4

Price elasticity

Exam practice (p. 35)

1 The PED for pineapples is likely to be price elastic. This is because there are plenty
of substitutes, such as bananas, oranges, melons or other fruits. The (market)
demand for pineapples is unlikely to be habit-forming, so again buyers can be
highly responsive to changes in the price of pineapples.
2 Tobacco is habit-forming (addictive) so is likely to be price elastic. For smokers
(who make up the market demand for tobacco), there are literally no substitutes
to tobacco as a product, hence their demand is relatively unresponsive to
changes in price. As the price of cigarettes might not take up a large proportion
of the typical households income, changes in price are unlikely to significantly
affect the demand for tobacco products.
3 Overseas holidays tend to take up a large proportion of an average households
income. Therefore, the demand for overseas holidays tends to be price elastic.
In addition, holiday-makers can choose cheaper alternatives, such as domestic
holiday destinations. This makes the demand for overseas holidays more
responsive to changes to price.
4 Textbooks are bought by teachers and students. If these textbooks are popular
and a requirement for the specific course, demand will be price inelastic because
customers will need to buy the product even if prices rise. In addition, textbooks
tend to be a one-off purchase, taking up an insignificant proportion of the typical
households monthly income; so many customers will not be too responsive
to changes in price. However, if there are plenty of alternative good-quality
textbooks available on the market, customers will become more responsive to
price differentials.
Award 12 marks if the explanation is limited but shows some understanding of
the concept of price elasticity of demand.
Award 34 marks for a detailed explanation that shows good understanding of
the concept of price elasticity of demand using the given examples.
Note: there is more than one possible answer to the above questions. Answers
that take an alternative approach but show good reasoning and substance
should be awarded accordingly. For example, students might give a balanced
answer, such as pineapples being price inelastic due to the small proportion of
the typical households income that is used to buy the fruit.

Activity (p. 36)

Students own answers. Students might be given the opportunity to present their
findings to the rest of the class and should, of course, be given the option to
investigate other multinationals of their choice.

Activity (p. 39)

Students own answers. Students might choose to use A2 poster paper to gather
their ideas and to use an appropriate price inelastic demand curve diagram. Teachers
might want to link this to the topic of market failure, i.e. tobacco, alcohol and petrol
create negative externalities.

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 4 Price elasticity

Exam practice (p. 39)

%Q = (875 850) = 2.94%
1 850
( )
%P = 24 25 = 4%
25

PED = 2.94 = 0.735
4
Therefore, the PED for rice is price inelastic (relatively unresponsive to changes in
price).
Award up to 2 marks for the correct calculation of PED.
Award up to 2 further marks for the comment about the value of the PED
calculation.
2 Two key reasons for the low PED for rice in India, Vietnam and China include:
l Rice is a staple food in these countries, thus part of peoples daily food intake,
i.e. there is no real substitute for rice in these countries/cultures.
l The price of rice is relatively insignificant compared to the income of the aver-
age person in these countries, so people are less sensitive to price changes.
l Given a continual rise in the price of rice, it would take time for people to
change their customary habits and tastes to seek an alternative food product.
Hence, PED for rice in these countries is inelastic, at least in the short run.

Activity (p. 41)

Students own answers.

Activity (p. 43)

Students own answers. Some students might choose to use price elasticity diagrams
to show how airlines receive more revenue from charging higher prices during peak
periods. Other examples of peak/off-peak pricing include:
l Taxi drivers in cities such as London and Singapore charging higher prices during
rush hour, public holidays or after midnight.
l Cinemas and theatres charging a lower price for matinee shows.
l Theme parks charging higher ticket prices during the summer holiday season.
l Happy hour drinks at restaurants and bars.

Exam practice (p. 43)

(1350 1215)
1 %Q = = 10%
1350
(4 4.6)
%P = = 15%
4
10
PED = = 0.667
15
Therefore, the PED for wool sold at Sharma Fabrics is price inelastic.
Award 1 mark for each correct step in the calculation of PED.
2 TR @ $4 = 1350 $4 = $5400
TR @ $4.6 = 1215 $4.6 = $5589
Therefore the change in TR = +$189

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 4 Price elasticity

Award 1 mark for each correct step in the calculation of the change in total
revenue (TR). Full marks can only be awarded if the answer shows the change
in TR.
3 Knowledge of PED can help Sharma Fabrics in several ways, including:
l Knowing the PED for its product is price inelastic (0.67), the firm can raise its
price knowing that total revenue will increase (by $189).
l Knowledge of PED can also inform Sharma Fabrics about the extent to which
the firm has market power, e.g. if demand becomes more price elastic the firm
may need to improve the marketing of its products to customers.
l Accept any other reasonably explained answer in the context of Sharma
Fabrics.

Activity (p. 45)

Students own answers which may cover the following:
1 The PES for smartphones is likely to be price elastic as producers mass produce
these so can adjust supply quickly according to the level of market demand.
2 The PES for organic vegetables is likely to be price inelastic as these products take
much longer to harvest than genetically modified or fortified vegetables.
3 The PES for fresh flowers is also likely to be price inelastic due to the time it takes
to grow fresh flowers. The weather can also have a large impact on the PES of
fresh flowers.
4 The PES for hotels is likely to be price inelastic as it will often take several years to
construct hotels.
5 The PES for Ferrari cars is likely to be relatively price inelastic as it takes longer
to build such luxury, often hand-made, cars than mass-produced cars such as
Toyota, Ford or Volkswagen.

Exam practice (p. 46)

1 The supply curve of supplying Angry Birds games is perfectly price elastic because
Rovio can supply an extra unit of output at zero cost (customers simply download
the games app) as there is no additional cost of production.

Supply
Price ($)

Pe

D1 D2
O Q1 Q2

Quantity (downloadable apps)

Award up to 3 marks for a fully labelled diagram, showing a perfectly price elastic
supply curve, and with the correct axis labels.
Award up to a further 3 marks for the explanation of why the increase in
demand for Angry Birds (from D1 to D2) has no effect on the market price of the
downloadable application.

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 4 Price elasticity

2 Businesses such as Rovio can benefit from the knowledge of PES because:
l It allows them to know the extent to which they can increase supply if the
market demand or price increases.
l A high PES value (as in the case of Rovio) means the firm does not need
to raise prices even if demand increases, thereby improving the firms
competitiveness.
l Accept any other reasonably explained answer in the context of businesses
such as Rovio.

Exam practice (p. 47)

1 Bananas low PES due to the time needed to grow bananas. External factors
such as climate, weather conditions and crop infestations can also prolong the
supply of bananas.
2 Fresh flowers low PES due to the varying nature of the weather and seasons.
Fresh flowers have a short life cycle so it is likely a large supply is harvested
although increasing supply will be difficult in the short run.
3 Computers high PES due to the capital intensive technologies used to mass
produce computers. Large computer manufacturers produce millions of
computers each year. Using specialised machinery means they can change the
level of output (supply) very easily.
4 Coal very low PES due to the (very long) time needed for these fossil fuels to be
produced. An increase in the price of coal will do very little to increase the supply
of coal, at least in the short run.
For each question, award 12 marks for a limited response.
Award 34 marks for a detailed and well-reasoned answer.

Cambridge IGCSE and O Level Economics Hodder & Stoughton 2013 4