Revision Elasticity its importance What is Price elasticity

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 falls BUT! 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

Consider a 10% increase in price Pe. D Mantra…. • If answer is between 0 and -1 • e. g. -0. 4 or -0. 8 • The relationship is inelastic Consumers DO NOT react much to a change in price • If the answer is between -1 and infinity • e. g. -1. 4 or 2 or 12. 3 Consumers DO react To changes in • The relationship is elastic prices 9/16/2020 4

Use your whiteboards Elastic or inelastic? ? Would customers react lots (ELASTIC) or not much (INELASTIC)…. . With the following Pe. D’s? ?

Elastic or inelastic? -3 Elastic – because a 10% increase in price would lead to a 30% fall in demand

Elastic or inelastic? -0. 4 Inelastic – because a 10% increase in price would lead to a 4% fall in demand

Elastic or inelastic? -0. 1 Inelastic – because a 10% increase in price would lead to a 1% fall in demand

Elastic or inelastic? -1. 1 Elastic – because a 10% increase in price would lead to a 11% fall in demand

Elastic or inelastic? -14 Elastic – because a 10% increase in price would lead to a 140% fall in demand

What about the effect on revenue?

Using Pe. D to calculate changes in TR • What if a company sells 10, 000 units at £ 5. • What if the company has a Pe. D of -0. 5? • What is their current TR? • If they reduced their price – would the customers react a bit or loads? • TR = P x Quantity sold • TR = £ 5 x 10, 000 = £ 50, 000 • is -0. 5 inelastic or elastic? • INELASTIC….

Using Pe. D to calculate changes in TR • What if a company sells 10, 000 units at £ 5. • What if the company has a Pe. D of -0. 5? • What is their current TR? • …. and they reduce their price to £ 4. 50 • TR = P x Quantity sold • TR = £ 5 x 10, 000 = £ 50, 000 • What would happen to their TR now? Will it increase or decrease? • 1 st you need to know what the % increase in price has been…. ?

Using Pe. D to calculate changes in TR • What if a company sells 10, 000 units at £ 5. So what’s • And now their price is £ 4. 50 • So if the company originally sold 10, 000 5% units…. . 0 f 10, 000 units? • And Pe. D is 0. 5 500 units • What is the % change? • And price has dropped by 10 % But would that be a fall or an • Difference/originalincrease x sales? ? ? 100 = % change • in. What will happen to DEMAND? • 5 - 4. 50 = 0. 5 / 5 x 100 = -10% x 0. 5 = 5%

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 New sales £ 5 x 10, 000 = £ 50, 000 £ 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? • 10, 000 x 5% • = 10, 000 -500 • Price increase is 0. 5/5 x 100 = +10% • So £ 5. 50 x 9, 500 • The company still has a Pe. D of -0. 5 • So sales will FALL by 5% • 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 Pe. D 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 Pe. D 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 Pe. D 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 Pe. D of 0. 8 and originally sold 30 units? • 10 -8 = 2/10 x 100 = 20% fall in price A price cut with • 20% x 0. 8 = 16% increase in sales an inelastic good will reduce your • 16% of 30 = 4. 8 units… can’t sell. 8 of a good so they revenue must sell 5… • Original TR = 10 x 30 = £ 300 • New TR = (30 +5) x £ 8 = £ 280 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 Pe. D of 2 and originally sold 100 units? • 20 -14 = 6/20 x 100 = 30% fall in price • 30% x 2 = 60% increase in sales • 60% of 100 = 60 units A price cut with an elastic good will increase revenue • Original TR = £ 20 x 100 = £ 2000 So a price rise with an elastic good will reduce revenue • New TR = £ 14 x (100+60) = £ 2240

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 Pe. D of 2 and originally sold 100 units? • 15 -16 = 1/15 x 100 = 6. 67% rise in price A price rise with • 6. 67% x 2 = 13. 34% fall in sales an elastic good • 13. 34% of 100 = 13. 34 units – but you can’t will sell reduce 0. 34 of revenue a product …so have to fall by 14 units • Original TR = £ 15 x 100 = £ 1500 • New TR = ( £ 16 x (100 – 14) = £ 1376 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!