Bread Milk & Cream Cereal % cereal products other than bread Price elasticity -­‐0.40 -­‐0.36 -­‐0.94 1. Assume that the price elasticities for Hovis Bread, a pint of milk and Italian pasta are those given in the table above. Calculate the effect on demand for those products given the prices mentioned in the data (6) In the data it mentions price rises for Hovis bread of 10%, a pint of milk 10% and Italian pasta 20% (1) PED = % change in QD / % change in P (1) The effect on demand can therefore be calculated by multiplying the % change in price by the PED (1) Therefore: For Hovis bread -­‐ With a price rise of 10% and a PED of -­‐0.4 there would be a fall in quantity demanded of 4%.(1) For Milk – with a price rise of 10% and a PED of -­‐0.36 there would be a fall in quantity demanded of 3.6% (1) For pasta – with a price rise of 20% and a PED of -­‐0.94 there would be fall in quantity demanded of 18.8% (1) 2. Define inelastic demand and suggest why milk and bread have such low elasticities of demand. (8) Price elasticity of demand measures the responsiveness of changes in quantity demanded to changes in price. (1) When demand is price inelastic, it means that a percentage change in price will result in a smaller percentage change in quantity demanded (1) For example, if bread has a price elasticity of demand of -­‐0.40, shown in Table 5 of the students' book. then a 10 per cent rise in price of bread will result in a lower percentage fall in quantity demanded of bread: in this case of 4 per cent (2) Milk and bread have such low price elasticities of demand because they have few good substitutes. (1) They form part of the staple diet of households in the UK. Large changes in price, therefore, are unlikely to see much change in the decision to purchase these items (1) Some economists would also argue that bread and milk are necessities rather than luxuries. Necessities, they argue, have a low price elasticity of demand. However; in this case, bread and milk are arguably necessities because they have few good substitutes. If they had more good substitutes, their price elasticity of demand would be likely to be higher (2) Some economists would also argue that bread and milk have low price elasticities of demand because households spend a relatively small proportion of their total income on these items. However; this is unlikely to be a good explanation given the intense price competition, particularly with bread. before the rises in price in 2007. Households would presumably have been indifferent to price cuts in bread when these were occurring. Hence, it is difficult to see why supermarkets would have bothered to lover prices (2) 3. Table 5 shows that the price elasticity of demand for all cereal and cereal products other than bread is -­‐0.94. Discuss whether the price elasticity of demand for pasta is likely to be higher or lower than this. The estimated average price elasticity of demand for cereal and cereal products other than bread is -­‐
0.94 according to calculations made by Defra economists from the 2000 National Food survey. There are a number of reasons why the price elasticity of demand for pasta is almost certainly different from this. One is that the -­‐0.94 is an average for all non-­‐bread cereal products. Pasta is only one of many such products. Whether the price elasticity of demand for pasta is higher or lower than 0.94 is likely to depend on the degree to which other products have good substitutes. If pasta has fewer good substitutes than other products in the group. then the demand for pasta is likely to be more inelastic. Support for this would come from the fact that pasta is a fairly narrowly defined product compared to 'all cereal and cereal products other than bread'. In general, the more narrowly defined the product range, the fewer the substitutes it will have and therefore the lower will be its price elasticity of demand. Another reason why the price elasticity of demand for pasta is unlikely to be exactly 0.94 is that the calculation is based on survey evidence from the National Food -­‐Survey. However; statistically reliable is the National Food Survey, it is unlikely to be 100 per cent accurate. Small variations in accuracy are likely to affect the calculation for the price elasticity of demand for pasta Another issue is that different formulas can be used to calculate price elasticity of demand. Exactly which formula is used will produce a different number for the price elasticity of demand of pasta