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Revision 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!