Economics: Price Elasticity of Demand - Cardiff University

Economics of Business and Society: Price elasticity of demand cardiff.ac.uk/isc International Study Centre  Learning Objectives By the end of this session, you will be able to: To understand the meaning of elasticity and app...

Economics of Business and Society: Price elasticity of demand cardiff.ac.uk/isc International Study Centre  Learning Objectives By the end of this session, you will be able to: To understand the meaning of elasticity and appreciate the different types of elasticity Define the price elasticity of demand and calculate it Explain the factors that influence it Explain the relationship between total revenue and price elasticity of demand cardiff.ac.uk/isc International Study Centre  3 types associated with demand: Elasticity is the responsiveness of quantity demanded to a change in another variable CHANGE IN INCOME CHANGE IN PRICE 2. Income elasticity of 1. Price Elasticity of Demand demand ELASTICITY CHANGE IN THE PRICE OF CHANGE IN THE PRICE OF A COMPLEMENT A SUBSTITUTE 3. Cross elasticity of demand 3. Cross elasticity of demand cardiff.ac.uk/isc International Study Centre  Demand and Supply - The demand for a good depends not only on its price, but also on consumer income and on the prices of other goods - The supply depends both on the price and on variables that affect production cost Consider: - If the price of coffee increases, the quantity demanded will fall and the quantity supplied will rise. - However, how much the quantity suppled or demanded will rise or fall? - Or if price increases by 10%, how much will the quantity demanded change? How much will it change if income rises by 5%? cardiff.ac.uk/isc International Study Centre  Elasticity - We use the concept of elasticity to answer questions like these. - An elasticity measures the sensitivity of one variable to another - It is a number that tells us the percentage change occurs in one variable in response to a 1% change in another variable cardiff.ac.uk/isc International Study Centre  Price elasticity of demand Price Elasticity of demand: The responsiveness of changes in quantity of demanded of a good to changes in its price Formula of the price elasticity of demand: is percentage change in Quantity andis percentage change in Price. cardiff.ac.uk/isc Pearson International Education Study Centre  Price Elasticity of Demand ?? Percentage Change in Price (Point Method): example (a) Suppose Starbucks raises the price of a latte from £3 to £5 a cup. What is the percentage change in price? Percentage change in price = ????? cardiff.ac.uk/isc You have 5 mins International Study Centre Pearson Education Ltd, 2015  Price Elasticity of Demand Percentage Change in Price: example (a) Suppose Starbucks raises the price of a latte from £3 to £5 a cup. What is the percentage change in price? Percentage change in price = Percentage change in price = =66.67% cardiff.ac.uk/isc International Study Centre Pearson Education Ltd, 2015  Price Elasticity of Demand ?? Percentage Change in Price example (b) Suppose Starbucks cuts the price of a latte from £5 to £3 a cup. What is the percentage change in price? cardiff.ac.uk/isc International Study Centre Pearson Education Ltd, 2015  Price Elasticity of Demand Percentage Change in Price: example (b) Suppose Starbucks cuts the price of a latte from £5 to £3 a cup. What is the percentage change in price? Percentage change in price = =-40% Note: Using elasticity method, the change direction can influence the value of price elasticity of demand. cardiff.ac.uk/isc International Study Centre Pearson Education Ltd, 2015  Individual Work cardiff.ac.uk/isc You have 10 mins International Study Centre  Price Elasticity of Demand Elastic, Unit Elastic, Inelastic, Perfectly Elastic & Perfectly Inelastic Demand: 1. Demand is elastic if the absolute value of price elasticity of demand is 1 2. Demand is unit elastic if the absolute value of price elasticity of demand is 3. Demand is inelastic if the absolute value of price elasticity of demand is - Demand is perfectly elastic if the quantity demanded changes by a very large percentage in response to an almost zero percentage change in price. - Demand is perfectly inelastic if the quantity demanded remains constant as the price changes. cardiff.ac.uk/isc International Study Centre Pearson Education Ltd, 2015  Price Elasticity of Demand cardiff.ac.uk/isc You have 20 mins International Study Centre Pearson Education Ltd, 2015  The ANSWERS… Question % change in % change in Qty Elasticity Type of elasticity Price Demanded A 10 20 =20/10 = 2 Elastic B 50 25 =25/50 = 0.5 Inelastic C 7 28 4 Elastic D 9 3 0.33 Inelastic E 5 10 2 Elastic F 20 60 3 Elastic UNITARY G 8 4 0.5 Inelastic H 9 9 1 ??? I 7 5 0.71 Inelastic J 11 8 0.73 Inelastic K 15 0 0 ??? PERFECTLY INELASTIC cardiff.ac.uk/isc International Study Centre  Price Elasticity of Demand (a) Perfectly Elastic Demand (b) Elastic Demand For a horizontal demand curve: a tiny change When the price of a Sony PlayStation rises by in price leads to a significant change in 10%, the quantity of PlayStations demanded demand, the elasticity of demand is infinite decreases by 20% 𝑷𝑬𝑫 ≈ ∞ Pearson Education Ltd, 2015 cardiff.ac.u cardiff.ac.uk/isc International International Study Centre Study k/isc Centre  Price Elasticity of Demand (c) Unit Elastic Demand (d) Inelastic Demand When the price of a trip rises by 10% the When the price of gum rises by 20%, the quantity of trips demanded decreases by quantity of gum demanded decreases 10% by 10% 𝑷𝑬𝑫