Worksheet on Elasticity (Student Version)

• Worksheet on Elasticity (Student Version)
• Tutor notes

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:

N.B. There are other alternative formulae and measures of elasticity that you may want to investigate in your textbook or library, but we shall use this measure throughout this worksheet.

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

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:

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):

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?

If the company want 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:

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:

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

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?)