ELASTICITY Price Elasticity of Demand (PED)

1. ELASTICITY Price Elasticity of Demand (PED) • PED measures how sensitive the quantity demanded is to changes in the price. • You would expect the demand for most goods to fall as the price increases, but PED measures how much of a fall is likely. • It is important to distinguish between elastic and inelastic demand.

2. ELASTICITY Price Elasticity of Demand (PED) Formula for PED: % change in quantity demanded % change in price How do we calculate the % change??? Change in Quantity Original Quantity ________________ (divided by) Change in Price Original Price

3. PED Example • The price of a popular chocolate bar increases from $3 to $4 per bar. • The quantity demanded per week falls from 10000 bars to 9000 bars. • Calculate the PED. Change in Quantity = 1000 Original Quantity 10000 = 0.1 0.1__ 0.333 = 0.3 Change in Price = 1 =0.3333 Original Price 3 What does this number mean ? – the product is inelastic. What does inelastic mean? Read on!

4. ELASTICITY Price Elasticity of Demand (PED) Elastic Demand • A small change in prices results in a relatively larger change in the quantity demanded. • Eg: If the price of a textbook increases by 10% and as result demands fall by 30%, demand is said to be elastic. • Demand is price elastic if the value calculated is more than 1. Therefore using our formula: 30 / 10 = 3

5. ELASTICITY Price Elasticity of Demand (PED) Inelastic Demand • A relatively large change in price, led to a smaller change in the quantity demanded. • If the price of a product increases by 10% and demand only falls by 1%, then demand is said to be inelastic. • The same is of course true, for price drops, leading to a rise in demand. • Demand is inelastic if the figure calculated is less than 1. Therefore using our formula: 1/10 = .1 • Our chocolate bar was an example of an inelastic good.

6. ELASTICITY Price Elasticity of Demand (PED) Unitary Elasticity • If PED is exactly 1, this is know as unitary elasticity, which means that a change in price will lead to an identical change in quantity demanded.

7. ELASTICITY Price Elasticity of Demand (PED) The Importance of PED for Business • It is useful for business to look at PED when deciding whether or not to change the price. • Revenue (price x quantity) will be affected by any change in price, but how it is affected depends on whether a product is elastic or inelastic.

8. ELASTICITY Price Elasticity of Demand (PED) PED is Inelastic (less than 1) = Business Can Increase Revenue by Increasing Price • They will lose some revenue from quantity demanded, but will gain more revenue from the higher prices, as demand changes less than proportionally to the change in price.

9. ELASTICITY Price Elasticity of Demand (PED) PED is Elastic (Greater than 1) = Businesses Can Increase Revenue by Lowering Prices • They will lose some revenue from the lower prices, but will gain more revenue from the higher quantity demanded, as demand changes more than proportionally to the change in price • This means that businesses must be careful to interpret their sales data correctly before making decisions on price changes.

10. PED EXERCISES (1) American Airlines (AA) decides to increase its airfares on the Caracas to Miami route from $400 one way to $600 one way during December and January. Weekly demands for the seats at this price level falls from 10000 per week to 9000 per week. • Calculate the Price Elasticity of Demand (PED) • Explain what the number means – are airfares on this route at this time elastic or inelastic?? • From a revenue perspective was this a wise and smart decision for AA.

11. PED EXERCISE (2) APPLE decides to decrease the selling price of its basic IPAD from $499 to $399. Weekly demand in a specific market increases from 10,000 units to 11,000 units. • Calculate the Price Elasticity of Demand • Explain what this number means • From a revenue perspective, was this a wise/ smart decision for APPLE.