1.2.4 Price elasticity of demand

what is PED

it measures the extent to which the quantity of a product demanded is affected by a change in price

PED formula

% change in quantity demanded / % change in price

what is the PED value for something price elastic

more than 1

what is the PED value for something price inelastic

Less than 1

what does it mean if a product is price elastic

that change in demand is more than the change in price

what does it mean if a product is price inelastic

that change in demand is less than the change in price

how does necessity affect PED

• the more necessary the product, the more demand tends to be inelastic and so changing prices doesn’t affect the demand

• e.g. milk

• if customers can switch to substitute products, demand will be elastic

• e.g. brands of cereal

how does brand loyalty affect PED

• products with strong brand loyalty and reputation tend to be price inelastic

• e.g. iphones are price inelastic due to the reputation of apple

how does habit affect PED

• products that are demanded and consumed as a matter of habit tend to be price inelastic

• e.g. cigarettes

how does availability of substitutes affect PED

• demand for products that have lots of alternatives tend to be price elastic

how does time affect PED

• in the short-run, price changes tend to have less impact on demand than over longer periods

how PED affects pricing decisions

• if a product is price elastic, then businesses are more likely to set low competitive prices to increase revenue

• in a product is price inelastic then businesses will more likely use high prices and price skimming to increase revenue

calculation of the relationship between PED and total revenue

• sales revenue = selling price x sales volume

• PED show hoe price affects sales revenue and therefore total revenue

interpretation of the relationship between PED and total revenue for price elastic products

• if a product is price elastic, a price increase will make sales revenue go down (the money lost from the % decrease in sales will be more than the money gained from the % increase in price)

• for price elastic products, a firm can increase sales revenue by reducing price (a small decrease in price will cause a large increase in demand)

interpretation of the relationship between PED and total revenue for price inelastic products

• if a product is price inelastic, a rise in price will make sales revenue increase (the money lost from the % decrease in sales will be less than the money gained from the % increase in price)

• for price inelastic products, decreasing the price will make sales increase slightly, but sales revenue go down (price has fallen and only a few more units have been sold)