Elasticity

20. the concept, and measurement, of price elasticity of demand 

21. determinants of price elasticity of demand

22. the distinction between goods that are price elastic and price inelastic in demand

23. the link between price elasticity of demand and total revenue

       24. the concept of price elasticity of supply

25. the distinction between goods that are price elastic and price inelastic in supply

26. determinants of price elasticity of supply

27. the application of price elasticity of demand and supply to markets 

28. the importance of price elasticity of demand and supply for business and government, including the incidence of a tax and price discrimination

Extra Dotpoint: Cross Elasticity of Demand and Income Elasticity of Demand

1. Define Price elasticity of demand (PED) 

Price elasticity of demand is a measure of how much the quantity demanded of a good changes (the responsiveness) when there is a change in its own price.

2. Explain the difference between elastic and inelastic demand 

Inelastic Demand - Is when the demand for a good or service is unresponsive to a change in price. The % change in demand is less than the % change in price. For example if the price of cigarettes increases, demand will only slightly decrease due to the addictive nature of the good 

Elastic Demand - Is when the demand for a good or service is responsive to a change in price. The % change in demand is more than the % change in price. For example if the price of a particular deodorant increases, demand could drop significantly due to the many substitutes on offer.

3. What is the formula for measuring PED? 

PED = %∆ in Qd        ∆ in Q    /     ∆ in P

    Q                   P                                                               #Note: Ignore minus signs

             %∆ in P

4. If price elasticity equals 0.4, what does that indicate? 

For a 1% change in price demands changes by 0.4%

5. Draw demand curves to visualize inelastic, elastic, unitary, perfectly inelastic and perfectly elastic price PED 

6. List four important factors that affect the level of price elasticity of demand 

• Whether the good is a necessity or luxury

• The amount od substitutes

• Brand Loyalty

• Addictive goods

• Definition of the market (Actual Good v Brands of the Good)

• The proportion of income spent

• Time

7. Determine which of the following groups of goods and services has a level of price elasticity of demand that could be described as being reasonably inelastic, moderately inelastic, moderately elastic and reasonably elastic. 

Group

Price elasticity of demand

1. 
   Milk, dental services, coffee

slightly inelastic

2. 
   Chocolate, visit to the movies

Slightly elastic

3. 
   Overseas holidays, gym membership, air travel

Very elastic

4. 
   Medicine, cigarettes and petrol

VeryInelastic

8. How is TR calculated? 

Price x Quantity

9. What happens to TR if price falls and demand is elastic? 

If Demand is elastic when price falls TR increases

10. Define the term ‘elasticity of supply’
    
    

Price Elasticity of Supply is defined as the responsiveness of quantity supplied to a change in the price of a good or service.

11. Identify three factors that affect the level of elasticity of supply
    
    

• Time

• Nature of Industry

• Availability to store stock

12. Would the supply of wheat be elastic or inelastic? Expalin why 

The supply of wheat is inelastic. This means that the supply of wheat is unresponsive to a change in price. This is due to the fact that farmers cannot increase the availability of wheat quicklyt. Farmers only have limited amount of crop lands, available resources to cut the wheat and it takes months to grow greater quantities of wheat

Calculation Questions

1. Assume Apple was considering what price to charge for the iPhone. Market research told them that at a price of $600 they would sell 10,000 units a day and at a price of $400 sales would be 27,000 units per day.

1. What would be their revenue at each of these price levels? 

TR = P x Q

At a price of $600= 600 x 10000 = 6,000,000

At a price of $400 = 400 x 27000 = 10,800,000

2. What, therefore, was the price elasticity of demand for the iPhone6? 

Revenue increasing when price decreasing, moving in opposite directions therefore demand is elastic

2. Suppose a war in the Middle East causes oil supplies to fall, increasing the price per barrel of oil from $100 to $120 and as a result oil consumption falls from 1m barrels to 900,000 barrels a month. Calculate PED for oil in this situation using the Point Method and the. How might this value for PED be interpreted?

Point Method

=(100,000/1,000,000) / (20/100)

= .1/.2= 0.5 therefore it is inelastic

7. Gaming firm ALCo Ltd produce children’s games that can be downloaded from the company site priced at $40 each and run on home PCs. The demand for home PCs has increased by 20% over the past two years as computer prices have fallen by 10%. At the same time the demand for ALCo games has increased by 25%.

1. Calculate the price elasticity of demand for home PCs.

20/10 = 2 (elastic)

These questions will challenge your understanding a liitle extra.

1. Explain how the concept of elasticity can be linked to each of the following.

1. Firms try to reduce competition and build up monopoly power. Because there are fewer substitute products they can raise prices and increase profits without a fear of a big (elastic) reaction by customers. 

Firms are in a healthy position if they can produce goods that are inelastic in demand. Firms which have high monopoly power and very few substitutes such as Google have the ability to raise prices without reaction from customers. This means that when price rises Total Revenue will rise

2. Firms may produce several versions of basically the same product. For example airlines may have economy, premium economy, business class and first class seats on the same plane. They do this because they know some customers are less sensitive to price and are willing to pay a premium price (their demand is price inelastic). By charging people more airlines can increase revenue and profit.

Airlines make a large portion of their revenue through first class tickets. This is because the targe market for these tickets are wealthy people who are less likely to react to increased prices. Therefore arlines can keep increasing the price of these already expensive tickets without much reaction to demand thus increasing total revenue

3. WA will not host a Test Match in 2021 because the capacity of Optus Stadium is too small. Regardless of how much cricket fans are willing to pay to watch Test cricket the capacity of the Optus Stadium is fixed. Elasticity of supply is inelastic.

Optus Stadium has a fixed supply of seats (60000). This means no matter how much comsumers are willimng to pay for an event the supply will be fixed once at capacity. The supply curve for Optus Stadium is perfectly inelastic

1. The Price Elasticity of Supply (PES) measures how responsive the quantity supplied of a good is to changes in its price. It is calculated as:

In the short run, the PES of wheat is inelastic. This is because wheat farming follows a fixed growing cycle, and farmers cannot immediately increase supply in response to a price rise. Once wheat has been planted, production is largely fixed until the next season. Even if prices rise significantly, farmers cannot instantly grow more wheat since factors like land availability, planting schedules, and weather conditions limit short-term adjustments.

Therefore, wheat has a low PES in the short run because supply takes time to respond. However, in the long run, PES becomes more elastic as farmers can allocate more land, invest in better technology, or switch to higher-yielding wheat varieties.

2. Price Elasticity of Demand (PED) measures how responsive the quantity demanded of a good is to a change in its price. It is calculated as:

Understanding PED helps coffee producers and retailers make pricing decisions by predicting how consumers will react to price changes.

For premium coffee brands like Starbucks, demand tends to be inelastic (PED < 1) because customers are brand-loyal and see few substitutes. Starbucks can raises prices, knowing the  quantity demanded decreases only slightly, allowing the company to increase revenue.

In contrast, generic supermarket coffee has a more elastic demand (PED > 1). Consumers can easily switch to other brands or beverages like tea if prices rise. This means retailers must be cautious with price increases, as they could lead to a significant drop in sales.

For coffee producers, knowing PED helps in pricing strategies, production planning, and marketing decisions. For example, premium brands can afford to raise prices during supply shortages, while generic brands might focus on competitive pricing to retain customers.

3. The demand for the high-end smartphone is likely inelastic in the short run due to brand loyalty and early adopters who are less sensitive to price increases, willing to pay a premium for the latest model with few substitutes available at launch. 

However, in the long run, as consumers have more time to research alternatives, including competitor models and older versions, demand becomes more elastic. With increased options and price sensitivity, the flagship's appeal diminishes, and consumers become more likely to seek out better value alternatives, causing a decline in demand for the high-priced model.

When a tax is imposed on inelastic goods, the burden falls primarily on consumers because of the nature of inelastic demand. Inelastic goods are those for which demand remains relatively unchanged even when prices rise, meaning consumers will continue purchasing them despite higher costs.

For example, addictive goods like cigarettes have inelastic demand because people are usually addicted. When a tax is applied to such goods, the supply curve shifts upward by the amount of the tax. However, because the demand curve is steep (inelastic), the quantity demanded decreases only slightly, even though the price increases. This allows producers to pass most, if not all, of the tax onto consumers. 

As a result, consumers bear the greater share of the tax burden since they are less responsive to price changes and still need to purchase the good. The price increase is close to the full amount of the tax, demonstrating that consumers pay the majority of the tax in the case of inelastic goods.

This can be seen below

As can be seen above, the tax has caused the S curve to shift to the left from S1 to S2. The yellow box shows the government revenue (Tax per unit x Qt). Due to the steepness of the inelastic curve and only a small change in Q, most of the tax is passed on and paid by the consumer as can be seen by the larger consumer box compared to producer