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AS & A-Level Economics — Elasticity and Market Surplus

AS & A-Level Economics — Elasticity and Market Surplus

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Original Deckloop economics study material on elasticity and market surplus, with 90 practice cards and 18 concept explainers. Includes worked applications and analytical reasoning.

Economics EN A-Level
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Calculating Price Elasticity of Demand (PED)

Price Elasticity of Demand (PED) measures the responsiveness of quantity demanded to a change in price. It is calculated as the percentage change in quantity demanded divided by the percentage change in price. When calculating PED, it is crucial to use the original price and original quantity as the base for calculating the percentage changes. This 'original value method' provides a clear, consistent measure of responsiveness from a specific starting point. A higher absolute value of PED indicates greater responsiveness, while a lower absolute value indicates less responsiveness. Understanding PED is vital for firms in making pricing decisions and for governments in assessing the impact of taxes on consumer behaviour.

Key points

  • PED=(% Change in Quantity Demanded)/(% Change in Price)PED = (\text{\% Change in}\,\text{Quantity}\,\text{Demanded}) / (\text{\% Change in}\,\text{Price}).
  • Percentage change is calculated as (New Value−Original Value)/Original Value×100(\text{New}\,\text{Value} - \text{Original}\,\text{Value}) / \text{Original}\,\text{Value} \times 100.
  • Always use the original price and original quantity as the base for percentage change calculations.
  • PED is typically a negative value due to the inverse relationship between price and quantity demanded.

Worked example

Question

A local bakery, 'The Daily Loaf', observes that when the price of its artisan sourdough bread was 3.50 monetary units3.50\,\text{monetary units}, customers bought 400 loaves per day400\,\text{loaves}\,\text{per}\,\mathrm{day}. After a price increase to 4.20 monetary units4.20\,\text{monetary units}, daily sales fell to 320 loaves320\,\text{loaves}. Calculate the Price Elasticity of Demand for the sourdough bread using the original value method.

Solution

1. Calculate the percentage change in quantity demanded:
2. Original Quantity (Q1)=400 loaves\text{Original}\,\text{Quantity}\,(Q_{1}) = 400\,\text{loaves}
3. New Quantity (Q2)=320 loaves\text{New}\,\text{Quantity}\,(Q_{2}) = 320\,\text{loaves}
4. Change in Quantity=320−400=−80 loaves\text{Change in}\,\text{Quantity} = 320 - 400 = - 80\,\text{loaves}
5. % Change in Quantity=(−80400)×100=−20%\text{\% Change in}\,\text{Quantity} = (- \frac{80}{400}) \times 100 = - 20 \%
6. Calculate the percentage change in price:
7. Original Price (P1)=3.50 monetary units\text{Original}\,\text{Price}\,(P_{1}) = 3.50\,\text{monetary units}
8. New Price (P2)=4.20 monetary units\text{New}\,\text{Price}\,(P_{2}) = 4.20\,\text{monetary units}
9. Change in Price=4.20−3.50=0.70 monetary units\text{Change in}\,\text{Price} = 4.20 - 3.50 = 0.70\,\text{monetary units}
10. % Change in Price=(0.703.50)×100=20%\text{\% Change in}\,\text{Price} = (\frac{0.70}{3.50}) \times 100 = 20 \%
11. Calculate PED:
12. PED=(% Change in Quantity Demanded)/(% Change in Price)PED = (\text{\% Change in}\,\text{Quantity}\,\text{Demanded}) / (\text{\% Change in}\,\text{Price})
13. PED=−20%20%=−1.0PED = - \frac{20 \%}{20 \%} = - 1.0

The Price Elasticity of Demand for the sourdough bread is -1.0.

Common pitfalls

  • Mistake 1: Using the new price or new quantity as the base for percentage change calculations. Correction: Always use the original (starting) values for price and quantity in the denominator when calculating percentage changes for PED.
  • Mistake 2: Incorrectly calculating the percentage change, for example, by forgetting to divide by the original value. Correction: Remember the formula: (Change in ValueOriginal Value)×100(\frac{\text{Change in}\,\text{Value}}{\text{Original}\,\text{Value}}) \times 100 for both price and quantity.

Prerequisites

  • Percentages and proportional change: To calculate percentage changes, which are the fundamental components of the Price Elasticity of Demand formula and are explicitly tested in the readiness check and examples.
  • Deck 02 — Demand Shifts vs. Movements: To understand the Law of Demand and that price changes cause movements along a demand curve, which PED measures the responsiveness of.