1.2.4 Price elasticity of demand

Price Elasticity of Demand (PED)

Definition of Price Elasticity

  • Price Elasticity: The responsiveness of demand to a change in price.

Demand Response to Price Changes

  • When prices rise: Demand falls.

  • Elasticity Measurement:

    • If the elasticity value is between 0 and 1 (e.g., -0.4, -0.8):

      • Demand is inelastic - customers do not react significantly to price changes.

    • If the elasticity value is between 1 and infinity (e.g., -1.4, 2, 12.3):

      • Demand is elastic - customers react significantly to price changes.

Factors Influencing Price Elasticity of Demand (PED)

  • S - Number of Substitutes: More substitutes lead to more elastic demand.

  • P - Proportion of Income: Higher proportion of income spent on a good makes demand more elastic.

  • L - Luxury or Necessity: Luxuries tend to have more elastic demand, while necessities have inelastic demand.

  • A - Addictiveness: Addictive goods tend to have inelastic demand.

  • T - Time Period Under Consideration: Demand may become more elastic over time.

Graphical Representation

  • Price Change Effects:

    • Price increase can lead to a significant drop in quantity demanded (elastic demand).

    • Price increase may cause little change in quantity demanded (inelastic demand).

Usefulness of Price Elasticity of Demand for Producers

  1. Predicting Revenue Changes: Firms can estimate the impact of price changes on total revenue.

  2. Market Price Volatility: Understanding how supply changes affect market prices is crucial, especially for commodity producers facing significant price fluctuations.

  3. Impact of Taxes on Demand: Analyzing the effects of indirect taxes on price and quantity demanded helps businesses determine whether they can pass taxes onto consumers.

Price Discrimination Using PED

  • Businesses may charge different prices for the same product to various market segments:

    • Example: Different prices during peak and off-peak times for rail travel or airline tickets.

    • Strategy: Higher prices are usually charged to consumers with inelastic demand.

    • Case Study: Uber's surge pricing during high demand periods.