1.2.4 Price Elasticity of Demand (PED)

Definition: PED

• PED measures the sensitivity of demand to a change in price

• can either be ELASTIC or INELASTIC

• PED values can be calculated to work out has elastic or inelastic demand

• PED values are always a negative value

PED formula

% change in QUANTITY DEMANDED ÷ % change in PRICE

Formula for % change in price formula

((New price - Old price) ÷ Old price) x 100

PED > 1 = ?

INELASTIC (demand is NOT sensitive to a change of price)

PED < 1 = ?

ELASTIC (demand is sensitive to a change in price)

if prices increase, causing demand to go down…is it Elastic or inelastic?

ELASTIC

effect of elastic demand

• too high prices can lead to less of customers, too low prices can lead to too low supply to meet demand.

• products with lots of substitutes have elastic demand

effect of inelastic demand

• demand stays the same for these products if they are necessities

• products with few substitutes have inelastic demand

• addictive product generally have inelastic demand

factors influencing PED - Availability of substitutes

lots of substitutes means that demand for products is more sensitive to price as there are other potentially cheaper options, thus product is more price elastic

factors influencing PED - Frequency of purchase

Frequent purchases mean consumers are always looking for cheaper prices and alternatives, like when youre doing groceries. Products are more elastic

factors influencing PED - Necessities

Petrol is a necessity, changing the price doesnt change the fact that they need it so they still buy it. This makes it inelastic

factors influencing PED - Luxury goods

as luxury goods are a large percentage of someones income, assuming they are spending responsibly, changes in price will highly affect demand as consumers pay attention to price. This means products are elastic

Competitive pricing

• businesses with close substitutes use competitive pricing so that customers must judge based on price to choose the cheaper option

• sometimes customers judge with ‘non-price’ methods such as reviews, speed, extras and quality of service

Price Skimming

• high price at launch

• unique or first in the market means products can have a high price at launch

• high demand for the product usually happens when said product has a USP at launch

• high prices are usually set to earn back money from R&D costs

PED and total revenue

There is a relationship between PED and Total Revenue

• For more revenue, business managers should know PED so they know how sensitive their customers are to a change in price

• a business has an objective of maximising profits, this is why PED is used to an advantage to increase total revenue