Answering the question...Answering the question...

By How Much?By How Much?

What we knowWhat we know• We all remember the law of demand that We all remember the law of demand that

says:says:

• But is that good enough for a Producer But is that good enough for a Producer wishing to plan their pricing stategies?wishing to plan their pricing stategies?

As the Price of a good or service As the Price of a good or service increases the quantity increases the quantity

demanded will decrease (Vice demanded will decrease (Vice Versa) ceteris Paribus.Versa) ceteris Paribus.

As the Price of a good or service As the Price of a good or service increases the quantity increases the quantity

demanded will decrease (Vice demanded will decrease (Vice Versa) ceteris Paribus.Versa) ceteris Paribus.

The Answer...The Answer...• We need to analyse the change in the We need to analyse the change in the quantity demanded so that we can tell the quantity demanded so that we can tell the

producer if they should increase their prices producer if they should increase their prices and what impact exactly it should have on and what impact exactly it should have on

their revenue.their revenue.• To do this we need to do a little ‘Math’.....To do this we need to do a little ‘Math’.....

What will we be working out?What will we be working out?• We will be working out the amount of We will be working out the amount of

change that occurs to quantity demanded as change that occurs to quantity demanded as the price changes i.e. When we are told that the price changes i.e. When we are told that the quantity demanded will change we can the quantity demanded will change we can

figure out ‘By How Much’.figure out ‘By How Much’.

The Maths...The Maths...• We are going to work out the ‘By how much’ We are going to work out the ‘By how much’

of a quantity demanded change to a change of a quantity demanded change to a change in price so:in price so:

• We need to work out the change in We need to work out the change in quantities and an average of the change in quantities and an average of the change in quantities and see that as a relationship to quantities and see that as a relationship to the change in prices and an average of the the change in prices and an average of the

changes in prices.changes in prices.

What does it look like?What does it look like?

((Q2-Q1)/((Q2-Q1)/((Q1+Q2)/2)) / ((Q1+Q2)/2)) /

((P2-P1)/((P2-P1)/((P1+P2)/2))((P1+P2)/2))

Is there an easier Equation?Is there an easier Equation?

• See if you can re-work the See if you can re-work the equation to make it easier?equation to make it easier?• What if they were all What if they were all

percentages? percentages? • What would it look like?What would it look like?

Case StudyCase Study

• Consider the market for music CDs. Consider the market for music CDs. When the price of CDs is $30 per unit, When the price of CDs is $30 per unit, consumers buy 6 per year. When the consumers buy 6 per year. When the price falls to $20 per unit, consumers price falls to $20 per unit, consumers

buy 12 per year. buy 12 per year.

The calculationsThe calculations

What does it all mean?What does it all mean?• We ignore the minus sign when calculating We ignore the minus sign when calculating

price elasticity. price elasticity. When the price of CDs falls from $30 to $20, When the price of CDs falls from $30 to $20, and the quantity sold increases from 6 per and the quantity sold increases from 6 per year to 12 per year, the price elasticity of year to 12 per year, the price elasticity of

demand is 1.67: demand is 1.67:

• CDs are CDs are price elastic price elastic over this price range over this price range i.e. They will be more responsive to a change i.e. They will be more responsive to a change

in price.in price.

Types of ElasticityTypes of Elasticity• More Responsive=ElasticMore Responsive=Elastic• Less Responsive=InelasticLess Responsive=Inelastic• Exactly proportional=UnitaryExactly proportional=Unitary

Is it the same along a demand curve?Is it the same along a demand curve?

Elastic DemandElastic Demand

Inelastic DemandInelastic Demand

Extreme casesExtreme cases

• What happens if we push the What happens if we push the responsiveness to the limit?responsiveness to the limit?

Extreme cases of PEDExtreme cases of PED

Elasticity examplesElasticity examples

Elasticity on the web...

•Price Elasticity of Demand Explained• Click on the link above to go to You tube video

on elasticity.