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Elasticity & it’s importance
What is Price elasticity?
• The responsiveness of one variable to changes
in another
• When price rises what happens to demand?
Demand falls
BUT!
How much does demand fall?
Elasticity – the concept
• If price rises by 10%, what happens to demand?
• We know demand will fall
• By more than 10%?
or
• By less than 10%?
• Elasticity measures the extent to which
demand will change
Consider a 10%
increase in price
PeD Mantra….
• If answer is between 0 and -1
• e.g. -0.4 or -0.8
• The relationship is inelastic
Consumers
DO NOT
react much to a
change in price
• If the answer is between -1 and infinity
• e.g. -1.4 or 2 or 12.3
Consumers
DO react
To changes in
• The relationship is elastic
prices
23/05/2017
4
Use your
whiteboards
Elastic or inelastic????
Would customers react lots (ELASTIC)
or not much (INELASTIC)….. With the
following PeD’s????
Elastic or inelastic?
-3
Elastic
– because a 10% increase in price
would lead to a 30% fall in demand
Elastic or inelastic?
-0.4
Inelastic
– because a 10% increase in price
would lead to a 4% fall in demand
Elastic or inelastic?
-0.1
Inelastic
– because a 10% increase in price
would lead to a 1% fall in demand
Elastic or inelastic?
-1.1
Elastic
– because a 10% increase in price
would lead to a 11% fall in demand
Elastic or inelastic?
-14
Elastic
– because a 10% increase in price
would lead to a 140% fall in demand
What about the effect on
revenue?
Using PeD to calculate changes in
TR
• What if a company sells
10,000 units at £5.
• What if the company has
a PeD of -0.5?
• What is their current TR?
• If they reduced their
price – would the
customers react a bit or
loads?
• TR = P x Quantity sold
• TR = £5 x 10,000 =
£50,000
• is -0.5 inelastic or elastic?
• INELASTIC….
Using PeD to calculate changes in
TR
• What if a company sells
10,000 units at £5.
• What if the company has
a PeD of -0.5?
• What is their current TR?
• …. and they reduce
their price to £4.50
• TR = P x Quantity sold
• TR = £5 x 10,000 =
£50,000
• What would happen to
their TR now? Will it
increase or decrease?
• 1st you need to know
what the % increase in
price has been….?
Using PeD to calculate changes in
TR
• What if a company sells
• So if the company
10,000 units at £5.
originally sold 10,000
units…..
So what’s 5% 0f 10,000 units?
• And now their price is
£4.50
• And PeD is 0.5
500 units
• What is the % change? • And price has dropped by
10 %
But would that be a fall or an
• Difference/original x
sales?????
100 = % change increase
• in
What
will happen to
DEMAND?
• 5 - 4.50 = 0.5 / 5 x 100
= -10%
10% x 0.5 = 5%
And the last step of the
calculation…
• The original Q is what would happen to the
company TR if they changed their price from £5
to £4.50, with original sales of 10,000?
Original TR
£5 x 10,000 = £50,000
And the last step of the
calculation…
• The original Q is what would happen to the
company TR if they changed their price from £5
to £4.50, with original sales of 10,000?
Original TR
New sales
£5 x 10,000 = £50,000
£4.50 x (10,000 + 500)
= £4.50 x 10,500
= £47,250
So a price cut ….
Doesn’t guarantee higher
profits!
What if they increased their price?
• Price was £5 but now
£5.50?
• 10,000 x 5%
• = 10,000 -500
• Price increase is 0.5/5 x
100 = +10%
• So £5.50 x 9,500
• The company still has a
PeD of -0.5
• So sales will FALL by
5%
• TR = £52,250
• So an inelastic product
will earn MORE
REVENUE with a price
rise!
Who needs a recap?
If not – get on with the worksheet
Worksheet Questions…
1. A company has a price cut from £10 to £8. What will
be the impact on their revenue if they have a PeD of
0.8 and originally sold 30 units?
2. A company has a price cut from £20 to £14. What will
be the impact on their revenue if they have a PeD of 2
and originally sold 100 units?
3. A company has a price rise from £15 to £16. What will
be the impact on their revenue if they have a PeD of 2
and originally sold 100 units?
Worksheet Question 1
• A company has a price cut from £10 to £8. What will be
the impact on their revenue if they have a PeD of 0.8
and originally sold 30 units?
• 10-8 = 2/10 x100 = 20% fall in price
A price cut with
• 20% x 0.8 = 16% increase in sales
an inelastic good
will reduce
your
• 16% of 30 = 4.8 units… can’t sell .8 of a good
so they
revenue
must sell 5…
• Original TR = 10 x 30 = £300
• New TR = (30 +5) x £8 = £280
So a price rise
with an inelastic
good will
increase your
revenue
Worksheet Question 2
• A company has a price cut from £20 to £14. What will be
the impact on their revenue if they have a PeD of 2 and
originally sold 100 units?
• 20-14 = 6/20 x100 = 30% fall in price
• 30% x 2 = 60% increase in sales
• 60% of 100 = 60 units
A price cut
with an elastic
good will
increase
revenue
• Original TR = £20 x 100 = £2000
So a price rise
with an elastic
good will
reduce
revenue
• New TR = £14 x (100+60) = £2240
Worksheet Question 3
• A company has a price rise from £15 to £16. What will
be the impact on their revenue if they have a PeD of 2
and originally sold 100 units?
• 15-16 = 1/15 x100 = 6.67% rise in price A price rise with
• 6.67% x 2 = 13.34% fall in sales
an elastic good
• 13.34% of 100 = 13.34 units – but you can’t will
sell reduce
0.34 of
revenue
a product …so have to fall by 14 units
• Original TR = £15 x 100 = £1500
• New TR = ( £16 x (100 – 14) = £1376
So a price cut
with an elastic
good will
increase revenue
How to make your product more
inelastic
• …why???
…so
customers
don’t react
to price
increases!
• Make your product
DIFFERENT to
competitors – to keep
them brand loyal.
• Take over the
competition! So
customers have to buy
your products.
• Make price changes over
a short period of time
– so customers don’t
notice!