Price Elasticity of Demand

Presented by Crystal Celestine

 Objectives
At the end of this lesson students are supposed to be able to:
1. Explain elasticity of demand
2. Calculate Price Elasticity
3. Calculate Income Elasticity
4. Calculate Cross Elasticity
5. Analyze Elasticity Calculations
6. Understand the various curves of elasticity of Demand
7. Explain the Factors that affect Elasticity
What is Elasticity?
• Elasticity is a measure of how much buyers and sellers respond to changes in
market conditions.
• It allows us to analyze supply and demand with greater precision.
• Price elasticity of demand is used by economists to understand how demand for a
good or service changes when there is a change in price of that good or service.
• Price elasticity of demand is the percentage change in quantity demanded given a
percent change in the price.
• It is a measure of how much the quantity demanded of a good responds to a change
in the price of that good.
Why is Elasticity of
Demand Important?

• When prices change consumers

react!
• Decision makers, such as firms
and government need to
understand how a change in
price will affect consumers!
Inelastic vs Elastic?

•When the price of a good changes and consumers

react in a big way, the good is said to be an elastic
good!

•When the price of a good changes and there is hardly

any consumer reaction, the good is said to be an
inelastic good!
Calculating Price Elasticity of Demand

PED= % Δ Quantity
%Δ Price

% Δ = new – old x 100

old
Let’s Practice
1. The price of a cheese pie falls from $4.50 to $3.00. The quantity of cheese pies
bought increases from 4 to 6. Calculate price elasticity of demand.
2. The price of a sandwich rises from $4.00 to $5.00. The quantity of sandwiches
bought decreases from 3 to 2. Calculate price elasticity of demand.
Solution Recall: PED= % Δ Quantity . % Δ = new – old x 100
%Δ Price old

• Step 1: Calculate % Δ Quantity 6 - 4 x 100. 2 x 100 = 50%

4 4
• Step 2: Calculate % Δ Price 3 – 4.50 x 100. -1.50 x 100 = -33%
4 .50 4.50

• Step 3: Plug in values 50% = -1.5

33%

PED=- 1.5
Solution Recall: PED= % Δ Quantity . % Δ = new – old x 100
%Δ Price old

• Step 1: Calculate % Δ Quantity 2 - 3 x 100. -1 x 100 = -33.3%

3 3
• Step 2: Calculate % Δ Price 5 – 4.00 x 100. 1 x 100 = 25%
4 .00 4

• Step 3: Plug in values -33% = -1.33

25%
PED=- 1.33
 On Your Own
1. Yesterday, the price of envelopes was $3 a box, and Julie was willing to buy 10
boxes. Today, the price has gone up to $3.75 a box, and Julie is now willing to
buy 8 boxes. Is Julie's demand for envelopes elastic or inelastic? What is Julie's
elasticity of demand?

2. When the price of CD increased from $20 to $22, the quantity of CDs
demanded decreased from 100 to 87.What is the price elasticity of demand for
CDs?

3. A local council raises the price of car parking from £3 per day to £5 per day
and finds that usage of car parks contracts from 1,200 cars a day to 900 cars
per day. Calculate the price elasticity of demand for this price change
 • If PED, is less than 1 the good is said to be
inelastic. This means that a price change will
cause consumers to have little to no reaction
where demand is concerned for that item!
Analyzing
• If PED, is more than 1, the good is said to be
Price elastic. This means that a price change will
Elasticity of cause a significant reaction from consumers
Demand where demand is concerned for that item!
• PED < 1 – Inelastic
• PED > 1 – Elastic
• PED = 1- Unitary Elastic
Analyzing Price Elasticity of Demand

Type of Elasticity Description Example

Price of a good rises by 5% while quantity

Quantity demanded changes by a larger
Elastic Demand demanded falls by 10%
proportion than the change in price
Elasticity = -2
Price of a good rises by 5% while quantity
Quantity demanded changes by a smaller
Inelastic Demand demanded falls by 2.5%
proportion than the change in price
Elasticity = -0.5
Price of a good rises by 5% while quantity
Quantity demanded changes by the same
Unitary demanded falls by 5%
proportion than the change in price
Elasticity = -1
Elasticity Graphs: Elastic Demand
Price

1. A 25% $5
increase
in price...
4

Demand

50 100 Quantity
2. ...leads to a 50% decrease in quantity.
Elasticity Graphs: Inelastic Demand
Price

1. A 25% $5
increase
in price...
4

Demand

90 100 Quantity
2. ...leads to a 10% decrease in quantity.
Elasticity Graphs: Unitary Demand
Price

1. A 25% $5
increase
in price...
4

Demand

75 100 Quantity
2. ...leads to a 25% decrease in quantity.
Income Elasticity of Demand

• Income elasticity of demand measures the relationship between

change in quantity demanded for a good or service in relation to a
change in income.
• In other words… it measures how a change in income affects the
quantity demanded for a good or service.

% change in Qd

% change in Income (Y)

Example
• 1. Sandra receives a raise at work, causing her monthly income to increase by 38%.
As a result, her demand for secondhand clothing falls by 15%. What is Sandra’s
income elasticity for secondhand clothing?
 Cross Price Elasticity of Demand

• Cross price elasticity of demand, is defined as the degree of

responsiveness of quantity demanded of one good in response to the
price change in another related good.
• In other words, it measures how the quantity demanded for one good is
affected based on the price change of another good
• For example, how would the demand of batteries be affected if the price
of flashlights decreased.
% change in Qd of Good A

% change in Price of Good B

Example
• 1. When the price of a flashlight falls from $100 to $50, the quantity of batteries
demanded increases from 50 to 125 units. Calculate the CED.
 Examples of price inelastic demand
• Petrol – petrol has few alternatives because people with a car need to buy petrol. For many driving is a necessity. There are weak
substitutes, such as train, walking and the bus. But, generally, if the price of petrol goes up, demand proves very inelastic.

• Salt. If the price of salt increased, demand would largely be unchanged. It is only a small % of income and people tend to buy
infrequently. It is a good with no real substitutes at all.

• A good produced by a monopoly. Any good produced by a monopoly is likely to be inelastic demand. For example, if Sky
increases the cost of premiership pay per view, many football fans will pay the extra price. Though because it isn’t a necessity,
demand may be less inelastic than say petrol.

• Tap water. For householders, tap water is a necessity with no alternatives. If the water company increase the cost of water bills,
people would keep buying the service. It would have to rise to a very high price before people disconnected their water supply.
This is why tap water is regulated by the government.

• Diamonds. Bought very infrequently, diamonds are the ultimate luxury with few exact alternatives. You could buy other precious
gems, but others may not have the same allure as diamonds. A cut in price wouldn’t increase demand very much.

• Cigarettes. If cigarette tax increases and the price of all tobacco increases, demand will be inelastic because many smokers are
addicted and don’t have any alternatives to keep buying.

• Apple iPhones, iPads. The Apple brand is so strong that many consumers will pay a premium for Apple products. If the price rises
for Apple iPhone, many will continue to buy. If it was a less well-known brand like Dell computers, you would expect demand to be
price elastic.
 Examples of price Elastic demand
• Pepsi. Pepsi will be highly price elastic because there are other alternatives.
If the price of Pepsi rises, consumers will switch to alternatives, such as
Coke, or Cola
• Porsche sports car. If a Porsche increases in price, demand will probably
be elastic because it is a high % of income, and so the higher price will put
people off. Also, there are other alternatives, such as Jaguar or Aston
Martin. However, this is a little less clear cut. Some car enthusiasts may
want to buy a Porsche whatever the price.
 Factors Affecting Elasticity
The Nature of the Good: Whether the good is a necessity or luxury.
• When a product is a necessity like food grains, vegetables, medicines, etc., its
demand is generally inelastic as it is required for human survival. Remember
inelastic means that demand hardly fluctuates much with changes in price.
• When a product is a comfort like fan, refrigerator, etc., its demand is generally
elastic, meaning demand will change significantly, as consumer can postpone its
consumption.
• When a product is a luxury like AC, DVD player, etc., its demand is generally more
elastic as compared to demand for comforts.
• The term ‘luxury’ is a relative term as any item (like AC), may be a luxury for a
poor person but a necessity for a rich person.
 Factors Affecting Elasticity
Availability of substitutes:
• Demand for a product with large number of substitutes will be more
elastic. The reason is that even a small rise in its prices will induce the
buyers to go for its substitutes. For example, a rise in the price of Pepsi
encourages buyers to buy Coke and vice-versa.
• Thus, availability of close substitutes makes the demand sensitive to
change in the prices. On the other hand, commodities with few or no
substitutes like wheat and salt have less price elasticity of demand.
• .
 Factors Affecting Elasticity
Income Level:
• Elasticity of demand for any product is generally less for higher income
level groups in comparison to people with low incomes. It happens
because rich people are not influenced much by changes in the price of
goods. But, poor people are highly affected by increase or decrease in the
price of goods. As a result, demand for lower income group is highly
elastic.
 Factors Affecting Elasticity
Level of price:
• Level of price also affects the price elasticity of demand. Costly goods
like laptop, Plasma TV, etc. have highly elastic demand as their demand is
very sensitive to changes in their prices. However, demand for
inexpensive goods like needle, match box, etc. is inelastic as change in
prices of such goods do not change their demand by a considerable
amount.
 Factors Affecting Elasticity
Time Period:
• Price elasticity of demand is always related to a period of time. It can be a
day, a week, a month, a year or a period of several years. Elasticity of
demand varies directly with the time period. Demand is generally inelastic
in the short period.
• It happens because consumers find it difficult to change their habits, in
the short period, in order to respond to a change in the price of the given
commodity. However, demand is more elastic in long rim as it is
comparatively easier to shift to other substitutes, if the price of the given
product rises.
 Factors Affecting Elasticity
Habits:
• Commodities, which have become habitual necessities for the consumers,
have less elastic demand. It happens because such a product becomes a
necessity for the consumer and he continues to purchase it even if its
price rises. Alcohol, tobacco, cigarettes, etc. are some examples of habit
forming commodities.
• Finally it can be concluded that elasticity of demand for a product is
affected by number of factors. However, it is difficult to say, which
particular factor or combination of factors determines the elasticity. It all
depends upon circumstances of each case.
IN CLASS ASSIGNMENT
THE END