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MANAGERIAL ECONOMICS
Price Elasticity of Demand
In this chapter we look at the idea of elasticity of demand, in other words, how
sensitive is the demand for a product to a change in the product’s own price.
You will find that elasticity of demand is perhaps one of the most important
concepts to understand in your AS economics course
Defining elasticity of demand
Ped measures the responsiveness of demand for a product following a
change in its own price.
The formula for calculating the co-efficient of elasticity of demand is:
Percentage change in quantity demanded divided by the percentage change in
price
Since changes in price and quantity nearly always move in opposite directions,
economists usually do not bother to put in the minus sign. We are concerned
with the co-efficient of elasticity of demand.
Understanding values for price elasticity of demand
If Ped = 0 then demand is said to be perfectly inelastic. This means that
demand does not change at all when the price changes the demand
curve will be vertical
If Ped is between 0 and 1 (i.e. the percentage change in demand from A
to B is smaller than the percentage change in price), then demand is
inelastic. Producers know that the change in demand will be
proportionately smaller than the percentage change in price
If Ped = 1 (i.e. the percentage change in demand is exactly the same as
the percentage change in price), then demand is said to unit elastic. A
15% rise in price would lead to a 15% contraction in demand leaving
total spending by the same at each price level.
If Ped > 1, then demand responds more than proportionately to a
change in price i.e. demand is elastic. For example a 20% increase in
the price of a good might lead to a 30% drop in demand. The price
elasticity of demand for this price change is 1.5
What Determines Price Elasticity of Demand?
Demand for rail services
At peak times, the demand for rail transport becomes inelastic and higher
prices are charged by rail companies who can then achieve higher revenues
and profits
The number of close substitutes for a good / uniqueness of the
product the more close substitutes in the market, the more elastic is
the demand for a product because consumers can more easily switch

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their demand if the price of one product changes relative to others in
the market. The huge range of package holiday tours and destinations
make this a highly competitive market in terms of pricing many holiday
makers are price sensitive
The cost of switching between different products there may be
significant transactions costs involved in switching between different
goods and services. In this case, demand tends to be relatively inelastic.
For example, mobile phone service providers may include penalty
clauses in contracts or insist on 12-month contracts being taken out
The degree of necessity or whether the good is a luxury goods
and services deemed by consumers to be necessities tend to have an
inelastic demand whereas luxuries will tend to have a more elastic
demand because consumers can make do without luxuries when their
budgets are stretched. I.e. in an economic recession we can cut back on
discretionary items of spending
The % of a consumer’s income allocated to spending on the good
goods and services that take up a high proportion of a household’s
income will tend to have a more elastic demand than products where
large price changes makes little or no difference to someone’s ability to
purchase the product.
The time period allowed following a price change demand tends to
be more price elastic, the longer that we allow consumers to respond to
a price change by varying their purchasing decisions. In the short run,
the demand may be inelastic, because it takes time for consumers both
to notice and then to respond to price fluctuations
Whether the good is subject to habitual consumption when this
occurs, the consumer becomes much less sensitive to the price of the
good in question. Examples such as cigarettes and alcohol and other
drugs come into this category
Peak and off-peak demand - demand tends to be price inelastic at
peak times a feature that suppliers can take advantage of when
setting higher prices. Demand is more elastic at off-peak times, leading
to lower prices for consumers. Consider for example the charges made
by car rental firms during the course of a week, or the cheaper deals
available at hotels at weekends and away from the high-season. Train
fares are also higher on Fridays (a peak day for travelling between
cities) and also at peak times during the day
The breadth of definition of a good or service if a good is broadly
defined, i.e. the demand for petrol or meat, demand is often fairly
inelastic. But specific brands of petrol or beef are likely to be more
elastic following a price change
Demand curves with different price elasticity of demand
Firms can use price elasticity of demand (PED) estimates to predict:
The effect of a change in price on the total revenue & expenditure on a product.
The likely price volatility in a market following unexpected changes in supply
this is important for commodity producers who may suffer big price movements
from time to time.

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﻿MANAGERIAL ECONOMICS Price Elasticity of Demand In this chapter we look at the idea of elasticity of demand, in other words, how sensitive is the demand for a product to a change in the product’s own price. You will find that elasticity of demand is perhaps one of the most important concepts to understand in your AS economics course Defining elasticity of demand Ped measures the responsiveness of demand for a product following a change in its own price.  The formula for calculating the co-efficient of elasticity of demand is: Percentage change in quantity demanded divided by the percentage change in price Since changes in price and quantity nearly always move in opposite directions, economists usually do not bother to put in the minus sign. We are concerned with the co-efficient of elasticity of demand. Understanding values for price elasticity of demand If Ped = 0 then demand is said to be perfectly inelastic. This means that demand does not change at all when the price changes – the demand curve will be vertical If Ped is between 0 and 1 (i.e. the percentage change in demand from A to B is smaller than the percentage change in price), then demand is inelastic. Producers know that the change in demand will be proportionately smaller than the percentage change in price If Ped = 1 (i.e. the percentage change in demand is exactly the same as the percentage change in price), then demand is said to unit elastic. A 15% rise in price would lead to a 15% contraction in de ...
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