A measure of the size of the effect on demand of a change in selling price is

# A measure of the size of the effect on demand of a

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A measure of the size of the effect on demand of a change in selling price is called the price elasticity of demand. Price elasticity of demand (PED) = % change in demand % change in price A high PED means that the demand is very sensitive to changes in price, or elastic . A low PED means that the demand is not very sensitive to changes in price, or inelastic . E XAMPLE 3 Using the figures from example 2, calculate the price elasticity of demand if the current selling price is \$16 per unit if the current selling price is \$15 per unit 27 June 2014 Examinations Paper F5 PRICING Chapter 7 Free ACCA course notes Free ACCA lectures Free tests Free tutor support StudyBuddy Largest ACCA forums 6 Optimal pricing – equations In section 4, we were presented with the price/demand relationship as a table, and used these figures to calculate the optimum level of selling price from those available. In principle, it would be possible to have an equation relating the selling price to the demand, and to then solve the problem algebraically. 6.1 Price/demand equation In the exam you could be asked to derive the price/demand equation yourself from information given, or alternatively you could be given the equation. If you were asked to derive the equation yourself, then it would always be on the basis that the relationship was linear (as is the case in example 2, from inspection). (\$)P Q (units) The equation would therefore be of the form: P = a – bQ where P = selling price Q = quantity demanded at that price a = theoretical maximum price (if the price is set at ‘a’ or above, then the demand will be zero) b = the change in price required to change demand by 1 unit (the gradient of the line) E XAMPLE 4 A company sells an article at \$12 per unit and has a demand of 16,000 units at this price. If the selling price were to be increased by \$1 per unit, it is estimated that demand will fall by 2,500 units. On the assumption that the price/demand relationship is linear, derive the equation relating the sell- ing price to the demand. June 2014 Examinations Paper F5 PRICING Chapter 7 28 Free ACCA course notes Free ACCA lectures Free tests Free tutor support StudyBuddy Largest ACCA forums 6.2 Optimal selling price Having identified the price/demand relationship, it is easy to derive the equation for the revenue at any level – the total revenue will be equal to PQ. We could then show on a graph the total revenue and total costs for any level of demand. It would be of this sort of shape: (\$) (units) Our objective is to maximise profit. We can do this by calculating the Marginal Revenue and Marginal Cost, and using the fact that the profit is maximised when the two are equal. E XAMPLE 5 A company currently has a demand for one of its products of 2000 units at a selling price of \$30 per unit.  #### You've reached the end of your free preview.

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