Elasticity of Demand
IB Business and Management
What is Elasticity?

Elasticity measures how responsive demand
is to a change in a particular variable
The IB syllabus includes:
Price Elasticity of Demand
Income Elasticity of Demand
Cross-price Elasticity of Demand
Advertising Elasticity of Demand
PRICE ELASTICITY OF
DEMAND
Elasticity
The relationship between
price and demand
Elastic Demand?
Price Elasticity of Demand
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Price Elasticity of demand is
concerned with how responsive the
demand for a product is to a change in
price
How much will the demand change as
a result of a change in the price?
Price Inelastic Goods
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Goods where demand is relatively
unresponsive to a change in price
Demand will reduce but by a relatively
small amount
Firms would like their products to be
price inelastic.... Why?
Can you think of any examples?
Price Elastic Goods

Demand for the product is relatively
responsive to a change in price
Firms will have very little freedom to
increase prices as this will result in a
large decrease in demand

Can you think of any examples?

Calculating Price Elasticity

PED = % Change in quantity demanded
% change in price
Example: The price for a wardrobe is reduced
from £50 to £47 and as a result sales rise
from 2,000 to 2,240 units.
% change in demand = 240/2000 X 100 = 12%
% change in price = -£3/£50 X 100 = -6%
PED = +12%/-6% = -2
Classifying Price Elasticity
Price Elasticity will always have a negative value – Why?
PED Value (ignoring
minus sign)
Negative value less than
Price Inelastic
1
Exactly -1
Unit Elasticity
Negative Value more
than 1
Price Elastic
PED and Revenue for Price
Elastic Products

Revenue = Selling Price x Quantity
Demanded
Increase in
SP
Large
Decrease in
QD
Revenue Falls
Decrease in
SP
Large
Increase in
QD
Revenue
Increases
Therefore firms who assess their products to be Price Elastic should consider
carefully before increasing prices and can be in a difficult position if their
costs increase
PED and Revenue for Price
Inelastic Products

Revenue = Selling Price x Quantity
Demanded
Increase in
SP
Decrease in
SP
Small
Decrease in
QD
Small
Increase in
QD
Revenue
Increases
Revenue
Decreases
Therefore firms who assess their products to be Price Inelastic have great
freedom with their selling price.
Using PED to calculate
changes in revenues
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PED = % Change in quantity demanded
% change in price
How could we rearrange this formula
to make % change in quantity
demanded the subject?
% change in quantity demanded = PED X % change in price
E.g. A product costs £100. At this level demand for the product
is 60 units
What would revenue be at this price level?
Total Revenue = £100 X 60 = £6,000
The company are considering increasing the price to £110
% change in quantity demanded = PED X % change in price
The product is Price Inelastic – PED -0.5
What will the % change in demand be?
If PED is -0.5 a 10% increase in price will result only in a 5%
decrease in demand
So the new level of demand will be?

60 ÷ 100 x 95 = 57
So what will the new revenue be?
New Total Revenue = £110 X 57 = £6,270
Answer:

The product is Price Elastic – PED -2
What will the % change in demand be?
If PED is -2 a 10% increase in price will result in a 20%
decrease in demand
So the new level of demand will be?
60 ÷ 100 x 80 = 48
So what will the new revenue be?
New Total Revenue = £110 X 48 = £5,280
Exam Question (b) (i)
Exam Question (b) (ii)
Factors influencing Price
Elasticity
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Necessity or luxury
Availability of substitutes
Income of customers
Brand Loyalty
Questions
1.
2.
Why do firms prefer to sell products
that are price inelastic?
How can firms reduce the price
elasticity of their products?
Implications of Price
Elasticity of Demand
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Helps firms decide on their pricing
policy
Helps predict the effect of exchange
rate fluctuations on exported goods
Helps governments to work out
optimum levels of taxation on goods to
maximise tax revenues
What do the following graphs
show?
Exam Question (b) (i)
Exam Question (b) (ii)
INCOME ELASTICITY OF
DEMAND
Income Elasticity of Demand
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Income elasticity of demand is
concerned with how responsive the
demand for a product is to a change in
income
How much does the demand for a
product increase or decrease with a
change in consumer’s incomes?
Calculating Income Elasticity
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IED = % change in demand
% change in income
Whereas an increase in price will always lead
to a fall in demand (negative correlation) an
increase in demand can lead to either a fall or
a rise in demand depending on the type of
product.
Therefore IED can be negative or positive
Interpreting Income Elasticity
of Demand
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An IED with a value < 1 is income
inelastic and a value of > 1 are income
elastic (regardless of whether they are
negative or positive)
Products can be split into one of three
categories: Normal Goods, Luxury
goods or Inferior goods
Inferior Products
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Inferior products are those where an increase in
income leads to a decrease in demand
Inferior products have a negative IED
Inferior products can be income elastic or inelastic
Demand falls as incomes rise and people tend to
buy more luxury products
E.g. A 10% increase in income leads to a 5%
decrease in demand for Tesco Value white bread.
IED = -5%/10% = -0.5
Luxury Goods

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Luxury goods are products where an
increase in income will lead to a large
increase in demand and vice versa.
Luxury goods are therefor income elastic
Luxury goods have a positive IED >1
E.g. An increase in income of 10% leads to a
20% increase in demand for cruise holidays.
IED = 20%/10% = +2
Normal goods
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Normal goods are products where an increase in
income leads to a small increase in demand and
vice versa
These products have a positive income elasticity < 1
Normal goods are therefore income inelastic
These products are normally ‘everyday’ items
E.g. A 10% increase in income leads to a 6%
increase in the demand for jammy dodgers. IED =
6%/10% = +0.6
Normal, Inferior or Luxury
Issues with income elasticity
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Can help a firm to predict sales if they
know the economic forecast
Goods can fall into different categories
to different groups of people. What is
considered a necessity is subjective
Goods can move between categories
over time
Question
Product A
Product B
Price Elasticity
-3.5
-0.5
Income Elasticity
+0.4
+2.5
What products can be drawn about the
nature of the two products A and B?
CROSS-PRICE ELASTICITY OF
DEMAND
Cross-price elasticity
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Measures how responsive the demand
for a product is to a change of price of
another product
These other products can be:
Substitutes
Complements
Not-related
Calculating Cross-price
elasticity
CED = % change in demand for Good A
% change price of Good B
Substitutes

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Substitute products compete for
demand as they can be used in place
of each other
These products can be competitor
products or other products that fulfill
the same needs
Suggest some substitutes for
these products…..
Train travel
Elasticity of demand and
substitute products
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What is likely to happen to the demand for a
product if the price of it’s substitute
increases?
There is a positive relationship between the
demand for a product and the price of it’s
substitutes
The cross-price elasticity will be a positive
number
The higher the value the greater the
elasticity
Complements

Complements are products that are
joint in demand as they are related
products
Suggest some complements
for these products…..
Elasticity of demand and
complement products
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What is likely to happen to the demand for a
product if the price of it’s complement
increases?
There is an inverse relationship between the
demand for a product and the price of it’s
complements
The cross-price elasticity will be a negative
number
The more negative the value the greater the
elasticity
Other considerations with
cross-price elasticity
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What would it mean if the calculation
returned a result of zero?
Knowledge of cross-price elasticity
can help businesses forecast the
impact on revenues if competitors
implement a price change
ADVERTISING ELASTICITY OF
DEMAND
Advertising elasticity of
demand

Advertising elasticity of demand (AED)
measures the degree of
responsiveness of demand for a
product following a change in the
advertising expenditure for the
product
Calculating Advertising
Elasticity of demand
AED = % change in demand
% change in advertising expenditure
Can the results be positive or negative?
What would a large figure suggest?
How might a firm use this information in
planning it’s marketing strategy?
Considerations with AED
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Is very difficult to determine in reality
as it is difficult to determine whether
advertising expenditure or another
factor lead to a change in demand
Also, AED is dependent on the
effectiveness of the advertising rather
than just the amount of expenditure