AS Micro - Elasticity of Demand and Supply

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Elasticity
• Classification is important
when applying elasticity
theory
• Be careful when discussing
‘food’ or ‘electrical goods’ –
different classifications within
these groups will have very
different values of elasticity of
demand and / or supply
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• Page 20 of your booklet has a
double-page dedicated to
formulae, definitions and
diagrams for elasticity
• Learn these really well – you
are guaranteed to be using
these concepts in your exams!
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Elasticity

List 6 factors that can affect
price elasticity of demand
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Necessity or
luxury?
Availability of
close substitutes
Consumer
income
Brand loyalty
Habitual
consumption
Frequency of
purchase
Who pays?

Price Elasticity of Demand
WH Smith have recently
reduced the price of its
Kobo Mini E-reader from
£60 to £40. They predict
that sales of the E-reader
will increase from 15,000
units a month to 25,000 a
month (nationwide).
What is the price
elasticity of demand for
this price change for the
Kobo Mini-reader?
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PED = % Δ in QD
% Δ in P
PED = 66%
-33%
PED = -2
Price
Elastic

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The diagram illustrates the
demand and supply for the
market of ‘weekend’-style
tents (small tents that are
designed to be used for
only a few days). Calculate
the Price Elasticity of
Demand for weekend-tents
following the fall in
manufacturing costs.
PED = % Δ in QD
% Δ in P
PED = 50
-20
PED = -2.5
Price
Elastic

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Calculate the
change in
revenues for
camping
manufacturers
following the
recent changes in
production costs.
Revenue =
Quantity x Sales Price
Revenue at E1 =
250 x 400 = £100,000
Revenue at E2 =
200 x 600 = £120,000
Difference in revenue =
+ £20,000

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The price elasticity
indicates what is likely
to happen to revenue
and profit following a
price change.
In this case, because
demand is elastic, the
fall in price was likely
to lead to an increase
in revenue
Price Elasticity and Producer
Revenue

A business that makes hard-shelled suitcases
aimed at holidaying tourists has increased its
prices by 5%. As a consequence, they have
seen a drop in sales between January and
March by 15% (compared to a same time of the
year last year).
It could be concluded that the price elasticity of
demand for the suitcases is and as a
result total spending by consumers on the
product will rise/fall/remain the same?
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Elastic

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Cross Price Elasticity of
Demand (XED)

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Beats Studio (by Dr Dre)
headphones retail at approximately
£200 per unit. Following a change
in price of the headphones (an
increase in £20), there is an increase
demand for a rival brand of
headphones by 7.5%.
What is the Cross Elasticity of
Demand between the Beats Studio
headphones and its rival?
Demand (XED)

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XED = % Δ in QDA
% Δ in PB
XED = +7.5
+10
XED = + 0.75
Products are
substitutes
+0.75 is a low value
Dr Dre can increase
price of product
without losing too
many customers.
Revenue will
increase.
Demand (XED)

A. +4
B. +2
C. −2
D. −4
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Price of X (£) Quantity
demanded of X
Quantity
demanded of Y
30 20 30
27 24 42
The table below shows the price and quantity
demanded of two goods, X and Y
When the price of X falls from £30 to
£27, the cross elasticity of demand for Y
with respect to the price of X is
Product X and Y are strong
complements
Demand (XED)

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A cinema chain calculates that the
cross elasticity of demand between
its cinema tickets and sales of its
popcorn is -2. The cinema is
considering a week-long reduction
in the price of its tickets as a
promotion – it is planning to drop its
prices by 20%.
Calculate what you would expect to
happen to the demand for popcorn.
XED = % Δ in QDA
% Δ in PB
Demand (XED)

Income Elasticity of Demand
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The government decreases the
rate of income tax so that, on
average, all citizens have 2% more
disposable income. A small cereal
firm, specialising in a granola-style
breakfast cereal sees an increase
in sales by 5%.
What is the Income Elasticity of
Demand for the breakfast cereal?
YED = % Δ in QD
% Δ in Y
YED = 5
2
YED = + 2.5
The granola cereal is
a luxury good

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The Income Elasticity of
Demand for a non-branded
chocolate bar in a
supermarket is -0.2.
If real incomes in the UK
increased by 1%, what is the
likely change to demand for
the chocolate bar?
YED = % Δ in QD
% Δ in Y
- 0.2 = % Δ in c
1
% Δ in c = - 0.2%
Non-branded
chocolate is an
inferior good

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Suggest 3 further inferior goods:
Inter-city bus services
(compared to trains)
Own-label burger
Non-Smart phones!

Price Elasticity of Supply
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What factors can impact on the PES?
Spare Capacity (e.g. with machinery)
Stock levels
Length of production times

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Two firms produce sports trophies
that are sold in retail outlets (who
will add value to the trophies by
using an inscribing machine to
personalise the trophy). If both
firms increase their prices by
5%, firm A will see an increase in
output by 2.5% and firm B will see
a rise in output by 7.5%.
Calculate the Price Elasticity of
Supply for both firms.

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PES = % Δ in QS
% Δ in P
PES = 2.5
5
PES = 0.5
Inelastic
FIRM A
PES = 7.5
5
PES = 1.5
Elastic
FIRM B

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PES = % Δ in QS
% Δ in P
FIRM A FIRM B
S
S

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A firm that produces sunflower oil-based margarine is faced with the following
conditions:
1. It is working at full capacity.
2. Its storage tanks are full.
3. It has negotiated a contract with 5 new producers of the sunflower oil to add
to its current group of suppliers.
4. It requires three months to train new workers to qualify in quality checking
procedures.
Which of the conditions will tend to make the supply of margarine relatively price
inelastic?
A: 1 and 2 B: 1 and 4 C: 2 and 3 D: 3 and 4

You are about to be presented with four
multi-choice questions relating to
‘elasticity.’. The correct answer for each
question should be recorded on your
‘Combination Cracker’ ticket (on page 18)
click to continue7:49:36

Be warned, one of the 4
questions has two possible
answers, so you will need a
5 digit code!
click to continue7:49:36

A 10% increase in
fares will lead to a
15% decrease in
passengers
Rail travel is an
inferior good
Rail travel has a
negative cross
elasticity of
demand
As unemployment
falls, more people
will use trains
1 The income elasticity of demand for rail travel is
− 1.5. This means that…….
A B C D
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less elastic in the
long run than in
the short run
determined by the
availability of
substitutes
affected by the
stocks of wheat
available
more inelastic
when the
production time
frame is long
2 The price elasticity of supply of maize is…
A B C D
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A negative income
elasticity of
demand
A positive price
elasticity of
demand
A positive cross
elasticity of
demand
A negative cross
elasticity of
demand
3 Which one of the following measures of elasticity
indicates that two goods are complements?
A B C D
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inversely
related to price
of unitary
elasticity
perfectly
elastic
perfectly
inelastic
4 An indirect tax on the production of a good will have no
effect on price if demand is…..
A B C D
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a 10% increase in
fares will lead to a
15% decrease in
passengers.
rail travel is an
inferior good.
rail travel has a
negative cross
elasticity of
demand.
as unemployment
falls, more people
will use trains.
1 The income elasticity of demand for rail travel is
− 1.5. This means that…….
A B C D
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B C D D
So the correct combination was…..
C
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AS Micro - Elasticity of Demand and Supply

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AS Micro - Elasticity of Demand and Supply