Markets - Price Elasticity of Demand

AS Business Unit 1

Price elasticity of demand (PED)�

• Price elasticity of demand is a measure of how responsive demand is to a change in price
• There is an inverse relationship between price and demand
• As price goes up demand goes down
• As price goes down demand goes up
• But the question is by how much? Is the change in demand more than proportional to the change in price or less than proportional?

Price elasticity of demand (PED)

• Price elastic demand means that a change in price will lead to a more than proportional change in demand i.e. demand is sensitive to price changes
• Price inelastic demand means that a change in price will lead to a less than proportional change in demand i.e. demand is not so sensitive to changes in price

​

https://www.youtube.com/watch?v=03Mz65mkulQ&feature=youtu.be

How to calculate a % change

• 1. Work out the difference between the two values
• 2. Divide that number by the original value
• 3. Multiply by 100
• E.G demand rises from 1000 units to 1200 units
• 200/ 1000 = 0.2
• 0.2 x 100 = 20% increase

Price elasticity of demand (PED)

In the A-level examination you can be asked to do a calculation. This will be covered again in Unit 3.

Price elasticity of demand (PED)

• In business it is assumed that the PED will always be negative i.e. price and demand will always move in the opposite direction
• If PED is between 0 and -1 e.g. -0.7 then demand is price inelastic
• If PED is less than -1 e.g. -1.4 then demand is price elastic

​

Factors influencing PED

A number of factors affect the value of the PED coefficient including:

• The availability of substitutes – the closer the substitutes and the more that are available the higher the price elasticity of demand
• The price of competitor goods – if the price of goods in competition with a product increase this will affect demand and price elasticity of demand
• Time – the longer the time period the higher the price elasticity of demand. Given more time other firms have the ability to produce similar products and customers have more chance of adapting their buying habits

Factors influencing PED

• Branding – firms spend time and money building up their brand image. By creating brand loyalty firms know that their customers will be willing to pay more for the product and they can therefore raise prices as the PED is lower
• Income - if consumer incomes are higher then the issue of price becomes less important to the consumer and it is easier for firms to raise price as the PED is lower
• Nature of the good
• a luxury good will be price elastic as demand will be more sensitive to changes in price
• a necessity good will be price inelastic as demand will be less sensitive to changes in price

The significance of PED in terms of implications on price

• Business people want to know how a change in price will impact on revenue
• This will help determine whether changing price is a good or bad marketing decision

Rearranging the formula

To calculate the percentage change in demand just multiply the percentage change in price by the price elasticity of demand.

​

The significance of PED

Price inelastic – if a product is price inelastic then a firm knows that if it raises price, even though demand will fall, total revenue will increase.

This can be shown mathematically.

Price = £1.00 Demand = 100 units

What is total revenue? Price x demand

£1.00 x 100 units = £100

PED = - 0.5

Should the firm raise price?

If the firm were to raise price by 10 pence, from £1.00 to £1.10, this is a 10% price rise (10%).

Using the PED formula: % change in Qd = - 0.5

10%

​

​

​

​

​

The significance of PED

Rearrange the formula:

-0.5 x 10% = 5%

There is a 5% change in demand

PED is –ve therefore in this case when price goes up by 10% demand goes down by 5%

Demand will go down from 100 units to 95 units

What is total revenue? Price x demand

£1.10 x 95 units = £104.50

By raising the price of a price inelastic product the firm has increased TR.

TR will fall if the firm attempts to lower price.

​

​

​

​

​

The significance of PED in terms of implications on price

​

​

Can this be shown mathematically?

​

A newsagent sells 200 cans of Coca-Cola a week at a price of £0.50. The newsagent raises the price of the Coca-Cola to £0.60 and demand falls to 180 cans.

​

The PED was -0.5.

​

What should happen to revenue as a result of the rise in price?

The significance of PED in terms of implications on price

​

​

Can this be shown mathematically?

​

A newsagent sells 200 cans of Coca-Cola a week at a price of £0.50. The newsagent raises the price of the Coca-Cola to £0.60 and demand falls to 180 cans.

​

The PED was -0.5.

​

What should happen to revenue as a result of the rise in price?

​

Revenue was 200 cans x £0.50 = £100

Revenue now 180 cans x £0.60 = £108

​

Therefore it was a good decision to change price.

Problems of forecasting price elasticity of demand

• The price elasticity of demand for a product is constantly changing in a dynamic world
• It is very difficult for firms to measure because:
• Difficulty in finding accurate information
• Price elasticity changes over different price ranges
• Price elasticity will change over the period of the economic cycle e.g. it will be affected in a recession
• Tastes and fashions are constantly changing
• Competitors don’t stand still
• They are continually improving existing products, bringing out new products and trying to promote their products

​

​

Income elasticity of demand

• Income elasticity of demand (YED) is a measure of the responsiveness of demand to a change in income

​

• The relationship between price and demand was straight forward they always moved in the opposite direction

​

• Is this true of the relationship between income and demand?
• If your income went up what products would you demand more of?
• Would you demand less of anything?

​

​

​

​

​

Income elasticity of demand

• Income elasticity of demand can be negative or positive i.e. income and demand can move in the same direction or opposite directions
• When demand for a product increases when incomes increase we call this a normal good
• Normal goods will always have a positive income elasticity of demand i.e. a + sign
• When demand for a product decreases when incomes increase we call this an inferior good
• Inferior goods will always have a negative income elasticity of demand i.e. a – sign

Income elasticity of demand

Income elasticity of demand

Factors influencing income elasticity of demand

• Income elasticity of demand is determined by:
• Whether the good is a necessity or a luxury
• At higher standards of living increased consumer incomes see additional demand tend towards luxury goods as demand for necessities is satiated
• The level of income of a consumer
• Poorer consumers tend to spend their income on necessities
• As they become wealthier the YED for necessities moves towards zero as consumers are satisfied with the amount of the product e.g. staple foods that they can buy
• Normal goods that are necessities will have lower positive YED coefficients
• As consumer incomes increase they are likely to spend some of their income on luxuries
• These products e.g. cars and foreign holidays will have higher positive YED coefficients

​

income elasticity of demand – relevance to business

• Standards of living
• Wealthier countries are likely to have consumers with higher disposable incomes
• This means that they have greater spending power and are likely to use some of this greater income to buy luxury goods and services
• Therefore, firms will produce superior products that meet the needs of these consumers e.g. high technology goods and complex financial services
• As global standards of living increase we would expect to see an increase in demand for luxury goods and a movement away from inferior goods
• Firms will identify the state of the economy e.g. recession and produce goods and services to meet the demand of consumers. For example, pound shops selling necessities and inferior goods are likely to expand in these market conditions

​

.

Market Research

Business AS-Level Unit 1

Market research

• Market research is the collection and analysis of data and information to inform a business about its market
• Data collected and analysed is used to:
• identify and anticipate customer needs and wants
• quantify likely demand
• plan resources to match anticipated demand
• gain insight into consumer behaviour
• spot trends in the market
• Inform the marketing mix

​

​

​

​

​

​

Primary market research

• Primary market research (field research) involves the collection of first hand data that did not exist before and therefore it is original data
• Examples of primary market research include:
• Surveys and questionnaires
• Postal
• Telephone
• Face–to-face
• On-line
• In depth interviews
• Focus groups
• Observations

​

Secondary market research

• Secondary market research (desk research) is research that has already been undertaken by another organisation and therefore already exists
• Examples of secondary market research include:
• National and Local Government e.g. Office for National Statistics
• Market Research organisations e.g. MORI, MINTEL
• Professional bodies e.g. ACCA
• Trade unions and Confederation of British Industry (CBI)
• International bodies e.g. EU, OECD
• Academic organisations e.g. universities
• Newspapers and magazines
• The Internet

​

Qualitative and quantitative data�

• Qualitative research is the gathering of non-statistical information that gives a company in depth insight into the reasons for human behaviour
• Quantitative research is the gathering of statistical data to inform the company about people’s behaviour but does not identify the reasons

​

​

​

​

​

​

Selecting the most appropriate method of research

• Budget available
• Time constraints
• Internal expertise
• Purpose of the research
• Importance of confidence levels

Value of sampling

• Businesses cannot ask for the opinions of all potential customers and therefore try to choose a representative sample

​

• A sample is a group of subjects that has been chosen from a larger group, the population, for investigation

​

• The value of sampling will depend upon:
• The sample technique used
• How the sample was carried out
• The size of the sample

​

• The size of a sample will depend upon a number of factors including:
• The budget available
• The importance of accuracy
• Degree of confidence in results

​

�Types of sampling techniques

• Random
• a sample is selected for study from a population where each individual is chosen entirely by chance and has an equal chance of being selected
• Quota
• The population is first segmented into subgroups before a judgement is made in selecting respondents that are representative of that subgroup
• e.g. within a sub group of women 60% may be aged 20-40, 20% 41-60 and 20% 61+, the sample should represent this

Limitations of market research

• Past data and trends may not be a fair indication of the future
• Accuracy of research findings
• Dependent upon ability to correctly analyse findings
• Financial and opportunity costs
• Bias:
• Questionnaire bias
• Sampling bias
• Respondent bias e.g. exaggerating or not telling truth

Business Structure

Business structure

• Different forms of business include:
• Sole traders
• Private limited companies and public limited companies
• Private sector and public sector organisations
• Non-profit organisations such as charities and social enterprises

​

Private sector and public sector organisations

• The private sector is that sector of the economy that is owned and controlled by individuals or groups of individuals rather than by the government
• Sole traders
• Private limited companies
• Public limited companies

• The public sector is that sector of the economy that is owned and controlled by the government rather than individuals or groups of individuals
• State education
• National Health Service
• Other services such as police, army, navy and air force

Aims of private sector businesses

• Business objectives include:
• Profit
• To achieve sales revenue that is higher than total costs
• Profit = SR - TC
• Growth
• To increase in size either by value of sales or volume of sales (or both!)
• This may be organically i.e. opening new stores, launching new products or externally i.e. by joining with other businesses or taking them over
• Survival
• To continue to exist as a business
• This may be the primary objective of a start-up business or one experiencing difficult trading conditions

​

Aims of public sector businesses

• Public sector objectives include:
• Provide services to society
• Make essential services available to all for the good of society as a whole
• Education and health care
• Services that would not be provided by the private sector
• Policing and defence
• Services that can not be easily charged for or sold profitably but benefit everyone
• Street lights, roads

​

Sole trader

• An individual who owns and runs their own business
• Registered as self-employed with Her Majesty’s Revenue and Customs (HMRC)
• Legally required to keep a record of all income and expenses and at the end of the tax year to fill in a self assessment tax return for HMRC
• Profits made by the sole trader are classed as income and are therefore taxable through income tax
• A sole trader has unlimited liability
• This means that they are personally responsible for all debts run up by the business
• Therefore, their home and all of their assets might be used to pay off any debts that they may incur and are unable to pay

Sole traders�Benefits and disadvantages of being a sole trader

• Benefits
• Cheap and easy to set up
• All profits go to the sole trader
• Autonomy in decision making
• Financial records remain private
• Motivation is high as the success of the individual and the business are one and the same

• Disadvantages
• Unlimited liability
• Limited capital for investment
• Little specialist skills as the owner is a ‘jack of all trades’ or will have to buy in specialists
• Difficult to find cover when ill – although sole traders often do employ people

​

​

​

​

​

Partnerships

• A partnership is where two or more people share the costs, risks and responsibilities of being in business together

​

• As with a sole trader, each partner has to register as self employed with HMRC and will have unlimited liability

​

• Each partner:
• is equally responsible for debts incurred
• will take a share of the profits made by the business
• has a share in the decision making
• normally contributes to the management of the business but can delegate responsibility

​

• ‘Sleeping’ partners invest in, but do not manage, the business

​

• Traditionally partnerships have had unlimited liability

Partnerships�

• Benefits
• Risks, costs and responsibilities are shared
• More scope for specialist skills
• Simple and flexible
• Financial records remain private
• More capital can be raised than as a sole trader

• Disadvantages
• Unlimited liability
• Arguments can occur with decision making
• If a partner dies, resigns or goes bankrupt the partnership is dissolved
• Trust becomes a significant element between partners – a written agreement between the partners should be drawn up

​

​

​

​

​

​

Limited Companies

• Limited companies exist in their own right
• The owners and the company are separate legal entities
• Therefore, the company’s finances are separate from the owner’s personal finances
• Shareholders are the owners of limited companies
• They have limited liability and are not responsible for the company’s debts
• They can only lose the money that they have invested in the business in the form of shares

Limited Companies

Incorporation

Companies must be registered (Incorporated) at Companies House. http://www.companieshouse.gov.uk

Companies must send to the Registrar of Companies the following:

1. A Memorandum of Association – name, registered office and what the company will do
2. Articles of Association – the rules for running the company
3. Form 10 – details of directors and company secretary
4. Form 12 – declaring that they comply with company law

Companies must deliver to Companies House each year a true and fair set of accounts along with an annual return.

Private limited companies

• Have Ltd. after the name
• Owned by shareholders who are known to the company, often family and friends
• Can only sell shares on to other shareholders i.e. they can not sell them openly on a stock exchange
• This means that shares are often sold at a discount to the real value of the shares because the shareholders are ‘locked in’ and either sell at the price that they are offered, or do not sell at all

​

​

Public limited companies

• Have Plc. after the name
• Shares can be sold to the public via a stock exchange
• Open to more public scrutiny
• Risk of hostile takeovers i.e. if anyone can obtain 51% of shares in the company

​

​

​

Private Limited Companies�

• Advantages
• Limited Liability
• Separate legal identity
• More flexible than a Plc.
• Financial records remain relatively private
• More capital can be raised through the sale of shares

• Disadvantages
• More complex to set up due to increased legal requirements
• Some loss of control as shareholders have voting rights
• Unable to sell shares to the public

​

​

​

​

​

​

​

Public Limited Companies�

• Advantages
• Limited Liability
• Separate legal identity
• Perceived status of having Plc after the name
• More capital can be raised through the sale of shares

​

• Disadvantages
• Lack of privacy as financial performance is available for all to view
• More complex to set up due to increased legal requirements and ongoing administrative costs
• Some loss of control as shareholders have voting rights
• Risk of hostile takeovers

​

Factors affecting the choice of legal structure

• Ability and need to raise finance
• Nature of the business e.g. professions such as accountants or dentists are often partnerships
• Personal preference
• Be totally independent
• Support from partners
• Willingness to share equity
• Limited and unlimited liability
• Size of the business

Not-profit organisations

• Not all businesses will have an objective of profit
• Businesses may have an objective to do good for society and any surplus made is ploughed back into achieving that goal
• These may be social enterprises or charities

Business Link states that:

“A social enterprise is a business with primarily social objectives whose surpluses are principally reinvested for that purpose in the business or in the community, rather than being driven by the need to maximise profit for shareholders and owners.”

Not-profit organisations

• Charities
• Organisations with an aim to support a specific cause or benefit for the well being of society
• Charities may support:
• Groups of society
• Animals
• Places e.g. conserving buildings
• Areas hit by natural disasters
• Research e.g. into cures for diseases
• Organisations have to be registered to gain charitable status and are treated differently by the government in terms of taxes

Not-profit organisations

• Societies
• Organisations, formal or informal, made up of groups of people with a common interest
• Societies may be:
• Religious groups
• Hobby based e.g. a rowing society at university
• Cultural e.g. a conservation group
• Political

Not-profit organisations

• Cooperatives are organisations that operate for the wellbeing of their members
• Members can be:
• Customers
• Employees
• Suppliers/producers

Business Loction

Factors influencing start-up location decisions�

• There are several factors that affect where a new business chooses to locate
• These include:
• Costs
• Infrastructure
• The market
• Technology
• Qualitative factors

Costs�

• A small business faces a number of costs that it will try to reduce
• Costs will include the costs of buying or renting premise as well as business rates
• Costs will vary based on whether the location is:
• Town, city or village
• Urban or rural
• Central or on the outskirts
• Prestigious or deprived area
• A new business will have to consider its target market and weigh this up against budgets
• Labour costs can be a significant drain on the business’ resources and these will also vary depending upon location
• Costs can be reduced if there is a good infrastructure, markets are nearby and there is a good pool of skilled workers
• For example, university towns tend to provide an educated workforce so it makes sense for a small business to locate in such areas

Infrastructure�

• Infrastructure will include transport links such as roads, railways and airports
• It also include communication links and local services e.g. street lights and refuge collection
• Small businesses will need access to the above in order to provide their good or service
• If customers find it difficult to access a firm they will go elsewhere
• The significance of infrastructure will depend on the nature of the business
• Businesses that do not rely on face to face contact might be able to set up anywhere, even a remote location
• On the other hand, a retailer needs access to customers in order to succeed
• A business selling goods around the country or even abroad will need good distribution networks

​

​

The market�

• The market is where buyers and sellers come together to exchange goods or services
• The significance of the market to a firm’s location decision will depend upon the nature of the business
• Many service sector businesses must be in an area where there is large footfall e.g. Wetherspoons started off as a small business, locating near tube and train stations in London
• Restaurants, salons and newsagents need to be in areas where the customers are
• If the small business is a supplier to a larger firm it will wish to be as close to that business as possible
• If a product is bulk gaining i.e. it gets physically bigger due to the production process it will want to be close to the market to reduce distribution costs
• Shopping goods are ones where the consumer does not rush into the purchase but compares different options weighing up the strengths and weaknesses of each option before reaching a decision, a new business may therefore want to be close to other similar businesses

Technology�

• Technology is the application of what has been learned through science
• This includes forms of communication and information provision through such mediums as the personal computer, the Internet, fax and mobile phones
• New technology has allowed the small business to communicate from home, gathering, processing and sending information through, for example, the Internet
• Teleworking means that the small business can work from home with instant communication methods
• New business might chose a virtual location when buyers and sellers meet to trade in a virtual market place e.g. on the internet

​

�Qualitative factors�

• These factors are based on the personal desires and needs of the owner
• They are very important for the small business, but their significance will depend upon the owner of the business
• The quality of life and lifestyle of the owner is likely to be fundamental to a location decision
• Small businesses might easily find cheaper premises in other areas but will these areas provide the same standard of living?
• Attractiveness, crime levels, school standards, family and friends all play an important role in location for a small business
• Often, it is difficult to separate the owner’s business and personal life.
• A large firm might relocate but the impact of location for a small business is far greater in personal terms