Price Elasticity of Demand

What is elasticity?

Elasticity measures the responsiveness of demand to change in a relevant variable- such as price or income

What is the price elasticity of demand?

Price elasticity of demand measures the extent to which the quantity of a product demanded changes in response to a change in price

What is the equation for price elasticity of demand?

% Change in Quantity Demanded/ % Change in Price

Why does price elasticity of demand matter?

• If PED > 1 (Price elastic) then a change in price will cause a larger change in demand

  • Overall revenues would increase with a price cut

  • Overall revenues would fall with a price increase

• Opposite is the case if PED < 1 (Price inelastic)

What are the factors influencing price elasticity of demand?

• Brand strength: Products with strong brand loyalty and reputation tend to be inelastic

• Necessity: The more necessary a product, the more demand tends to be inelastic

• Habit: Products that are demanded and consumed as a matter of habit tend to be price-inelastic

• Availability of substitutes: Demand for products that have lots of alternatives (substitutes) tends to be price-elastic

• Time: In the short run, price changes tend to have less impact on demand than over longer periods