Project #92811 - Economecs

Elasticity of demand

When you raise the price of most items, people will buy less of them. For example, when one airline raises its price, air passengers may switch to a rival airline.

When you reduce the price of most items, people will buy more of them. For example, when supermarkets make special offers with reduced prices, they expect a sharp increase in corresponding sales.

Common sense tells us that when prices change, so too will the quantities bought. However, businesses need to have more precise information than this - they need to have a clear measure of how the quantity demanded will change as a result of a price change.

The relationship between price and quantity demanded is measured by 'price elasticity of demand' (PED). This is calculated as: %change in sales/% change in price

 

Example 1

Suppose that a supermarket reduces the price of a packaged cake from £1.00 to 80p then it is assumed that sales per week would rise from 500 to 700.

Question:

 

  1. Calculate the price Elasticity of Demand

 

2.            What does the answer to question I tell you? Is the product packaged cake elastic, inelastic or unitary elasticity?

  

3.            Explain your answer

 

Example 2

Now suppose that the supermarket increases the price of washing up liquid from £1.00 to £1.20. Weekly sales drop only from 1,000 to 900 bottles.

 

1.  What is the percentage change in sales of washing up liquid?

 

2.            What is the percentage change of the price of washing up liquid?

 

 

3.            Calculate the price Elasticity of Demand of the washing up liquid?

 

 

What can you say about the elasticity of the washing up liquid? Elastic? Inelastic? Unitary elasticity?

 

 

Conclusion: Price elasticity data is very useful in making pricing decisions. Generally, the more the customer has good substitutes available, the more demand will be price elastic.

Where there are few if any alternatives, price is usually inelastic. This principle leads to, for example, fierce price competition among airlines flying to the Dubai/Abu Dhabi (price elastic) but frequent fare increases for commuters travelling by rail to London.

Subject Business
Due By (Pacific Time) 11/13/2015 12:00 am
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