their magazines from $5.00 to $4.50 the number of magazines that are bought rises from 200,000 to 230,000.
- The price has fallen by 50 cents so this a change or -10%

Ped = -50x 100 = -10%

100

30,000 the price of one of their magazines from $5.00 to $4.50 the number of magazines that are bought rises from 200,000 to 230,000.x 100 = 15%

200,000

- The quantity demanded has increased by 30,000 from the original demand of 200,000 an increase of 15%
- If we put the two values into the PED equations we get 15% -
10% a value of -1.5

- The negative value indicates that there is an inverse relationship between price and the quantity demanded.
- In order to make thing easier economist unusually ignore the the negative value so the PED for the magazines would be 1.5

- Range of values = 0 to Infinity, with 0 and infinity being theoretical
- Just to remind you - Values of PED are always expressed as positive numbers

- Price Elasticity of Demand – (PED) theoretical
- Two extremes – no REAL examples of these extreme points!
- The demand is perfectly inelastic – it is completely unresponsive to price changes.
- No matter what the price is demand will always be the same.

- At the price (p1) the demand is curve will go on forever so the quantity demanded is infinite.
- However if the price is raised above this price even by the smallest amount the demand will fall to zero.

Inelastic demand the quantity demanded is infinite.

- The Value of PED is less than one and greater than zero.
- If a product has inelastic demand, then a change in the price of the product leads to a proportionally smaller change in the quantity demanded of it.
- This means that if the price is raised, the quantity demanded will not fall by much in comparison, and so the total revenue gained by the firm (the number of units sold x the price of the product) will increase.

Elastic demand the quantity demanded is infinite.

- The value of PED is greater than one and less than infinity.
- If a product has elastic demand, then a change in the price of the product leads to a greater than proportionate change in the quantity demanded of it.
- This means that if price is raised, the quantity demanded will fall by more in comparison, and so the total revenue gained by the firm (the number of units sold x the price of the product) will fall.

Unit elastic demand the quantity demanded is infinite.

- The value of PED is equal to one.
- If a product has unit elastic demand, then a change in the price of the product leads to a proportionate, opposite, change in the quantity demanded of it
- This means that if price is raised by percentage then the quantity demanded will fall by the same percentage and so PED is equal to 1 and the total revenue gamed by the firm (the number of units sold x the price of the product) will not change.

When the price falls form $20 to $18, quantity demanded increases from 60 to 80 unites. (A to B)

When price falls from $10 to $8, quantity demanded increase from 160 to 180 units.

(C to D)

A

B

20

15

10

5

0

C

D

50 100 150 200 250

“Not always the same!!!” increases from 60 to 80 unites. (A to B)

When the price falls form $20 to $18, quantity demanded increases from 60 to 80 unites. (A to B)

When price falls from $10 to $8, quantity demanded increase from 160 to 180 units.

(C to D)

PED = 3.3

(Elastic )

A

B

20

15

10

5

0

Demand

becomes

less

elastic

PED = 0.625

(Inelastic)

C

D

50 100 150 200 250

Mathematical equation increases from 60 to 80 unites. (A to B)

- It is a common mistake for students to assume that elasticity is a measure of the slope of the demand curve and that the value is always the same at any point on the curve.
- This is not the case.
- Low-priced products have a more inelastic demand than high-priced products, consumers are less concerned when the price of an inexpensive product rises than they are when the price of an expensive product rises.

determinants increases from 60 to 80 unites. (A to B)of price elasticity of demand

- The number and closeness of substitutes:
- The number and closeness of substitutes that are available is certainly the most important determinate of PED. It is fair to say that the more substitutes there are for a product, the more elastic will be the demand for it
- Also, the closer the substitutes available, the more elastic will be the demand.
- Elastic – household good, food, (meats fruits vegetables)
- Inelastic – oil demand falls relatively little with increase of price.

The necessity of the product and how widely the product is defined:

- Food is a necessary product. Indeed, if we do not have food, then we will die, so it is very necessary.
- So we would expect the demand for food to be very inelastic, which it is. However, if we define food more narrowly and consider meat, we would expect the demand to be less inelastic, since there are many alternatives, such as vegetables. Once again, if we then define meat more narrowly and consider chicken, beef, lamb, and pork, we could once again reasonably assume that the demand for each would be relatively elastic, since the consumer can easily change from one type of meat to another, if the price of one rises.

- As the product is defined even more narrowly, into chicken products and then identical, but branded, chicken products, demand becomes even more elastic.

Food products and then identical, but branded, chicken products, demand becomes even more elastic.

Very inelastic demand

Meat

Vegetable

Pork

Beef

Chicken

Chicken wings

Chicken nuggets

Brand A nuggets

Brand B nuggets

Very elastic demand

- It is worth remembering that for many goods, necessity will change from consumer to consumer, since different people have different tastes and necessity is often a subjective view.
- For example, in Malaysia, chicken is very popular among the population and so the demand for it is less elastic than it would be in Italy, where it is not valued as highly.
- Necessity may go to extremes when individuals consider products to be very ‘necessary”, such as habit-forming goods, like cigarettes alcohol or hard drugs Such products tend to have inelastic demand.

The time period considered: change from consumer to consumer, since different people have different tastes and necessity is often a subjective view.

- As the price of a product changes, it often takes time for consumers to change their buying and consumption habits.
- PED thus tends to be more inelastic in the short term and then becomes more elastic the longer the time period it is measured over.
- It may take people some time to locate substitutes or figure out how to use them or even how to do with out certain products.

Cross Elasticity of Demand change from consumer to consumer, since different people have different tastes and necessity is often a subjective view.

- Cross elasticity of demand is a measure of how much the demand for a product changes when there is a change in the price of another product.
- The equation

XED = Percentage change in quantity demanded of the product X

Percentage change in price of product Y

- Owner of the noodle stand finds out that his competitor, a dumpling stand, lowers the price of his plate of dumplings from 20¥ to 18¥ , then the quantity of bowls on noodles he sells each week falls from 400 to 380.
- The price of the competitors dumplings have fallen by 2¥ from the original price of 20¥ a change of -10%
- The quantity demanded of the bowl of noodles has fallen by 20 from the original demand of 400 a change of 5%
- Put the two values into the equation for XED we get which is a value of +0.5

-5

-10

The range of values for cross elasticity of demand dumpling stand, lowers the price of his plate of dumplings from 20¥ to 18¥ , then the quantity of bowls on noodles he sells each week falls from 400 to 380.

- Unlike price elasticity of demand, where the vast majority of products have a positive value for PED, the value of XED may be positive or negative and the sign is important, since it tells us what the relationship between the two goods in question is.
- If the value of XED is positive, then the two goods in question may said to be substitutes for each other.
- Products that are very close substitutes will have a higher positive value than products that are not so close.

- Two types of cheese may be very close substitutes in the view of consumers, and so a rise in the price of one will lead a significant fall in the demand for it and a large increase in the demand for the competitor’s cheese.
- So there would be a high positive value for XED.

- If the value of XED is negative, then the two goods in question may he said to be complements for each other.
- Products that are very close complements will have a lower negative value than products that are not so close.
- A computer gaming machine and the games that are played on it may be very close complements for consumers. A rise in the price of the gaming machine may lead to a significant fall in the quantity demanded of it and so a large fall in the demand for the games.
- Thus there would be a strong negative value for XED.

- Some products (chocolate and rollerblades) are not connected.
- A increase in the price of chocolate will have no effect on the demand for rollerblades.
- The value of XED is zero and we say the two products are unrelated.

- Firms need to be aware of the XED for the products that they produce.
- It is essential that firms are aware of the possible impact on the demand for their products that may arise if there is a change in the price of a close rival’s products and vice versa
- Firms that produce complementary products, need to be aware of the effect that any price change they make on one product might have on the demand for complementary products that they also produce.

XED Value produce.

Negative Zero Positive

Relationship

Close Remote Unrelated Remote Close

Comp. Comp. products Subs Subs

Income elasticity of demand (YED) produce.

- Formula and definition Income elasticity of demand is a measure of how much the demand for a product changes when there is a change in the consumer’s income.
- It is usually calculated by using the equation below:

YED = Percentage of change in quantity demanded of the product

Percentage change in income of the consumer

- A person has an increase in annual income from $60,000 per year to $66,000.
- She then increases her annual spending on clothes from $2,500 to $3,000.
- With this information, we can calculate her income elasticity of demand for clothes. 1 Her income has risen by $6,000 from an original income of $60,000, which is a change of
+ 10%. This is calculated by the equation

+6,000 x 100= +10%. 60,000

- The quantity demanded of shoes has increased by $500 from an original demand of $2,500, which is a change of +20%. This is calculated by the equation
500 x 100 = +20%. 2,500

- If we put the two values above into the equation for
- YED, we get , +20% + 10%
which gives a value of +2.

The range of values for income elasticity of demand original demand of $2,500, which is a change of

- Like XED, the sign obtained from the equation is important.
- In this case, the sign of YED tells us whether the product we are looking at is a normal good or an inferior good.
- Remember that the demand for a normal good rises as income rises and the demand for an inferior good falls as income rises.

- For normal goods, the value of YED is positive, i.e. the demand increases as income increases.
- If the percentage increase in quantity demanded is less than the percentage increase in income, then a YED value between zero and one is obtained and the demand is said to be income-inelastic.
- If the percentage increase in quantity demanded is greater than the percentage increase in income then a YED value greater than one is obtained and the demand is said to be income-elastic

Necessity goods demand increases as income increases.

- Necessity goods are products that have low income elasticity.
- The demand for them will change very little if income rises. For example, the demand for bread does not increase significantly as income rises, because people feel that they already have enough bread and so will not increase consumption.

Superior goods demand increases as income increases.

- Superior goods are products that have high income elasticity.
- The demand for them changes significantly if income rises.
- As people have more income and have satisfied their needs, they begin to purchase products that are wants, i.e. non-essential, in greater number.
- For example, the demand for holidays in foreign countries likely to be income-elastic.

- For inferior goods, the value of YED is negative, because the demand decreases as income increases.
- People start to switch their expenditure from the inferior goods that they had been buying to superior goods, which they can now afford.
- For example, the inexpensive for inexpensive jeans falls as income rises because people switch to buying branded jeans.

Price elasticity of supply (PES) the demand decreases as income increases.

- Formula and definition
- Price elasticity of supply is a measure of how much the supply of a product changes when there is a change in the price of the product.
- It is usually calculated by using the equation below. PES = Percentage change in quantity supplied of the product Percentage change in price of the product

- For example, a publishing firm realizes that they can now sell their monthly magazine for $5.50 instead of $5.00.
- Because of this, they increase their supply from 200,000 to 230,000 magazines per month. With this information, we can calculate the price elasticity of supply for the magazine.
- The price has risen by 50¢ from an original price of $5, which is a change of + 10%.
- This is calculated by the equation
50xlOO= -10%. 500

- The quantity supplied has increased by 30,000 from an original supply of 200,000, which is a change of 15%.
- This is calculated by the equation 30,000 x100 = 15%. 200,000
- If we put the two values above into the equation for PBS, we get15%
10%

which gives a value of 1.5.

- The value of PBS will almost always be positive.

The range of values of price elasticity of supply original supply of 200,000, which is a change of 15%.

- The possible range of values for price elasticity of supply usually goes from zero to infinity.
- Unlike PED, we will come across examples of both extreme values as we continue our study of economics.

s

A supply curve with the value of zero. The supply is said to be perfectly inelastic.

- In the very short run, sometimes known as the immediate time period, it is impossible for firms to increase their supply straight away, no matter what happens to price.
- There also may be a sudden demand for a product that is seasonal so in the long run it will not be sustained but firms do not want to employ more factors of production.
- Ice cream in Scotland.

At the price P1. the supply curve goes on forever period, it is impossible for firms to increase their supply straight away, no matter what happens to price.so the quantity supplied is infinite.

However, if price falls below P1, even by the smallest amount, supply will fall to zero, an infinite change.

P1

s

- In international trade, it is often assumed that the supply of commodities, such as wheat, available to a country for import is infinite
- The consumers in the country can have all that they want as long as they are prepared to pay the current world market price.
- The market in the country will have a “world supply” curve is perfectly elastic at the current world market price.

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