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Price Elasticity of Demand
Price Elasticity of Demand (PED)
Definition
Price Elasticity of Demand (PED) measures the responsiveness of the quantity demanded of a good to a change in its price.
Formula
PED = (% Change in Quantity Demanded) / (% Change in Price)
Types of Elasticity
Elastic Demand (PED > 1)
Quantity demanded changes significantly with price changes.
Example: Luxury goods.
Inelastic Demand (PED < 1)
Quantity demanded changes little with price changes.
Example: Necessities like salt or bread.
Unitary Elastic Demand (PED = 1)
Quantity demanded changes proportionally with price changes.
Perfectly Elastic Demand (PED = ∞)
Consumers will only buy at one price; any increase leads to zero demand.
Perfectly Inelastic Demand (PED = 0)
Quantity demanded remains constant regardless of price changes.
Example: Life-saving medications.
Factors Affecting PED
Availability of Substitutes
More substitutes = more elastic demand.
Necessity vs. Luxury
Necessities tend to have inelastic demand; luxuries are more elastic.
Proportion of Income
Higher cost relative to income = more elastic demand.
Time Period
Demand is generally more elastic over the long run as consumers find alternatives.
Brand Loyalty
Strong brand loyalty can make demand more inelastic.
Importance of PED
Pricing Strategy: Helps businesses set prices to maximize revenue.
Taxation: Governments consider PED when imposing taxes; inelastic goods generate stable revenue.
Market Analysis: Understanding consumer behavior and market dynamics.
Applications
Revenue Implications:
If demand is elastic, lowering prices can increase total revenue.
If demand is inelastic, raising prices can increase total revenue.
Business Decisions: Helps in forecasting sales and adjusting production levels.
Conclusion
Understanding price elasticity of demand is crucial for businesses, policymakers, and economists to make informed decisions regarding pricing, taxation, and resource allocation.
