# This worksheet looks at the measure of price elasticity

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```					This worksheet looks at the measure of price elasticity of demand;
how to measure it, what determines its value and what value it is to
companies as a measure. To cover the worksheet fully, you should
have a sound knowledge of the principles underlying supply, demand
and the determination of price in a market.

Step 1 - E L A S T I C or INELASTIC?

Price Elasticity of Demand is a measure of how responsive demand is to a
change in price. If a price change leads to a considerably bigger change in
quantity demanded, we would consider the good to be responsive to a
price change: hence elastic. If, however, a similar price change leads to a
much smaller change in demand, we would consider it inelastic.

To get a more precise measure than this of the responsiveness to a price
change we can calculate a value for price elasticity of demand. We use
the formula:

percentage change in demand
PRICE ELASTICITY OF DEMAND =
percentage change in price

Use the formula above to calculate values of Price Elasticity for all the
situations below:

Price         Quantity    % change in
% change     Price Elasticity
quantity
Initial New Initial New                       in price      of Demand
demanded

25        30    100   40                                 1. ___________

40        70    120   90                                2. ___________

200    220      80    64                                3. ___________

50        75    150   135                               4. ___________

In each case identify whether you would describe it as elastic / unit
elastic / inelastic

1. _________________________
2. _________________________
3. _________________________
4. _________________________
Step 2 - E L A S T I C MONEY?

Different elasticity values will lead to different effects on the level of
total revenue a firm receives. For example, if a good is elastic and a firm
increases the price, by say 10%, they will lose more than 10% of their
business, and so although they are getting more money for each one they
sell, they are selling far fewer.

To see the effect that elasticity has on total revenue fill in the table
below:

Price        Quantity               Revenue

Before                   Price Elasticity of
After price        Demand
Initial New Initial New          price
change
change
25        30   100    40                                   1. ___________

40        70   120    90                                   2. ___________

200    210     80     64                                   3. ___________

50        75   150    135                                  4. ___________

Has revenue increased or decreased in each case?

1. _________________________
2. _________________________
3. _________________________
4. _________________________

In the table below put a tick in the box that associates the appropriate
elasticity value with the appropriate effect on total revenue when price
rises (as in the above examples):

Elasticity value         Elastic   Inelastic Unit elastic

Effect on total revenue      *****       *****      *****

Increase

Decrease

Stay same
Step 3 - What determines E L A S T I C I T Y?

As we have seen above it is important to a company to have an idea of the
value of the elasticity of demand of its good or service as it will affect
what happens to their total revenue as price changes. What should the
company aim to do with their price in each of the circumstances below?

Elasticity     Change in price to increase total revenue??
(Increase or decrease price?)

Elastic

Inelastic

Unit elastic

If the company wants to estimate the value of the price elasticity of
their product, then they need to judge it against the following criteria:

   Proportion of income spent on the good - the lower the proportion
of income spent, the more inelastic the good will tend to be
   The number of substitutes - the more substitutes a good has the
easier it is for consumers to switch to another product if the price
goes up
   The strength of the brand - the stronger the brand, the more
inelastic the product will be
   The level of necessity or addiction - the more necessary or
addictive something is, the more inelastic it will be

Judge the products in the table below to decide whether you think they
will be elastic or inelastic:

Elastic or
Product                                       Reasons?
inelastic?

A box of matches

A luxury holiday

'Heinz' baked beans

Computers - home users

users

Cigarettes
Step 4 - E L A S T I C brands? (not bands!)

As we saw above, the strength of the brand will affect the elasticity. The
stronger the brand, the more likely people are to buy it whatever the
price. Draw a new demand curve on the diagram below to show the effect
of a major advertising campaign that strengthens the brand:

We can see this effect if we consider the price of a well-established
consumer product - JEANS. To see the effect, try going to the Lycos
shopping channel and follow the links to clothing and then to trousers.
Find the price of a branded pair of jeans - say Levis, and then find the
price of an equivalent pair of unbranded jeans (or perhaps a less well-
known brand). Fill these prices in in the table below:

Brand/Make       Price

Write a short explanation (referring to price elasticity where possible) of
why these different brands of jeans differ in price.
Step 5 - Needing E L A S T I C I T Y

You may certainly not feel you need elasticity at the moment, but as we
have seen above it is important information for firms. The value of the
price elasticity will affect their pricing strategy. We have also seen above
that the value of the elasticity depends on the degree of necessity.

To check this, go to the British Airways site
(http://www.britishairways.com/) and look at their on-line booking
section. Then go through the following steps:

   Choose an international flight (to New York?)
   Choose dates to fly out and back a week apart
   Find out the price for economy class
   Find out the price for business class
   Find out the price for first class

Class                     Price

Economy

First class

Why do these prices differ?
To what extent do these prices show that the greater the level of need,
the more inelastic the demand for the flight? (N.B. Try comparing the
business price and the economy price - does the price difference fully
justify the difference in the level of service?)

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 views: 70 posted: 3/19/2010 language: English pages: 6