Price, income and cross price elasticities of demand, price elasticity of supply
How do you calculate income elasticity of demand (YED)?
% change in demand / % change in income
What is the formula for working out price elasticity of supply (PES)?
% change in quantity supplied / % change in price
What is the formula for working out cross price elasticities of demand (XED)?
% change in the quantity demanded of good A / % change in price of good B
What is the relationship between price elasticity of demand and total revenue?
Elastic demand : Decrease Price, Increase Revenue (Quantity will increase proportionally more than the fall in price) Inelastic demand: Increase Price, Increase Revenue (Quantity will decrease proportionally less than the increase in price)
What is a perfectly elastic and perfectly inelastic good?
If PED is: - Zero (0), it is perfectly inelastic. - Infinite (∞), it is perfectly elastic.
What is a very elastic good / service and what is a very inelastic good?
- A very elastic good means that a small change in price will have a large impact on quantity sold. - A very inelastic good means that a large change in price will have a small impact on quantity sold. (Note: PED > 1 is often seen as elastic; while a PED < 1 is deemed as inelastic)
How would price elasticity of demand affect the impact of an indirect tax?
- In an elastic market the tax significantly reduces quantity but since it only increases price by a small quantity most of the tax is paid by the supplier. - In an inelastic market the opposite happens
How would price elasticity of demand affect the impacts of a subsidy?
- In an inelastic market a subsidy significantly reduces price, while increasing output by a small amount. This is due to the steepness of the demand curve. - In an elastic market the opposite happens
How does the concept of income elasticity help distinguish between normal and inferior goods?
- Normal goods have a positive income elasticity of demand so as consumers' income rises more is demanded at each price i.e. there is an outward shift of the demand curve - Inferior goods have a negative income elasticity of demand meaning that demand falls as income rises.
Calculate the percentage increase / decrease in revenue for the following questions and why revenue did what it did: 1) Iris sets up a lemonade stall, one day she sells 43 glasses of lemonade at a price of 20p each. The next day she raises the price to 50p but only manages to sell 26 glasses. 2) Nintendo have seen falling sales of their new console as a result they reduce the price of the console from £400 to £320. Subsequently, sales increase from 500,000 to 550,000.
1) Revenue pre price change: £0.20 × 43 = £8.60 Revenue post price change: £0.5 × 26 = £13.00 % change (((13/8.6) -1) × 100) = +51.2% Revenue rose because when the price rose, demand fell less than proportionally. 2) Revenue pre price change: £400 × 500,000 = £200m Revenue post price change: £320 × 550,000 = 176m (((176/200) -1) × 100) = -12% Price fell and demand rose less than proportionally, therefore revenue fell.
What are the factors influencing price elasticities of supply?
1) Spare production capacity - If there is plenty of spare capacity then a business can increase output without a rise in costs and supply will be elastic in response to a change in demand. The supply of goods and services is most elastic during a recession, when there is plenty of spare labour and capital resources. 2) Stocks of finished products and components - If stocks of raw materials and finished products are at a high level then a firm is able to respond to a change in demand - supply will be elastic. Conversely when stocks are low, dwindling supplies force prices higher because of scarcity. 3) The ease and cost of factor substitution/mobility - If both capital and labour are occupationally mobile then the elasticity of supply for a product is higher than if capital and labour cannot easily be switched. E.g. a printing press which can switch easily between printing magazines and greetings cards. Or falling prices of cocoa encourage farmers to switch into rubber production. 4) Time period and production speed - Supply is more price elastic the longer the time period that a firm is allowed to adjust its production levels. In some agricultural markets the momentary supply is fixed and is determined mainly by planting decisions made months before, and also climatic conditions, which affect the production yield. In contrast the supply of milk is price elastic because of a short time span from cows producing milk and products reaching the market place.
What are the factors affecting price elasticity of demand (PED)?
1) The number of close substitutes - the more close substitutes there are in the market, the more elastic demand is because consumers find it easy to switch. E.g. for domestic flights there are many substitutes such as train, car or even coach. However none of these are suitable for inter-continental flights. 2) The cost of switching between products - there may be costs involved in switching. In this case, demand tends to be inelastic. E.g. a mobile phone contract, though there are numerous other examples of this. http://blog.strategyzer.com/posts/2015/7/27/switching-costs-6-strategies-to-lock-customers-in-your-ecosystem 3) Brand loyalty - Products which have strong consumer brand loyalty often have relatively inelastic demand - consumers are prepared to accept price increases because of other attractive features of the brand which mean they will stay loyal. 4) Whether the good is subject to habitual consumption - consumers become less sensitive to the price of the good if they buy something out of habit (it has become the default choice). 5) The degree of necessity or whether the good is a luxury - necessities tend to have an inelastic demand whereas luxuries tend to have a more elastic demand. E.g. food, water, electricity etc. 6) Peak and off-peak demand - demand is price inelastic at peak times and more elastic at off-peak times - this is particularly the case for transport services. 7) The proportion of a consumer's income allocated to spending on the good - products that take up a high % of income will have a more elastic demand
Hogmageddon - pork shortage drives up prices Consumers can expect sharp increases in pork (pig meat) prices by summer 2014 as a viral disease that first appeared in U.S. swine herds earlier this year continues to kill young pigs. The disease killed about 1.4 million piglets in the three months to December 2013 and appears to be accelerating in U.S. herds. Pig stocks are down 1% on a year earlier and analysts estimate that pork prices are likely to be 8% higher compared with a year earlier. With the aid of a diagram, explain why pork prices were expected to rise 8% by summer 2014. (6)
AO1: 2 Marks for a complete labeled diagram with a clear rise in the price and a shift of the supply curve to the left AO2 & AO3 : (AO2: To achieve 2 marks here you must make reference to specific reference to the data) (AO3: Explains why despite pig stocks falling by just 1% prices are expected to rise by 8%) E.g. The disease has caused 1.4 million piglets to die reducing pig stocks by 1%. This has caused a decline in supply and because of this prices have risen; the 8% rise in prices is a far greater increase than the decrease in the pig stocks. This is because of the price inelasticity of demand of pork. It is price inelastic because pork is a necessity which the majority of people buying the product will continue buying despite a change in price; for example pork is essential for big food producers who need to acquire supplies. (Furthermore speculators may pour into the market causing demand to shift to the right.) - dubious
What is cross-price elasticities of demand (XED)?
Cross elasticity of demand (XED) is the responsiveness of demand for one product to a change in the price of another product.
What is income elasticity of demand?
Income elasticity of demand measures the relationship between a change in quantity demanded for good X and a change in real income.
What is the difference between a normal necessity and a normal luxury?
Normal necessities (income inelastic): - These products have a low but positive income elasticity - typically necessities such as milk and fruits (PED between 0 and +1) Normal luxuries (income elastic): These products have a high and positive income elasticity - typically high end products considered as a luxury by the relevant group of consumers (PED > 1) (Note: What's considered as a luxury is contextual, depends on the circumstances of the specific group of consumers)
How do you calculate the elasticity of demand?
PED = (% ΔQ) / ( % ΔP)
Calculate the PED for the following questions: 1) Iris sets up a lemonade stall, one day she sells 43 glasses of lemonade at a price of 20p each. The next day she raises the price to 50p but only manages to sell 26 glasses. 2) Nintendo have seen falling sales of their new console as a result they reduce the price of the console from £400 to £320. Subsequently, sales increase from 500,000 to 550,000.
Price elasticity of demand = (% change in Q) / ( % change in P) 1) % change in P = (final price / initial price) % change in P = (50/20)-1 = 1.5 1.5 × 100 = 150% % change in Q = ΔQ / Initial Q = -17/43 = -0.395 -0.395 × 100 = -39.5% PED = -39.5 / 150 = -0.263 = 0.263 2) % change in P = (320/400)-1 = -0.2 -0.2 × 100 = -20% % change in Q = ΔQ / Initial Q = (50,000 / 500,000) × 100 = 10% PED = 10 / -20 = -0.5
What is the price elasticity of supply (PES)?
Price elasticity of supply (PES) measures the responsiveness of quantity supplied to a change in price.
What are the factors influencing income elasticity of demand (YED)?
The main factor affecting YED is what type of good the product is. Normal necessity - have an income elasticity of between 0 and +1, e.g. if income rises by 10% and the demand for fresh fruit rises by 4% then the PED is +0.4. Demand rises proportionally less than income. Luxury goods and service - have an income elasticity of demand > +1, e.g. an increase of income by 8% could lead to a 10% increase in demand for new kitchens, giving it a PED of +1.25. Demand rises proportionally more than income. Inferior goods - have an income elasticity of demand < 0, or a negative PED. Typically inferior goods or services exist where superior goods are available if the consumer has the money to be able to buy it. Examples include the demand for cigarettes, low-priced own label foods in supermarkets and the demand for council-owned properties.
What is the price elasticity of demand (PED)?
The responsiveness of the quantity demanded of a good after a change in it's price. (Elasticity of demand is how the change in price impacts the quantity demanded.) (Note: PED > 1 is often seen as elastic; while a PED < 1 is deemed as inelastic)
For a straight-lined demand curve how will PED vary
This is due to the quantity effect and price effect outweighing each other at certain points. For example take the factors of 10. 9 × 1 = 9 (top of demand curve) but 8 × 2 = 16 think of this as an increase in revenue and so it's elastic. When we get towards the bottom of the curve decreasing price and increasing quantity will lead to a inelastic effect or a decrease in revenue since 3 × 7 = 21, 2 × 8 = 16. Very simplified but alas I am stupid.
What are the factors influencing cross-price elasticities of demand (XED)? (Comp)
With complementary goods such as DVD Players and DVDs, an increase in the demand of one good (DVD Player) will lead to an increase in demand for the complementary product (DVDs). So if the price falls for one good then generally the demand for the complementary good will rise. The stronger the relationship between two products, the higher the co-efficient of cross-price elasticity of demand will be. Example: A fall in the price of a cinema ticket may lead to a large increase in the demand for popcorn and so this will have a highly negative XED. If the goods are only weakly complementary then a large decrease in the price of good A will only lead to a small increase in demand for good B.
What are the factors influencing cross-price elasticities of demand (XED)? (Sub)
With substitute goods such as brands of cereal, an increase in the price of one good will lead to an increase in demand for the rival product. However it depends on how closely related these two goods are on how much a price rise of good A will affect the demand for good B. Key revision point: The cross price elasticity for two substitutes will always be positive. Example: Sales of digital music downloads have been soaring with the growth of broadband and falling prices for downloads. As a result, sales of music CDs have fallen sharply.
A new manager has started at Sainsbury's and she is considering lowering the price of the own-brand range of shampoo. She knows that last year a cut in price from 80p to 70p increased annual sales from 10,000 units to 12,000 and therefore she is considering a further 10p cut this year. a) What was the PED for Sainsbury's own-brand shampoo last year? b) How much did revenue increase/decrease by after the 10p cut? c) Will cutting a further 10p off the price of the shampoo result in an even greater sum of revenue?
a) PED = (% change in Q) / ( % change in P) % change in Q = (2,000 / 10,000) × 100 = 20% % change in P = (((70/80)-1) × 100) = -12.5% PED = 20 / -12.5 = -1.6 b) Before price cut: £0.80 × 10,000 = £8,000 After price cut: £0.70 × 12,000 = £8,400 8,400 - 8,000 = £400 c) This depends on whether PED stays the same. If it does then demand will rise more than proportionally, so revenue should rise.
A book store currently sell their books for an average of £5. However due to increasing costs they may have to raise this to £6 in the near future. Previous research has shown that the likely PED for children's books is -1.5. Last year the firm sold 20,000 children's books. a) Calculate the number of children's books they sell if they increase the price to £6 b) What was the firm's revenue and what will it likely be?
a) PED = (% change in Q) / ( % change in P) % change in Q = PED × % change in P = -1.5 × (((6/5) -1) × 100) = -30% 20,000 × 0.7 = 14,000 b) Firm's revenue = 5 × 20,000 = £100,000 Firm's likely revenue next with the price rise = 6 × (20,000 × 0.7) = £84,000
