Elasticity and Pricing Strategies

• Elasticity and pricing strategies are key components of business and economics.
• The lecture covers price elasticity of demand(PED), revenue implications, demand curve types, pricing strategies, and price elasticity of supply.

Price Elasticity of Demand (PED)

• Measures the responsiveness or sensitivity of quantity demanded to a change in price.

PED and Revenue

• Some firms increase revenue by lowering prices when demand is elastic.
• Other firms increase revenue by raising prices when demand is inelastic.
• Revenue for a firm represents expenditure for consumers, indicating a transfer of money.

Demand Curve

• Elastic and inelastic demand curves represent the different relationships between price and quantity demanded.

Pricing Strategy

• Focuses on how firms determine the optimal prices for its products or services

Price Elasticity of Supply

• Measures the responsiveness of quantity supplied to a change in price.

Defining Price Elasticity of Demand

• PED’s measurement is the percentage change in quantity demanded divided by the percentage change in price (%∆Q/%∆P).
• Proportionate or percentage changes are used in calculations, such as %∆Q or %∆P.
• PED can be positive or negative but is typically negative, as price and quantity demanded usually move in opposite directions.
• The value of PED is assessed as greater or less than one to determine if demand is elastic (e > 1) or inelastic (e < 1).

Formula for Calculating PED

• PED is equal to %∆Q divided by %ΔΡ
• %AQD represents percentage or proportionate change in quantity.
• %∆P means percentage or proportionate change in price.
• AQ = (Q2 – Q1) / [(Q1 + Q2)/2]
• ∆Qp = (P2 – P1) / [(P1 + P2)/2]
• Q2 represents the most recent quantity, while P2 represents the most recent price.
• Q1 represents the old quantity, while P1 represents the old price
• (Q1 +Q2)/2 calculates the average of quantity
• (P1 + P2)/2 calculates the average of price

Determinants of Price Elasticity of Demand

• The number and closeness of substitute goods available affects price elasticity.
• Closeness of products (Esso & Shell) impacts elasticity.
• Closeness of brands (Pepsi & Coke) matters as well.
• The proportion of income spent on the good influences elasticity (e.g., house & paracetamol).
• The time period: Short term is generally price inelastic for most goods.

Price Elasticity of Demand and Business

• A firm's sales revenue (TR) is calculated as Price (P) multiplied by Quantity (Q) (TR = P x Q).

The Effect of a Price Change on Sales Revenue

• With elastic demand, TR changes in the same direction as quantity.
• With inelastic demand, TR changes in the opposite direction as quantity.

Elastic Demand Between Two Points

• The expenditure falls as price rises
• E = TR = 5 * £10 = £50
• E = TR = 4 * £20 = £80

Inelastic Demand

• Expenditures rise as price rises
• E = TR = 8 * £15 = £120
• E = TR = 4 * £20 = £80

Effects of a Change in Price on Total Expenditure

• With price elastic demand, if price rises, quantity falls proportionately more, and total expenditure (P x Q) falls
• With price elastic demand, if price falls, quantity rises proportionately more, and therefore total expenditure (P x Q) rises.
• With price inelastic demand, if price rises, quantity falls proportionately less; therefore total expenditure (P x Q) rises.
• With price inelastic demand, if price falls, quantity rises proportionately less; therefore total expenditure (P x Q) falls.
• Revenue (sales) for business is expenditure for consumers (buyers).
• Total revenue is always equal to total expenditure.

Totally Inelastic Demand (PED = 0)

• Quantity demanded does not change regardless of price change

Infinitely Elastic Demand (PED = ∞)

• Any price increase will cause demand to drop to zero

Income Elasticity of Demand (YED)

• Measures the responsiveness of quantity demanded to a change in income.
• The measurement is %∆Q/%∆Y
  • Normal goods, positive elasticity
  • Inferior goods, a rise in income leads to a fall in demand
  • Degree of 'necessity' of the good
• Applications to business include: Importance of perceptions of the product and repositioning a product

Cross-Price Elasticity of Demand (CPDab)

• Measures the responsiveness of the quantity demanded of one good to a change in the price of another good. -Substitute goods, positive elasticity.
• Measurement is %∆QDa/%∆Pb
• Complementary goods, negative elasticity
• The determinants include: the closeness of complements or substitutes and the time period.
• Applications to business include: effects of changes in competitors’ pricing strategy and strategies to make a product less cross elastic.

Price Elasticity of Supply (PES)

• Measures the responsiveness of quantity supplied to a change in price: %∆Qs/ %∆Ρ.
• Determinants include: the amount that costs rise as output increases and the time period (immediate, short run, or long run).

Different Price Elasticity of Supply

• Inelastic supply is where S₁= Inelastic supply
• Elastic supply is where S₂ = Elastic Supply

Question

• In which one of the following cases is good X likely to have a more price-elastic supply than good Y?
• The cost of producing extra units increases more rapidly in the case of Y than in the case of X.

Key Terms: Learning Outcome

• Calculation and application of:
• Price elasticity of demand
• Income elasticity of demand
• Cross price elasticity of demand
• Price elasticity of supply
• How to apply elasticity to make pricing decisions and react to rivals’ pricing strategies.