Lecture Notes: Price Elasticity of Demand

Introduction

• Concept: Price elasticity of demand (PED)
• Key Question: How is demand affected by price changes?
• Examples:
  • M&M Bars: Would you continue to buy if prices increased by 20%?
  • Bread: Would you switch to a cheaper brand if prices increased?
  • Apple Products: Some consumers are insensitive to price changes.

Understanding Elasticity

• Elasticity: Measures the sensitivity or responsiveness of demand to changes in variables.
• Variables:
  • Price: Focus of this lecture.
  • Income: To be discussed in another session.
• Price Elasticity: Measures how demand changes in response to price changes.

Calculating Price Elasticity of Demand (PED)

• Formula: PED = Percentage Change in Quantity Demanded / Percentage Change in Price
• Example:
  • Product X:
    • Initial Price: £4
    • Initial Demand: 1,000 units
    • New Price: £5
    • New Demand: 800 units
  • Calculations:
    • Demand Change: 20% decrease
    • Price Change: 25% increase
    • PED = -0.8
• Interpretation:
  • Elastic Demand: PED > 1 (Demand change > Price change)
  • Inelastic Demand: PED < 1 (Demand change < Price change)
  • Unitary Elasticity: PED = 1 (Demand change = Price change)

Implications for Businesses

• Elastic (PED > 1):
  • Price increase leads to larger demand decrease, reducing revenue.
• Inelastic (PED < 1):
  • Price increase leads to smaller demand decrease, possibly increasing revenue.
• Important Consideration:
  • A product can become elastic if the price is too high.

Factors Influencing Elasticity

• Brand Loyalty: Strong brands are often price inelastic.
• Necessities: Essential products have inelastic demand.
• Habitual Consumption: Regularly consumed products often have inelastic demand.
• Alternatives/Substitutes: Availability of substitutes can increase elasticity.

Examples of Elastic and Inelastic Products

• Elastic Products:
  • Chocolate Bars: Easily substituted, e.g., switching from Cadbury to Mars.
  • Bread: Switching from Hovis to other brands if prices rise.
  • Newspapers: Sensitive to price, frequent price wars.
• Inelastic Products:
  • Tobacco: Habitual consumption leads to inelastic demand.
  • Commuter Tickets: Necessary for daily travel, less price-sensitive.
  • Leisure Subscriptions: Essential sports or club subscriptions.

Conclusion

• Key Takeaway: Calculate PED by assessing percentage changes in demand and price.
• Understand whether a product's demand is elastic or inelastic to make informed pricing decisions.