PED

PED measures how responsive quantity demanded is to a change in price

  • if price changes demand changes→ the key question is by how much?


in elastic demand: demand is sensitive → small price change leads to a more than proportional change in quantity demanded


In inelastic demand: demand is less price sensitive → a price change leads to a less than proportional change in quantity demanded

Formula (learn it): 

PED = % change in quantity demanded ÷ % change in price 


if PED is bigger than 1 → elastic ( quantity responds a lot)

if PED is less than 1 → inelastic ( quantity responds a little)


  • with inelastic demand, a price rise tends to increase revenue

  • with elastic demand, a price rise tends to reduce revenue

therefore firms must know PED before changing price


Factors that influence PED: 

substitute:

  • more substitutes → more elastic; fewer substitute / unique → more inelastic


Necessities vs luxury:

necessities are more inelastic; luxuries are more elastic


Habitual consumption:

habits can make demand more inelastic


Niche markets and PED:

  • in a niche market firms typically target specific markets where consumers are looking for higher quality

  • this means that consumers are willing to pay more for the product

  • therefore demand is less responsive to a change in price

  • this suggest that niche market products are price inelastic

  • as a result firms will charge higher prices and have a higher added value, but demand will be less

  • Depends on availability of substitutes — if other premium brands exist, demand may be more elastic.

  • Depends on consumer income levels — in a recession, even niche buyers may become more price‑sensitive.

  • Depends on brand loyalty — weaker loyalty means higher prices could reduce demand more than expected.

  • Depends on how “niche” the niche actually is — some markets are small but still competitive, reducing firms’ pricing power.


Mass markets and PED:

  • in a mass market firms typically target the market as a whole where consumers see price as important

  • this means that consumers are willing to pay less for the products especially when there is plenty of competition.

  • therefore demand is more responsive to a change in price

  • this suggest that mass market products are price elastic

  • as a result firms will charge lower prices and have smaller added value, but demand will be greater

  • Depends on the degree of competition — if one or two firms dominate the mass market (e.g., supermarkets or smartphone brands), they may have enough market power to keep demand relatively inelastic because consumers have fewer realistic alternatives.

  • Depends on product differentiation — even in mass markets, strong branding or perceived quality differences can reduce price sensitivity. For example, Coca‑Cola can raise prices more easily than an unbranded cola because consumers see it as a distinct product.

  • Depends on consumer loyalty — if customers repeatedly buy the same brand due to habit or trust, they may not react strongly to price changes. This loyalty can make demand less elastic than the typical mass‑market assumption.

  • Depends on necessity vs. luxury — some mass‑market goods (e.g., bread, milk, toiletries) are essential, so consumers will buy them even if prices rise. In these cases, demand becomes more price inelastic despite being sold in a mass market.





competitive pricing:

what it means:

  • lots of competition

  • many close substitutes

  • consumers can easily switch

  • firms have very little pricing power

so firms end up charging the going market price- because if they change even a little

why does this happen:

  • when products are similar( like in a supermarket selling milk) consumers compare prices

  • rival firms watch each other closely

  • a “market price” emerges that everyone sticks close to

Implication:

  • firms can’t boost profit by raising price

  • so they can focus on: cost control(becoming efficient) and differentiation( branding, quality, service) to escape pure price competition



Cost-plus pricing (cost-based):

what it means:

  • firms calculates unit cost( average cost per product)

  • them adds a mark up( e.g. 20%)

  • common in retail, construction restaurants etc

Why firms use it:

  • simple

  • predictable profit margin

  • works well when competition is weaker, products are differentiated, costs are stable


risk:

if a firm sets a mark-up without checking the market, it can go wrong

price too high → low sales → losses

price too low→ low profits → high sales



competitive pricing = market decides the price

cost-plus pricing = firms decide the pricing based on cost

and the deciding factor is competition + subs


Price Skimming

a firm sets a high initial price for a new or innovative product, then gradually lowers the price over time


why firms use price skimming:

  • they want to profit maximise from early buyers who are willing to pay more

  • recover R&D cost quickly (common in tech)

  • create premium brand image


Where you see it in real life:

  • New iPhones

  • PlayStation / Xbox consoles

  • New TVs

  • High‑end trainers or fashion drops

  • Pharmaceuticals (when patents allow)

Early buyers pay £1,000+.
Months later, the price drops to £800, then £700, etc.


why it works:

because early adopters:

  • value product highly

  • care about being first

  • are less price sensitive

  • have fewer substitutes

so firms have strong pricing power at the start


Evaluation:

  • high price may encourage competitors to enter

  • customers may feel ripped off after the price drops

  • only works if demand is price inelastic at launch

  • requires strong brand loyalty



Price penetration

a firm sets a very low initial price to enter the market quickly, attract customers, and build market share.

once enough customers are gained, then firms may raise the price later'

why firms use penetration pricing

they want to:

  • attract customers fast

  • discourage competitors from entering

  • build brand loyalty early

  • achieve high sales volume

  • exploit economies of scale( lower average cost as output increases)

its all about getting into the market and growing quickly

🟩 Where you see it in real life

  • New streaming services (Disney+, Apple TV+ starting cheap)

  • New food brands in supermarkets

  • Broadband / phone contracts (“£10 for the first 6 months”)

  • New gyms offering £1 joining fees

  • Fast‑food chains launching new items at low prices

Low price → lots of customers → raise price later.


🟧 Why it works

Because customers are:

  • Price sensitive

  • Willing to try a new product if it’s cheap

  • Likely to stick with the brand once they’re used to it

And the firm benefits from high sales volume.


Evaluation

  • profits margins are very low at first

  • consumers may leave when the price rises

  • competitors might match the low price, starting a price war

  • only works if the firm can handle high demand


Predatory Pricing

a firm deliberately sets prices very low ( often below cost) to force rivals out of the market. once competitors exit, they raise prices again

This is illegal in the UK because its anti-competitive


🟦 How predatory pricing works

  1. A big firm cuts prices to a level smaller rivals cannot match

  2. Rivals make losses and eventually exit the market

  3. The big firm gains market power / monopoly power

  4. It then raises prices to recoup losses and earn high profits

It’s basically “kill the competition now, profit later”.


🟩 Why firms use predatory pricing

  • to eliminate competitors

  • to deter new entrants

  • to increase market share

  • to gain long-term monopoly power

  • to charge higher prices later


🟧 Evaluation points

  • Hard to prove a firm is pricing below cost

  • Large firms may claim it’s just a “sale” or “promotion”

  • Only works if the firm has deep pockets to absorb losses

  • Consumers benefit in the short run (cheap prices)

  • But lose in the long run (higher prices, less choice)



⭐ 1. Psychological Pricing

setting prices in a way that feels cheaper to consume, even if the difference is tiny


🟩 Why firms use it

  • makes product seem more affordable

  • increases sales volume

  • helps firms compete without actually lowering price much

  • works well in retail, supermarkets, online shopping


🟥 Evaluation points

  • consumers may become less responsive if they realise its a trick

  • doesn’t work well for high-involvement purchases (cars, houses)

  • competitors can easily copy it


⭐ 2. Price Leadership

one dominant firm sets the price, and smaller firms follow it.


🟩 Why it happens

  • firms want to avoid price wars

  • smaller firms lack market power

  • consumers expect similar prices across the market


🟥 Evaluation points

  • Can reduce competition → higher prices

  • May attract CMA investigation if it looks like collusion

  • Followers may struggle if the leader’s price is too low

  • Works only if firms are interdependent and watch each other closely