Price Elasticity of Demand

Question 1
The markets for cars and tyres are closely related. The five largest tyre firms used to make 66%
of all tyres. The entry of more than 250 Chinese firms has reduced the global market share of the
largest five firms to less than 50%. This also changed the price elasticity of demand (PED) for
individual firms’ tyres. Some of these firms are state-owned enterprises and some are in the
private sector.
Explain what effect more firms producing tyres would have on the PED of individual firms’
tyres

Indicative content
 To explain factors affecting PED of a product (here, more firms means more substitutes,
hence demand will be more elastic.

The effect of more firms producing tyres is that it will increase competition (1) as more
substitutes will be available (1). A rise in the price of one firm’s tyres would cause people to
switch to other firms’ tyres (1) and demand would become more elastic (1)

Question 2
The food items people buy can be influenced by taxes, subsidies and health reports. A report
published in 2017outlinedthe health benefits of eating tomatoes including improved vision and
reduced risk of heart disease. Egypt is a major producer of tomatoes and it also produces a large
amount of cement. Cement is a product with price-inelastic demand. Egyptian cement producers
have introduced more capital-intensive production methods.
Explain two reasons why demand for a product may be price-inelastic
Indicative content

 The product may take up a small proportion of income → consumers may not notice a
price rise
 The product may be addictive → consumers cannot do without the product

One reason why demand for a product may be price-inelastic is that the product may not have a
close substitute (1). Therefore, consumers will not be able to switch to rival products for
example potatoes (1). Secondly, the product may be a necessity (1) and people will need to
buy it even if price rises for example electricity (1)
Question 3

Analyse, using Fig. 1.1, the relationship between copper output and revenue from the sale of
copper.

Indicative content
 In 2014 copper revenue was highest 128 and output at its lowest 90
 2017 copper revenue was at its lowest 90 and output at its highest 108
 Changes in revenue were greater than changes in output of copper (inverse relationship)

Revenue is the income generated through sales (1). A direct relationship would
have been expected as copper output rose, revenue should have risen (1).
However, there appears to be an inverse relationship (1), which is shown in the
extract as between 2010–14 revenue rose (from 100 to 128) but output fell (from
100 to 90) so prices rose (1). Additionally, between 2014–17 revenue fell (from 128
to 90) but output rose (from 90 to 108) (1) The inverse relationship may be a result
of the fact that Copper is likely to be inelastic in demand (1) so prices rise by more
than fall in output increasing revenue (1)
Question 4,5,6
Indicative content
 When PED < 1, then a rise in price will increase total revenue

 When PED > 1, then a price fall will increase total revenue

 Unitary → a rise in price will leave total revenue unchanged → as the proportionate
change in quantity demanded and price will be the same

 Perfectly inelastic → a rise in price will cause an equally proportionate rise in revenue
→ quantity demanded will not change

 Perfectly elastic, a rise in price will cause revenue to fall to zero → people will stop
buying the product

Question 4
A number of book publishers operate in Pakistan. These include multinational companies
(MNCs). They employ a range of specialist workers. A number of these specialists estimate the
price elasticity of demand (PED) for their firms’ books. There is a debate about whether some
books should be subsidised by the government.
Analyse how a change in the PED for its products may benefit a firm.

PED is the responsiveness of quantity demanded to a change in price (1). Firstly, a more
elastic demand (1) would mean that the firm could raise revenue (1) by lowering
price (1). Profits would rise (1) if revenue rises by more than costs (1) Secondly, a more
inelastic demand (1) would mean the firm could raise revenue (1) by raising price (1). Profit
would rise (1) if a lower output increases the gap between revenue and cost (1)

Question 5
Droughts in the Pacific Coast region of the US and regulations, in the form of limits on the
amount of salmon that can be caught in the wild, have reduced the supply of wild salmon. These
limits were imposed to avoid market failure in the salmon market. However, the effect of this on
the revenue of salmon producers is uncertain. In addition, producers of farmed salmon in the US
states of Washington and Alaska have received subsidies from the US government.
Analyse how information on changes in a firm’s revenue can be obtained from price elasticity of
demand calculations.
PED is the responsiveness of quantity demanded to a change in price (1). Firstly, if PED is
elastic / PED > 1, a fall in price will raise revenue (1) as quantity demanded will increase
more (1) than proportionately/percentage (1). A rise in price will have the opposite effect (1)
Secondly, if PED is inelastic / PED < 1, a rise in price will raise revenue (1) as quantity
demanded will decrease less (1) than proportionately / percentage (1). A fall in price will
decrease revenue (1)
Question 6
In the UK, bus journeys outside London have fallen by nearly 40% since 1980. This fall in
demand has been largely due to a rise in bus fares, a rise in income and changes in the price and
quality of substitutes. On some routes there are monopolies operating and this lack of
competition can push up the price.
Analyse how price elasticity of demand for a product influences the revenue a firm receives.
PED is the responsiveness of quantity demanded to a change in price (1). Firstly, if demand is
elastic, a rise in price will cause a fall in revenue (1) because the quantity demanded will fall by
more than the rise in price (1) in percentage terms (1). An example of type of product with
elastic demand is a luxury car (1) Secondly, if demand is inelastic, a rise in price will cause a
rise in revenue (1) because the quantity demanded will fall by less than the rise in price (1) in
percentage terms (1). An example of a product with inelastic demand is petrol (1)