Revision

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 fallsBUT!

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

20/04/23 4

PeD Mantra….

• If answer is between 0 and -1 • e.g. -0.4 or -0.8• The relationship is inelastic

• If the answer is between -1 and infinity

• e.g. -1.4 or 2 or 12.3 • The relationship is elastic

Consumers DO NOT

react much to a change in

price

Consumers DO react

To changes in prices

Consider a 10% increase

in price

Elastic or inelastic????

Would customers react lots (ELASTIC) or not much

(INELASTIC)….. With the following PeD’s????

Use your whiteboards

Elastic or inelastic?

-3

Elastic– because a 10% increase in price would lead to a 30% fall in demand


-0.4

Inelastic– because a 10% increase in price would lead to a 4% fall in demand


-0.1

Inelastic– because a 10% increase in price would lead to a 1% fall in demand


-1.1

Elastic– because a 10% increase in price would lead to a 11% fall in demand


-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 is their current TR?

• TR = P x Quantity sold

• TR = £5 x 10,000 = £50,000

• What if the company has a PeD of -0.5?

• If they reduced their price – would the customers react a bit or loads?

• is -0.5 inelastic or elastic?

• INELASTIC….



• What is their current TR?

• TR = P x Quantity sold

• TR = £5 x 10,000 = £50,000

• What if the company has a PeD of -0.5?

• …. and they reduce their price to £4.50

• What would happen to their TR now? Will it increase or decrease?

• 1st you need to know what the % increase in price has been….?



• And now their price is £4.50

• What is the % change?

• Difference/original x 100 = % change

• 5 - 4.50 = 0.5 / 5 x 100 = -10%

• So if the company originally sold 10,000 units…..

• And PeD is 0.5

• And price has dropped by 10 %

• What will happen to DEMAND?

10% x 0.5 = 5%

So what’s 5% 0f 10,000 units?

500 units

But would that be a fall or an increase in sales?????

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

£5 x 10,000 = £50,000

New sales

£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?

• Price increase is 0.5/5 x 100 = +10%

• The company still has a PeD of -0.5

• So sales will FALL by 5%

• 10,000 x 5%• = 10,000 -500

• So £5.50 x 9,500

• 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• 20% x 0.8 = 16% increase in sales• 16% of 30 = 4.8 units… can’t sell .8 of a good so

they must sell 5…

• Original TR = 10 x 30 = £300

• New TR = (30 +5) x £8 = £280

A price cut with an

inelastic good will reduce

your revenue

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

• Original TR = £20 x 100 = £2000

• New TR = £14 x (100+60) = £2240

A price cut with an

elastic good will increase

revenue

So a price rise with an elastic good will reduce

revenue

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• 6.67% x 2 = 13.34% fall in sales• 13.34% of 100 = 13.34 units – but you can’t sell

0.34 of a product …so have to fall by 14 units

• Original TR = £15 x 100 = £1500

• New TR = ( £16 x (100 – 14) = £1376

A price rise with an elastic

good will reduce revenue

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!

Revision

Documents